Inside Ferrero

FIFTEEN PEOPLE FLEW FROM India to Italy last Diwali, carrying suitcases stuffed with traditional Indian sweets and savouries, mouth-fresheners, and spices. Many expats do that when they leave India—except that these were employees of Italian chocolate giant, Ferrero, who had spent a week here visiting stores and studying the market. Some of them discovered there was no space in their bags for the goodies, so they dumped their designer Italian suits to make room. The sweets were taken to the Ferrero headquarters in Alba, a hilly town in northern Italy, where 87-year-old Michele Ferrero, owner of the group, and his R&D team spent some days inspecting and snacking on them. It’s not clear if it resulted in a new product for Ferrero, but senior executives who have taken part in several such sessions say that these do influence what is made.

The sweets haul from India was in line with Ferrero’s focus on this country, and is part of its almost manic obsession with innovation. Research and innovation is not merely a division, but a separate company called Soremartec, employing more than 300 people, and allocated 3% of the group’s profits each year. “In my 20-plus years with Ferrero, the two spent in innovation were the most stressful. There are no full stops. You can never sit down and say you’ve got it. There’s always something better. Unique products do not come unless you are always unhappy. The key is to never ever be happy with what you have,” says a Ferrero manager. There is one cardinal rule, he adds: “If an idea [product] already exists, we don’t make it.”

In 1982, Ferrero introduced Rocher, the first ever chocolate to have a round wafer, which took five years to develop; until then wafers came only in thin strips. According to a February 2012 Euromonitor report, Rocher is the world’s leading brand of boxed chocolates with sales of $1.4 billion (Rs 7,795.2 crore) in 2010.

Ferrero was built around innovation. During the Second World War, when cocoa became expensive, Pietro Ferrero, a confectioner who converted his pastry shop into a small factory, blended locally-grown hazelnuts with cocoa to make a spread that became hugely popular; that was Ferrero’s first product, named Giandujot. In 1964, Michele Ferrero, his son, tinkered with this recipe slightly and marketed the spread as Nutella. The small workshop at Alba has grown to 18 factories across the world, and the €7.2 billion outfit is now the world’s fourth-largest confectioner, behind Kraft, Mars, and Nestlé.

But for all its size, Ferrero has long been one of the world’s most secretive companies, guarding its mysteries zealously. “It’s like NASA”, says one of the few news reports on the company. Michele Ferrero is a bit of an enigma, known for his love of chocolates and deep Catholic beliefs—every May he takes his family over to France to pay respects to Our Lady of Lourdes, whom he believes to be one of the reasons behind his success. Fortune India is one of the few publications anywhere in the world to have been given access to any Ferrero operation. Senior executives at Ferrero India were more than willing to talk, but asked not to be named. They say Michele Ferrero insists that the company is about products, not people.

A STRONG SCENT OF PEPPERMINT greets visitors to Ferrero’s first Asian factory in Baramati near Pune, Maharashtra. This is where TicTac, Ferrero’s hugely popular mint sweet, and Kinder Joy (a chocolate with a toy inside) are made. (Nutella and Rocher are imported.) At one end, a batch of TicTac pills weighing about 100 kg waits for the final stage of manufacturing. They will be transferred into a bassina—a large drum with a diameter of more than a metre, spinning at slow speeds—containing processed sugar and flavour. The bassina will roll for about 18 hours, until the pills are coated with hundreds of layers of the mixture and each weighs between 0.45 g and 0.5 g. Once the pills achieve the right weight (every 100 TicTac pills are weighed), they are transferred to the packaging area.

A little further away, in the Kinder Joy production area where the smell of chocolate overpowers the mint, senior Ferrero employees snack on the chocolate balls off the production line. “I have to eat at least one every day to just check if it’s okay,” says the plant manager, all earnest. To ensure that quality standards are consistent, Ferrero has appointed an Italian head of quality control who spends about eight hours daily on the shop floor. She heads a team of eight who ensure that before each box of Kinder Joy is sealed, the toy does not protrude into the chocolate, and that the tiny chocolate chips don’t get crushed and fall into the white chocolate. (Most key functions at the factory are headed by Italians.)

