Abstract

Dissertation Title: “The bittersweet taste of growing a traditional chocolate manufacturer” Author: Tiago Aires da Fonseca Keywords: Internationalization; Expansion; Growth; SMEs

Arcádia is a family-owned Portuguese confectionary, recognized for its quality products, especially its chocolates. The company has a long history, founded in 1933, by Manuel Bastos, and has been managed by the family ever since. Throughout its lifetime, Arcádia has established a recognizable brand in its local market and has grown from its origin city to the rest of the country. Under the management of João and Margarida Bastos, the company expanded its store presence to several locations in Portugal. Their expansion process included through the creation of new store concepts as well as franchising. Their growth plan leads to the focus of this Case Study, which aims to understand the current situation of Arcádia and the viability of its expansion to international markets. Relevant subjects are addressed in the Literature Review, such as: internationalization; definition of SMEs, their context in internationalization as well as their motivation and difficulties encountered in this process; firms’ resources and capabilities. The Teaching Note includes an analysis of the Case Study and the company’s current situation, as well as suggestions for future challenges that Arcádia would face if it decides to internationalize. The main focus of this dissertation is to analyse this company’s specific situation and motivations to explore new markets. Also the paper tries to explore if, as an SME, Arcádia’s resources and capabilities better position the company for an internationalization challenge and what difficulties it will face in this process.

2 Resumo

Título da dissertação: “O sabor amargo de crescer uma fabricante de chocolate tradicional” Autor: Tiago Aires da Fonseca Palavras-Chave: Internacionalização; Expansão; Crescimento; PMEs

A Arcádia é uma confeitaria portuguesa, reconhecida pelos seus produtos de qualidade, especialmente pelos seus chocolates. A empresa, gerida pela família de Manuel Bastos, responsável pela fundação da empresa em 1993, tem uma longa história. Ao longo da sua existência, a Arcádia conseguiu estabelecer uma marca reconhecida no seu mercado e expandir da cidade de origem para o resto do país. Sobre a gestão de João e Margarida Bastos, a empresa ampliou a sua presença no País. O processo de expansão inclui a criação de novos conceitos de lojas, bem como o franchising. O plano de crescimento da empresa leva-nos ao centro deste Estudo de Caso, que visa compreender a situação atual da Arcádia e a viabilidade da sua possível expansão para mercados internacionais. Temas académicos relevantes são abordados na Revisão da Literatura, tais como: internacionalização; definição de PMEs, o contexto das mesmas em processos de internacionalização, bem como as motivação e dificuldades encontradas neste processo; recursos e capacidades das empresas. A secção da Nota de Ensino inclui uma análise do Estudo de Caso e da situação atual da empresa, bem como sugestões e desafios que a empresa possa enfrentar caso decida internacionalizar o seu negócio. O principal foco desta dissertação passa pela análise da situação e motivações específicas desta empresa para explorar novos mercados. Além disso o estudo procura explorar se os recursos e capacidades da Arcádia, como uma PME, a posicionam para o desafio deste processo de internacionalização e quais as eventuais dificuldades que enfrentarão neste mesmo processo.

3 Acknowledgements

I would like to express my gratitude to João Bastos, for allowing this thesis to be developed and for his complete availability and cooperation throughout the whole study. I would also like to thank my academic advisor, Professor Nuno Magalhães Guedes, for his support and guidance throughout all this process. His experience, supervision and motivational words, were essential for my completion of this paper while working at the same time. Lastly, and most importantly, I would like to thank my parents for their full support throughout all my academic life and their investment in my academic path. They allowed me to best position myself to complete this study and face the marketplace well prepared. I owe all my qualities and my achievements to their efforts in supporting me. Also, I would like to highlight the support of my friends and colleagues which were also important in motivating me to conclude this part of my academic life.

4 Table of Contents Abstract ...... 2 Resumo ...... 3 Acknowledgements ...... 4 1. Case Study ...... 6 1.1. The Origins ...... 6 1.2. The market ...... 8 1.2.1. Pricing ...... 9 1.2.2. Clients ...... 11 1.3. The evolution of the stores ...... 11 1.3.1. The new store concept and the Financial Crisis ...... 13 1.4. The Expansion ...... 15 1.4.1. The move to Lisbon ...... 15 1.4.2. The New Points of Sale and Line of Products ...... 17 1.5. The next steps ...... 18 1.6. Exhibits ...... 20 2. Literature Review ...... 30 2.1 Internationalization ...... 30 2.2 Internationalization of SMEs ...... 30 2.2.1 Definition of SMEs ...... 30 2.2.2 Context of internationalization of SMEs ...... 31 2.3 Why SMEs go International? ...... 32 2.3.1 The motivations ...... 32 2.3.1.1 Globalization ...... 33 2.3.1.2 Network Theory ...... 33 2.3.2 Challenges ...... 34 2.4 Resources and Capabilities ...... 34 2.4.1 Tangible and Intangible Resources ...... 34 2.4.2 Classifying Capabilities ...... 35 3. Teaching Note ...... 36 3.1 Learning Objectives ...... 36 3.2 Class Plan ...... 36 3.3 Analysis ...... 37 3.4 Teaching Note Exhibits ...... 49 4. Conclusion ...... 50 5. References ...... 52

5 1. Case Study

It was a cold mid-September 2017 afternoon in Porto, the second largest city in Portugal. João Bastos, the CEO and owner of Arcádia, was meeting with his sister, Margarida, at the iconic deco style office covered in pictures of the history of the well-known chocolate maker. The third-generation management was discussing the past success of the company and all its accomplishments: “We have reached our growth objectives. All the hard work led us to the point we find ourselves in now, but how should we grow further and explore more revenue streams?” The 84 year-old producer of the famous “cat tongues” and bonbons had grown steadily since the early 2000s, building on the planned expansion designed by João and Margarida. From the opening of several new stores to the investment in new lines of products, Arcádia had been able to reach revenues of 5.8 million euros in 2016, despite some risky investments late in the previous decade. This was during the financial crisis, which led to rocky times for Arcádia. Arcádia had several issues to take care over the next few years, such as the franchising process, new partnerships and rejuvenating product lines. João considered that the company had to continue its expansion while keeping intact the roots and tradition in the recipes and manufacturing processes. However, the real question came down to what was the next step for Arcádia. After the Portuguese market is saturated, would Arcádia be happy with its size and success? Although the operations in Portugal presented successful outcomes, they had a probable limit. The exploring of new opportunities outside their comfort zone, their local market, could bring unseen results.

1.1. The Origins

“What we have accomplished in the last few years is a product of the full commitment of the family generations to turn the company into a household name in the Chocolate industry as well as the strategic decision to continue to grow and expand within the Portuguese market” - João Bastos, Owner and CEO of Arcádia

João Bastos started his career at Crédit Lyonnais, at the same time as he was an assistant teacher at Porto’s Economy University. In 1984, two years later, he moved to one of the largest retailers in Portugal that was growing in their international operations. His motivation

6 and thrive led him to become one of the top executives in the company after being part of several national and international management teams of subsidiaries of the conglomerate throughout 23 years. He later held, while managing Arcádia, the position of President of the Fiscal Board of Sonae IM, the conglomerate’s private equity fund. This experience was a strong backbone for his position as the number one man in Arcádia. In May, 2001, João decided to take the command of his family business, along with his sister, Margarida (Exhibit 1), something he had long planned. His understanding of the business, the passion for the family’s company and his deep experience in managerial roles led him to start the ascendance of Arcádia. The old chocolate confectionary was, throughout all its history, located in the historical centre of Porto. It was founded in 1933 by Manuel Bastos (Exhibit 2), João’s grandfather, an entrepreneur in spirit and a visionary. The company has remained in the hands of the Bastos family ever since its inception. Manuel started Arcádia as a typical Porto confectionary, a local coffee shop (Exhibit 3). At the time, there were many confectionaries, all of them focusing on the production of delicious bakery products. From croissants to the typical Portuguese cake “Bolo Rei”, the King’s cake, confectionaries were extremely famous around Porto and would battle for the individual status of the best store crown. At the time, these businesses used to produce their own chocolates within their range of products. Arcádia and Manuel were no different. Throughout the years Arcádia developed a name for its delicious chocolates and French inspired bonjour liquor dragees. These almonds were one of the most differentiating points for Arcádia, as it followed a typical French production process and it was the only Portuguese manufacturer that provided such products in Portugal. Manuel Bastos was an entrepreneur with vision and passion. He believed that in order to have a healthy and capable company he had to have an excellent and close relationship with all his staff. This was something still seen rooted in the company’s culture. This tended to create a friendly and family environment within the company. He also believed that in order to be better than his competition, he would have to differentiate. His first real step towards differentiation was to bring a French pastry cook to teach his employees at Arcádia how to produce the almonds and paint them. He would later on bring to his company students from the Fine Arts University in Porto, to paint individually each almond with their own style and personality for a part-time salary (Exhibit 4). Manuel would also have the care to give to his clients English tea bags that he would bring from his occasional trips to London.

