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Abstract

This report adds to research on the cocoa–chocolate chain. It specifically assesses the issue of vertical integration and horizontal concentration within the chain and discusses possible implications for competition law and policy in cocoa producing countries, presenting evidence from Cameroon and, to a more limited extent, other selected West and Central African countries, based on primary data collection and fact-finding missions.

The cocoa–chocolate chain is marked by a high degree of vertical integration and significant concentration at various stages along the supply chain.

At the global level, important structural changes have taken place in terms of the characteristics of the international cocoa trade and in cocoa processing. The chocolate manufacturing sector has also undergone notable changes, with an impact on the structure of the cocoa market as a whole. The processes involved featured both vertical integration and horizontal concentration, albeit in different respects.

Two notable developments have had a significant affect on the degree of vertical integration in the global cocoa and chocolate industry. First, the boundaries between trading and processing companies have become blurred, as the main trading companies on the international market now also engage in cocoa processing. Second, the largest cocoa
processors have expanded their presence downstream into the industrial chocolate (couverture) segment. These developments reflect the trend towards branded consumer chocolate companies (such as Nestlé, Hershey and Cadbury) outsourcing their cocoa and chocolate ingredient needs to a few selected processing companies. The largest cocoa traders and processors on the international market (including Barry Callebaut, Cargill and Archer
Daniels Midland) have thus developed interests ranging from trade in cocoa beans through production and trade of semi-finished cocoa products to the manufacture of industrial chocolate, achieving a significant degree of vertical integration in the market. These integrated companies are active in both producing countries and consumer countries. In the global cocoa–chocolate chain, they increasingly act as transmission channels that convey market information, standards and prices from consumer to producer countries.

The horizontal concentration process has involved mergers between large multinationals to form larger combined entities as well as takeovers by the large international concerns of smaller companies that mainly operated in a national context. It would appear that concentration at the cocoa processing stage has increased in response to the need to gain scale in order to increase cost efficiency. The market share expansion of the leading processing companies (semi-finished cocoa products and couverture) is also linked to a desire by the branded consumer goods companies to increasingly source their requirements for chocolate from relatively few established processors. The importance of global brand recognition and commercial marketing strategies are major factors underlying structural developments in the consumer segment. The market is now dominated by large multinational confectionery
companies which market their brand in all major consumer countries.

There is a need for a detailed examination of these processes, which have also impacted on producing countries. Most notably, the consolidation of the processing segment in the chocolate industry in Europe, coupled with the vertical integration between trading and processing companies, is a fundamental factor behind the emergence of oligopsonistic structures in cocoa purchasing. In producing countries in Africa, local exporters sell on to an oligopsony of a few major foreign cocoa trading and processing companies, from which they often receive financing or to which they are formally related. Indeed, there has been a tendency for foreign trading and processing companies to integrate backward into producing countries, to some extent taking over the exporting functions. The “internalization” of activities at different segments of the cocoa value chain within networks of related companies
(exporters and international buyers) renders collusive behaviours a priori possible.

Oligopsonistic structures have also emerged within producing countries in cocoa purchasing at or close to farmgate. At origin, producers do not have now bargaining power vis-à-vis a handful of major exporters that, directly or though agency relationships, purchase at or close to farm gate.

This structural configuration (i.e. a high degree of vertical integration and significant horizontal concentration at various successive stages within the chain) is the fundamental element underlying the relative bargaining positions of different stakeholders within the chain. Three aspects can be singled out.

First, there seems to be a structural imbalance, upstream in the cocoa chain, between cocoa producers (with a structure of production characterized by the predominance of small-scale producers) and buyers (highly concentrated, with the emergence of oligopsonistic or even – in remote locations – monopsonistic market structures). This asymmetry gives rise to the potential for the exercise of oligopsonistic or monopsonistic power in cocoa purchasing, both at the farmgate and at the international level. Available evidence shows a decline in nominal terms in the producer share of world cocoa prices across three of the four largest producing countries in Africa. However, the establishment of causal links between this negative evolution of the producers’ share and structural changes that have occurred at origin (penetration of foreign capital and concentration) is merely speculative in this instance. More
rigorous analysis of transmission mechanisms is needed to establish fundamental correlations. Yet, there is some evidence pointing to practices that may come under the reach of competition law.

Second, at the processing and manufacturing stages, there seems to be some form of balance between “successive oligopolies”. In particular, the power – on the supply side – of the largest cocoa trading and processing companies (Barry Callebaut is an example) appears to be balanced by the strength and purchasing behaviour of customers to some extent. In the couverture market, these include large multinational food manufacturers (Nestlé, for example) with professional procurement departments. The strength of such companies is an effective deterrent against any supplier attempting to abuse its market share. Moreover, these customers are generally well informed about the costs of raw materials inputs, overheads and additional costs involved in producing semi-finished cocoa products and couverture. Over time, they can identify (and check) the margin charged by the couverture supplier, increasing supplier accountability and enhancing relative market efficacy.

