FMCG
Page 64
Summary
Unilever is perhaps the best example of how understanding a company’s formation, roots and early evolution helps us to understand it both today and tomorrow. The company seems to have been evolving since the day of the merger and is only now emerging from its chrysalis. Not that such a prolonged evolution has been a major problem; along the way, the company has built skills and market positions that now simply cannot be replicated.
The single major question mark over Unilever is the role of the foods division, which doesn’t really fit in with today’s company. Skippy has already been sold and surely Slimfast can’t be far behind. We believe the rest of the foods division should be added too, and for four key reasons:
· The logic that brought margarine and detergents together in the first place no longer applies: their technologies and ingredients have diverged too far
· As the company becomes ever more global in what and how it operates, many of the foods brand are more local in strength, with thousands of differing recipes. 65% of sales are outside emerging markets where the company is strategically advantaged. Instead they operate in developed markets where Unilever perennially struggles to gain momentum
· While the benefits of green tea in the company’s Unilever Sustainable Living Plan are plain to see, it’s hard to see how the planet will benefit from the sale of more Hellmann’s Mayonnaise.
· We believe the Unilever of today would not buy Bestfoods if it were still independent and up for sale. It doesn’t leverage its strengths or strengthen its powers and abilities. If P&G bought those brands today Unilever wouldn’t lose any sleep.
· The tea and ice cream businesses have global scale, with global and regional brands and a much clearer role in the company’s strategy. Margarine, stock cubes and salad dressings don’t. They need to go and the sooner the better
And with that, Unilever would be unstoppable.
Emerging Markets
China
We may live in a global economy but the eighteen businesses we have looked at so far embrace just six locations: twelve American, two French, one Swiss, one German, one British/Dutch and one British/Dutch/German based in Britain. Of the CEOs on April 17th, 2013 there was a little more diversity: seven Americans, two French, two Indians, a Turkish-American and one each from Italy, Australia, the U.K., Belgium, Holland, and Denmark. And every company except Estée Lauder Company predates the Second World War, although several - Dean Foods and Reckitt Benkiser are good examples of those who have radically transformed themselves into their current guises more recently.
So is it the case that today’s biggest FMCG companies, most of who have been big for a very long time, will remain the biggest? How likely is it that new global giants will arise from the emerging markets in which virtually all packaged goods growth is taking place? After all, there are plenty of giants in other markets: India’s Tata group is now a global player in steel, soda ash, cars and, in a formerly exclusive packaged goods fiefdom, tea. Lenovo was established in China in 1984 to conduct quality checks on computers. Then it developed a circuit board that allowed IBM-compatible personal computers to process Chinese characters. Twenty-one years later, it bought out IBM’s personal computer division to become the world’s third-largest PC manufacturer.
However, virtually all the companies we have looked at have already built up substantial businesses in the key emerging markets, firmly establishing their brands and usually setting the performance benchmarks for the categories in which they compete for business. Does this mean they are invulnerable to a new generation of competitors? Are they not big enough and global enough to buy any emerging markets players before they are powerful enough to pose a threat? And would it really matter if a local Indian firm took on Hindustan Unilever Ltd and beat it? When Hindustan Unilever itself is already a huge, successful and thoroughly Indian business, what difference would it make to anyone other than Unilever employees and shareholders?
There are many reasons to believe that there will be no big new players joining those we have already covered, at least for the next ten or even twenty years. But that’s the way it often seems; the reasons for decline and fall only become obvious in hindsight. Nineteenth century giants included Lydia Pinkham’s Vegetable Compound and Brandreth’s Purgative Pills, yet they and others like them were comprehensively undone by a long-running campaign against the patent medicine industry by the deceptively benign-sounding Ladies Home Journal. No doubt the Pinkham and Brandreth managers thought of themselves as both invincible and immortal. But they had been cheating the consumer for many years; their products’ lavish claims were exposed as illusory -temporary and palliative at best - and their corporate cynicism and greed led to ignominious oblivion. Today’s products, undoubtedly as well equipped in the cynicism and greed departments, do at least deliver the benefits they claim: the law says they have to. So we are inclined to forgive them the rest.
But new technology can radically change the existing order: Nestlé was founded on the invention of infant formula and Kraft on processed cheese. Might such watersheds happen again? Or will the tens of thousands of R&D professionals working in the large firms, and backed by hundreds of millions of dollars, permanently maintain the upper hand? The answer is no. The unlikely pairing of Chaleo Yoovidhya and Dietrich Mateschitz beat the combined brains of the world’s largest soft drinks firms with the product they devised: in 2011, Red Bull shifted 4.6 billion cans.
The rise of Red Bull, and the many similar drinks riding on its coat-tails - including some from the established giants - is a good example of an inherent weakness in the large packaged goods firms, the desire to perpetuate the brands that made them giants and kept them that way. While many companies preach disruptive innovation, they are very selective about where the disruption should take place: in other peoples’ brands. Huge chunks of every company’s R&D budget go not to innovation but to perpetuating existing products’ status quo, improving profitability by cheaper ingredients with the same functionality or improved production processes. No real innovation there, and certainly no disruption.