7 It was for reasons like these that Arcádia became extremely well known for its quality and traditional recipes. The recipes exclusively used natural selected products for their famous “cat tongues”, hand-made dragees, handcrafted almonds, their worldwide exclusive port wine chocolates and other products. They were chocolates, that according to the company’s claim, “smell and taste like real chocolate, handmade and genuine as the tradition dictates”. The chocolates would be exposed in the storefront in boxes delicately wrapped in blue paper with a golden lace around it. Clients were already familiarized with this detailed presentation and would value it (Exhibit 5). These traditional production processes and recipes were a key in the company’s identity throughout the years and it still was what distinguished the brand in the 21st century. Arcádia sold an extensive range of over 250 different products, from theme packed chocolates, of Portuguese Cities, football teams and season themed packs, to individual products such as the chocolate almonds. Its top-sellers were the:  Chocolate milk cat tongue boxes (210 grams) – 6500 units sold on average per year (€8.79 per box) (Exhibit 6)  Chocolate almonds – 2200 kg sold on average per year (€18.99 per kg)  Port wine chocolate boxes (100 grams) – 8300 units sold on average per year (€6.79 per box) (Exhibit 7) Although these were the top individual products, Arcádia had assorted boxes which were composed of several of their products. These boxes were differentiated only by their weight, 250 or 500 grams, and were filled by the customers. Customers chose the individual products they wanted in the box and paid the total price per weight (Exhibit 8). On average, per year, Arcádia sold 9800 units of the 250g box, with an average price of €10 per box.

1.2. The market

The chocolate market in Portugal, a country with a population of around 10 million, represented, in 2017, roughly around 200 million euros. 60% of sales were made on Christmas and Easter seasons. Arcádia represented about 2.5% of this market with revenues of 5.5 million euros in 2016. Portugal was the smallest market in Europe for chocolate consumption. It had an average yearly consumption per capita of 1.7kg, or a little more than half of the consumptions in

8 Spain, and around one fifth of the consumption in countries such as the UK or Germany. In Europe the average consumption of 5.2kg per capita felt like the typical amount you would find in Western countries. The high VAT tax rate of 23% on these products, or simply the warm, southern European climate, could help to explain this phenomenon. To build on top of this, Portugal, by 2015, was only the 19th member state on the PPP (Purchasing Power Parity) of the 28 members of the EU, with a lower purchasing power than the average European citizen. The country had a couple of its own national chocolate producers that were established in the early 1900’s. Portuguese manufacturers were selling their products through their own stores, or through supermarkets and hypermarkets and other retailers. Arcádia’s main channel were its own stores, followed by major retailers. The regular chocolate consumer in Portugal was quite price sensitive. Consumers looked for quality at low prices. The tendency was to lose some of this sensitivity towards the high seasons of chocolate consumption, such as Christmas or Easter. The distribution of products by Arcádia and its Portuguese competitors to the big retail stores was higher during the high seasons for chocolate consumption. This was also true in online orders in Arcádia’s website. For additional information on the main competitors of Arcádia please see Exhibit 9.

1.2.1. Pricing

In Portugal, chocolate prices vary substantially between seasons. One reason was the huge sales seasonality. As an example, Arcádia’s sales in Easter represented 35% of total annual sales. In the summer and spring prices tend to be lower in major retailers and they tend to set promotions on chocolate products to keep sales stable throughout the year. This is the case with Arcádia products available in the retail channels and if they are not sold, they are returned back to the company. “In the autumn and winter, prices tend to get higher” João stated. Because of this phenomenon it was hard for companies like Arcádia, with reduced economies of scale, to compete pricewise with established international brands. This was one of the reasons why it decided to keep its positioning in the high-end, quality hand-made chocolates. Although it saw itself as “brand for all”, transversal in clients’ segments, its pricing kept it away from more price-sensitive customers and defined it more as an elite brand. Arcádia kept its prices constant year-round, both in their stores and online, which was

9 risky due to the seasonality of the consumption of chocolates in Portugal, but helped it protect its identity. Arcádia sold its products by packs, usually measured in grams. In stores, customers could fill boxes with bundles of different products and these were also priced through the combination of the weight of different categories of Arcádia’s products. For the basic product segment, like the bonbons or the milk chocolate cat tongues, Arcádia would charge, on average, around 50 cents per 10 grams. They sold boxes of 100, 250, 500 and 1000 grams, priced from 5€ to 50€. The cat tongues were priced at an initial price of 11€ for 210 grams, while the simple chocolate almonds were priced at 5€ for 100 grams. The bonjour liquor dragees, Arcádia’s “pearl”, were more expensive, priced by packs of boxes starting at 36€ to 62.5€. The port wine bonbons were sold in a pack of 4 boxes of 100 grams priced at 31€. The premium category of products, ranged from 15€ to 32.5€ such as: the cat tongue chocolate bundle, the mint chocolates, the Christmas special packs or the heart-shaped chocolates packs. Arcádia was investing in developing this premium line. The margins were higher and the “bundle of products tended to be very successful for gifts and Christmas baskets and this was becoming a prosperous strategy” João stated. Arcádia would occasionally have trouble with its pricing strategy when its products were sold in the large retail stores like Pingo Doce and Continente, the reference supermarkets companies in Portugal. João feared that his clients felt betrayed with the price discrepancy found in Arcádia stores and large specialist retail stores. Arcádia had the care to differentiate the packaging of their products in their own stores, which had a higher quality from the ones sold in supermarkets, as “we wanted to avoid the damaging of our brand image”. Still, “loyal customers understood that they were being sold the exact same product for lower prices in large retail stores, but this was something that we could not control directly since these large corporations defined their own promotions”. This also implied higher costs for Arcádia, since all the unsold products that were returned had to be repackaged or “thrown out” because of their expiration dates. This implied a time effort and the cost of repackaging of these returns. Its competitors would have different prices in general. Regina would have its chocolates and bonbons priced in retail stores at 2.99€ for 150 grams, 20 cents per 10 grams. Leonidas was closer to Arcádia’s price range with an average of 45 cents per 10 grams of chocolate. Their premium packs were quite expensive, like their “Jewels Box” with several chocolates and bonbons priced at 43.25€ for 450 grams. Both Neuhaus and Valrhona had an average price, per 10 grams, of above 80 cents. Their products were high-end, expensive chocolates that were only sold in high-priced retailers, such as El Corte Inglés, one of the most expensive

10 supermarkets in Portugal. This pricing strategy was clearly focused on customers that were chocolate connoisseurs and had purchasing power, which was very close to what Arcádia intended to target.

1.2.2. Clients

Arcádia started out as being a go-to place for chocolate lovers. Since its inception, people would go to the store to take chocolates home for their families. The original Arcádia clientele were loyal customers looking for high quality hand-made chocolates. This was something that was established by Arcádia’s reputation early on, and moved on throughout new generations and new family members. This almost personal connection between the brand and the client was something cherished and taken advantage of by Arcádia over the years. Clients tended to be people that knew the brand and understood its history. Arcádia wanted its products to be available to all social and economic classes, but its positioning as quality brand and the high priced products led the company to focus on the upper-middle class segment. This was something that had been present in Arcádia’s strategy and positioning, but became more obvious as years went by, especially after João and Margarida took command of the family’s business. Also, as time evolved the entrance of new brands in the Portuguese market also grew, particularly international brands. These brands, like Kinder, Nestle’s chocolate brands had a massified production and their prices were hard to compete with. “This was one more reason why we kept Arcádia’s positioning intact and even fortified this strategy over time” said João.

1.3. The evolution of the stores

From 1933 to 2000, Arcádia’s main store in downtown Porto was kept as the location of the offices of the company and a place where people would go and get a range of products from chocolates to whisky and port wine flavoured bonbons to the traditional Portuguese pastry. It was in the year 2000 that João felt that the company needed to take a step forward. The confectionary was closed and turned into a store that only sold Arcádia products. It was also at this time that the handcrafted almonds were starting to be sold in the big retail stores. This was a decision made by both brothers since the product had such a high demand and could stand out from other products in large retail stores for its uniqueness and identity.

