FMCG

by Greg Thain

  We would argue this description is a little too narrow and, to at least some extent, not truly reflective of today’s P&G. Dolce & Gabbana and Old Spice advertising talks little of true product superiority and Bounty Basic is not a superior product, although it may be a better-value one than those offered by competitors. In our view, P&G’s DNA is:

  P&G Is In the Business of Building Brands

  Since the launch of Ivory, P&G has built brands. Across the branded goods era, there can be no question that P&G has not only been the biggest but also the best at building, reinforcing and cashing in on branded properties. Not only has it been the largest packaged goods advertiser for more than a century, but it also invented, refined and perfected many of the inherent processes and capabilities of brand building.

  It was not only the first company to produce half-hour television serials, it was also the first company to align every function in the business around the sole goal of building brands. It holds massive global shares in most of the categories in which it competes and has far more billion-dollar brands than anyone else. Nor does it restrict itself to building its own brands. P&G has been an extremely acquisitive company and many of its greatest successes have come from creating much more growth and value from brands and technologies than previous owners were able to. Its market capitalisation of around $180 billion is more than $100 billion greater than the book value of the company’s tangible assets, so it doesn’t just build brands: it builds brand value, $100 billion of it, out of everyday products that slightly improve the lives of billions of people.

  The Appliance of Science to Brand-building

  While all consumer goods companies would claim to be in the business of building brands, where P&G has been most noticeably different in its approach to brand building has been its focus on and expertise in core science. P&G spends hundreds of millions of dollars researching billions of consumers and more often than not its biggest successes have come from deriving new consumer benefits from scientific advances.

  This emphasis on the science that underlies consumer products has been a feature of the company since James Norris Gamble reverse engineered his competitors’ products and experimented on how to improve them further. By 1890, Gamble had recruited university chemistry graduates to populate one of the first corporate laboratories in the emerging consumer goods industry. The company was a pioneer in building dedicated pilot plants rather than utilising unwanted or unused bits of kit. By the 1920s, P&G was employing hundreds of science graduates in a multi-faceted chemical division where the Research Department worked on base science, passing on its discoveries to the process department, which would find ways to leverage them into a mass production environment to deliver clear, demonstrable, product usage benefits.

  It also mastered the skill of cross-fertilisation, where scientific advances in one part of the product range could be used to enhance or create completely new benefits in another part of the business. Thus, its original expertise in fats and oils in soaps led directly to the creation of a new kind of shortening and later to peanut butter and potato chips. Its post-Tide skills in detergents provided openings in other kinds of cleaning such as hair and teeth. Its understanding of cellulose that came from the Charmin acquisition led straight to Pampers and Always; the combination of Tide and Charmin knowledge led to Bounce, and so on and so on.

  No other consumer goods company has P&G’s breadth and depth of scientific expertise; it spends $2 billion a year on R & D across 150 different sciences. Data showed that P&G had had 132 products on the Top 25 New Product Pacesetters list over the past sixteen years – more than its six largest competitors combined. Its move towards open innovation continues a long tradition of being open to and incorporating ideas from outside the business, but its skills have always predominantly been in what it does inside its business that its competitors don’t. Open innovation is, well, open to everyone else, so the required attributes shift from having the most and best science to finding and nurturing the best external science. It is unclear whether P&G will be as competitively advantaged at that as it has been in doing the science itself.

  Rigour and Tenacity

  It perhaps shouldn’t be a surprise that a company which has thousands of scientists in the building would be a believer in methodical and rigorous analysis, experimentation, testing, tweaking, retesting and rollout. P&G has built an empire demonstrating that product is king and the world will wait for a great idea. It has also demonstrated Edison’s mantra that genius is 99% perspiration. Tide came about because of one researcher’s perspiration over years, Charmin was a money pit for a decade, Pampers failed in its first three test markets, Crest was initially poo-pooed by the dental establishment and Pringles looked like it was never going to break even.

