Don't Let the Dog Eat this Paper

On Scharffen Berger, a pioneer of the American Chocolate Industry

Samantha (Herbert) Tanzer, 'X

Swarthmore College
Spring 2007

On average, a U.S. citizen consumed 5.3 kilograms of chocolate last year, a tiny fraction of the 3.6

million tons of cacao harvested [17]. Chocolate is a big industry; in the United States in 2002, chocolate

confectionary generated 13.7 billion dollars in sales. It is also an industry that is dominated by big players;

Hershey's , Mars, and Nestle hold 75% of the market share. In the upscale sector of American producers,

Campbell Soup Company's subsidiary, Godiva, reigned. These mass-producers hold their market share

secure with their brand-recognition and economies of scale, but have not wholly blocked out smaller

producers of artisan chocolate from the market. The confectionary market, like many gastronomical

markets, is strongly differentiable on the high-end. One firm to brave the barriers to entry is Scharffen

Berger, a fledgling chocolate maker from food-trendy San Francisco area, first conceived of by a wine-

maker and a doctor in 1994 and is now considered one of the highest-quality American chocolate-makers

in business, enjoying an ever-growing demand and revenue-flow.

Chocolate comes from cacao, the fruit of the mesoamerican tree, Theobroma cacao. When the

Spanish conquistadors arrived to the Americas, the cacao beans were used as a currency by the Aztecs,

and chocolate was only enjoyed as a beverage by the aristocracy, clergy, and warrior classes. The Aztecs

mixed ground beans with water, and flavored it with maize, chili pepper, and ear flower.. The colonial

Spanish, fascinated by the natives' fascination with the drink, altered it to suit European tastes, flavoring it

instead with vanilla, anise flower, and cane sugar, and imported it to Europe, where it was likewise

enjoyed primarily by the aristocracy and the clergy.

Chocolate remained a luxury commodity until the nineteenth century. The dutchman Van

Houten's cocoa press, invented in 1828, separated the cacao butter, and the remaining cacao solids could
be ground into the powder we know as cocoa. The inexpensive cocoa became a huge success with the

working classes, whose purchasing power increased in the wake of the Industrial Revolution. The

audience of chocolate also began to change, primarily towards women and children. In 1849, Fry's, ,an

English chocolate company, introduced "Chocolat Délicieux à Manger", the world's first mass produced

chocolate bar [9]. 1879, Henri Nestlé, a Swiss, invented powered milk, which allowed him to produce milk

chocolate. In the same year, another Swiss, Budolphe Lindt, invented the conche, a machine that churned

the chocolate to create the smooth, creamy mouthfeel that we have come to associate with chocolate.

The industry proceeded to grow at a rapid pace with the birth of other large chocolate makers, such as

Cadbury's, Walter Baker, and Hershey's. The industry stratified into two primary camps: large scale

chocolate makers that processed beans into chocolate, both for professional and consumer consumption,

and chocolatiers who bought, couverture, to finish to create their own pastries and confections.

The chocolate manufacturing process is involved and delicate, as cacao is a fickle plant. The three

major varieties of T. cacao are criollo, trinitario, and foastero. The latter is the the hardiest and most

productive, and accounts for 90% of the world crop, but has a strong bitter taste. The fruitier criollo was

the predominant strain in pre-colonial Mesoamerica, but its low productivity and susceptibility to disease

caused it to almost be eradicated. It now counts for only 2% of all cacao production. Trinitario is a hybrid

of the two, originating in Trinidad in the eighteenth century. Currently, the Ivory Coast is the world's

largest producer of forastero cacao, producing for over 40% of the world's cacao crop.

Cacao is grown in shaded plantations, within 20 degrees of the equator. The trees give two crops a

year, which are picked by hand. The cacao pods are opened and the beans are left to dry and ferment in

the sun to remove acidity from the flavor. The beans are then shipped to the chocolate-maker's facilities,

where they are roasted and the inedible husks are winnowed. The beans are then ground in a mélangeur

into a semi-liquid. Sugar, flavorings (such as vanilla), and an emulsifier (most usually soy lecithin) are

often added. The chocolate is then churned extensively in a conche, which, at their most simple, are large
vats with granite rollers, to reduce particle size and improve flavor and mouthfeel. The chocolate is then

tempered, moulded, and cooled.

The upscale chocolate industry, which generated 1.2 billion dollars in annual sales in 2005, is tiny

compared to the mass industry. However, recent years has seen a renaissance in gastronomy and artisan

foodstuffs. Chocolate in particular has recieved positive attention from the middle class's recent obsession

with connoisseurship. High-end chocolate is being marketed much like wine, complete with its own

tasting vocabulary. Recent scientific studies highlighting the potential heath benefits of the anti-oxidents

found in high cacao content chocolate have also help increase demand. The industry is embracing this

marketing and exposure, and the premium chocolate sector has growth rates predicted to range between

15% and 20% per year for the next decade compared to the 1-2$ for the mass industry [24].