Finally, some evidence points to extra value being captured in consuming countries in activities downstream of cocoa processing and chocolate manufacture – brand marketing and distribution. On the one hand, this situation may be indicative of increasing profit margins, especially at the brand/retail level. To the extent that this situation reflects the growing market power of the big retail chains, it may raise competition law issues in the consuming countries. On the other hand, it may reflect the relative weight and growth of marketing and distribution costs in the value-adding process. These added costs – incurred in the consuming countries – typically refer to advertising and other forms of marketing communications, packaging, and distribution.

It should be emphasized that, across all these stages (from cocoa sourcing through cocoa trading and processing to the manufacture and supply of consumer chocolate), the relationship between concentration, competition and efficiency is a complex one. In particular, market concentration should not be automatically considered as equivalent to genuine “market power” – interpreted here as the ability of a firm, or a group of firms acting jointly, to raise
(or decrease) and profitably maintain prices above (or below) the level that would prevail under competition for a significant period of time. If barriers to entry are low, competition is a process which is not exclusively related to the number of competitors Furthermore, where market concentration decreases competition, it may nonetheless lead to greater efficiency by allowing economies of scale in production, organization or other activities, the benefits of which may be passed on to consumers. Some divisive issues may arise in this connection.

When efficiency gains are realized in cocoa sourcing and logistics through concentration and economies of scale, part of the benefits of the costs savings realized may be passed on to consumers in consuming countries. Yet, adverse effects may be felt in cocoa-producing countries, where concentration on the demand side may give rise to the potential for the exercise of oligopsonistic or monopsonistic power in cocoa purchasing. In special factual circumstances, this asymmetry may thwart the implementation of a “common” international competition strategy to address mergers in the cocoa sector.

At the policy level, a spectrum of policy options exists to address imbalances in bargaining power between stakeholders along the cocoa–chocolate chain and to improve the participation of producers in the high-value added part of the chain.

Competition law figures prominently in this context. Two areas of intervention deserve particular attention. Firstly, abuse of market power provisions under competition laws may be designed so as to cover abuse of buyer power – the ability of a firm, or a group of firms acting jointly, to decrease and profitably maintain prices below the level that would prevail under competition. Some countries have provisions in their national competition legislations for the
prevention of abuse of buying power based on economic dependency. This legislation may well be considered by commodity producer countries in designing competition laws and in developing rules to deal with abusive bargaining practices not only in the cocoa sector but also in other agriculture or commodity sectors. Second, a strictly applied merger control mechanism may help prevent mergers or acquisitions that increase market concentration, reduce potential competition or result in excessive vertical concentration. The biggest challenge in implementing such a policy is that cocoa markets are characterized by the involvement of large international companies which, albeit based outside the territories of cocoa-producing countries, nevertheless impact negatively on those countries.
Extraterritoriality becomes a major concern because these large multinational companies do not fall under the jurisdiction of cocoa-producing countries. One way to address extraterritoriality would be to act at a regional level in dealing with potential anti-competitive practices by or mergers of large multinationals in the cocoa market. Some commentators have gone one step further, putting forward a proposal for a development-oriented international
competition authority to control anti-competitive conduct and growth by mergers of large multinationals.

Competition policy should be complemented by other economic policies addressed to improve the situation of local producers and firms in the sector.

Producers in developing countries may reclaim at least part of the extra value associated with the brand marketing. In special factual circumstances, this can be done by implementing a strategy based on geographical indication (GI) or trademark protection, in the context of strategic alliances between producer associations (built around appellation areas) and the large international processors/manufacturers. In practice, the effectiveness of this strategy is a matter of consumer perception, legal protection and effective price transmission back to producers of the extra value captured.

Access to finance, as well as market information and transparency, both have important structural implications in cocoa. The lack of efficient access to finance was identified as one of the factors underlying the concentration process at the export level within origin countries. In a negotiating context characterized by imperfect and asymmetric information, market knowledge may imply market power, and asymmetry in accessing market information may become a key factor behind inequitable income distribution. Structured finance tools, alongside measures aimed at redressing asymmetry of information, provide practical ways to empower producers by addressing market imperfections/failures. Overall, well-organized structures can help farmers gain power in the marketplace, and producer organizations should have a major part to play in this framework. The challenge here is to create a virtuous circle where interventions aimed at improving information, promoting group marketing structures and improving access to commodity finance feed back into each other. More ambitiously, new models of organized supply chains should holistically acknowledge – and try to redress – all of the major constraints that work against the effective and sustainable integration of developing countries’ producers in commodity chains.

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