The obsession with products is evident in anyone who has spent a few years at the company. A senior Italian executive sent to the India factory says: “I just feel uncomfortable to talk [about the company] without the products in front of me.” He puts boxes of Ferrero confectionery on his desk before speaking.

There’s never been a brand Ferrero—there’s TicTac, there’s Nutella, there’s the Kinder range, there’s Mon Chéri, and dozens of other brands, but few people know that all these are from the same outfit. With the exception of Ferrero Rocher, no sweet incorporates the company name. “We have never wanted to invest in the Ferrero brand,” says a Ferrero India senior manager, who has spent decades with the group. He explains that each brand—chocolates, candies, spreads, pralines, snacks, frozen desserts—is treated almost like a separate company even though they aren’t even divisions. They believe a consumer buys a product because of the value it brings and not because of the company behind it. “TicTac is the largest selling mint in the U.S. and Australia; very few people there know it’s by Ferrero,” he adds. This shows up on Facebook: Rocher has around 16 million likes, Nutella and Kinder Surprise around 4 million each, while Ferrero, the group, has just 25,938 likes.

This obsession with products also led the company to pick India as its Asian manufacturing base over China, which is a bigger market. “The Indian customer is much more discerning when it comes to buying sweets. Indians buy with their pocket and head, while the Chinese buy because of the image of the brand,” says a senior executive at the plant. Their experience of battling fakes in China hasn’t been pleasant either.

Ferrero’s push into this part of the world is recent. Most of Ferrero’s 56 products are sold in Western Europe, which contributed to 70% of its revenue in 2010. Throw in North America and Australasia, and that’s 80%. Ferrero’s presence in some of the fastest growing markets is limited, which may explain why its share by value in the global chocolate confectionery market fell to 7.3% in 2010, from 7.5% in 2008, according to Euromonitor data.

Around 2004, Ferrero began importing chocolates into India. By 2007 it had a plot, not far from the Baramati factory, where it packaged TicTac and Kinder Joy, which were imported in a semi-finished state. By 2009 it began looking for vendors for the supply chain and the following year began building the factory. Baramati has already become Ferrero’s second-largest producer of Kinder Joy (after Poland), and exports to West Asia and China. In November, Ferrero announced a plant in Turkey, and this February, one in Mexico.

Michele Ferrero is deeply interested in India. Executives from here travel every six weeks to Alba to meet the patriarch, apart from monthly team video conferences with him. “The Indian market is new, and he wants to get it right from the beginning,” says a Ferrero executive. The potential of the market is a draw. The per capita consumption of chocolate in India is 0.4 kg a year compared with Britain where it is 15.4 kg or the U.S. (8.8 kg).

While Ferrero doesn’t share financials, trade partners estimate that Ferrero India’s sales top Rs 350 crore with a portfolio of just four products—Rocher, Kinder Joy, TicTac, and Nutella. “Sales of Ferrero products in 2008 were less than 5% of the total chocolate sales at Food Bazaar, but today they are about a quarter,” says Devendra Chawla, president, food and FMCG, Future Group, Ferrero’s largest Indian customer.

Distributors gearing up for the festive season say volumes are likely to grow by 40% to 50% in the coming year. (Ferrero’s financial year ends August 31. Since much of its revenue comes from chocolates, and winter is peak time for sales, Ferrero, unlike Italian companies that end their financial year in December, shifted the year-end to August.) A senior executive from a competing firm, who did not want to be named, says, “Ferrero has created a distinct position in the gifting segment which is a great way of getting into the homes of potential customers.” According to a Euromonitor report on the Indian confectionery market, the increase in Ferrero’s market share in 2010 from 3% to 5.8% was mainly due to the success of Kinder Joy and Rocher. In 2011, the Indian chocolate market, by value, grew around 33%, to Rs 4,690 crore, while the chocolate with toys category is expected to grow 143% by 2016.