  Pringles is an excellent example of P&G’s tenacity. It began as a project in the mid-1950s as P&G had close links with the potato chip industry, being a leading supplier of fats and oils to it at the time. Potato chips have a short shelf life and are mostly delivered by a dedicated rapid distribution system, which P&G did not have or want. So the product had to be packed in nitrogen to extend the shelf life and packaged much more space efficiently to keep packaging costs down. So the tube and the stackability were driven by P&G’s desired means of distribution rather than some underlying consumer need. It wasn’t until ten years later that the basic formula and production process was finally cracked, at which point $70 million was pumped in to take the concept to test market stage by 1968. After rollout, the brand peaked with sales north of $100 million, but by the end of the 1970s sales had dropped by two-thirds. Pringles were expensive, the flavour and texture were sub-optimal and the brand was slated for discontinuation. The product was re-engineered to be cheaper and better and, just as importantly, P&G realised that competing in the snack category was not only about demonstrable product benefits: other features such as variety and fun were equally important. The brand first made an annual profit in the early 1980s, a quarter of a century after its genesis, and went on to reach billion-dollar brand status by the late 1990s, almost half a century on!

  However, it must be said that tenacity has its downside. Olestra, its patented fat replacement food ingredient, was laboured over for far too long. In the face of overwhelming evidence that the public would not accept a food ingredient that did nothing but give them a better chance of a stomach upset, it should have been dropped. In any case, it had been discovered by accident during research for a fat that could be better digested by premature infants. It was first considered as an anti-cholesterol-drug, but the FDA disagreed. Only at the end was the idea born to use Olestra as a food additive replacing ‘bad’ fats. It was simply a very expensive idea looking for a use. However, it must also be said that two of the greatest successes came when caution was thrown to the winds. The trick is not to let the rigour get in the way when the idea really is great and not to let an idea continue without a use – literally useless – run forever, or far too long.

  Summary

  The combination of these three attributes, applied over different times, in different product sectors, in different geographies and countries, has resulted in a company ranked Number Six in Fortune’s World’s Most Admired Companies, Number Two in Fortune’s Top Companies for Leaders, Number Three in Barron’s World’s Most Respected Companies and Number Twelve in Business Week’s World’s Most Innovative Companies. How long it will maintain these kinds of rankings depends to a very large extent on its current strategies.

  Its growth in developing markets will undoubtedly continue. P&G learnt the hard way how to apply its DNA successfully in markets very different from its US/Europe heartland, and with $32 billion in sales already from these markets, it is better positioned than anyone else to capture the further growth that will come from hundreds of millions of new consumers entering the middle classes and extending the consumption of its products.

  P&G currently sells 40 billion products a year and it expects to increase that to 60 bill
ion in the next few years. But, as we have seen, this inexorable growth in developing markets is for cheaper products and lower margins than P&G has become accustomed to in developed markets, which is why it is currently looking to get $10 billion of costs out of its business.

  After protecting margins, its second challenge is to return to growth - and above-average growth - in the developed markets. Since the economic crisis, P&G has suffered volume and market share declines in many categories. It has been taking on heavy price increases, has produced no blockbuster innovations and has completed no transformative acquisitions. Not a pretty sight. Turning this around while simultaneously cutting costs savagely, with all the internal navel-gazing such an exercise entails, will be its biggest challenge.

  PepsiCo

  Where Did It Come from?

  Two American men, 25 years apart, invented drinks that would bestride the world – as Coca-Cola and Pepsi-Cola have done - and both died in obscure penury, knowing nothing of their ultimate success. John Styth Pemberton mixed and drank his first glass of Coca-Cola in 1866, the year before Caleb D. Bradham was born.

  Caleb became a North Carolina pharmacist and drug store owner and he was not one to accept for a moment Coca-Cola’s dominance over the soft drinks market. Caleb mixed prescriptions and also new concoctions to be sold at his store’s soda fountain. Sometime during the early 1890s he was selling a drink consisting of sugar, vanilla, oils, spices and extract of the African kola nut. Caleb was alert to feedback from his enthusiastic customers about what they called Brad’s Drink. Caleb became convinced his drink relieved upset stomachs and the pain from peptic ulcers, so, by 1898, he had christened it Pepsi-Cola. Its success caused him to expand his distribution base. Caleb hired a manager to run the drug store while he set up a syrup factory in the back room. He set about finding more soda fountain customers for his newly patented drink.

  Business boomed surprisingly quickly. In 1902, the first year of operation, he shifted around 2,000 gallons of syrup and the next year ran advertising campaigns - Exhilarating, Invigorating, Aids Digestion - which quadrupled sales to almost 8,000 gallons. This volume was 1% of Coca-Cola’s sales in the same year. Caleb had started a long, arduous and tortuous journey. Could Pepsi-Cola become a serious rival to Coca-Cola? He made a good start: the speed of his subsequent growth was astounding. Within eight years, mostly due to an enthusiastic pursuit of bottled sales, he was selling 100,000 gallons of syrup a year. These came from a combination of his own factory, thousands of soda fountains and 280 bottlers across 24 states. For all Coca-Cola’s dominance, it seemed there were absolutely no barriers to entry into the category.

  However, in 1920/21 the price of sugar first rocketed and then collapsed. This almost bankrupted the mighty Coca-Cola, so little Pepsi-Cola had no chance. Its assets of well over $1 million were not insufficient to withstand a $150,000 loss on sugar when the 1920 price of 25 cents/lb. collapsed by 90% the year after. Caleb sold off everything not nailed down and got a mortgage on what was. It wasn’t enough. In January 1922, with liabilities five times assets on the balance sheet, Caleb lost control to a Wall Street firm and left the beverages business for good.

  The all-but-broke company changed hands more than once for peanuts and lost money throughout the 1920s, even though Prohibition did wonders for the soft drinks industry in general. Pepsi-Cola was in no fit state to survive the Great Depression so, in 1931, it was declared bankrupt once again.

  How Did They Evolve?

  Pepsi-Cola’s saviour was, ironically, a Coca-Cola customer. Charles C. Guth, the president of the Loft Inc. chain of confectionery stores, was a mercurial chancer. He was as stubborn as a mule with a temper to match. Loft Inc. ran 200 stores, which sold over 30,000 gallons of Coca-Cola a year from its soda fountains. This made Charles a substantial Coke customer, who was accounting for around 1% of their syrup sales. Yet his request for a bigger discount was turned down flat. An outraged Charles recalled a bankrupt drinks firm he had been offered for a song three years earlier.

  Determined to show Atlanta they couldn’t push Charles C. Guth around, he bought the Pepsi-Cola firm for around $12,000 and kicked Coke out of his stores. To misquote Don Corleone, this move was personal, not business. It made no sense. Coca-Cola was already a national institution and its availability drove the traffic of soda fountains. Hence Loft Stores’ takings plummeted in the aftermath of the switch. In the following few years, Loft’s purchases of Pepsi syrup declined by 30% compared to their earlier volumes of Coke. Charles’ initial hope that he could substitute the syrups and nobody would notice had been stymied – partly because he liked the taste of his Pepsi drink even less than did his customers.

  Charles commissioned his confectionery expert, Richard Richie, to reformulate Pepsi to taste something like Coca-Cola. Richard achieved this feat in a shade under three weeks. But it still wasn’t Coca-Cola and Loft’s customers drifted away.

  Loft stores were purchasing around half of all Pepsi-Cola syrup, making the drink little more than the store’s private label cola. Charles needed new outlets for his drink. His breakthrough came in 1933 in the form of a used bottle dealer. He suggested to the ever bargain-conscious Charles that he put Pepsi in used beer bottles. These were twice the size of Coke bottles but cost next to nothing. Like a drowning man grasping a lifebelt, Charles was all over this idea. He had been struggling to come up with a proposition for bottled sales that stood a chance against Coca. After some experimentation and following a suggestion from his head candy salesman, Charles had discovered the only chink in Coke’s armour: value.

