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Diversity Collection BAB285 / DECEMBER 2016

Chocolate Remedies: A Healthy Twist “I went from making transmission gear to making truffles.” Mark Harris Anita Harris walked slowly from her car to the front door of Chocolate Remedies and gently turned the key in the lock. She paused for a moment, looking at the newly painted sign above the front door and the customized chocolate goat welcoming customers into the store. “Our new intern has really helped to freshen the look and feel of our store. I hope this catches more eyes as people walk by,” she thought. As she entered, closing and relocking the door behind her, Harris reflected. “Five years into this location and this is the first time that we can finally see a small light at the end of the tunnel. This year has given us some hope, but nothing is certain. We are still not profitable and have not even come close to earning back all the money we personally invested in this business since we signed our lease in October 2010.” Anita and Mark Harr is had opened their first Chocolate Remedies retail store at Legacy Place in Dedham, Massachusetts in May 2011. They were filled with inspiration and ambitious dreams, following six weeks of formal chocolate-making experience at the Cambridge School of Culinary Arts. They started with a strong first year of sales, then watched as traffic and sales came to a crawl. They had chosen Legacy Place because they believed foot traffic was critical to their success but realized this new outdoor mall wasn’t delivering on its promise. Inhibited by high rent and limited retail space, they saw they needed to expand their operating space before they could realize a profit. "We needed more than a retail front. We wanted to host events and fulfill wholesale orders," said Harris. "This was our original concept, and we recognized too late that Legacy Place wasn’t going to allow us to achieve this. Since chocolate is a season-driven business, it’s important to produce large capacity when required. We needed a location that would give us the ability to churn out thousands of truffles a day."

This case was prepared by Dennis Ceru, Senior Lecturer in Entrepreneurship, and Beth Goldstein, Adjunct Lecturer in Entrepreneurship, both at Babson College. It was developed as a basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. It is not intended to serve as an endorsement, source of primary data or illustration of effective or ineffective management. Copyright © 2016 Babson College and licensed for publication to Harvard Business School Publishing. All rights reserved. No part of this publication can be reproduced, stored or transmitted in any form or by any means without prior written permission of Babson College.

Chocolate Remedies BAB285 / DECEMBER 2016

Only two years into their first lease, they began hunting for a new location. They soon found a store front neatly located on the side of a quiet strip mall along a well-travelled major access road. The lease price was close to what they were already paying, but the space was more than triple the size of their current location. Although opening a second location before seeing any profit was less than ideal, they agreed to the terms effective December 2012. Having signed a five-year lease at Legacy Place, they needed to maintain both retail shops until August 2015 when they would close the shop at Legacy Place. Now in July 2016, with more than five years running the business, they started to see small signs of success. Although Anita ti red o f the seven-day work week, Mark believed they would succeed.

An Entrepreneurial Lens An ita an d Mark Harri s, an African American couple, had worked together to build a business. The entrepreneurial bug hit in the early years of their marriage when they resided in Chicago, Illinois. In the Hyde Park area of Chicago, they opened a gourmet coffee shop called Café Coffee. Since Mark was employed as an operations manager for a thriving company, they decided he would not be involved with day-to-day activity running the shop. Over the next seven years, Anita committed to operating the business while raising their two children. They never managed to break even, but Anita loved the experience of running her own café. When friends approached them to open a second cafe in 1990, they jumped at the opportunity to expand their business. Hoping to build a strong brand presence, they opened Café Coffee Two only a mile away. Neither shop ever saw a profit, so in 1993 they decided to walk away from both. This was not as simple as they had hoped, and it took almost three years to pay back federal and state taxes they owed. For the next few years, Mark continued work as an operations manager, and Anita secured a management position with Starbucks. In 2005, Mark received a job offer he could not turn down. The opportunity required moving to Massachusetts, where he would become a senior operations manager for a national supplier of engineered solutions in appliances, telecommunications, motor controls, and data processing and controls. Starbucks allowed Anita to transfer, and she continued to grow her career. However, only two short years later, in December 2007, Mark found himself unemployed when the company he worked for was sold and corporate positions were eliminated. Mark knew his unique expertise in operations and engineering put him in a strong position to run his own manufacturing plant and quickly found the job of his dreams as a division president with Tekfor in Ohio, a manufacturer of steel parts and components for the automotive industry. However, it required that he either relocate or commute to Ohio from Massachusetts. Since Anita was experiencing success with Starbucks and the family had settled into their local community, they agreed Mark would commute. From April 2008 until March 2010, Mark thrived as president of his division, even with a weekly commute of more than 700 miles. Subsequently, changes within the industry and the company required that he move to Mexico to continue his role. This option was not acceptable for the family, so Mark agreed to a generous buyout. Mark explained, "We were ready to do something for ourselves. Anita had retail experience and I had operations experience. I thought we could make a go of it.” Mark believed that at his age, now in his mid-50s, it would be difficult to find a high-level manufac tur ing position in Massachusetts.

