By Pratibha Singh, MBA-I, Finance
First came investment banking; then mutual funds; now the insurance industry is mired in scandal-Eliot Spitzer, New York's formidable Attorney-General on October 14th, 2004, filed charges against AIG (American International Group Inc.), the world's biggest insurer. The charges were part of an ongoing investigation into industry practices that suggested insurers and brokers had acted collectively to betray customers. In 2005, after an AIG scandal on insurance and mutual funds the year before, AIG was once again under investigation for accounting fraud. The company has already lost over $58 billion worth of market compensation because of the AIG scandal. Here’s a look at the story so far.
About AIG
AIG was founded in 1919 by Cornelius Vander Starr in Shanghai, China. Starr was the first Westerner in Shanghai to sell insurance to the Chinese.
AIG owns ILFC, the world's largest aircraft leasing company, with hundreds of aircraft like Boeing 747-400. It also is the world's leading international insurance and financial services organization, with operations in more than 130 countries and jurisdictions.
AIG member companies serve commercial, institutional and individual customers through the most extensive worldwide property-casualty and life insurance networks of any insurer.
In the United States, AIG companies are the largest underwriters of commercial and industrial insurance and AIG American General is a top-ranked life insurer. Maurice Hank Greenberg till recently led AIG.
The scandal
The AIG scandal involves the unusually arcane and obscure world of reinsurance. Insurers don't simply take premiums and hope you don't collect. They insure themselves with other insurers. By doing so, they move risk and liabilities off their balance sheets and onto others'. Because the transactions are complicated and ambiguous, both insurers and reinsurers may be tempted to engage in transactions that seem to be insurance but are really just deals to make earnings or balance sheets look better. AIG seems to have done that to keep its stock price healthy.
In February 2005, AIG received subpoenas from the Office of the Attorney General of the state of New York (NYAG) and the Securities and Exchange Commission (SEC) relating to "investigations of non traditional insurance products and certain assumed reinsurance transactions and AIG’s accounting for such transactions." One of the deals involved a loss portfolio transfer from Gen Re, which is owned by Warren Buffet’s Berkshire Hathaway (the primary user) to AIG (the reinsurer). AIG booked as income $500 million in premium for the loss portfolio transfer and then added $500 million in reserves against future claims to its balance sheet. AIG counted the transaction as an insurance deal but later concluded that the Gen Re transaction documentation was improper and that it should not have been recorded as insurance. What makes this deal "scandalous" is the fact that there was no underwriting risk transferred in the deal. Instead the loss portfolio transfer was essentially a $500 million loan from Gen Re to AIG that AIG would repay through $500 million in claims payments to Gen Re. AIG did not face any chance of loss in this deal, its limit of liability was evidently capped at $500 million. Because of this, it is argued that the $500 million should have been accounted for as deposits on AIG’s books. But by recording the deal as "insurance", AIG was able to effectively boost its loss reserves by $500 million.
It has been reported that 10 other similar transactions have now come under the microscope.
The result 9
The AIG/Gen Re scandal has put financial reinsurance in the limelight and has caused the industry to revaluate such products. The financial devastation caused by the scandal is not trivial.
~Forthright~ Research Factory
On May 31st, 2005, AIG came out with its restated financial statements and issued a reduction in book value of USD $2.7 billion; a 3.3 percent reduction in net worth. AIG also adjusted its shareholders’ equity for the year 2004 downward by $2.26 billion or 2.7%. Between February 2005 and May 2005, its stock price fell by 25%.
Maurice "Hank" Greenberg was forced out as Chairman and CEO of AIG in March.
On the Gen Re side- Richard Napier (former Gen Re senior VP) and John Houldsworth pleaded guilty to conspiracy to file false financial records, falsify books, records and also mislead auditors in connection with the AIG deal.
The auditor’s role
The AIG fraud once again put pressure on the auditors, questioning their credibility. In this case, PwC, AIG’s major auditor has been engulfed in controversy over the series of accounting restatements.
Beginning with Enron, large accountancy firms have seen their reputations shattered by corporate scandals. Auditors are being blamed to varying extents for failing to spot fraud and accounting errors, and Andersen - one of the erstwhile big five firms - was destroyed by its role at Enron. Deloitte is facing billion-dollar lawsuits over the role of its Italian firm as joint auditor of Parmalat. The rigour of auditing has been further thrown into the spotlight after the Refco fiasco last year (Covered in an earlier issue of Forthright). PwC however believes that in the AIG case, its audit work was "appropriate". To the extent they were not aware of situations; they should not have been expected to be aware.
As per section 404 of the 2002 Sarbanes-Oxley law on accounting and corporate governance all companies are required to evaluate their internal controls. However this is a costly affair. As a result auditors have had to double their fees and thus accused of going over the top and doing too much testing.
Although PwC supports the Sarbanes-Oxley law, it argues that the US has to wean itself off its rules- based system of accounting and corporative governance. It calls for a mixed model involving principles as well as rules. The principles could set the tone inside companies by stressing the importance of "doing the right thing", although rules would still be necessary in financial reporting. One essential ingredient to achieving such a change would be the willingness of companies and auditors to exercise greater judgment in their accounting work-and not just following rules.
Despite all the turmoil surrounding the AIG/Gen Re scandal, however, it is important to realize that it is not financial reinsurance itself that is scandalous; rather it is the misuse of it that is wrong. The various scandals in the financial field in the last couple of years are enough to signal that it’s high time not just for the auditors and legislators to take their roles more seriously, but also for the companies to realize that ethical practices have to be followed if they wish to survive and compete.
Monday, April 03, 2006
New strategies for FMCG companies
By Ahmed Faiyaz
The industry has already extracted much of the benefit to be had from improving productivity and concentrating on core brands. Meanwhile, its dynamics are changing. What comes next?
At first glance, the leading consumer goods companies' strategy for handling the fierce competition of the past ten years looks robust enough to carry them through the next ten. Indeed, with the industry still caught between price-sensitive consumers, poor infrastructure and powerful retailers, some of the challenges facing it remain the same.
In the 1990s the industry's executives developed strikingly similar strategies to address these issues: focusing rigorously on the strongest brands and pursuing productivity gains. The results confounded those who forecast the demise of brands and the industry's rapid consolidation. Remember the day in 2004 when P&G and HLL slashed the price of their core detergent brands by almost 40 percent? A business weekly wrote, "Many brands will perish or never be so profitable again." But such pessimists were wrong. Anyone who invested every year since 2004 in the top 10 consumer goods companies (minus HLL which has under gone a massive restructuring) received a 12 percent annual return over two years results that outperformed those of most industry sectors. Eight of the top fifty companies of 2000 (ranked by sales) were still in the list of leaders in 2005, and roughly in the same order.
But the strategy that worked so well might have run its course. A string of recent profit warnings at big consumer goods companies hints that the industry's dynamics may be shifting in important ways. The surge of discount retailing, emergence of local & regional brands, entering of more global players and the spread of private-label products are putting ever greater pressure on the price of branded goods. Companies have extracted much of the financial benefit from restructuring their portfolios and concentrating on core brands. And though managers doggedly pursue further improvements in productivity, most of the obvious gains have already been achieved.
The glory days
In confronting the challenges of the past five years, big consumer goods companies all chose much the same strategy. They began by reshaping their product portfolios through mergers and acquisitions, with the aim of becoming national leaders in a few core categories. Marico, went on to buy its closest competitor Nihar from HLL to prevent Dabur from moving to a position of strength. Dabur itself bought the ailing Balsara brands to give meat to its ailing oral care products. Even globally companies made acquisitions to fill geographic gaps (L'Oreal in Asia) or to strengthen a specific category (Procter & Gamble's hair-care business).
Then, most companies focused on their core brands, where they concentrated marketing and other resources, and eliminated weaker ones. Strengthened brands made it more difficult for retailers to insist on price cuts. Even the cross-category heavyweights HLL, Nestle, Procter & Gamble, and Dabur concentrated on fewer brands. 2
Next, to reduce costs and finance growth, most companies in the industry went after
~Forthright~ Research Factory
productivity gains. Large savings came from global purchasing and from centralized supply chains facilitated by information technology. Outsourcing and setting up plants in Uttaranchal to avail tax benefits were the most visible sign of the push for higher productivity and efficiency. Nestle, Brittania and ITC have set up world class production facilities in Uttaranchal. ITC has been outsourcing the manufacturing for its categories and P&G has been sourcing the H&S and Pantene shampoo it sells in India from Thailand.
For many companies, this strategy created a virtuous circle. Productivity gains financed investments in marketing and product innovation. Brands gained market share and expanded internationally. Their growth unleashed further productivity gains as burgeoning companies generated new economies of scale. Contrary to conventional wisdom, it did not take a unique, creative strategy to win; companies of different sizes successfully applied the same approach. The key lay in how well, and how quickly, they executed it.
Their results were impressive. A composite index of the top 10 consumer goods companies, excluding tobacco, shows that over the past three years show gross margins improved by an average of five percentage points and earnings before interest, taxes, and amortization (EBITA) by four percentage points. The strategy has weaknesses, however.
First, it is proving difficult to propel the virtuous circle beyond portfolio restructuring and core brands. Acquisitions did make up for the lack of organic growth and helped increase margins as companies reaped the benefits of postmerger synergies. But they were costly: the industry-wide return on capital has been flat since 1998 as the amortization of Crores of Rs in intangibles and goodwill absorbed from these acquisitions weighed on corporate balance sheets.
Another worry is that the easiest savings from improvements in purchasing, logistics, and manufacturing have already been pocketed. The move to centralized purchasing, for example, saved plenty of money but can take place only once; furthermore, the savings were achieved in a decade of favorable raw-material costs. The industry's strategic position is also troubling. Retailers continue to consolidate, adding to the bargaining power of the bulked-up survivors, and discounters continue to grow, especially in the South, where chains like Nilgiri’s & Fab Mall offering inexpensive private-label and branded goods are gaining strength.
Where now?
Given this list of concerns, senior management could be excused for wondering how companies will grow. In our view, they must accelerate the pace at which they build capabilities in core functions, because day-to-day execution is and will remain an important factor for success. They must also serve emerging markets better, respond to the growing emphasis on value and reap the benefits of scale and scope. Finally, we believe, some companies will strike out in bold new directions: outsourcing, entering new service businesses, or developing product categories that others have shunned.
Improving execution 3
Discipline in execution is nothing new, but it remains a top priority, despite the likelihood of decreasing returns. The important point is that big differences in
~Forthright~ Research Factory
the performance of companies persist; in other words, superior capabilities can be built and exploited. In the coming years, success will require ever sharper capabilities in the four main areas that sustain consumer goods companies: brand marketing, sales, innovation, and the supply chain. Average performance and best practices have improved spectacularly in each area compared with a decade ago. Tomorrow's winners will be the companies that not only adopt and roll out best practices more quickly but also introduce new approaches, often borrowed from other industries.
Marketing effectiveness remains a big source of gain for consumer goods companies; most, for example, are still struggling to maximize the value of trade spending the money passed on to retailers to promote sales. Given how much money these companies invest in marketing, and the declining productivity of traditional advertising in many markets, managers will be under increasing pressure to allocate resources wisely across not only brands but also marketing tools and consumer segments. In sales, managing relations with retailers and the customer interface they control will be particularly important for the biggest multicategory companies like HLL and ITC, which will seek to take advantage of scale and scope.
Although every consumer goods company views innovation as vital, few are happy with what they have accomplished in this respect, especially compared with pharmaceutical and consumer electronics companies. The most successful consumer businesses will treat innovation as a strategic and organizational challenge, striving particularly to blur the distinction between home-grown and external ideas (obtained through acquisitions or partnerships) and tailoring their approaches to different types of innovation.
Some leading companies will also find ways to squeeze more efficiency from their supply chains by offshoring some of their operations, employing new technologies (such as radio frequency identification tags to track inventories), or redesigning processes to reduce waste and variability, as manufacturers in other sectors have done.
Winning in emerging markets
Although almost all consumer goods companies are active in markets across the country, few take advantage of their full potential. Many concentrate on the minority of the population that can afford expensive, Western-style goods, leaving local competitors to target the overwhelming majority of consumers with modest means. The locals have the edge in supplying neighborhood stores, which global companies find harder to reach, and have held off the big players by selling some products at very low prices while nonetheless generating profits. Venky’s known for its presence in packaged chicken and newly launch wine business has recently launched four variants of glucose biscuits in the large and profitable Maharashtrian market. 4
It is hardly news to senior executives that big consumer goods companies must tailor their products to meet local needs; indeed, companies such as Unilever & Nestle have had some success with that formula. But many others still find it hard to come to grips with the big changes required in branding, distribution, and manufacturing strategies. Global majors like Bungee, Heinz and Henkel Spic are still coming to terms with the way business is done in the
~Forthright~ Research Factory
Indian market. Competing for the mass market in developing countries means rethinking the way things are done not easy for huge, successful organizations. Those that do well there will become truly global corporations and will shake up the industry's balance of power.
The value conundrum
Serving value-conscious consumers in mature markets is also increasingly necessary. This notion might seem counterintuitive, since many companies have focused on introducing expensive innovations at the premium end of their markets. Nonetheless, though the premium segment is growing in many categories, the shift toward value is a more important trend for companies that mainly target the mass market. Retreating to a narrow premium segment might make sense in categories such as wine but would prove self-defeating in household cleaners. In addition, price competition stalks the premium segment: a growing number of retailers, such as the Pantaloon’s Big Bazaar, excel at offering consumers premium private-label alternatives.
The growth of discounters has accelerated the trend toward private-label goods and split companies into two camps. A few hard-liners continue to make and market only branded products and deploy marketing and sales skills to defend their share at the low end of the market. Many other manufacturers, in a spirit of "if you can't beat them, join them," supply retailers with private-label products, at least in some categories. A number of paper-product companies, for instance, have developed a sizable private-label business outside their home markets while retaining a strong branded domestic business.
To decide which approach to take, companies must weigh their strengths and weaknesses. Those whose brands are below second or third place in market share and don't occupy a clearly defined niche might find making private-label goods the most attractive option. The same goes for companies that can't sustain the advertising and research spending needed to keep brands on top.
But underestimating the risks would be dangerous: private-label supply is no longer an amateur sport. The skills required to stand out in that business are different from the core know-how of a supplier of branded products not just in manufacturing but also in product development, logistics, and sales. The decision to develop those new skills must be a conscious, strategic one, not an afterthought.
Exploiting scale and scope
The biggest companies are still trying to figure out how to wring a competitive advantage from global scale and broad scope. The aggregate financial and economic performance of industry heavyweights such as ITC, Nestle, Procter & Gamble, and Unilever, for example, hasn't been markedly different from that of the category champions, which compete in a more focused range of products like Brittania in Biscuits and Amul in Dairy. We can imagine two extreme scenarios. 5
One is that single-mindedness, responsiveness to consumer needs, and the ability to move quickly will continue to help category champions match or beat the giants' performance. Some of these champions will continue to consolidate fragmented categories-a trend that has already affected categories such as biscuits and some segments of personal care,
~Forthright~ Research Factory
among others. A handful, aiming to defend their independence, might join forces in mergers of equals, thereby avoiding the acquisition premiums that have hurt the industry's performance in the past. Others will seek to defend their independence by entering into alliances and joint ventures to find new avenues for growth (as PepsiCo and Unilever have done in tea-based drinks). Ultimately, new category champions will emerge as the heavyweights spin off some of their categories or break themselves up into several companies. This development would represent the final triumph of the focused category champion model.
In the alternative scenario, the heavyweights would find creative organizational solutions to the traditional trade-offs between the global management of a number of categories and brands, on the one hand, and local responsiveness, on the other. Companies like ITC and P&G would harness their considerable resources, for example, to pioneer breakthroughs in fundamental technologies. The payoff from using electronic identification tags to track inventories more efficiently would make it easier to swallow that technology's high cost. And they and some retailers would develop strategic partnerships leveraging scope advantages based on better insights into shoppers' preferences. Companies that succeed with these strategies will be in a good position to justify acquisitions prompting a new wave of industry consolidation and challenging the prevailing orthodoxy that favors category champions.
Try unorthodox strategies
Some companies now limited by the orthodox approach might consider quite different strategies to spur growth. They have several innovative options. Marico is entering the higher end of the hair care market with its Parachute advanced therapy hair oil and through its foray in Kaya skin clinic.
New business models
Traditionally, consumer goods companies have been vertically integrated: they design, make, market, and sell their products. Increasingly, however, they will depart from this model and outsource some or all of their production to third parties. A trend that has already started in apparel and consumer electronics. The final form these consumer goods companies take will differ markedly from one category to another, but a range of business models could replace the integrated monoliths that now dominate. Contract manufacturers that make but don't brand products, for example, will coexist with pure branding companies that do no manufacturing. Often the former will build capacity by acquiring and restructuring assets from the latter.
This approach is less radical than it sounds. Coca-Cola and many other beverage companies routinely outsource bottling operations. High-end perfumes often come from contract manufacturers. And in some segments, such as home and personal-care products, the outsourcing strategy is steadily gaining ground in developed countries. The contract manufacturer Budelpack, based in the Netherlands, recently announced its acquisition of manufacturing assets from Colgate-Palmolive, Henkel, Sara Lee Corporation, and Unilever. P&G which for long used to manufacture Vicks has outsourced it to a firm in Hyderabad. 6
Where brands continue to rule, the rationale for outsourcing is simple:
~Forthright~ Research Factory
management can concentrate entirely on dealing with customers and consumers - the main engines of growth. Indeed, many companies find that they can think more creatively about developing new products and stretching their brands into new categories when they no longer have to worry about keeping factories occupied. This approach would also promote a great leap in a company's return on capital employed.
The supply company too can create value. A management team focusing 100 percent on operations is better placed to build skills and generate improvements than the management of an integrated company. Operational excellence has a direct impact on profits; our evaluation of the best pure private-label suppliers shows that their profitability is on par with that of their average-performing branded counterparts. Moreover, the prospects for growth are better, since supply companies can produce goods for a variety of customers and tap into the growing market for value-oriented products.
Not every maker of branded goods should play this game. In some cases, proprietary manufacturing expertise is a source of competitive advantage that cannot be risked, even with watertight contracts to protect products and processes. In other categories, margins are too slim and the potential to cut costs is too slight for profits to be shared with a contract manufacturer. Concerns about product safety or the sourcing of ingredients are also easier to address with in-house operations. To decide whether outsourcing makes sense, companies need to assess each product and category in individual geographic regions and, of course, evaluate possible suppliers.
Venturing into services
Nescafe and Bru’s range of premixed ready to drink coffees is a service that extends a product. Another example: the drinking fountains and bottled water supplied by Bisleri Parle's home- and office-delivery division to 0.7 million residential and business customers in India. L’oreal and Wella are setting up and supporting as number of up market saloons and beauty parlours in cities like Delhi, Mumbai and Bangalore to provide consumers the experience of using their products along with professional guidance
These businesses and other successful forays into the world of services share several important characteristics. They have real consumer appeal and avoid head-on competition with mainstream retailers. They are managed separately from the core of the enterprise to avoid stifling them with big-company controls, costs, and attitudes. Most important of all, their senior executives understand that developing new businesses takes time and that nascent ones cannot be measured by the same yardsticks applied to established brands.
The move toward services is challenging. It requires new skills and runs the risk of damaging core brands by stretching them into territory that is hard to control. Moreover, during the initial growth phase, returns are paltry compared with those from a core business. Still, as consumers everywhere demand more service, some companies will find ways to provide it. In principle, any corporation, whether large or small, could enter this new arena, but the bar is high: you need not only creativity to invent attractive concepts but also determination to realize them.
7 ~Forthright~ Research Factory
The forgotten categories
A handful of companies might gain an advantage by focusing on product categories, such as traditional grocery products like packaged pulses and canned foods (fruit pulp, baked beans etc), that global operators have forgotten. While multinational companies were busy consolidating, a new breed of consumer goods player stealthily gained ground: private equity firms that acquired local businesses in categories that multinationals were divesting or ignoring.
So far, the evidence suggests that firms such as Nutrine, Parle and Parry’s have been highly successful in the industry. Their formula is well-known: acquire a stand-alone business, either from independent shareholders or from a multinational reshaping its portfolio, add financial leverage consistent with predictable cash flows, and give management the incentives and authority to improve the performance of the acquisition. After spending a few years building it up, such firms sell it to a trade buyer, another private equity firm, or the public through a stock offering.
This approach provides a template for some consumer goods companies searching for growth. They can optimize a portfolio of local businesses concentrating on categories that are too small or fragmented for the giants without much regard for the synergies among them. Usually, these categories (which include some canned foods, breads, fresh-and-ready meals, and seafood) are relatively small, sensitive to local tastes, or dependent on local supply chains.
The industry's largest companies might have difficulty playing such a game: after all, they have spent the past decade getting rid of small brands and would have a hard time explaining an about-face to investors. But some midsize consumer goods companies could make this a viable strategy. They have little hope of becoming global category champions, because they lack the brands, the marketing capabilities, and sometimes the financial wherewithal. Rather than mimicking the global giants, they could adopt a different mind-set and organizational model, taking the private equity firms as their inspiration.
Ever greater price competition means that the pace of change in consumer goods is likely to accelerate. The companies best placed to thrive will be those prepared to take their quest for growth into new arenas.
Source: Mc Kinsey Quarterly and analysis of articles read over the recent months
The industry has already extracted much of the benefit to be had from improving productivity and concentrating on core brands. Meanwhile, its dynamics are changing. What comes next?
At first glance, the leading consumer goods companies' strategy for handling the fierce competition of the past ten years looks robust enough to carry them through the next ten. Indeed, with the industry still caught between price-sensitive consumers, poor infrastructure and powerful retailers, some of the challenges facing it remain the same.
In the 1990s the industry's executives developed strikingly similar strategies to address these issues: focusing rigorously on the strongest brands and pursuing productivity gains. The results confounded those who forecast the demise of brands and the industry's rapid consolidation. Remember the day in 2004 when P&G and HLL slashed the price of their core detergent brands by almost 40 percent? A business weekly wrote, "Many brands will perish or never be so profitable again." But such pessimists were wrong. Anyone who invested every year since 2004 in the top 10 consumer goods companies (minus HLL which has under gone a massive restructuring) received a 12 percent annual return over two years results that outperformed those of most industry sectors. Eight of the top fifty companies of 2000 (ranked by sales) were still in the list of leaders in 2005, and roughly in the same order.
But the strategy that worked so well might have run its course. A string of recent profit warnings at big consumer goods companies hints that the industry's dynamics may be shifting in important ways. The surge of discount retailing, emergence of local & regional brands, entering of more global players and the spread of private-label products are putting ever greater pressure on the price of branded goods. Companies have extracted much of the financial benefit from restructuring their portfolios and concentrating on core brands. And though managers doggedly pursue further improvements in productivity, most of the obvious gains have already been achieved.
The glory days
In confronting the challenges of the past five years, big consumer goods companies all chose much the same strategy. They began by reshaping their product portfolios through mergers and acquisitions, with the aim of becoming national leaders in a few core categories. Marico, went on to buy its closest competitor Nihar from HLL to prevent Dabur from moving to a position of strength. Dabur itself bought the ailing Balsara brands to give meat to its ailing oral care products. Even globally companies made acquisitions to fill geographic gaps (L'Oreal in Asia) or to strengthen a specific category (Procter & Gamble's hair-care business).
Then, most companies focused on their core brands, where they concentrated marketing and other resources, and eliminated weaker ones. Strengthened brands made it more difficult for retailers to insist on price cuts. Even the cross-category heavyweights HLL, Nestle, Procter & Gamble, and Dabur concentrated on fewer brands. 2
Next, to reduce costs and finance growth, most companies in the industry went after
~Forthright~ Research Factory
productivity gains. Large savings came from global purchasing and from centralized supply chains facilitated by information technology. Outsourcing and setting up plants in Uttaranchal to avail tax benefits were the most visible sign of the push for higher productivity and efficiency. Nestle, Brittania and ITC have set up world class production facilities in Uttaranchal. ITC has been outsourcing the manufacturing for its categories and P&G has been sourcing the H&S and Pantene shampoo it sells in India from Thailand.
For many companies, this strategy created a virtuous circle. Productivity gains financed investments in marketing and product innovation. Brands gained market share and expanded internationally. Their growth unleashed further productivity gains as burgeoning companies generated new economies of scale. Contrary to conventional wisdom, it did not take a unique, creative strategy to win; companies of different sizes successfully applied the same approach. The key lay in how well, and how quickly, they executed it.
Their results were impressive. A composite index of the top 10 consumer goods companies, excluding tobacco, shows that over the past three years show gross margins improved by an average of five percentage points and earnings before interest, taxes, and amortization (EBITA) by four percentage points. The strategy has weaknesses, however.
First, it is proving difficult to propel the virtuous circle beyond portfolio restructuring and core brands. Acquisitions did make up for the lack of organic growth and helped increase margins as companies reaped the benefits of postmerger synergies. But they were costly: the industry-wide return on capital has been flat since 1998 as the amortization of Crores of Rs in intangibles and goodwill absorbed from these acquisitions weighed on corporate balance sheets.
Another worry is that the easiest savings from improvements in purchasing, logistics, and manufacturing have already been pocketed. The move to centralized purchasing, for example, saved plenty of money but can take place only once; furthermore, the savings were achieved in a decade of favorable raw-material costs. The industry's strategic position is also troubling. Retailers continue to consolidate, adding to the bargaining power of the bulked-up survivors, and discounters continue to grow, especially in the South, where chains like Nilgiri’s & Fab Mall offering inexpensive private-label and branded goods are gaining strength.
Where now?
Given this list of concerns, senior management could be excused for wondering how companies will grow. In our view, they must accelerate the pace at which they build capabilities in core functions, because day-to-day execution is and will remain an important factor for success. They must also serve emerging markets better, respond to the growing emphasis on value and reap the benefits of scale and scope. Finally, we believe, some companies will strike out in bold new directions: outsourcing, entering new service businesses, or developing product categories that others have shunned.
Improving execution 3
Discipline in execution is nothing new, but it remains a top priority, despite the likelihood of decreasing returns. The important point is that big differences in
~Forthright~ Research Factory
the performance of companies persist; in other words, superior capabilities can be built and exploited. In the coming years, success will require ever sharper capabilities in the four main areas that sustain consumer goods companies: brand marketing, sales, innovation, and the supply chain. Average performance and best practices have improved spectacularly in each area compared with a decade ago. Tomorrow's winners will be the companies that not only adopt and roll out best practices more quickly but also introduce new approaches, often borrowed from other industries.
Marketing effectiveness remains a big source of gain for consumer goods companies; most, for example, are still struggling to maximize the value of trade spending the money passed on to retailers to promote sales. Given how much money these companies invest in marketing, and the declining productivity of traditional advertising in many markets, managers will be under increasing pressure to allocate resources wisely across not only brands but also marketing tools and consumer segments. In sales, managing relations with retailers and the customer interface they control will be particularly important for the biggest multicategory companies like HLL and ITC, which will seek to take advantage of scale and scope.
Although every consumer goods company views innovation as vital, few are happy with what they have accomplished in this respect, especially compared with pharmaceutical and consumer electronics companies. The most successful consumer businesses will treat innovation as a strategic and organizational challenge, striving particularly to blur the distinction between home-grown and external ideas (obtained through acquisitions or partnerships) and tailoring their approaches to different types of innovation.
Some leading companies will also find ways to squeeze more efficiency from their supply chains by offshoring some of their operations, employing new technologies (such as radio frequency identification tags to track inventories), or redesigning processes to reduce waste and variability, as manufacturers in other sectors have done.
Winning in emerging markets
Although almost all consumer goods companies are active in markets across the country, few take advantage of their full potential. Many concentrate on the minority of the population that can afford expensive, Western-style goods, leaving local competitors to target the overwhelming majority of consumers with modest means. The locals have the edge in supplying neighborhood stores, which global companies find harder to reach, and have held off the big players by selling some products at very low prices while nonetheless generating profits. Venky’s known for its presence in packaged chicken and newly launch wine business has recently launched four variants of glucose biscuits in the large and profitable Maharashtrian market. 4
It is hardly news to senior executives that big consumer goods companies must tailor their products to meet local needs; indeed, companies such as Unilever & Nestle have had some success with that formula. But many others still find it hard to come to grips with the big changes required in branding, distribution, and manufacturing strategies. Global majors like Bungee, Heinz and Henkel Spic are still coming to terms with the way business is done in the
~Forthright~ Research Factory
Indian market. Competing for the mass market in developing countries means rethinking the way things are done not easy for huge, successful organizations. Those that do well there will become truly global corporations and will shake up the industry's balance of power.
The value conundrum
Serving value-conscious consumers in mature markets is also increasingly necessary. This notion might seem counterintuitive, since many companies have focused on introducing expensive innovations at the premium end of their markets. Nonetheless, though the premium segment is growing in many categories, the shift toward value is a more important trend for companies that mainly target the mass market. Retreating to a narrow premium segment might make sense in categories such as wine but would prove self-defeating in household cleaners. In addition, price competition stalks the premium segment: a growing number of retailers, such as the Pantaloon’s Big Bazaar, excel at offering consumers premium private-label alternatives.
The growth of discounters has accelerated the trend toward private-label goods and split companies into two camps. A few hard-liners continue to make and market only branded products and deploy marketing and sales skills to defend their share at the low end of the market. Many other manufacturers, in a spirit of "if you can't beat them, join them," supply retailers with private-label products, at least in some categories. A number of paper-product companies, for instance, have developed a sizable private-label business outside their home markets while retaining a strong branded domestic business.
To decide which approach to take, companies must weigh their strengths and weaknesses. Those whose brands are below second or third place in market share and don't occupy a clearly defined niche might find making private-label goods the most attractive option. The same goes for companies that can't sustain the advertising and research spending needed to keep brands on top.
But underestimating the risks would be dangerous: private-label supply is no longer an amateur sport. The skills required to stand out in that business are different from the core know-how of a supplier of branded products not just in manufacturing but also in product development, logistics, and sales. The decision to develop those new skills must be a conscious, strategic one, not an afterthought.
Exploiting scale and scope
The biggest companies are still trying to figure out how to wring a competitive advantage from global scale and broad scope. The aggregate financial and economic performance of industry heavyweights such as ITC, Nestle, Procter & Gamble, and Unilever, for example, hasn't been markedly different from that of the category champions, which compete in a more focused range of products like Brittania in Biscuits and Amul in Dairy. We can imagine two extreme scenarios. 5
One is that single-mindedness, responsiveness to consumer needs, and the ability to move quickly will continue to help category champions match or beat the giants' performance. Some of these champions will continue to consolidate fragmented categories-a trend that has already affected categories such as biscuits and some segments of personal care,
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among others. A handful, aiming to defend their independence, might join forces in mergers of equals, thereby avoiding the acquisition premiums that have hurt the industry's performance in the past. Others will seek to defend their independence by entering into alliances and joint ventures to find new avenues for growth (as PepsiCo and Unilever have done in tea-based drinks). Ultimately, new category champions will emerge as the heavyweights spin off some of their categories or break themselves up into several companies. This development would represent the final triumph of the focused category champion model.
In the alternative scenario, the heavyweights would find creative organizational solutions to the traditional trade-offs between the global management of a number of categories and brands, on the one hand, and local responsiveness, on the other. Companies like ITC and P&G would harness their considerable resources, for example, to pioneer breakthroughs in fundamental technologies. The payoff from using electronic identification tags to track inventories more efficiently would make it easier to swallow that technology's high cost. And they and some retailers would develop strategic partnerships leveraging scope advantages based on better insights into shoppers' preferences. Companies that succeed with these strategies will be in a good position to justify acquisitions prompting a new wave of industry consolidation and challenging the prevailing orthodoxy that favors category champions.
Try unorthodox strategies
Some companies now limited by the orthodox approach might consider quite different strategies to spur growth. They have several innovative options. Marico is entering the higher end of the hair care market with its Parachute advanced therapy hair oil and through its foray in Kaya skin clinic.
New business models
Traditionally, consumer goods companies have been vertically integrated: they design, make, market, and sell their products. Increasingly, however, they will depart from this model and outsource some or all of their production to third parties. A trend that has already started in apparel and consumer electronics. The final form these consumer goods companies take will differ markedly from one category to another, but a range of business models could replace the integrated monoliths that now dominate. Contract manufacturers that make but don't brand products, for example, will coexist with pure branding companies that do no manufacturing. Often the former will build capacity by acquiring and restructuring assets from the latter.
This approach is less radical than it sounds. Coca-Cola and many other beverage companies routinely outsource bottling operations. High-end perfumes often come from contract manufacturers. And in some segments, such as home and personal-care products, the outsourcing strategy is steadily gaining ground in developed countries. The contract manufacturer Budelpack, based in the Netherlands, recently announced its acquisition of manufacturing assets from Colgate-Palmolive, Henkel, Sara Lee Corporation, and Unilever. P&G which for long used to manufacture Vicks has outsourced it to a firm in Hyderabad. 6
Where brands continue to rule, the rationale for outsourcing is simple:
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management can concentrate entirely on dealing with customers and consumers - the main engines of growth. Indeed, many companies find that they can think more creatively about developing new products and stretching their brands into new categories when they no longer have to worry about keeping factories occupied. This approach would also promote a great leap in a company's return on capital employed.
The supply company too can create value. A management team focusing 100 percent on operations is better placed to build skills and generate improvements than the management of an integrated company. Operational excellence has a direct impact on profits; our evaluation of the best pure private-label suppliers shows that their profitability is on par with that of their average-performing branded counterparts. Moreover, the prospects for growth are better, since supply companies can produce goods for a variety of customers and tap into the growing market for value-oriented products.
Not every maker of branded goods should play this game. In some cases, proprietary manufacturing expertise is a source of competitive advantage that cannot be risked, even with watertight contracts to protect products and processes. In other categories, margins are too slim and the potential to cut costs is too slight for profits to be shared with a contract manufacturer. Concerns about product safety or the sourcing of ingredients are also easier to address with in-house operations. To decide whether outsourcing makes sense, companies need to assess each product and category in individual geographic regions and, of course, evaluate possible suppliers.
Venturing into services
Nescafe and Bru’s range of premixed ready to drink coffees is a service that extends a product. Another example: the drinking fountains and bottled water supplied by Bisleri Parle's home- and office-delivery division to 0.7 million residential and business customers in India. L’oreal and Wella are setting up and supporting as number of up market saloons and beauty parlours in cities like Delhi, Mumbai and Bangalore to provide consumers the experience of using their products along with professional guidance
These businesses and other successful forays into the world of services share several important characteristics. They have real consumer appeal and avoid head-on competition with mainstream retailers. They are managed separately from the core of the enterprise to avoid stifling them with big-company controls, costs, and attitudes. Most important of all, their senior executives understand that developing new businesses takes time and that nascent ones cannot be measured by the same yardsticks applied to established brands.
The move toward services is challenging. It requires new skills and runs the risk of damaging core brands by stretching them into territory that is hard to control. Moreover, during the initial growth phase, returns are paltry compared with those from a core business. Still, as consumers everywhere demand more service, some companies will find ways to provide it. In principle, any corporation, whether large or small, could enter this new arena, but the bar is high: you need not only creativity to invent attractive concepts but also determination to realize them.
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The forgotten categories
A handful of companies might gain an advantage by focusing on product categories, such as traditional grocery products like packaged pulses and canned foods (fruit pulp, baked beans etc), that global operators have forgotten. While multinational companies were busy consolidating, a new breed of consumer goods player stealthily gained ground: private equity firms that acquired local businesses in categories that multinationals were divesting or ignoring.
So far, the evidence suggests that firms such as Nutrine, Parle and Parry’s have been highly successful in the industry. Their formula is well-known: acquire a stand-alone business, either from independent shareholders or from a multinational reshaping its portfolio, add financial leverage consistent with predictable cash flows, and give management the incentives and authority to improve the performance of the acquisition. After spending a few years building it up, such firms sell it to a trade buyer, another private equity firm, or the public through a stock offering.
This approach provides a template for some consumer goods companies searching for growth. They can optimize a portfolio of local businesses concentrating on categories that are too small or fragmented for the giants without much regard for the synergies among them. Usually, these categories (which include some canned foods, breads, fresh-and-ready meals, and seafood) are relatively small, sensitive to local tastes, or dependent on local supply chains.
The industry's largest companies might have difficulty playing such a game: after all, they have spent the past decade getting rid of small brands and would have a hard time explaining an about-face to investors. But some midsize consumer goods companies could make this a viable strategy. They have little hope of becoming global category champions, because they lack the brands, the marketing capabilities, and sometimes the financial wherewithal. Rather than mimicking the global giants, they could adopt a different mind-set and organizational model, taking the private equity firms as their inspiration.
Ever greater price competition means that the pace of change in consumer goods is likely to accelerate. The companies best placed to thrive will be those prepared to take their quest for growth into new arenas.
Source: Mc Kinsey Quarterly and analysis of articles read over the recent months
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