The mass chocolate manufacturing sector is a highly competitive industry dominated by a few

small players who aggressively protect their market share. However,American mass producers focus on

milk chocolate, which the FDA requires to be only 10% cacao solids [13], which is less than half of that

required by the European Union regulations [11]. High cacao content chocolates are primarily produced

European companies, such as Valrhona, Lindt, Barry Callebaut, and Bonnat. The American chocolate

industry held the opinion, much like the one the coffee industry had a couple decades back, that

Americans do not like strong flavors and they did not see see a market for premium dark chocolate.

However, a growing demand for premium chocolate reflected shifting consumer preferences and there

grew a a vacuum in the market niche of artisan American chocolate makers. Indeed, a new chocolate

maker had not been seen in the United States in fifty years.

Enter Scharffen Berger. In 1989, Dr. Robert Steinberg was diagnosed with leukemia and he gave

up his practice to pursue a career in the culinary arts. He became enamored of the idea of chocolate

making. He spent a few weeks in France with Bernachon, a traditional small-scale chocolate maker, which
gave him a feel for what he wanted to do. In 1994 he approached John Scharffenberger for advice. John

had recently sold his winery, and was looking to try something new that appealed to his entrepreneurial

and gastronomological tendencies. He agreed to form a partnership with Robert.

The original plan was to produce small batch chocolate primarily for use by culinary professionals.

At the 1996 candy equipment show in Düsseldorf, they saw machinery for large-scale production, with

mélangeurs costing upwards of $350,000. Those prices were utterly unaffordable. their entire start-up

budget was $150,000. Steinberg and Scharffenberger's plans were met with skepticism of whether they

could complete against entrenched industry participants. Equipment manufacturers told them that they

were better off buying couverture from an established large-scale producer. However, they finally found

a small used mélangeur for $6,000, of the same type that Steinberg used when working with Bernachon.

This had the advantage of being a machine that he already knew how to use, and had some sense of the

flavor it produced. They also bought an ancient leather-belt driven winnower for $20,000, and a

Macintyre grinder-conche.

Normally, obtaining start-up capital for a risky venture like chocolate manufacturing is very

difficult. Initial equipment and production investment is high and reasonable returns on investment are

dubious given the competitiveness of the market and the fickleness of the cacao. However, their

ambitions for small-batch production using old-style European equipment fit within the budget they were

constrained by. Since the pair were the only initial investors in their company, they had much greater

control over their procedures and less pressure to produce immediate results and profits. While the pair

were assuming all the financial risk, neither of them seemed risk-adverse. Scharffenberger had previous

experience of a similar venture with his winery, and the success of that presumably gave him confidence

as well as knew how to minimize risk. Steinberg was assuming a shortened life expectancy and thus

probably felt like he had less to lose by taking risks. Furthermore, $150,000 is not a devastating amount

to lose, especially when compared to the millions of dollars required for large scale production
 Their next step was finding a supplier of cacao beans. Robert went down to Venezuela to negotiate

with the farmers themselves, as well as learn about T. Cacao as a plant and crop. Instead of finding a

distributer, Scharffen Berger chose vertical integration of bean sourcing, allowing them to pay a price for

their cacao that is lower than one that included middleman profits yet still higher than market.

Furthermore by fostering a relationship with their bean suppliers, Scharffen Berger has worked with

them to control the quality of the beans and the plantations. They are able to better control the flavors by

supervising farming and fermentation methods as well as promote source loyalty.

The market price of cacao in 2006 ranged between $0.67-$0.75 per pound of beans[1], which

primarily represents bulk purchases of forastero beans from Africa. Fair trade standards mandates a

minimum price of $0.80 per pound or market, whichever was higher [12]. Retail prices for large Criollo

purchases range around $10 per pound [5]. While no direct data for Scharffen Berger costs is available, an

estimate of $1-3 per pound is reasonable given their commitment to sustainable and fair farming practices

as well as the high quality of beans that they source. The higher pricer of beans is directly reflected in

Scharffen Berger's retail prices of chocolate, which range $1-2 per ounce compared to $0.35 per ounce for

retail mass produced chocolate.

Steinberg created the first batches of Scharffen Berger chocolate in his kitchen. He roasted the

beans in his oven, winnowed them by hand, and ground them in a coffee grinder. The primitive

experimentation methods kept costs down. They minimized risk and waste by allowing them to

experiment with how proportions and processes affected the sensitive flavor of the chocolate without

committing to a production run of a few hundred kilograms.