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Anita had achieved success with Starbucks, rising to district manager in only a few years. However, her responsibilities required more than a 50-hour week and heavy travel to ensure a strong presence in her 94-store district. She managed the stores as if they were her own, showing h er man agers respect and compassion. Starbucks was tightly run with many controls, systems, and reporting procedures. At times it seemed she was managing to the metrics rather than to the business. The stores were profitable and Anita was paid well with good benefits, but she was feeling burned out and ready for a change.

The Next Great Thing Mark began searching for “the next great thing.” He decided to focus on retail, believing it provided the best opportunities for low capital investment with high potential return. Mark explored online clearing houses and working with a business broker to navigate opportunities but quickly rejected both options. He turned to franchises, believing he would find established businesses with a strong track record. In the fitness industry, he reviewed opportunities to open exercise and training centers, but this sector lost appeal due to the choice of locations and his understanding of the competition. Next Mark looked at the health and vitamin market, appealing because of the trend to natural, healthy solutions. He found the space interesting but could not envision selling vitamins for a living. At dinner each night, Anita and Mark talked about various options, but nothing caught their passion. One night, Anita mentioned the number of non-coffee products in high demand at Starbucks, noting how anything with chocolate sold quickly at fairly high prices. They both began to read about chocolate and its many health claims. Having somewhat of a sweet tooth themselves, they began visiting chocolate stores, sampling chocolates and engaging owners in c onv er satio n about their businesses. They quickly learned about the retail chocolate space within a 25-mile radius of their Massachusetts home. They decided that even though there was a solid representation of well established brands ranging from Godiva and Lindt to small, boutique chocolatiers, this was an attractive retail niche with potential for new entrants. Mark commented, “The chocolate market is over $10 billion, and the average American eats almost 12 pounds each year. This is a growing industry and one that that we wanted to be part of, if we could identify the right unique niche.” While Anita continued at Starbucks, Mark researched the chocolate industry and identified a franchise that appealed on many levels, Schakolad Chocolate Factory.1 The business h ad opened in the late 1960s and had enjoyed continuous success. After developing manuals, systems, processes, and procedures, the founder’s son, Edgar Schaked, created the Schakolad Chocolate Factory as a turn-key retai l franchise. The complete cost to open a Schakolad Chocolate Factory store ranged from $130,000 to $170,000 depending on the location. The cost included a franchise fee of $39,500 which provided the franchisee with all required equipment, marketing materials, and an initial stock of supplies. The monthly license fee of $600 for the first year increased annually by $100. In addition, a monthly marketing fee of $100 meant a total fee structure of $8,400 in the first year, with fees increasing by $1,200 every year thereafter. The company offered two weeks of intensive training, assistance with location selection, and connections through approved partner suppliers and vendors. 1

http://chocolatefranchise.com/index.asp.

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The Schakolad Chocolate Factory business model was built on multiple revenue streams: in-store retail sales, off-site parties, “sweet night out” team-building and corporate events, weddings and parties, and custom-made chocolates for hotels, grand openings, or other promotions. Th e b u s i n es s m o d el al l o w ed the franchisee options to generate revenue specific to the business location and interests. It also offered income pro tec tio n for seasonal industry cyc les, gi v en th at many consumers bought primarily during holidays (e.g., Christmas, Valentine’s Day, Mother’s Day) and for special events such as birthdays and anniversaries.

The Decision Despite the highly structured Schakolad model, Mark and Anita preferred to set up their own operation rather than pay for the right to market someone else’s brand and product. Mark explained. I was impressed with Schakolad’s franchise model since i t aligned quite well to the one we were thinking about. I liked their operation and their concept. However, cost was an issue. We thought we could do it for less money on our own. We no longer wanted to share control over how the business was run or product quality, especially with a franchise that was not a recognizable brand like Godiva or Lindt. There is risk in everything, but we just wanted to do our own thing. In the end, we had enough faith in our product to risk our personal investments. Mark enrolled in a six-week chocolate-making class at the Cambridge School of Culinary Arts, mastering industry basics as quickly as possible. He learned about grades of chocolate, how bean origin and cultivation impact its taste, options for buying raw chocolate, how to melt bulk chocolate, how to make the soft tasty center of a truffle called the ganache, how to create the hard shell glaze that forms the outer layer, setting molds, and decorating finished pieces. Mark reflected on the link between his manufactur ing career and making chocolate. While it sounds daunting to the uninitiated, it is actually a simple process, albeit labor-intensive. The class showed me that making chocolate truffles was a process. I know process. I lived it. If I could make steel rivets, I could make chocolate, as long as I studied the steps, learned a system, and followed it with discipline. All we had to add was quality, to make chocolate better than what was on the market. Anita and I were confident we could do just that: make a better tasting, higher quality chocolate! Anita and Mark agreed they should start small and make a few batches from their kitchen to test the product. Anita took finished chocolate goodies to work as she travelled throughout her Starbucks territory and shared them with staff in the stores. Mark continued, “They went wild. Everyone loved our truffles! ‘The best we’ve ever had,’ they’d say time and time again. We both believed we were on the verge of something really big.” They decided to self-finance the chocolate venture as they had with their coffee shop 25 years ago. They used a combination of personal savings and the remainder of Mark’s severance and bonus package from Tekfor. They agreed to forgo paying themselves a salary, instead drawing only what they needed to cover basic expenses.

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Location, Location, Location The search for a retail location began. In a few months, they found a store in a new destination mall that combined a multiplex theater, a selection of restaurants, and a few high-end retailers. Legacy Place had been designed small enough to be easily navigable yet large enough to provide variety. Anita and Mark were confident foot traffic would generate sales as people flocked here from nearby cities. In October 2010, they negotiated and signed a five-year lease for a 550-square-foot space costing $5,300 a month. They needed to generate approximately $20,000 per month in gross sales to break even. They believed their superior truffle would sell easily; if they added ice cream and exclusive events such as kids’ birthday or wine and chocolate parties, they would quickly balance their income streams. They opened the store seven months later in May 2011 and were pleased with initial sales during busy summer months. However, success would depend on year-round foot traffic flowing through this new destination mall. Trouble came quickly. Fall turned into a brutally cold and snowy winter, and foot traffic dwindled more rapidly than they h ad anticipated. Sales picked up a bit for the winter holiday season, then declined until spring. Summer came with long days and few sales as people left on vacation. Anita and Mark realized how seasonal the retail chocolate industry was, and also how the unique weather patterns of New England influenced consumer behavior and spending. First-year sales of $238,000 were far below their expectations. Anita and Mark continued to support the business by drawing down their own personal savings and reserves. Trouble continued into year two with total sales reaching o nl y $225,000. Anita and Mark were accumulating debt quickly, often running 90 to 180 days behind on rent and other bills while still not taking a salary. They had selected Legacy Place because they anticipated significant foot traffic. They wanted to manufacture chocolate on site and hold events. However, the shop was too small to do either. Therefore, they rented manufacturing space at a shared commercial facility, Commonwealth Kitchen, located in nearb y Dorchester. They held most events off-site, adding to mounting costs. They heard about a space three times the size of their current location, available for the same rental fee. Winter was approaching, and they feared sales would fall again. In December 2012, less than two years after opening their first retail shop in Legacy Place, which remained unprofitable, they signed a second lease for 1,875 square feet for $5,300 a month. They knew this was a risk, but the space would allow them to manufacture on site and hold events. This second location had limited access by foot, so they decided to find ways to become a destination instead of relying only on foot traffic. In addition, they broadened their so urces of rev enue. (Please see Exhi bit 1.)

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The Chocolate Industry According to Erste Asset Management GmbH, a research firm based in Vienna, Austria, an average person in the United States consumed some 11.5 pounds of chocolate each year. The chocolate industry was a crowded space, subject to fluctuations in demand. (Please see Exhibit 2 and Exhibit 3.) More than three million tons of cocoa beans were consumed worldwide annually, according to the World Cocoa Foundation. The chocolate market increased 13% between 2010 and 2015, reaching sales of $101 billion. Sales of dark chocolate grew by 5.1% in 2015 in the United States, according to Euromonitor. Two companies controlled the industry, The Hershey Company and Mars, Inc. In 2016, they accounted for a combined 64% mark et s hare with no other company achieving more than 4%.2 Consumer trends heavily impacted demand. According to Business Insights, premium-priced chocolate sales increased continuously. There was growing interest in medical research on health risks associated with high-fat milk chocolates, and also on health benefits associated with dark chocolate and premium cocoa containing antioxidant flavanols. According to a Euromonitor In tern ation al report of July 2016, Chocolate Confectionery in the US: This healthy indulgence trend also spurred demand for premium chocolate con fectio nery in 2016. Premium brands typically offer dark chocolate with higher cocoa content and gourmet ingredients. As a result, premium companies like Lindt & Sprüngli USA, Ghirardelli Chocolate and many small batch, craft, artisanal, and bean-to-bar manufacturers gained shares over the review period. At the same time, major manufacturers have introduced their own premium offerings, including Hershey’s launch of Hershey’s Kisses Deluxe. […] This shift toward premium products helped drive up average unit prices […] by 3% in 2016.3

Positioning the Brand Anita explained their marketing approach focused on the increasing demand for health benefits of chocolate. It would set them apart from competitors in this crowded space. “Our decision was always to take a unique approach to chocolate. Capitalizing on the well-documented health benefits of dark chocolate, we agreed that by adding therapeutic ingredients, we would achieve a winning combination, and the response would be overwhelmingly positive.” Chocolate Remedies positioned itself as a new kind of chocolate shop, dedicated to providing customers with highest quality, locally produced, handmade chocolates. “Customers will be delighted to find a line of fine chocolates to indulge their senses, treat their body, and soothe their soul!” explained Mark. Anita added, “We offer truffles and specialty chocolates with healthy twists and unique flavors. Inside the dark chocolate Aristaeus truffle, you’ll find cold pressed olive oil and sea salt. Other chocolates incorporate sweet potato and ginger. This is therapy with chocolate. It makes you happy. It makes you smile, and it's good for you. It's a source of antioxidants, and it’s heart-healthy." They decided to sell tiny pieces of chocolate in a pill bottle with the label reading prescription for joy and happiness.

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http://www.euromonitor.com/chocolate-confectionery-in-the-us/report. Passport, Chocolate Confectionery in the US, Euromonitor International, July 2016.

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Revenue and Distribution Channels Chocolate Remedies had started with an original plan to have multiple sources of revenue. However, size of the Legacy Place store limited activity, so during the first two years in business they focused on two revenue streams: in-store sales of chocol...