Procter & Gamble: Time to freshen up; Investors are hoping that AG Lafley will unveil plans to reinvigorate the company

July 28, 2013 3:27 pm

Procter & Gamble: Time to freshen up

By Barney Jopson

Investors are hoping that AG Lafley will unveil plans to reinvigorate the company

Nick Mangold, a burly American footballer, eases his 6ft 4in frame into a barber’s chair and lets the Gillette whisker trimmer get to work on his bushy beard. The New York Jets star is in Greenwich Village as a celebrity spokesman for Procter & Gamble, which counts Gillette as one its many brands. But a clean cut is not on the cards. “I’m not a complete shave guy, as your eyes will attest,” he says. The Fusion ProGlide Styler, a $19.99 razor-cum-trimmer, helps ensure “the wife won’t kill me”, Mr Mangold explains, but his strawberry blonde beard still bears hints of the unruly haystack to which it was once likened. For P&G, beards are big business. But this pillar of corporate America is in need of more than a trim. With a market value of $223bn, it has long been the gold standard in inventing, packaging and advertising high-end products to clean hair, bodies, clothes and dishes. But the personal and household products group has reached a defining juncture in its 175-year history. In both developed and emerging economies, it faces consumer markets that are more cost-conscious, commoditised and volatile. Analysts, long in awe of its consistently high performance, are now asking: has the P&G playbook run its course?The Cincinnati company still sells more consumer goods than any other – $84bn worth in the past year – including Crest toothpaste, Pampers nappies, Ariel detergent and Pantene shampoo. But it lost share in 49 per cent of the markets where it competes in the first quarter of this year. Investors, led by Bill Ackman, the hedge fund activist, complain it is not as profitable as it should be – even though it is already more profitable than most of its peers. Its stock price is labouring under a subpar market valuation as a result, trading at 20 times estimated earnings for the past 12 months while its peer group trades at 24 times earnings.

For a company needing a clean break, it turned to an unexpected saviour: AG Lafley, who was P&G’s chief executive from 2000-09 before handing the reins to Bob McDonald and becoming a management guru. But the company began to drift during Mr McDonald’s tenure. In May, the board called Mr Lafley back.

On August 1, he will announce how he plans to get the company back on track. His solution should be pithy: one P&G insider says Mr Lafley likes things “Sesame Street simple”.

Ali Dibadj, an analyst at Alliance Bernstein, says Mr Lafley will have to present a strategy that achieves a double that has been elusive in the past: making sales and profit margins expand simultaneously. Mr McDonald delivered decent revenue growth, or decent profit growth, but never both in the same quarter. Extra sales tended to come at the price of spiralling costs. Mr Dibadj says the key will be cutting overheads and improving returns on investment by making smarter choices about where to spend.

The market has changed in the four years since Mr Lafley left the company. His old dictum that “the consumer is boss” still holds true but the consumer is different. The financial crisis made shoppers in North America and Europe more cost-conscious. Many emerging economies have slowed. The competition is tougher. Unilever andColgate-Palmolive are winning market share from P&G, a trend made more galling because Unilever is led by Paul Polman. a former P&G man.

Mr McDonald took the fall for not adjusting to these changes. But some of the company’s problems took root during Mr Lafley’s tenure.

A history student, Mr Lafley learnt about retail as a naval supply officer in Japan. During his first years in charge of P&G he was lionised as a superstar. He forged a successful strategy for the pre-crisis world and with Gillette he doubled down. He bought it for $57bn in a blockbuster 2005 deal. Its model was the same as that of P&G: persuade comfortable westerners to trade up to pricier products by marketing premium “innovations” such as extra gentle, moisturising razors.

Then Lehman Brothers collapsed in September 2008, nine months before Mr Lafley would step down as chief executive and the trade-up stalled. Instead of adjusting P&G’s strategy to harder times, he had one foot out of the door. At a meeting with analysts in December 2008, he said that the premium strategy still made sense. He said he was comfortable that almost a third of P&G’s sales came from emerging markets, even though peers got more. On Wall Street, some say his priority now should be the overhaul he should have started then. When he speaks on August 1, Mr Lafley should indicate whether he will change his strategy towards emerging markets and premium brands.

The essence of P&G’s woes in North America and Europe is the commoditisation of consumer products, accelerated by the downturn and the spread of technology.

When Mr Lafley announced the Gillette deal in 2005, he said: “You have to ask yourself whether you’re inherently a commodity business or inherently an innovation business.” His answer was innovation. P&G used high technology and charged high prices. He divested businesses that made peanut butter, juice drinks and low-end household cleaners because their products were not distinctive. He liked Gillette because it made smart new razors that “command premium value”.

. . .

Mr McDonald stuck to that premium strategy and pushed up prices further in spite of the worst recession in decades. “The people managing P&G’s US business were wishing US consumers would behave as they did to 2007,” says Javier Escalante, analyst at Consumer Edge Research.

New product innovation was incremental: P&G made Duracell batteries that stay powered for 10 years in storage and produced a Febreze air freshener that you can stick on the wall. Investors want Mr Lafley to invest less money in the kind of innovation that excites P&G engineers and more in technology that provides post-recession westerners with what they want: good enough products at affordable prices. Doing that has enabled Unilever to thrive with Dove soap and TRESemmé shampoo. Colgate has done so with its toothpaste.

By contrast, P&G’s troubles are exemplified by Olay, which is losing share, most notably to L’Oréal. Olay used to be a $4 cream for old ladies but in 2000 P&G relaunched it as a classier, $19 anti-ageing product for 35-plus women that could still sell at mass-market retailers. Until 2008 the strategy worked. Then the crisis eviscerated the middle market. Jon Moeller, P&G’s chief financial officer, said the company was working hard to fix it, but added: “It’ll take some time.”

