The economics of gifting Cadbury explained

The monetary consideration involved in gifting gives rise to a whole industry that thrives on people gifting each other gifts that have materialistic touch about it. However, hard we may decry the economics and materialism involved in gifting it would be difficult for us not to be happy when we get gifts. We are in the middle of the peak season of gifting. Diwali is around the corner and this is the time when we exchange the maximum gifts in India. India is an important market for the multinational companies as along with Brazil, Russia and China they have captured approximately 45% of the market.  So let us now understand what the big pain point is for these chocolate companies using Cadbury India example

What are the factors we need to look at to estimate the profitability of these companies through sales of chocolates?

·         Total Sales - (Product of Selling Price and Units sold)

o   Ability to increase the selling price of chocolate depends on the responsiveness of change in quantity demand. It is expected that the price of certain high end chocolates such as Cadbury Dairy Milk Silk and Bournville should increase as the demand for these chocolates are inelastic, hence increase in price does not lead to decrease in quantity demanded..

o   The demand (units sold) for chocolates peaks in the seasons when there is festivity. Hence, October to December is the best quarter for the company. The increase in demand might also be attributed to increase in total online gifting.

Cost of Raw Material: As can be seen from the table below raw material as % of sales has increased over the years.

              Table 1 - Cadbury India – Raw Material to Sales

              

Particular (INR Cr.)	Dec 2012	Dec 2011	Dec 2010	Dec 2009	Dec 2008	Dec 2007	Dec 2006
Net Sales	4,065.98	3,364.65	2,503.24	1,934.38	1,588.59	1,293.47	1,058.24
Raw Materials	1,576.33	1,247.80	903.81	617.29	522.06	394.55	295.95
Raw Materials as % of sales	39%	37%	36%	32%	33%	31%	28%

Source: Capitaline

The table above finds the ratio between cost of raw materials and sales for the FY 2006 to 2012. As the cost of raw material to sales has been more than 25% it can be deduced that that cost of raw material is an important cost for the company. The other conclusion that we can arrive at is cost of raw material has been eating into the potential profits as it has increased in proportion from 28% to approximately 40% .

Now the important question is why is cost of raw materials increasing?

The cost of raw materials is increasing primarily because the cost of cocoa which is an important ingredient is going up. The reason why the price of cocoa is going up is that there is a mismatch between demand and supply with demand outstripping supply. Hence, one alternative for manufacturers of chocolate is to reduce cocoa content and increase artificial ingredients. The other alternative is to decrease the size of the chocolate bars and keep the price same. I believe most companies would prefer decreasing the size of the bar rather than impacting the taste of the chocolate.

Author: Abhishek Sinha

Abhishek Sinha has approximately 8 year of experience in equity research, business research and consultancy. He has also had the privilege of managing a small portfolio of INR 3 million. However, his interest lies in teaching and "demystifying concepts." He has taught students right from the age of 3 years at PP1, to 40 years at executive courses and believes teaching is not about knowing the concepts; it is about relating the concepts to the audience. At present he is "gainfully employed" at Vignana Jyothi Institute of Management, Hyderabad; where he loves to teach finance to an enthusiastic bunch of management students. His hobbies include analyzing income statement, balance sheet and cash flow.> Google +