  The price of Charles’ 12 oz. bottles of Pepsi was 5 cents, the same as charged for the 6 oz. bottle of Coke. This would be the saving of the brand, if not of Charles’ career. This bold tactic demonstrated two things. First, that Charles had been right to demand a discount. If he and his bottlers could fill and sell a 12 oz. bottle for 5 cents and both still make money, then Coca-Cola was abusing its brand monopoly and gouging its customers. Secondly, the move demonstrated something that remains true to this day: every brand has its price. If you can undercut a brand leader by a big enough price gap with a good enough product, then a significant number of consumers will switch.

  Charles was a bright enough to realise the vulnerability of Pepsi’s own position. If he could sell twice as much cola for the price of a Coke, then so could anyone else. He had a limited window of opportunity to make the most of this opening and solidify his position as the low cost supplier. His first move was to call all the bottlers he knew personally and plead with them to tool up for the 12 oz. bottle, promising to cover any losses should it not pan out. Within six months of agreeing, the first Pepsi bottler to do so was shifting a thousand cases a day. Charles used this evidence to sign up as many new bottlers as quickly as possible.

  The 12 oz. bottle was a runaway success. Within four years Pepsi was making over $3 million profit a year, through a network of over 300 bottlers covering the nation. Throughout this time, Charles C. Guth had been double-hatting. He was head of Pepsi-Cola (of which he owned 91%) while still managing Loft Stores. He had not run it very well. Loft lost money throughout the time he was resurrecting Pepsi from the grave. Loft and Charles fell out in spectacular style. The Loft owners sued him for his stake in Pepsi, claiming he had used their assets and people to build it up. Outside investors, seeing a juicy prize if the case was won, bankrolled Loft’s lawsuit, which they won. In 1935, ownership of Pepsi was transferred to Loft by the courts.

  Guth, who clearly had the skin of a rhino, stayed on as general manager hoping for a chance to win Pepsi back. He was finally kicked out in 1939 when he purchased another cola company to try the same trick. Loft paid him $3 million to go away and no doubt felt it a bargain. While Guth was a loose cannon (to put it mildly) and was perhaps not the man to take things forward, the fact is Pepsi would have died without him. If he hadn’t picked a fight with Coke and then latched onto the 12 oz bottle for 5 cents, Pepsi-Cola would have gone the way of all the
others Coke had put out of business. Instead, by 1940, Pepsi-Cola was the market number two, slightly ahead of Seven-Up with sales around 20% of Coke’s. They had a network of over 400 bottlers, earning the company over $8 million in profit a year; an amazing figure for a brand on its uppers seven years previously.

  Coca-Cola was hugely dominant in fountain sales where there was usually only one supplier. However, when it came to bottle sales in stores where there were many suppliers, Pepsi’s 12oz was accounting for an impressive 26% of sales. Coke bottlers and franchises, already living high off the hog with a license to print money, were not keen to wipe out the capital invested in the 6oz size. A bigger bottle was not introduced for another fifteen years, giving Pepsi the time to become a firmly entrenched competitor.

  Guth had been succeeded at the head of Pepsi by Walter Staunton Mack Junior, who would put his own indelible mark on the evolution of the Pepsi-Cola brand. Even though Pepsi was now well established, it was still very much the David to Coke’s Goliath. With an advertising budget one-thirteenth the size of Coca-Cola’s, Pepsi had no choice but to be creative. Mack endlessly encouraged a risk-taking approach. So when what looked like a couple of deadbeats walked into his office claiming to have the answer to all his problems, he did not throw them out. They immediately burst into song with a Pepsi jingle they had written. Mack couldn’t wait to sign them up. Most radio commercials at the time, including Coke’s, were five-minute-long, cover-all-the-bases eulogies to the endless benefits of the brand. A thirty-second ditty, sung to the tune of Do Ye Ken John Peel, while not unique (Wheaties had run something similar), was certainly in the margins of advertising practice. Radio stations didn’t want to sell airtime in 30-second chunks, when they could save 90% of the work by selling it in five-minute slabs. Nor was the advertising agency thrilled to be cut out of the creative process.