11 In 2003 Arcádia, for the first time, opened a sales point outside of its origin location. It opened a kiosk focused on the selling of chocolates and almonds in the main shopping centre in Porto. This kiosk was meant to stay open only during two periods of the year: Christmas and Easter holidays. “The intention was to create a higher presence and visibility of a brand that, although well known by the Portuguese costumer, was only present in one place”. Once again, the success of this approach led João and Margarida to consider a bigger investment. The next year, in 2004, the company opened the kiosk the whole year (Exhibit 10). “What we found out is that, while Christmas and Easter were without doubt the high seasons for sales, we were still having good sales number during the rest of the year and at the same time exposing the brand in a location with a lot of traffic”. The company was ready for the next step, one that would require a bigger investment. In 2005 Arcádia opened a store in the same shopping centre, located in the highly competitive food court. The concept of the store was simple: sell basic products, like chocolate, almonds and coffee, and be a reference for a post meal destination, a concept which was highly common in Portugal. “From then on, things just moved really fast. We opened stores in two new locations, once again shopping centres, since street commerce was extremely underperforming in Portugal at the time, and, on the other hand, shopping centres was a prime and profitable location”, João explained. It was also at this time, that Arcádia was about to open its largest and most successful store. As João was driving down the main avenue in Porto, Avenida da Boavista, he saw a store for rental. This prime location store was of reasonable size, surrounded by several office buildings. Besides being a busy area, the location itself was ideal for brand visibility as João had envisioned. “It was a light bulb moment, as I was driving through the store for rental and realized the potential it might have for both brand awareness and actual selling of our products. It is still our biggest and most successful store, and we believe it is going to stay that way as the city and its population continue to grow”. This store also proved to be a success due to its simple but effective objective: to serve as a coffee shop, a concept extremely blended with the Portuguese culture and to sell brand products in the store. Independently of the store concepts, there was one thing that Arcádia had always cherished and incentivised: “we had to keep service at a high quality, not luxury service, but quality service, where clients felt welcomed and like entering their corner café” said João. This was made clearer when João and Margarida started to realise how one particular store, in the downtown area in Porto, had a sudden increase in sales from one month to the other. “I saw

12 this increase in one month and though that it had been an exception, more traffic in the store, for whatever reason. But I soon came to find out that it was going on each month and kept the sales constantly growing”. When João investigated a little bit deeper, he found out that the manager of the store had changed and that she was taking the role of an Arcádia employee seriously: being a social, warm and interactive individual; receiving customers with attentiveness and care; helping customers make their decision based on their preferences and taste; creating familiar empathy. This was a turning point for João to realise the importance of this factor.

1.3.1. The new store concept and the Financial Crisis

As the stores in the shopping centres kept their constant stream of revenue, João felt that these prime locations had more potential. “For such a prime location, with all the high costs, I believed we weren’t taking full advantage of our stores”. At the time, in 2008, the stores were highly focused on being a selling point for Arcádia’s main products but the question was: “why not compete directly with other players of these food courts?”. João and Margarida envisioned a store concept where people could isolate themselves from the crowded and noisy environment of the food court area. Arcádia would differentiate from other stores and make a higher return from these costly locations. João believed that this concept would “fit well with the costumers that would patronize these shopping centre food courts, as they would have the opportunity to have quality meals in a more private location with a quieter environment”. Arcádia signed two contracts in 2009 to implement this new store concept in two shopping malls: Dolce Vita Tejo, where the main clientele was lower income families, and Marshopping, where the clientele was very transversal, from all socioeconomic status. The new store concept had a lounge area, where people could sit down and drink a coffee, and also had several tables with big comfortable chairs and black wood tables (Exhibit 11). It resonated with a high-end small restaurant and this was the actual objective. It was just like the envisioned plan, a quiet destination in a noisy location. Each day, the stores had a meal of the day that would be presented in a menu including drink, coffee and an Arcádia chocolate treat. This store concept meant a heavy investment for Arcádia, since it required adequate conditions for the preparation of daily meals. It had to rent a larger store with kitchen space. An investment was also needed for all the equipment/utensils needed for cooking and storage of large quantities of food.

13 What Arcádia soon found out was that this concept was not successful. Sales were low compared to the estimates and people kept using the store as a destination for their coffees and “sweet treats”. The customer persona was still the same. João and Margarida concluded that they had made a mistake. They idealized a concept that drifted too much from their brand identity, something they believed wouldn’t influence their sales in the stores. “Typically our customers wouldn’t even look at the daily meal menu that we presented in our windows and would look for the main references in the food courts. Even if they were looking for a new alternative to have lunch or dinner, just the Arcádia logo would lead them to think that this was not the alternative for food”. This was something that seemed obvious after seeing the results of the launch of the new store concept, but didn’t seem that apparent beforehand. The locations of the stores were also not ideal. Arcádia was located in the far ends of the food courts, a place that was typically associated by customers as coffee and pastery locations. The decision to open a store in Dolce Vita was also not the best, according to João, mainly because “the target customers were not the people that went to this shopping, they did not associate to the brand and didn’t value what we had to offer”. Since the contracts with the shopping centres required a minimum stay of 5 years, Arcádia kept them running till 2015 then renewed the contract for the Marshopping store only, as it was not losing money and had branding potential due to its visibility and location in a high traffic shopping mall. These heavy investments were made just before the peak of the financial crisis in Portugal, felt strongly in 2009, where “credit was extremely accessible and banks were allowing sizable loans for the expansion of businesses” and with rent contracts of 18 months for the new stores, left the company with a high leverage. Portugal felt the crisis in a very impactful way, where people reduced their consumption substantially, especially for non-essential goods. Arcádia’s main store, in Avenida da Boavista, felt this impact throughout 2008 to 2012 and was still recovering its sales in 2017. “People reduced the consumption of meals out of home and even reduced the basic tradition of having their morning and lunch espressos, which were so important for the consumption of other products in our stores”. The company’s debt, plus the impactful reduction of consumption by the Portuguese consumers that was felt directly in Arcádia’s store, left the company in a hard situation to decide its next steps: “we had to decide to wait for the storm to pass or to continue investing in order to attack this bad phase heads on”.

14 1.4. The Expansion

João and Margarida had long meetings discussing what strategy should Arcádia follow afterwards and how to solve the high debt crisis. The decision they arrived to was “to continue to invest and move to a new city, a new market, a breath of fresh air”, where the company could get more revenue streams. Both of them believed that they could replicate the successful strategy of the initial small stores, a basic selling point of the main Arcádia products, and could get back on track to the growth they were seeing from 2000 to 2008. They desired growth and wanted this growth to be true for a long period of time. In 2010 Arcádia also took a step forward, by acquiring a company with whom they worked with. Coffee Box was a company that had several small kiosk stores in shopping centres that only sold basic pastry products, a few drinks and coffee. Before the acquisition of a 75% participation in Coffee Box, Arcádia had a partnership with the company to sell their main products and expose them in the glass showcases. In 2010, João felt that they could acquire Coffee Box and take advantage of this to leverage their current situation. They renovated their brand image, more modern and clean, making the kiosks more appealing. This was a way to increase the number of revenue streams and it worked out well with sales doubling over a period of two years for the Coffee Box stores, reaching 3.3 million euros in revenue in 2016 alone. Just in one of their renovated locations, in Cascais, monthly sales for December moved from around €7,500 to €24,000 from one year to the other. Also, by this period, the chocolate company had grown from an annual production of, around, 3 tons of chocolate into an annual production of about 80 tons by 2013. This had led João and Margarida to move their offices and storage facilities to a 1200 square metre warehouse in Grijó, in the outskirts of Porto, with more space for bigger machinery as well storage. The purpose was to eventually have all the productive process, storage and offices relocated to this location.

1.4.1. The move to Lisbon

Lisbon is 300 kilometres away from Porto, and although the brand was a resounding name in the northern city, Lisboners were no stranger to the brand. When visiting the city, older generations would go to the historical city centre of Porto just to buy Arcádia’s “cat tongues” and almonds. Also, the brand had a strong presence in the Christmas and Easter periods in the large retail chains all over Portugal. But Arcádia had yet to have a store in Lisbon, a highly

15 potential market since it was Portugal’s capital. The Metropolitan area of Lisbon had a population of around 2.8 million inhabitants, while Porto had around 2/3 of that with 1.75 million residents. Porto’s purchasing power per capita was 82% of Lisbon’s. This was another indicator of the potential of what Lisbon could provide to Arcádia’s growth. The only thing that João and Margarida kept in mind was that “we could not have heavy investment in new stores, we had to keep the store concept simple in order to keep our debt levels stable”. The first store opened in Avenida de Roma, a busy prime location in Lisbon, with a lot of affluence, and similar to the location of their main store in Porto. The difference was that this time, Arcádia wasn’t putting their chips all in play. They took the decision of keeping the stores simple, just like their initial stores in the early 2000’s. João was surprised that “even though it was a minor investment, with a simple concept as planned, the store had an immediate success. We didn’t even promote the opening of the store besides a few leaflets distributed in the street”. This success soon led to the opening of more stores in the city, all of them in strategic spots, with easy access as well as strong traffic. It was also around this time, between 2011 and 2013, that Arcádia decided to allow the franchising of their stores. By 2017 they had 10 franchises that kept the standards that Arcádia wanted in order to avoid damaging the brand image. These were mainly stores that were located in areas where Arcádia was not looking to invest in, but were open to a franchise concept provided the standards were all met. “This wasn’t an easy decision for us, since we had had several proposals for franchising our stores over the years, but we simply weren’t ready”. João and Margarida felt it was way of attaining “more revenue streams in locations where we wouldn’t invest otherwise, plus the sharing of the risk with lower, or even no investment”. “We also took into consideration that we needed training in the first few weeks of the opening of the store” said João, as they brought the managers of the main stores in Porto to Lisbon to train employees for the standards and service that was required in an Arcádia store. Still, this was not a strategy Arcádia was looking to pursue since they did not identify with it. Plus, they were afraid it might dilute the brand. “We would typically only allow the ownership of a franchise when we actually knew the person looking to use our brand” João left clear. From then on, Arcádia kept opening stores over the next years. They opened 4 stores in areas such as Campo de Ourique, Belém or Parque das Nações, with similar concepts as the first stores in Lisbon, and this was an essential turning point for Arcádia’s financial stability since

16 “50% of our cash-flows came from the new stores and this was essential to comply with the company’s debt”.