Supermarkets and drugstores have also made headway against P&G with bargain own-brand or private-label products.

“One of big controversies is: now you are using private-label toilet paper, are you going to go back?” says Mr Escalante.

P&G rejects the idea that it is not serving cash-strapped consumers – it says one of Mr Lafley’s previous initiatives was “rounding out” its product portfolio into middle- and low-price tiers, citing Bounty Basic paper towels as an example. But while Walmart trumpets its cheapness, there is a hint of snobbery at P&G, where employees speak with pride about the high prices that its products command.

P&G has not helped its cause with botched launches: the Pampers Dry Max nappy triggered complaints in 2010 that it was causing rashes; its new Tide Pods laundry capsules were delayed by almost a year because of manufacturing problems, then P&G had to redo the packaging out of concern that young children would eat it.

Even when P&G has a big innovation that works – such as the Swiffer sweeper that has replaced many mops and buckets since 2000 – it is becoming harder to protect it because companies that offer contract manufacturing and packaging services enable rivals to follow suit more quickly than ever.

“Everyone’s ability to offer a me-too product is much higher than 10 years ago,” says Peter Wietfeldt, head of the retail and consumer practice at PwC, the professional services firm. “A growing proportion of the consumer packaged goods space is being commoditised. It’s very hard to hold on to that true premium position.”

In the developing world, P&G’s problems are different. Economic growth in emerging markets has become more “choppy”, as P&G says, but people are buying more personal and household products. Investors want P&G to secure a bigger proportion of its sales from them.

P&G’s centralised organisation is one reason why it does not. Another has been Mr Lafley himself.

In 2000, 20 per cent of P&G’s sales came from emerging markets, primarily China and Russia. By 2008 Mr Lafley had lifted that figure to almost a third – and he could point to low-cost innovations such as a nappy that cost Chinese parents no more than an egg. But Unilever and Colgate were consistently ahead of P&G and Mr Lafley could have done more.

Buying Gillette was partly about securing its superior distribution channels in India and Brazil, but Lauren Lieberman, an analyst at Barclays, says the task of integrating the company ironically ended up distracting P&G from the need to expand faster in emerging markets.

Today P&G makes 40 per cent of its sales in emerging markets but this puts it behind Colgate and Unilever, with their respective totals of 53 per cent and 57 per cent.

Mr McDonald was criticised for launching assaults on rival strongholds, such as the Unilever-controlled market for laundry products in South Africa, which only served to dilute profitability.

At a publicity event for his book in March, Mr Lafley said that when people say their strategy is “emerging markets” he asks: “Which of the 160?” Mr Dibadj expects him to focus on places where P&G dominates, and fragmented, immature “white spaces”.

. . .

If catching up with Unilever and Colgate also requires learning from them, Mr Lafley may need to reduce P&G’s centralism. The company insists it has reduced the power of its Cincinnati headquarters: Singapore is home to its baby care, skin care and prestige beauty businesses, laundry is based in Geneva and it has research centres on five continents.

But its modus operandi is still to cultivate big foot brands that stomp around the globe. This presents a challenge. In China, for example, consumers are drifting back to traditional “herbal” products and that works against global brands such as Crest and Olay, says Mr Escalante.

P&G’s messages on Mr Lafley’s return have been oddly uncertain. It says it remains “on track” with its existing plans for improving sales and profits – just as Mr McDonald did. So why did the board need to change chief executive? When Mr Moeller was asked last month he said: “I really don’t have perspective that I can share that you could count on as being credible.”

At least Mr Mangold, the American footballer, remains reliable. “When this all started I was surprised how many products I use that are P&G,” he says. He washes his hair with Head & Shoulders and mops up after his toddler with Bounty.

“I think we actually keep P&G in business,” he says. If free-spending American families such as Mr Mangold’s were ever enough for Mr Lafley, they are not any more.

Gillette: Cut-throat competition for razor sales

Cut corners on shaving costs and you will be punished with cuts on your face. That is the implicit message of much old-school Gillette marketing. But according to a band of start-ups selling razors online, it is high prices that have really gouged consumers.

Raz*War in Belgium was the first to seize the chance to offer more affordable options in 2009. It was followed by the US’s ultra-cheap Dollar Shave Club in 2011, then this year by Harry’s, which sells classier products from New York.

“There is a significant mark up on razors,” says Jeff Raider, co-founder of Harry’s. “Lots of guys are upset that they have to pay so much.”

Harry’s offers “high quality at a fair price”, he says. It lets consumers order online and get home delivery of a $10 or $20 razor handle and a 12 pack of German-made blade cartridges whose price works out at $1.67 each.

By comparison, a 15-pack of Gillette’s mid-range Mach3 refills sells at $2.43 per blade at Walmart.

Since 1990, the price of Gillette blade cartridges, adjusted for inflation, has risen by 236 per cent, according to prices in media reports.

Mr Raider reckons that razor steel costs the incumbents a fraction of its selling price.

Dollar Shave Club is a subscription service, whose founder Michael Dubin starred in an irreverent viral video that mocked Gillette’s vibrating handles. It offers five basic blades a month for a total of $1 (plus shipping) and has 250,000 active members.

The latest start-up is the UK’s Close Shave Society. They are all variants on the classic model of selling razor handles at near-cost and making money on the blades.

But by cutting out overheads and middlemen, while collecting a modest profit margin for themselves, the start-ups are disrupting the traditional financial formula.

One former P&G brand manager faults Gillette for spending too much time on technology innovation and not enough on business ideas that could have stopped the start-ups from showing it up.

“I think they should take us seriously,” says Mr Dubin of Dollar Shave Club.

“It’s about a smarter lifestyle built around convenience, simplicity, affordability.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: