Posh hot chocolate. The sign marking the entrance to Sir Hans Sloane’s factory in Surrey may not immediately explain what’s inside, but the smell that wafts out as the door opens is unmistakable.
Brian Watt, managing director of the upmarket drinking chocolate brand, is getting stuck in this Wednesday morning.
More than 250 years since the British physician’s death, the boss of the brand that bears his name has swapped Sir Hans’s wig and cravat for a lab coat and a hair net.
Watt’s just received two bumper Christmas orders from Waitrose and Morrisons, and the machines he uses to give the chocolate beads their distinctive shine have been whirring away since the early hours.
Four of his seven employees are busy hand weighing, sealing and packing boxes of drinking chocolate to send out this afternoon.
The current record for a day is 1,200. Watt says he’ll easily beat it this month.
But while the surge in demand has provided reasons to celebrate, Watt is also dealing with the impact of the Brexit vote and the weaker pound.
As a manufacturer who imports raw materials, he is feeling the squeeze, and not just from his suppliers. Official statistics show input prices – which measure the cost of goods bought by UK manufacturers – jumped after the Brexit vote.
Between September and October alone they surged by 4.6pc, representing the biggest monthly rise since 1996. Closely watched manufacturing surveys also show input costs rising at their fastest pace in five years. The battle between suppliers and retailers has begun.
But while the figures are stark and warnings frequent, who will end up hurting most, and what do the numbers mean in the real world?
Exchange rate headache
For Watt’s drinking chocolate, the journey begins 4,000 miles south of Surrey, in the Ivory coast.
Farmers here harvest cocoa pods which are split open, refined and bought by commodity giants such as US-based Cargill and ADM, Swiss cocoa producer Barry Callebaut, and French chocolate maker Cémoi.
Toussaint Nguessan, president of Union Inter-Régionale Victoire, which represents the farmers, says that the Brexit vote hasn’t yet “had a direct impact on the producers and cultivators of cacao in the Ivory Coast”, partly thanks to guaranteed prices by the government.
He claims it may even “open up opportunities” between the UK and Ivory Coast. Most buyers use the euro, but Nguessan says exporting co-ops have been hit on open contracts because “the arbitrage is done in sterling”.
Suppliers have also been dealing with a drop in the cocoa price over the past year as funds have pulled out in anticipation of a supply glut.
But Watt buys in pounds, which pushed his costs up almost 20pc overnight following the fall in its value.
As the 90kg vats of chocolate on his factory floor start to empty, he says he has little option but to pay up. “We are the little guy and have very little leverage as the customer or the seller because you don’t have what they’re interested in – volume.’’
While he could buy on the open market, as a small business with little room for manoeuvre in terms of cashflow, he says certainty is paramount.
Watt’s packaging costs have also climbed by 6pc in the wake of the Brexit vote, though not all costs have surged.
The clear bag and gold tie that contains the chocolate beans is imported from France, but the red paper box that holds it is made in the UK.
This price has not increased, and has led Watt to rethink where he will source future packaging from. Watt, who used to work for Kraft, says the impact of the weaker pound is different for large and small companies.
“When I worked at a big corporation, the central focus was how to manage profit and loss. I was looking at it all the time because there was that ability to work with different factors and still get results. “As a small business, what can I do? Do I tell someone to go home? Do I switch the microwave off? Do I force people to work in the cold?”
He will have to find more creative ways to save money. “We’ll probably delay booking roadshows until next year, because that’s an upfront cost.
“If we book a show now, we’ll get the prime position we had this year, but if we leave it for four months, maybe that position will be gone and we’ll have to settle for an area that is less advantageous.”
There is another way to absorb price rises: cutting margins. History shows that, while input costs have fluctuated wildly with the pound’s rise and fall, factory gate, or output prices have broadly tracked the headline inflation rate.
As consumers shop around, the reluctance to push up prices is unsurprising. Watt’s 270g packs of drinking chocolate currently retail for £4.99. It’s a price he does not want to exceed.
“We’re a premium product, but if I suddenly go to Waitrose and say: ‘I’m going to put up my price by 5pc’, if they also put it up 5pc the price suddenly tips over £5. That’s a psychological barrier for the consumer,” he says.
There are still two levers he can pull, promotions and volume. His flagship drinking chocolate is selling in supermarkets at £3.99 this Christmas in a bid to bag more sales.
While he won’t reveal how the pain is shared, he admits shouldering some of the burden. “For me it’s a strategic decision. I’m on a price below £5 and I want to stay there. It would be wonderful if I could reduce my price, and for the retailer to reduce his margin, but I don’t think that’s realistic.”
Chocolate companies have long deployed another tactic – shrinking their products.
Office for National Statistics data show that this year, there have been 394 instances where the people who collect price quotes for inflation data have recorded decreases in the product’s size or weight, compared with 114 price quotes where sizes increased. Food and drink is the most common category.
Toblerone recently announced it would reduce the size of two of its bars by 10pc.
Watt smiles when asked if he is considering shrinking his packs. However, one former executive of a major chocolate brand says managers were always looking for ways to “get away with cutting costs”.
“We visited our research lab where they had just developed a new formula for one of the top brands because new legislation allowed us to put certain ingredients in that helped to reduce costs.
We just needed to find other ingredients to mask it. The challenge was always whether we could pass the taste test.”
Whether through inflation or shrinkflation, Rachel Lund, head of insight at the British Retail Consortium, says price rises are coming.
“It’s almost certainly not going to be that suddenly on January 1 everything goes up, but we have a number of retailers in the first half of next year that have pencilled in price rises, and it will filter down throughout the year. “There will be an element of who goes first,” she says.
“So it may happen quite suddenly, or retailers may prefer to hold off for ages to see who goes first. But if they put their price up before their competitors, consumers may not buy from them anymore.” While Watt has faced challenges, there have also been opportunities.
He’s just secured a deal with supermarket chain Spinneys in Dubai which he says was a result of sterling’s fall. “We’d had a meeting in April, and they loved the product, but our premium compared to the market was quite high, so it went dead.
But in September I got a phone call confirming an order. That’s definitely because we’ve become more competitive with the exchange rate.”
Ian Wright, director general of the Food and Drink Federation, says the Brexit vote has led to opportunities as well as setbacks.
However, he cautions that businesses cannot switch their models overnight. “In most cases, new export opportunities take time for businesses to find a market, agree the contract and deliver the goods.”
Watt is concentrating on delivering what he hopes will be the best Christmas ever. While he may cut more costs, he won’t compromise on cocoa content. “People care a lot more about provenance and quality as well as price.”