For Ferrero, growth means more in a market where there are already well-entrenched brands—Cadbury and Nestlé account for a significant share, and there are smaller players such as Amul jostling for space. These companies have chocolates at all prices—from Rs 2 for Cadbury Dairy Milk Shots, to Rs 80 for a bar of Bournville. Ferrero, however, is focussing on the top end—Kinder Joy costs Rs 30 a piece, while Rocher costs Rs 275 for a box of 16.

“India is about affordability, which are the Rs 5, Rs 10, and Rs 20 price points. The challenge is to provide a real chocolate at that price,” says M.V. Natarajan, head of India at Mars Inc. None of Ferrero India’s chocolates is priced in this range. “The company needs to introduce products in the Rs 5 to Rs 10 range, as chocolates priced above that tend to be slow-moving,” says Kiran Patel, owner of a Mumbai-based distributor, Chetana Trading. Another dealer in the same city says that people are attracted to Kinder Joy because of the toy inside, “but many hesitate to buy it after they hear the price”.

Even the biggest, Cadbury India, believes in this approach. Chandramouli Venkatesan, director - snacking, Cadbury India, explains the logic behind the Cadbury Dairy Milk Shots, aimed at bringing in new consumers. He says it was “positioned as ‘chocolate laddoo’ and priced at Rs 2 for two pieces with an attempt to introduce the product to consumers as the perfect value-for-money accompaniment for small celebratory occasions”.

Ferrero managers admit that entering India with premium products was “a brave decision”. “We are used to being a big company in big markets, in Italy, France, and Germany. We are not used to being a small company in a big market,” says an executive. But he adds that they are willing to be patient.

The fact that the chocolate-with-toys category did not exist actually helped Ferrero, allowing it to pitch its product at a higher price. A few months after Kinder Joy was launched, market leader Cadbury introduced Gems Surprise—with a toy inside, at Rs 30. Retailers stocking both products say, “Most customers don’t want an upgrade of Gems, even if it comes with a toy. They want something new.” Ferrero also seems to have tapped into the aspirational middle class segment that is willing to pay for quality.

CONVENTIONAL WISDOM SAYS that Ferrero should capitalise on its success with high-priced chocolates and flood the market with its other products. But the company doesn’t want to rush in with too many labels till it is absolutely sure that its quality standards can be met. Each summer, it’s impossible to buy Kinder Surprise (a variant of Kinder Joy) in Italy and Greece. “Even the most airtight packaging cannot protect the chocolate from high temperatures. So we take them off the shelves,” explains an executive.

Ferrero behaves like a luxury brand. Like Hermès, rumoured to have destroyed a batch of defective handbags, Ferrero is known to destroy entire shipments of chocolate if there’s anything wrong—not with the chocolate but with the toy, or even the packaging. An ex-employee talks of a batch of Kinder Joy sent from the Baramati factory to China. “There was nothing wrong with the chocolate. The leaflet with some basic warnings and instructions to assemble the toy was wrong. They destroyed the whole batch, worth more than Rs 2 crore.” And during the initial run in the Baramati factory, the company destroyed Rs 23 lakh worth of Kinder Joy because it “wasn’t happy with the material used to make the toys. There was no problem with the chocolate”, says a Ferrero distributor in the western region. The toys and plastic wrappers were sent to recyclers, while the chocolate itself was fed to cattle. The company’s executives admit that there were times when they wondered if the factory would ever get it right.

Like all companies in the food business, Ferrero is extremely conscious of the quality of ingredients used. It sources hazelnuts from Turkey and Italy, and pays up to seven times the market rate for the extra-large hazelnuts for Rocher.“We never negotiate on costs, [we] always [insist] on quality. If you go for the best deal, you play on dangerous ground,” says the managing director of the plant.

But in India, paying top dollar doesn’t always ensure top quality. Ferrero, like its competitors, uses powdered milk, since fresh milk has a limited shelf life. Schreiber Dynamix, a dairy company that supplies to Nestlé, Danone, Britannia, and McDonald’s, provides the milk powder, but Ferrero was not fully satisfied. Some batches of the powder were found to be sweeter than others, depending on the freshness of the fodder fed to the cattle. To get around this, Ferrero blends different batches of milk powder to get the taste right. “There is a reason why Scotch whiskey is blended. It’s to guarantee consistency; while blending, you can manage differences,” says an executive who handles production.

Even though Ferrero India’s plant is located in the heart of Maharashtra’s sugar belt, the company has been buying sugar from Coimbatore in South India. That’s largely for TicTac, which has no colours added; the white comes from the sugar. The sugar used for TicTac has an ICUMSA rating (International Commission for Uniform Methods of Sugar Analysis or the unit for colour measurement in sugar; the lower the rating the whiter the sugar) of 15 and costs about 10% more than the regular quality.

“The sugar available in Maharashtra had ICUMSA levels starting at 70 going up to 120, so we had to buy from Coimbatore,” says the head of purchasing. The extra cost has been more than offset by demand; the market for TicTac has grown so much that the company increased production within five months of starting the plant.

QUALITY APPLIES TO EVERYTHING, from packaging to transportation. A senior executive at a cold chain company that serves Ferrero and its competitors, says: “Ferrero has been extremely aggressive in setting up its cold chain. It has come into the market wholeheartedly, so it has been able to scale up in a short time.” Rocher and Kinder Joy are currently sold across 1.5 lakh outlets, which is about a fifth of Cadbury’s distribution muscle. But with 27 air-conditioned depots across the country, Ferrero India is looking to push this number up quickly.

Until now, Ferrero had asked distributors not to supply to shops without temperature-controlled storage. Rocher and Kinder Joy need temperatures between 8°C and 12°C. Also, says Future Group’s Chawla, “the company has been very selective about where it wants its products to be seen”. That meant a presence in large stores, despite the fact that 75% of chocolate sales in India are at small grocery stores (according to a Euromonitor report).

Natarajan of Mars says, “Growth comes from both modern trade as well as the traditional formats. You need a distribution infrastructure that reaches across all trade formats.” That’s why, starting next month, Ferrero India plans to distribute chillers to bring more stores into its fold while ensuring product quality. “The company is making a huge investment as the chillers cost about Rs 22,000 each,” says the owner of a small grocery shop in Pune.

V. Balaji, vice president of Positive Packaging Industries, the company making the laminated shells for Kinder Joy, says that during the selection process, teams from Italy conducted trials at the vendor’s factory as well as at the Ferrero plant. It was six months before Positive Packaging was approved. “Only then did they talk about price,” says Balaji. Executives say this was a relatively quick decision; Ferrero has been known to take up to two years to decide on a vendor. Positive Packaging is now one of the group’s approved global vendors, but not before Ferrero asked Positive to buy a colour spectrophotometer to calibrate the exact shade. “The human eye can measure colour differences up to a certain level, but Ferrero doesn’t accept such variations. So we invested Rs 30 lakh for the device,” says Balaji.

To maintain standards across factories, Ferrero has an engineering unit. “We design the production line and machinery needed to manufacture our products. This is not just to protect industrial secrets but also to have control over the process and quality,” says an executive.

It is, perhaps, this insistence on consistent quality that has kept the group from making acquisitions, unlike Nestlé and Kraft, which have expanded inorganically.

In November 2009, there were reports that a Ferrero-Hershey’s combination would bid for Cadbury, countering a $17 billion offer by Kraft. While no official comments were made, the buzz then was that Michele Ferrero vetoed the decision, saying Cadbury’s products wouldn’t be a strategic fit. Analysts say that money wouldn’t have been an issue, despite Ferrero being a third of Cadbury’s size. The group has never needed to borrow to fund or grow its operations. With a personal wealth estimated at $19 billion, Michele Ferrero is the richest man in Italy, way ahead of Silvio Berlusconi ($5.9 billion), Italy’s ex-prime minister.

For 66 years, Ferrero has remained a closely held company owned by the Ferrero family. And as long as the family continues to hold the reins, Italy’s Willy Wonka will continue to churn out sweet treats.