Their first distribution batch of chocolate used a blend of cacao beans from eight different

plantations, four from Venezuela, and one each from Ghana, Papua New Guinea, Bahia, and Madagascar.

Scharffen Berger chocolate is a contrast to mass-produced chocolate, like Hershey's, whose use of low-

quality foastero beans reflect a reliance on artificial flavor modifications as well as from recent trends in
premium chocolate which emphasize single-origin beans and flavors. Also, y using beans from several

different geographic regions, Scharffen Berger mitigates the risk of supply shortages from regional crop

disturbances. Furthermore, Scharffen Berger's palatable use of whole vanilla beans, instead of the more

common powdered vanilla or vanillin, gives their chocolate a memorable taste, distinguishable even to

those with uneducated palates, which is particularly important for creating broad consumer appeal.

Scharffen Berger debuted their product at the 1996 Aspen Food and Wine Show, where their

chocolate received compliments from Jacques Pepin and Julia Child. They also received glowing reviews

from local tasters. Their location in San Francisco, currently the hub of culinary fashion, gave them a

boost in exposure from culinary professionals and the media.

Scharffen Berger originally targeted culinary professionals and they visited many restaurants and

pastry chefs, giving out many free samples. They received a limited response, but less than they had

anticipated, and less than they needed to stay in business. They had not estimated the high switching

costs the chefs had with regard to chocolate. Couverture is a pastry chef's biggest expense, and switching

to an unknown producer is risky. Most chefs already had a supplier they were satisfied with and new

chocolate-maker does not have an established history of consistent quality. Furthermore, chefs rarely

purchase directly from the producer, rather usually going through distributers. It took Scharffen Berger a

few months and the influence of Scharffenberger's culinary celebrity to find a distributer who would be

willing to take a chance on them. A distributer has to protect their reputation of offering products of

consistent high quality, and there are significant expenses associated with promoting a new brand. Here

the variability of chocolate is again a problem. If a batch turned out bad, the distributor's reputation, and

revenue, would be hurt.

However, Scharffen Berger was not without any network advantage. John Scharffenberger has a

strong positive reputation from his winery of the same name, which was known for creating high quality

Californian sparkling wines and creating demand for a market niche that previously did not exist; which
he was not trying to do for chocolate. Culinary professions, distributors, and retailers were more willing

to take a chance on Scharffen Berger chocolate because they were familiar with John's wines and held him

and his products in high regard.

Scharffen Berger did not strongly consider retail sales until John set up a table at the San Francisco

Farmers' Market in 1997. He anticipated to sell mostly to serious home chefs, but it was their 3-ounce

sample bars that went the quickest. They sold over $1,000 of chocolate in one day. Before then, John and

Robert held a similar opinion as the industry, that there just was not a strong consumer demand for high

cacao-content chocolate. Their experience proved to them that a retail market would be worth pursuing.

Here again John's culinary connections proved invaluable, as retailers familiar with his wines were more

inclined to carry his chocolate, assured of his reputation for quality. Fortunately, the target audience for

high end wines has strong overlaps to that for high end chocolate. Both sets of consumers must be

willing to spend significant money on a product are are willing to experiment with new ones. Their sales

boomed from $600,000 in 1998 to 2.3 million dollars in 2000. In 2001, their sales were 70% to retail and

30% to the food industry. Trader Joe's, their largest customer, accounts for 20% of their total sales. Other

major retailers carrying Scharffen Berger are Whole Foods and William and Sonoma [24].

Chocolate, as previously mentioned, is extremely temperamental, and the flavor is affected even

by subtle variations in bean origin, fermentation time, roasting temperature, conching time, and must be

tempered to degree-precision. This is especially true with high-cacao content chocolate, whose flavor is

almost solely dependent on the quality of the cacao, instead of relying on high proportions of milk, sugar,

vegetable fat, and other additives commonly found in mass produced milk chocolate. Scharffen Berger

emphasizes their commitment to quality. However, their narrow margin for quality variation is reflected

in their profit margins, which Scharffenberger admits are below the industry average, despite their high

prices.

While data for Scharffen Berger is not directly avaliable, two of premium chocolate
manufactures, Barry Callebaut and Lindt & Sprüngil had net profit margins of 4.31% and 8.05%,

respectively, inthe past year. Scharffen Berger's profit margins are probably to those of Barry Callebaut,

and Lindt generates a significant amount of revenue from sales of truffles and similar confections.

Hershey's, on the mass production side, had a net profit margin of 11.31% [14].