1.4.2. The New Points of Sale and Line of Products

Arcádia was going through a moment of prosperity and both João and Margarida believed that they could find other selling points and ways to increase sales. On top of this, João was considering the possibility to stop the distribution of Arcádia products through large retail stores, since this “was damaging the brand’s image and exclusivity, in addition to all the logistical problems and costs associated to these sales”. Arcádia identified new outlets that had potential for its products. The company believed it could be associated to a more exclusive range of products associated to quality and scarcity: Port Wine. This wine was originated from the city of Porto, with several vineyards along the Douro Valley. Arcádia’s headquarters were located in the heart of the city’s old town close to the main touristic spots, like wine cellars. The Porto Cálem cellars were the most visited in town with 230 thousand visitors annually. “We saw a good opportunity with the increase of tourism and traffic in these wine cellars and decided to develop a partnership with Cálem’s wines, with whom we identified with and shared quality standards” João mentioned, so they created a box that had Cálem’s port wine and two small boxes of port wine bonbons. This turned out to be a successful product bundle for the tourist traffic in the cellars, even with a 50€ price tag, and would often be sold out. These chocolates were an Arcádia’s specialty and the only similar products were chocolate port truffles sold by a few boutique brands. Besides this new outlet, Arcádia was also now selling their products in the Porto, Lisbon and Funchal Airports, all of them in the chocolate lounge. The chocolate lounge was shared with several well-known international brands. The lounges would often be organized under the brand of the main supplier of the store, such as Godiva. One day, when João was getting a plane in the Porto airport he found out, surprisingly enough, that Arcádia was the top seller. “I just took the opportunity to make a ghost visit to the lounge and randomly ask the employees of the store, what were the best seller products and the answer was not what I expected. The employee said that people would usually choose the Arcádia chocolates over others, because of its Portuguese origin or because they knew the brand from previous trips to the city”. João was starting to find out that Arcádia was already winning over some foreign clients and understanding that it could have potential for exportations.

17 By 2017 Arcádia was also thinking of ways to address the sales seasonality, since in the summer sales would decrease drastically compared to high seasons such as the Easter time and winter. For example, considering the two most important stores in Lisbon in Campo de Ourique and Avenida de Roma, the sales in December represented 45% of annual sales. The months of June, July and August summed up, represented a mere 5%. There was another thing that João had been envisioning for a couple of years to be developed along with Gianfausto Pellegrinetti (Exhibit 12), an Italian Ice Cream master. Arcádia’s own ice cream product range. This was a big step for Arcádia, a new adventure and risk, but João believed it could help win over customers during the hot seasons. “Ice creams are great, and they even have flavours that originate from our existing products, like the cat tongues”, João pointed out. They used the opening of a new store in a prime area in Lisbon, close to the Tejo River, at EXPO, to premier the new line of products. Still the success of this strategy was yet to be measured.

1.5. The next steps

Under the management of João and Margarida, Arcádia had always been looking forward, finding ways to grow, gain more revenue and reputation. This was no different in 2017. Besides reconsidering the continuance of their franchise model and the exit of large retail stores, their objective was to reach a valuation of the company, worthy of the iconic brand, by the end of 2020. This meant they had to grow beyond their, current, 17 owned shops they had to have new revenue streams. But where to expand? Was the market in Portugal too small for the growth in scale? “The issue in internationalizing is that we do not have the infrastructures, experience and labour capacity to make such a big move” said João as he looked at his Grandfather’s photograph just above Margarida’s chair. “We have tried some fairs in Cologne and Paris, but we have seen that this wasn’t a successful strategy” Margarida stated. It was clear that there was approval of the product by tourists in Porto and that some were even repeat purchasers “but was this enough?”. The team in 2017 included 48 members plus some part-time employees in the high seasons. “This is not the size of a team that is capable of producing in scale for international markets. If we were to export, it would have to be in a smaller scale compared to our activity in Portugal”. Arcádia was yet to understand the success of its new lines of products, plus, the Cálem cellars were about to invest heavily on their infrastructure and marketing to become the most visited wine cellars in the world, which meant higher visibility for Arcádia. This

18 wine producer, was also selling in over 30 countries which meant more open doors. “We are even thinking of turning our original store into a museum that could become a tourist destination in Porto” Margarida affirmed. Although there was still room to grow in Portugal, it still had a low average consumption of chocolate and the tendency was there to stay. If Arcádia were to expand to international borders, should it open new stores, or should it associate with other partners like Cálem wines? Should it buy a chain of established stores like Coffe Box? Was it the right time to expand, or should Arcádia wait a little longer? Could João’s experience, as a manager in Arcádia and several other national and international businesses, together with Margarida’s deep knowledge of the business help them take a leap towards other markets? The siblings certainly had many things to figure out in the near future.

19

1.6. Exhibits

Exhibit 1 – João and Margarida Bastos

Exhibit 2 – Manuel Bastos, Arcádia’s Founder

20 Exhibit 3 – Arcádia’s first store, in Rua do Almada

Exhibit 4 – Arcádia’s employees painting the famous dragees

21

Exhibit 5 – Old packaging of Arcádia’s products

Exhibit 6 – Chocolate “cat tongues”

22 Exhibit 7 – Port wine chocolates’ package

Exhibit 8 – Mix package

23 Exhibit 9 – Competition

Imperial In the national market, Arcádia was facing several competitors, but only a few local players. Imperial, a large chocolate manufacturer in Portugal, with estimated sales of 27 million euros in 2017, was one of Arcádia’s competitors. Imperial estimated was also founded in the early 1930’s and grew to become a company that detained 6 chocolate brands. It produced, on average, 3300 tons of chocolate per year, had 150 employees and a 50% growth rate between 2012 and 2017, mainly due to its effort on expanding to new markets abroad. Regina, one of Imperial’s brands, was considered to be the top Portuguese chocolate brand that conquered the affection of all generations in Portugal. This brand was actually created before the Imperial group, but was eventually acquired. Regina was present in 25 countries, such as the U.S., Italy or Brazil. In 2017, international sales were around 20% of the brands’ total revenue. In 2017 it was still considered the main chocolate trademark for the Portuguese market, but did not mean a clear or direct threat to Arcádia since it did not have their own physical stores and focused mainly on retail store mass sales. They also sold bonbons, cat tongues and several other chocolate derived products. The company was also bringing in chocolates from Spain, where it had several suppliers, and packaging in Portugal.

Equador & Leonidas

Arcádia faced other competitors in Portugal with their own store presence such as Equador, a Portuguese family owned company who started its business in 2008, and Leonidas, the Belgium chocolate company that was, at the time, already present in 40 countries. In Portugal, Leonidas had 9 franchised stores, spread throughout the country and had the pricing and brand strategy more aligned with the one of Arcádia. Equador, had 3 stores, located in both Lisbon, the capital of Portugal, and Porto. Arcádia and its main competitors competed pricewise as well as in their positioning strategy, although Equador had more difficulties in reaching older generations, due to its very recent history. Godiva, Neuhaus & Valrhona

Besides these competitors, João felt that brands such as Godiva, Neuhaus or Valrhona, were also a high threat because they compete on Arcádia’s price level, as well as in quality. These

24 brands are only seen in high-end retail stores such as El Corte Ingles. These were the competitors that target and attract the customers that look for Arcádia’s products: upper middle class, or above, clientele, that look for quality when purchasing chocolate products. These were brands with a global presence and greater dimension than Arcádia. Unlike Leonidas, a clear direct competitor of Arcádia in Portugal, these chocolate manufacturers did not own stores in Portugal, but their renowned brand image was still a clear threat to the company.

Exhibit 10 – Arcádia kiosk store

25

Exhibit 11 – Arcádia’s new store concept

Exhibit 12 – Gianfausto Pellegrinetti

26 Exhibit 13 – Arcádia’s Stores

ARCÁDIA’s STORE LIST, LISBON:

CAMPO DE OURIQUE

Opening – October 2011

AVENIDA JOÃO CRISÓSTOMO

Opening – September 2012

PARQUE DAS NAÇÕES

Opening – November 2017

AV. DE ROMA

Opening - December 2010

BELÉM

Opening – December 2013

CASCAIS SHOPPING

Opening – January 2013; Rebranding, Arcádia Café December 2016

CHIADO

Opening – November 2013 - Closed June 2016

AV. DA REPÚBLICA

Opening – April 2014 - Closed December 2014

DOLCE VITA TEJO

Opening – November 2013 - Closed May 2014

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ARCÁDIA’s STORE LIST, ALGARVE:

Opening – October 2017

ARCÁDIA’s STORE LIST, PORTO:

RUA DO ALMADA

Opening – January 2003

RUA SANTA CATARINA

Opening – Septmeber 2009

AV. DA BOAVISTA

Opening – October 2010

CAMPUS SÃO JOÃO

Opening – January 2003; Rebranding, Arcádia Café October 2010

MERCADO BOM SUCESSO

Opening – November 2017

NORTE SHOPPING

Opening – October 2010

MAR SHOPPING

Opening – October 2010

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ARCÁDIA’s STORE LIST, PORTO:

SHOPPING CIDADE DO PORTO

Opening – October 2010

ALAMEDA SHOP&SPOT

Opening – September 2010

QUIOSQUE NORTE SHOPPING - COFFEE BOX

Opening – January 2003

PARQUE NASCENTE

Opening – January 2003 - Closed August 2017

GAIA SHOPPING

Opening – January 2011 - Closed July 2016

29 2. Literature Review

2.1 Internationalization

Several authors have dedicated their studies towards the process of internationalization of enterprises. There is a broad amount of definitions for this concept. While (Jan Johanson and Vahlne 1977) consider it as an increase in involvement in individual foreign countries, other authors consider it as an adaption of the company's operations into foreign markets (Calof and Beamish 1995) or simply as a firm’s geographical expansion across national borders (Ruzzier, Hirish, and Antoncic 2006). Due to this inconsistency, for the purpose of this study, we will assume internationalization as a firm’s geographical expansion across national borders. Therefore, it is important to take into consideration the factors that motivate SMEs to go abroad and become international, rather than the incentives to continue to grow once in the international market.

2.2 Internationalization of SMEs

In this section, initially we will analyse the definition of a Small Medium Enterprise, and in second instance understand the drivers of engagement in international activities, the factors to consider, as well the difficulties faced by SMEs in the process of internationalization.

2.2.1 Definition of SMEs

For the purpose of this study we will assume the definition of SME generally used by the European Commission. This is because perceptions and definitions tend to vary between countries, as to what constitutes a small, medium or large company (Fillis 2001). According to the European Commission, what determines whether a company is a SME or not are the following factors:

 number of employees;  either turnover or balance sheet total.

30 The following table provides us with the conditions that the European Commission designates for the definition of a SME, considering the conditions mentioned above.

2.2.2 Context of internationalization of SMEs

Internationalization was once seen as a strategy almost exclusively adopted by large and multinational companies. However, this view has been shifting over the time. Taking into consideration today’s competitive environment, SMEs are progressively chasing internationalization strategies. Although this internationalization process seems to lead naturally to a higher yielded performance, SME’s face numerous challenges and threats posed by global and local competitors (Lu & Beamish, 2001; Oliveira & Teixeira, 2011) which consequently impact their international performance. Going international usually incurs costs and risks commonly accredited to liabilities of foreignness and newness (Chen & Hsu, 2010); it requires transversal and differential resource investments which may, or may not, lead to a negative impact on profitability (Khavul, Benson, & Datta, 2010; Lu & Beamish, 2001). It is often the case that going abroad poses challenges in terms of complexity and absence of information, which increases, inevitably, the difficulties of processing information across international activities and locations (Pinho, José & Prange, Christiane, 2017). These uncertainties lead to higher costs associated to the increased governance and transaction costs, as well as to unanticipated changes in the external environment which require an improved coordination, leadership efforts and communication (Chen, Sousa & He, 2016). A very important factor, firstly, is that SMEs must develop capabilities for internationalization which subsequently facilitate the deployment of other capabilities or resources that contribute to a prosperous international performance (Pinho, José & Prange, Christiane, 2017). Thus, it is essential for SMEs to strengthen their innovation capability and organizational innovation – the activities that lead to changes in the company’s strategy, structure and systems (Damanpour & Aravind, 2012) - as it leads to deployment of resources

31 transferred into innovative products, services or processes (Azar & Ciabuschi, 2016; Pla- Barber & Alegre, 2007). In recent researches, it has been emphasized the importance of a firm’s resources and capabilities as drivers of international performance. This has been done, for example, with the support of the theoretical lens of the resource-based view (RBV) (Morgan, Katsikeas, & Vorhies,2012; Makri, Theodosiou, & Katsikea, 2016). The RBV views firms as a set of individual and organizational resources that are heterogeneously distributed across firms, with distinct and endurable resources, given they are valuable, rare inimitable and non- substitutable. One must look at both resources as well as capabilities of an enterprise. Resources comprise the base of competitive advantage in domestic and international markets (Barney, 1991; Pla-Barber & Alegre, 2007).

2.3 Why SMEs go International?

The reasons for SMEs to go international, typically, vary immensely from the reasons of larger corporations. When making the decision to internationalization, these corporations rely mostly on the risks analysis and costs, considering the market’s characteristics and its own resources (Hood & Young, 1979). For SMEs, in order to sustain competitiveness and attain a long-term profitability, the process of internationalization is becoming increasingly inevitable (Kubíčková, Votoupalová, Toulová, 2014).

2.3.1 The motivations

Next we discuss two motives that push SMEs to move operations abroad, entering foreign markets. Mainly, this session considers the following motivations: globalization, as a means to remain competitive; network theory, which contemplates the informal and formal network contacts;

32

2.3.1.1 Globalization

There are several definitions to describe the phenomenon of Globalization. When taking into consideration globalization applied to the firm’s context, the definition tends to be different. For the purpose of this study we will only consider the one from the Organization for Economic Co-operation and Development (“OECD” 2013) that states that globalization is an “increasing internationalization of markets for goods and services, the means of production, financial systems, competition, corporations, technology and industries. Amongst other things this gives rise to increased mobility of capital, faster propagation of technological innovations and an increasing interdependency and uniformity of national markets”. Nowadays enterprises, especially SME’s, need to adapt to the fast changing environment that is a consequence of globalization. It is arguable that SMEs should view internationalization, not as an option, but as an opportunity that should be taken into account to remain competitive or even, in certain situations, survive in this global market (McDougall and Oviatt 2000). According to (Jakobson and Voss, 2003), the endurance of competitiveness means the maximization of profit through the access of new markets by the diversification of markets, introduction of new products and the assurance of access to sub-suppliers as this supports the need of minimizing labour costs. Other studies also conclude that, in the last decade, SMEs have had successful operations outside their local markets when investment is made towards their own resources and capabilities (Prange and Pinho, 2017). Concluding, globalization has pushed companies, and in particular SMEs, to consider and actually proceed with the internationalization of their businesses by adopting international strategies in order to maintain competitiveness in the local and global market.

2.3.1.2 Network Theory

Considering a firm’s network, there are two types of network contacts: formal and informal contacts (Coviello and Munro 1995). The first one considers the business-related contacts in their network. This is referring to contacts such as suppliers, customers, competitors and so on. The second refers to personal contacts such as friends or family. If there is contact and interest by other non-local players with one’s network of relationships, the firm’s position can be in jeopardy. This is, for example, for formal contacts, competitors moving abroad, forcing

33 the firm to follow in order to remain competitive, or following a suppliers move to international markets to keep the relationship strong. For informal contacts the move to international markets by a firm might be motivated by friends’ or family contacts. As stated by (Ruzzier, Hirish, and Antoncic 2006), “if the relationships between firms are seen as a network, it can be argued that firms internationalize because other firms in their (inter)national network do so.”

2.3.2 Challenges

In a process of internationalization firms, especially SME’s, will encounter several challenges (Grant, Robert 1999). Such difficulties can be:

 Shortage of working capital  Identifying and exploiting foreign business opportunities  Limited information to locate/analyse markets  Lack of managerial time, skills and knowledge  Complexity of conducting business in international markets  Fostering and establishing networks  Product adaptation to host country

2.4 Resources and Capabilities

According to Robert Grant, it is relevant to distinguish resources and capabilities:  Resources: “productive assets owned by the firm”  Capabilities: “what the firm can do” It is the combination of resources that that creates organizational capability. This appraisal of capabilities is the essence to superior performance: competitive advantage.