The slimness of Scharffen Berger's profit margins can be attributed primarily to their high quality

of inputs required by their production. Their ingredients, both beans and vanilla, are of much higher

quality than mass market, and their products contain a much higher percentage of cacao, instead of

substituting cheaper substitutes. Compare Hershey's milk chocolate with 12% cacao solids versus

Scharffen Berger milk chocolate with 41% cacao solids. Furthermore, small batch production prevents

economies of scale and production time is not minimized, with the conching in particular taking up to 60

hours per batch. A kilogram of retail Scharffen Berger costs $24.67 at its cheapest (62% semi-sweet

purchased in a 3kg block), and over $100 per kilogram at its most expensive (82% bitter purchased in 12 x

5 gram squares) [22] while a kilogram of retail Hershey's costs $19.38 at its most expensive (unsweetened

purchased in 4 x 12 oz blocks) [2]. However, since Scharffen Berger was a private company, they did not

have shareholders pressing them to maximize profit. More money could be spent in quality control and

research and development instead of supplementing dividends.

A large factor in the overwhelming positive response to Scharffen Berger is their openness about

their production methods, a rarity in the secretive chocolate industry. As noted in an Associated Press

article, Scharffen Berger "...was the first U.S. [chocolate maker] to feature the cacao count prominently on

its wrappers" [3]. This packaging differentiated their chocolate from the American chocolate already on

the market, associating it more with the gourmet European brands that it was influenced by. Their

chocolate seems less generic, and it appeals to the increasingly health and ingredient-conscious consumer

base.

Scharffen Berger offers free factory tours, showcasing the process of chocolate making "from bean
to bar," as well as providing free samples of their chocolate. Their factory in Berkeley was refurbished

and laid out to maximize the visual appeal to improve their public image. Many consumers are swayed

by the company's history and the old-fashioned European style of equipment and production. The

founders even published a book, The Essence of Chocolate, which alternates chapters of recipes (all using

their chocolate, of course) with chapters detailing the company history, production methods, and cacao

sources. The book was good marketing, romanticizing their company image while connecting with the

consumer. Scharffen Berger appeals to the public's curiosity about the industry of chocolate, as well as

giving them the ability to interest consumers who are otherwise indifferent to gourmet chocolate, and

thusly create new customers.

However, by creating new consumers for artisan chocolate, Scharffen Berger also risks creating

more competition for themselves. Retail chocolate consumers have essentially zero switching costs, and

consumers of high end food products are often very willing to experiment with new products. So

Scharffen Berger has to maintain rigorous quality and public relations standards to retain a loyal

following.

Scharffen Berger's openness with the press in particular garnered a positive response, and glowing

reviews and interviews gave the fledging company much-appreciated free advertising. By their

willingness to talk to the public, they are able to gain exposure and control their public image while

having no advertising budget. The press and consumers are guided to the same conclusions that Matt

Rosenblum reached in his book on the culture of the chocolate business, Bittersweet, ""When you see an

operation like Scharffen Berger, you know its products are good. Tastes might be personal, but when

individuals put so much care itno getting each detail of their chocolate right, and take pride in showing it

off, quality seems logical" (271) [21].

Demand for Scharffen Berger chocolate far exceeded even the founder's expectations and they are

quickly becoming a major player in artisan chocolate manufacture. In his interview with Matt
Rosenblum, John told him, "We're one-twentieth the size of Valrhona, tiny in the world of

chocolate...We'd like to settle into the range of $5 million a year in sales. That's about the size of one

healthy McDonalds" (274) [21]. Scharffen Berger broke $5 million in 2003, and are now projecting revenue

of four times that amount for 2006. But their popularity is a double-edged blade. It has been difficult to

maintain the quality of their product while increasing the scale of production to meet demand. Sourcing

beans becomes more difficult as a limited consistent supply is matched against increased global demand.

Cacao prices are already on the rise. Also, obtaining and restoring vintage equipment, which the

company relies upon to help produce their unique flavor has become increasingly difficult and less cost

effective. New machinery produced unacceptable alterations in flavor. Recently, the company acquired a

custom ball mill conche which allows for larger batches as well as reducing conching time per batch from

fifty hours to fifteen. However, at their current rate of growth, it is quite possible that Scharffen Berger

will hit a production ceiling in the near future.

However, the big players of the chocolate industry were not blind to the success of the upstart

chocolate maker. In July 2005, Hershey's announced its impending acquisition of Scharffen Berger under

their wholly owned subsidiary, Artisan Confections Company. The terms of the deal remained

confidential, but Scharffen Berger has been quick to assure consumers that their production methods

would not be affected. The acquisition however has given them greater capital to use for equipment,

bean sourcing, and expansion. Growing demand for their product and continued rave reviews have

given weight to the company assurances. And while Hershey's might own Scharffen Berger on paper,

there is no mistaking a Hershey's bar for a Scharffen Berger one or visca-versa. Hershey's is candy.

Scharffen Berger is chocolate.

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