2.4.1 Tangible and Intangible Resources

According to Robert Grant’s Contemporary Strategy Analysis, the following distinguishes Tangible from Intangible and Human resources:  Tangible: “the financial and physical assets that are identified and valued in the firm’s financial statements”

34  Intangible: “these resources are a major reason for the large and growing divergence between companies’ balance-sheet valuations and stock-market valuations. Resources such as Brand names and other trademarks are a form of reputational asset: their value is in the confidence they instill in customers. Also, like reputation, technology is an intangible asset whose value is not evident from most companies’ balance sheets. Intellectual property—patents, copyrights, trade secrets, and trademarks—comprise technological and artistic resources where ownership is defined in law.”  Human: “The firm’s human resources comprise the expertise and effort offered by employees. The ability of employees to harmonize their efforts and integrate their separate skills depends not only on their interpersonal skills but also the organizational context”.

2.4.2 Classifying Capabilities

For the purpose of this study, we will use a functional analysis in order to identify organizational capabilities. This is done with relation to each of the principal functional areas of a firm, such as:  Corporate Functions – ex: strategic innovation; financial control; international management  Management Information – ex: integrated Management Information System  R&D  Operations – ex: efficient volume manufacturing; fast-cycle new product development  Product Design Marketing – ex: brand management; building reputation for quality  Sales and Distribution – ex: speed of distribution

35 3. Teaching Note 3.1 Learning Objectives

The main teaching objectives are:  To understand the underlying managerial approach of Arcádia’s strategy, namely regarding branding and positioning.  To let the reader explore how and what strategic and operational decisions lead to the challenges similarly faced by Arcádia.  To explore the impact of strategic decision making under pressure.  To understand the fundamental factors that motivate a company to expand and grow its business, both in local and international markets.  To understand the impact of limited local markets.  To allow the reader to identify and envision the requirements, resources and capabilities, and introspection needed to consider an expansion to new markets.

3.2 Class Plan

a) What was Arcádia’s strategy in terms of branding and pricing? What type of customers did it target? b) What were Arcádia’s main resources and capabilities? c) What were the main adversities/challenges and strategic decisions that Arcádia faced over the years? And what is their main concern at this point? d) Considering Arcádia’s expertise, its resources and capabilities what are its competitive advantages compared to local and international chocolate manufacturers? e) Should Arcádia internationalize? And what are the modes of entry that Arcádia should consider if it were to internationalize? f) What should Arcádia take into consideration when deciding to move abroad? What are the determinants for the choice of geographical location? What would be the main difficulties that it might face outside its local market? g) What should be the first international target market for Arcádia?

36

3.3 Analysis

a) What was Arcádia’s strategy in terms of branding and pricing? What type of customers did it target?

Arcádia had, over the years, been able to develop a strong positioning in the Portuguese market. Their differentiation point was achieved through, its distinctive and historical products, such as the cat tongues, French inspired bonjour dragees and port wine chocolates, as well as through its store concept and personalized service. Its products were distinguished by features and attributes. They were, at the same time, a great company for an afternoon coffee, tea, or late dinner desert. In such a global market, where consumers have an extensive variety of products, of all prices and quality range, to choose from, Arcádia was able to have its own space in the Portuguese market. It also captured new international clientele which, in the most recent years, it targeted through new selling points and partnerships. Nonetheless, taking into consideration its history, savoir faire, and main market, the chocolate manufacturer was focusing mainly on chocolate connoisseurs and upper middle class Portuguese consumers. These tended to be loyal customers who valued the company’s quality and personalization of products as well as its high-end service. This loyalty led to less vulnerability to competitive marketing actions as well price sensitiveness of customers, since they cherished the company’s identity and the products’ uniqueness. Regarding pricing, the company distinguished itself from several national and international brands, but this wasn’t their main factor. With prices both above and below other competitors, they found themselves in the high-end of the chocolate market. This was its clear strategy, that was aligned with what the brand wanted to convey to customers. That was one of the reasons why they planned to end their relationships with large retail stores. Due to the lack of power in setting prices and positioning in shelves in these selling points, Arcádia’s brand and positioning was hurt by the difference in price range and customer perception. When Arcádia decide to introduce a new store concept in shopping centres, it was faced with the reality that it had deviated too far away from its intrinsic identity. It was a sharp demonstration of how the brand’s positioning and target consumer was well established before this new strategic decision. This led the company to go back to its success formula and expand its presence throughout the country.

37

b) What were Arcádia’s main resources and capabilities?

One could analyse Arcádia’s potential in the local and international markets through its resources and capabilities. These are essential to understand in what way a firm distinguishes from competitors and its ability to prosper in its industry. Considering Robert M. Grant’s 3 types of resources, Arcádia benefited from the following:  It had tangible resources such as its manufacturing equipment, its reserves for chocolate production, its raw materials and its cash reserves. All these could be used in order to sustain its current operations in 2017. Still, it did have margin to grow, especially after moving their physical production operations to their new offices. Since the plans are to take on more storage and increase in this location, it is fit to say that Arcádia had the capacity to grow their operations, for both local and international purposes. On top of this, Arcádia benefited from its owned retail stores located in premium areas. This was an essential factor that promoted its brand.  It also profited from intangible resources such as its reputation and brand awareness in its local market and foreigners who visited Portugal and got to know Arcádia products. Other intangible resources were its culture and history, the processes, supplier relationships and its network resources. All were extremely valuable for the company’s future success and advantage in the local market. For international markets, its connection to port wine was also a competitive advantage in face of foreign competitors.  Its final resource, and perhaps the most important, was its human resources. Arcádia’s labour benefited from an aligned relationship between all the company’s/hierarchy’s stakeholders, mainly due to the company’s culture, the organization’s values, traditions and social norms that had been established over the years. Its dedication to high quality products, attention to detail, its several handmade personalized products, harmonized allocation of employees’ skills to their tasks, the close relationship between management and staff and excellence in store service, led the company to sustain its success and grow past an ordinary chocolate manufacturer in Portugal to a country-known, established brand. It is also essential to consider the human factor in older products, with the knowledge and experience passed onto its French originated dragees, as well as in its most recent products such as their new ice cream segment of products created together with Gianfausto Pellegrinetti.

38 On top of this the combination of João and Margarida’s managerial skills, was steering Arcádia to an established position in the market and in the Portuguese chocolate industry. This was especially true when considering João’s vision of the company’s growth in the long-term. His experience in turn-around situations working in Private Equity also made him better prepared for the obstacles faced during the financial crisis. Both João and Margarida were also able to better establish and position Arcádia as a significant brand for loyal customers whose experience was reinforced with high-end, quality products. Still, to consider its resources as valuable, one must take into consideration Arcádia’s capabilities. According to C. E. Helfat and M. Lieberman, capabilities are defined as the “firm’s capacity to deploy resources for a desired end result”. Using the functional analysis approach, Arcádia has the following capabilities within its functional areas:  Within its corporate functions, Arcádia has its own solid strategic capacity to innovate and a set of efficient operational procedures. Considering the first capability, although it does not have introduced breakthrough innovation in its industry, it does have a solid pivoting capacity towards adversity as well as to pursue growth opportunities. This was seen with its bold move to change its store concept and the resultant pivoting of its strategy when it faced its consequences, as well as the constant introduction of new selling points and product lines as a way to expand its revenue streams. Regarding the second capability, Arcádia has a well-defined structure and procedures for all its employees, which in turn leads to highly efficient operations throughout the year, especially in the chocolate high seasons.  Regarding its product design and marketing area, Arcádia benefits from a strong brand management and development of reputation for quality. Both capabilities are connected but distinct when considering how they were achieved. On one hand, Arcádia has been able to create a solid brand image throughout its life, through its consistency (both in service and products), its history and its ability to retain the loyalty of multiple generations of customers. On the other hand, it has also been able to establish a reputation for its quality products and service with a meticulous choice of raw materials and suppliers. In addition, the set of highly skilled and trained employees passing on this care into the store experience as well as into the products and their personalization, helps achieve this value.

39 c) What were the main adversities/challenges and strategic decisions that Arcádia faced over the years? And what is their main concern at this point?

Over time, Arcádia was faced with several challenges that impacted the company’s growth path, as well as its strategic positioning and decision making. However, its main challenge, throughout its existence, has been to standout from its competitors and explore financial potential in a market with the lowest consumption than any other country in the continent. This was a daily concern that Arcádia, as an SME, overcame through its strategy, positioning, new product development and expansion into new locations. The chocolate manufacturer also faced other decisions and adversities. Arcádia had to overcome the consequences that resulted from its decision to change its store concept. Customers were not aligned with this new concept and did not associate the brand and its positioning to what they were now offering in the new stores. For that reason, Arcádia had a strong investment in a new business model that was not paying off. On top of this, the investment had been made just before the financial risk took off. This was a threat to Arcádia’s financial health and stability which led to serious strategic decisions. João and Margarida decision ended up being to follow through with the expansion into Lisbon, which turned out be a fruitful choice that was essential for Arcádia’s success throughout the financial crisis and the years ahead. This aligned with the acquisition of CoffeBox was a boost to Arcádia’s revenue and its financial prosperity. In the meanwhile, João and Margarida also had to reconsider the possibility of allowing the franchising of their stores. This was a difficult decision to make, as both managers felt that it could lead to the dilution of its brand image. Franchised stores could endanger this by allowing poor service and by reducing its exclusiveness. On the other hand, with a tight control and defined processes, the company could take advantage of opening a new selling point in locations where they wouldn’t typically invest in. Another of Arcádia’s main struggles, was its relationship with large retailers. This was something it was considering to end since it caused several negative effects. This exposure in large retail stores diluted the brand. The fact that the company did not control prices led to customer complaints for selling the same products at higher prices in its own stores. It also led to an operational nightmare when it came to the high seasons, both for sending the products to the retailers as well as receiving the returns. In 2017, Arcádia’s main concern was how to continue to grow and increase its value. The big question was that the Portuguese market was perhaps over saturated and had the characteristic

40 of being one of the regions with the lowest consumption of chocolate per capita. This was a motivation to explore new markets, new opportunities and new revenue streams. Although the market in Portugal did have some opportunity to grow, it could not be enough for the expected growth they desired in the years ahead.

d) Considering Arcádia’s expertise, its resources and capabilities what are its competitive advantages compared to local and international chocolate manufacturers?

In order to sustain a competitive advantage, a firm must appraise its resources and capabilities. The Resource-Based View (RBV) lets us evaluate four criteria of the firm’s resources and analyse if they are: valuable (allow a firm to implement strategies that improve its efficiency as well as its effectiveness); rare (if they are available to other companies); imperfectly imitable (not easily implemented by competitors); organization (is the firm organized, ready, and able to exploit its resources). If we analyse step by step, we can have a better understanding of Arcádia’s advantage over competitors:  Valuable – they had resources that helped them increase the value offered to customers, through their quality service, raw materials and end product. They emphasized differentiation and not cost reduction. These were advantages in its local market but not as relevant in international markets. This is because in other regions, this mixture of in-store quality service and products already existed. What did not exist in international markets, was the penetration of Portuguese chocolate brands, especially associated with Port wine. These were the intangible resources that it could take advantage of, since it did intertwine its culture with its Portuguese origins, making Arcádia a differentiated brand in other markets.  Rare – Arcádia did have rare resources. Namely, it had its store presence in premium areas all over Portugal, which created a significant brand awareness; this was unmatched by its local and international competitors in Portugal. It also, took advantage of some of its most distinguished and differentiating products, such as the cat tongues, dragees, or the Port wine chocolates. The last one, especially, was rare and could only be truly exploited by a company with connections to Port wine cellars in the Douro region, which was Arcádia’s case.  Imperfectly imitable – most of Arcádia’s products were, by no means, a relevant innovation in the chocolate industry, but they did have their distinct touch. Still, they

41 were replicable by other players in the local and international market. Its only product that could be harder to replicate, was its Port wine chocolates. Besides being a “trademark” of the company, the fact that the company and brand was associated to Portugal, more specifically to the city of Porto, gave a clear distinctive advantage to Arcádia. This is something that very few chocolate brands could achieve and replicate. Something else that was not replicable was the firm’s intangible resources such as its brand, generational loyalty and its customer perception. Arcádia had developed a solid brand image that was recognized, was associated to quality in both products and service, was historically significant and was still a family business, which helped customer perception in Portugal and could potentially do the same abroad.  Organization – Arcádia was in fact organized and able to respond to high demand seasons in its local market. Its production processes were all efficient and stable throughout the year, although they needed to hire some part-time employees for seasons such as Christmas. Nonetheless, this hiring was part of Arcádia’s response process to busier periods of the year and it never had any trouble sourcing its own stores or retailers. Still, this organization within Arcádia was also aligned with how its resources could benefit the company. It was flexible when it came to strategy implementation and alteration, due to its human resources flexible capabilities. Its customer perception was held consistent and positive throughout several generations, being looked at as a historic Portuguese chocolate manufacturer. Its new product lines were developed with care and quality, as was the case with the ice-cream introduced in the summer of 2017. These products were well exploited in the Portuguese market, such as the Port wine chocolates sold in adequate selling points, the wine cellars. They targeted both Portuguese and international tourism. The number of tourists in Portugal grew to 12.7 million visits in Portugal in 2017 alone. Arcádia also took advantage of its stores in prime areas spread throughout the country, with a simple concept, low budget, and high returns. The move of the offices to a more spacious, suitable location, was also an excellent way to improve storage space and the whole production processes. This allowed for the use of the main original store, in the centre of Porto, as a tourist attraction and museum.

42 e) Should Arcádia internationalize? And what are the modes of entry that Arcádia should consider if it were to internationalize?

The fact that the Portuguese chocolate consumption is the lowest in Europe, that consumers’ purchasing power is low and that Arcádia has its operations in the country reaching its probable maximum potential, makes the decision to explore overseas markets adequate. This is true when considering the desire of the company to keep growing. Direct investment in foreign markets should be a less probable choice because of the high levels of investment and an increase debt needed. The most adequate operational means of exploring these markets would be through transactions, either through exporting or licensing. Still, Arcádia, as an SME, would have to consider five key factors, as mentioned in Robert Grant’s framework, in order to understand the viability of going abroad:  Is the firm’s competitive advantage based on firm-specific or country-specific resources? – Arcádia has competitive advantages that are firm-specific, such as their hand-made quality products, their industry experienced employees, their prime location stores and the service provided in-store. Nonetheless, they also have their country-specific advantage, when it comes to their proximity to port wine regions in Portugal, which is relevant taking into consideration their product differentiation derived from port wine chocolates. This proximity is extremely relevant cost wise, since Arcádia is in a better position to negotiate prices with their suppliers, with whom they have a long lasting relationship. This is also relevant since the cost of transport of the raw material is cheaper due to geographical advantage. Still, their gain goes beyond cost advantages. The fact that they “own” such a distinct and differentiating product, which is country associated, gives Arcádia a branding advantage which could benefit their operations abroad.  Is the product tradable and what are the barriers to trade? – Arcádia’s product is easily tradable with very low transportation constraints, such as the temperature at which it needs to be transported. Regarding barriers to trade, that would be very specific to the company that Arcádia would consider having its operations. In Europe, this factor would not be as relevant due to the trade agreements between EU members.  Does the firm possess the full range of resources and capabilities for establishing a competitive advantage in the overseas market? – For Arcádia to succeed overseas it would have to acquire additional resources and capabilities. This is crucial when considering marketing and distributing in a new market. To have access to such

43 country-specific resources Arcádia would have to consider collaborating with a local firm. The form of collaboration depends on the resources and capabilities needed by Arcádia in the hypothetical location. As mentioned before, with its new offices and storage capacity, Arcádia is better positioned to have production capacity to satisfy demand in new markets. Its network of partners, like the Cálem wine cellars, are also advantage to penetrate other new markets. Cálem’s wines were being sold in over 30 countries. Taking this into consideration, Arcádia already had its products in partnership with this company that could be sold in these locations. This could even be a market test, as they could analyse sales and understand which geographies and consumers had best acceptance.  Can the firm directly appropriate the returns to its resources? – For Arcádia, licensing their products to potential partners abroad could be somewhat of a problematic situation. Its legal department was outsourced and their investment in this area tended to be low. This is an area that would need to be improved in order to fully exploit their returns from foreign markets if an option to license their brand and products was viable. Still, this turns out to be a something that goes against their culture and strategy. Arcádia likes to preserve its identity and wants to maintain its branding and customer perspective intact. This makes the decision to focus on exporting more natural.  What transaction costs are involved? – Arcádia must consider the costs involved in exporting or licensing. These transaction costs could be: 1. Tariffs or restrictions 2. Customer preferences between countries 3. Firm-specific intangible resources, such as Arcádia’s brand Arcádia would have to be strategic in the choice of countries where to export, when considering the first two transaction costs. Initially Arcádia should choose countries with trading agreement benefits. The EU region would be a first choice due the benefits of trade agreements. Spain should be considered a viable market due to its geographical and cultural proximity. On top of this, it is the country that Portugal exports most, meaning that trade partners are easier to find. Still, the country’s annual consumption per capita was 2,8kg in 2017, which is not much superior to Portugal, though the population is close to five times bigger. Nevertheless, this location will be analysed more in depth in the next question. Both France and the United Kingdom could also be a possibility for Arcádia, since they are the second and fourth most relevant destinations of exports for Portugal. Cálem also exported

44 to both, which meant more possible open doors for the chocolate company. The UK and France were both on the top 15 biggest chocolate consumers in the world, with averages of between 7kg and 9kg annual consumption per capita. Also both countries have a long tradition of high quality chocolate consumption. Countries in Western Europe have the highest chocolate consumption globally, representing 36% (Euromonitor) of total consumption. Thus, this region should be a higher priority for Arcádia, although it is where they will most probably find stronger competition. They should also consider Brazil because of the historical benefits of trade between both countries. This destination also has the advantage of its language proximity as well as the purchasing power of the upper-middle class in its main cities. According to ABICAB (Brazilian Association of Chocolate, Cocoa, Peanut, Candy and Derivatives), the premium chocolate segment and local consumption (Arcádia’s intended segment) has been growing substantially since 2014. Also the local confectionaries have increased exports to the EU by 73%. However, transport logistics are much more demanding due to distance, plus weather conditions in the North of the country do not favour the conservation of chocolates. Besides these new geographies, Arcádia should also consider, in a further stage, growing markets in chocolate consumption, like Estonia and Lithuania, where “. The exporting of their products, rather than licensing, would better avoid transaction costs of firm-specific intangible resources, such as Arcádia’s brand. By exporting products and choosing a local distributor or agent, Arcádia would have the ability of better controlling the brand’s exposure in these markets. After analysing these five factors, the conclusion is that Arcádia should internationalize, taking advantage of its network of formal and informal contacts, plus its resources and capabilities, as well as its potential competitive advantage abroad. This should be done initially through transactions, focused in exporting through either spot sales or foreign agents/distributors. This would avoid higher transaction costs. The locations should be those that promote a higher return/cost ratio. Thus, locations with low export tariffs or restrictions with high cultural, language and geographical proximity could lead to a higher probability of success. These countries should large consumer segments with a strong purchasing power and with attractive chocolate consumption per capita. The benefits of this move would be: potential increase in sales; global expansion of the Arcádia brand; new sources of income could help finance new projects in Portugal and abroad.

45 As mentioned by (Kubíčková, Votoupalová, Toulová, 2014) for SMEs, like Arcádia, in order to sustain competitiveness and attain a long-term profitability, the process of internationalization is becoming increasingly inevitable in today’s globalised world.

f) What should Arcádia take into consideration when deciding to move abroad? What are the determinants for the choice of geographical location? What would be the main difficulties that it might face outside its local market?

Gehmawat’s CAGE framework, can help to understand the most important determinants for country choice when expanding geographically. The most important factors are those in the Teaching Note Exhibit 1. Teaching Note Exhibit 2 applies those factors to the situation of Arcádia. Cultural distance tends to be extremely important for companies looking to thrive in new markets. In the case of high-end products, where Arcádia looks to position itself, having its own identity is a plus, since customers are looking for a unique experience that usually comes from the culture built within the company and the culture of the country of origin. In Arcádia’s case, marketing strategies should differ slightly within each geography, but its brand identity should remain intact as should its origins. The lack of Portuguese products in other countries could be an advantage for Arcádia. Nonetheless, it should always take into consideration the countries where its cultural background can adapt best, such as European countries. Arcádia should also consider the costs of exporting to countries with tarrifs and the impact of exchange rates. Once again, members of the EU that use the Euro would be more beneficial for Arcádia. Also, avoiding politically unstable locations is always important due to policy changes in the local market and trade agreements (ex: the case of the UK leaving the EU). Arcádia must reflect on transportation costs when exporting and related logistical improvements. The closer the geographical location and its transportation access the better. Also, time differences can be important for customer support, especially if Arcádia does not have a local office. It is also imperative to analyse the countries’ economic situation, if they are stable and if consumers find themselves willing and capable of purchasing high-end, more expensive chocolates. It is essential to export to a market where there would be demand for Arcádia’s products, rather than markets where consumers tend to only look to purchase low-end, cheap chocolates. This should be done through research of consumers’ behaviour in overseas

46 markets, as well as testing the product through small investments abroad before fully committing to a market. Besides these decisive factors for location choice, Arcádia would also have to overcome hurdles:  Working capital – in order to fulfil the needs of an internationalisation strategy, Arcádia would have to slightly increase its human capital, both in top positions, as well as in its production process. To meet a probable higher demand, supply and productive capacity would have to grow accordingly.  Limited information to analyse local markets – Arcádia would have to study some of the markets mentioned before, to understand its potential. This would demand distributing these tasks among top management. Besides this, Arcádia could hire a consultancy firm specialised in the internationalization of SMEs. Also, its partner network could also provide information such as: trade restrictions, economic conditions, consumer behaviour, etc. Information on competition, consumer behaviour or tariffs/restrictions is extremely relevant before entering a market.  Lack of managerial time – taking into consideration the expansion process of Arcádia in its local market, managing time to study and prepare an international strategy could be somewhat of a work overload. João had experience in this process, still, his availability at this time was limited. Thus, Arcádia would have to look for someone inside the company, or hire someone, to fill the position in charge of developing its international strategy. Then, this person, together with João and Margarida, would have the responsibility of dealing with the complexity of international markets.  To adapt products to the host country – this is something that Arcádia should not consider for the product itself, the chocolates, but perhaps for the packaging and slogans. Some countries prefer different packaging, either more colourful, more extravagant or less ostentatious. The slogans could also adapt to the host country, especially because of language barriers and restrictions. The cultural meaning of words changes from language to language, so this would be something to be highly considered.

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g) What should be the first international target market for Arcádia?

As mentioned before, Spain should be considered a potential market for Arcádia, for some obvious reasons:  Shared border = lower costs of exportation  Historical trade relationship between both countries  Arcádia’s partners with operations in Spain  Spain is a member of the EU = better tariffs  Cultural closeness  Bigger population Nevertheless, chocolate consumption has been decreasing in 2016 and 2017. This is a consequence of a changing consumer behaviour and eating habits. According to analysts from (Monzon & Aller, 2017), consumers are looking to reduce their sugar consumption. This tendency builds on top of an aging population who consumes less chocolate on average. But the interesting factor, is that consumers are now looking to purchase higher quality chocolates, especially those above the age of 45. According to UBS analysts, the market is moving to high quality products in this industry, expecting a growth of 5% by the end of 2018, in this segment. This will be important for confectionaries like Mondelez and Lindt and Pacari, potential Arcádia competitors. This market segment is the one Arcádia is focused on, which means it could be an opportunity window for it. On top of this, Spanish tourism was the fourth highest in Portugal in 2017 (Granadeiro, 2017). This comes to show the Spanish’s interest for the country and its products. The chocolate industry in Spain represents 1.221M €, which represents a very big market opportunity. Spanish confectionaries have been increasing exportation, with a current volume of 35% of exports. This would also represent a networking opportunity for Arcádia to find other potential markets to target further on.

48 3.4 Teaching Note Exhibits

2 1 Administrative Cultural /Political Distance distance

3 4 Geographical Economic Distance Differences

Exhibit 1: Main Factors for Internationalization – Robert M. Grant “Contemporary Strategy Analysis”

1. 2. - Lack of shared political - Different and/or monetary association language/ethnicities/religion/ social norms - Political hostility and instability - Absence of social networks - Weak legal and financial institutions

4. 3. - Different purchasing power - No common border, - Different costs and quality of transportation or natural, financial and human communication links resources - Physical remoteness - Different information or knowledge and consumer profiles

Exhibit 2: Description of Internationalization Factors – Robert M. Grant “Contemporary Strategy Analysis” 49 4. Conclusion

I chose Arcádia as the focus for my Thesis because it would allow me to analyse a topic that is of my interest: the internationalization process of SME’s. This was a topic I had already had contact with in one of my courses during the Masters program. Additionally, the helpful availability that the CEO, João, showed with concrete figures and data was most valuable to support my Case Study and conclusions (from financial to strategic information). This work allowed me to deepen my knowledge of both the industry analysed in this study as well as the theme of internationalization. This process is essential for any SME in order to grow its operations and revenues in such a globalized world. Globalization is another relevant factor for such processes to be considered by SMEs, especially for those with smaller local markets. Nonetheless, Arcádia’s ability and willingness to proceed with an internationalization process is still under debate at the company. However, the need for the company to move towards this strategic path is, in fact, urgent, in my opinion, although the company’s management is still reluctant of this move. Due to the several strategic problems encountered over the years by Arcádia, it was hard for myself to pinpoint the most appealing point of interest to analyse. I admire the company’s ability to overcome some less fortunate strategic decisions made in the past and appreciate the situation they find themselves in their local market. For this reason, I wanted to include the full scope of Arcádia’s history up to the current situation it finds itself in and analyse the next steps it should take, rather than examining the past and making suggestions for solved adversities. I was able to understand that the Portuguese market is not appealing for its local chocolate manufacturers. Consumption is low and there are several national and international players. For that reason, it makes sense for companies such as Arcádia to expand their horizon and either export or open operations abroad. Although Arcádia, as mentioned before, is not ready for this step, it has in fact resources and capabilities that leave it better positioned to have a successful experience in new markets. This is true because of its uniqueness and historical expertise developed over the years. Its unique product lines also make Arcádia a valuable option in foreign markets, especially in a time where the “Portuguese brand” is becoming ever more recognized. This strategic option, in my opinion, is something Arcádia should consider in the upcoming years, especially after the market in Portugal matures for the company. This study is not a

50 business plan for such process but rather an approach to factors and incentives to reflect on when this move is considered.

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