But many of the giants will also feel that diversification itself protects against disruptive innovation. If some brash new idea makes Swiffers redundant overnight, P&G have enough other businesses to make this a problem to be solved in time rather than a catastrophe to be weathered at all costs. But diversification can itself become a weakness. Is Dolce & Gabana a stronger brand for being owned by P&G? Is P&G stronger for owning it? Are the executives running Estée Lauder quaking at the thought of a shoot-out with P&G? Or are they relishing the opportunity to use their industry expertise to teach the makers of Pampers a lesson about perfumes?
In fact, many of the companies we have looked at remain complacent, despite the fact that their annual reports increasingly chart a private label growth that is beginning to restrict their ability to pile on the price increases. In the glory days of television advertising, retailers could be and were treated like second-class citizens and their cheap, poor quality, private label offerings dismissed as jokes. However retailers today arecomplex modern businesses, with both manufacturing capacity and resources that are greater than some of the companies we have looked at in the preceding pages. If you analyse the world’s top 20 FMCG, manufactures, you will find that seven of them are retailers.
And the world is changing. Asia and South America are driving the growth of a global middle class, which means that these days, the giants cannot afford to be anything like so laisser-faire. The possibility of being taken on and beaten by upstart companies in emerging markets is all too real. How? Let’s take three developments in China as our examples.
Inherently Local Industries
Whether the multinationals like it or not, there are some key packaged goods categories in which being global gives few, if any, advantages beyond cash resources. PepsiCo, for example, sets great store by its ability to offer local flavours of potato chips. This is possible because it is more economical to
disperse potato chip manufacturing, than to set up colossal regional or global factories, whose efficiency is compromised by short product life and the product’s high volume. When you have only six weeks to distribute and sell a product whose packaging is mostly air, you make more money by having smaller factories as close to the market volume as possible. But this reduces any would-be competitor’s entry costs dramatically. And China, the world’s largest potato producer, already has over fifty companies in the market.
Mengniu
An industry that demands even greater localisation is dairy. The Mengniu Dairy Group was founded in 1999 by Niu Gensheng who began his career in 1978 working for a dairy in Hohhot, capital of the Inner Mongolian Autonomous Region in north-central China. By 1998, Niu worked his way up to become the Vice CEO of Inner Mongolia Yili Group, one of the largest dairy manufacturers in China. But Niu Gensheng would not be the first manager in the dairy industry to think he could do things better than his employer. Like Dean Foods’ Ted Best, Niu Gensheng set out on his own, took over a small dairy producer, Mengniu Dairy. In five years Mengiu was a listed company on the Hong Kong exchange.
In this case, scale was the key. The dairy chiller, perhaps the least glamorous part of the grocery store, has a huge turnover per linear inch compared to the darker recesses of the dry goods aisles, yet it depends mainly on local, relatively small suppliers, dairy even more than potato chips, since it is mostly commoditised and so does not usually come to the attention of the large-scale branded companies. But when you buy up a lot of dairies, you also buy the scale to invest in the production of other dairy products where brands play a greater role - such as yoghurt and ice cream, and an equally scaled-up retailer relationship for your branded products.
Following this pattern, by 2005, Mengniu was operating 14 production sites, processing 2.8 million tons of liquid milk and selling three categories of products: liquid milk products (UHT milk, milk beverages and yoghurt), ice cream and other dairy (milk powder and milk tablets). Turnover had reached $1.3 billion, only $200 million behind his old employer Yii, the market leader.
If the highly fragmented nature of the Chinese dairy industry had made the achievement possible in the first place, it took two further ingredients to catapult Mengniu to the number one spot: better technology enabling more differentiated products and effective branding. The technology came through a 2006 joint venture with the European dairy giant, Arla Foods, a Danish, Swedish and German-owned dairy co-operative. Together, the companies established Mengniu Arla (Inner Mongolia) Dairy Products Co. Ltd. The goal was to build the best milk powder brand in China by adding high- value nutrition products. That such a product could also continuously improve the health and life-quality of Chinese people did no harm at all, and, within one year, Mengniu Arla opened one of the world’s most advanced dairy R&D centres, simultaneously launching a full series of milk powder products catering for practically every group you can thinks of, from babies to adults, milk powder for pregnant women, newborns, 7-year-olds, students and seniors. The company advertised hugely throughout China, sponsoring the Chinese space programme via campaigns announcing ‘special milk for Chinese astronauts’ on and after the launches of the manned Shenzou 5 and Shenzou 6 spacecraft.
Not all joint ventures proved so productive, however. Mengniu signed a series of contracts with Danone in December 2006 to set up three yoghurt joint ventures in Inner Mongolia, Beijing and Ma’anshan with ownership split 51:49 in favour of Mengniu, with a one-year get-out clause in case of corporate fire. Some progress was made, but the partnership failed, due primarily to local governments failing to grant the required approvals and consents, and parties agreed a termination in December 2007. Some cooperation continued - co-packing and distribution of yoghurt under the BIO brand, for example – but that too came to nothing, as Danone reconsidered its China strategy following a huge legal battle with the Wahaha group.
The trouble with going the branded route is that your business increasingly depends on the brand reputation. So when the Chinese tainted milk scandal broke in 2008, Mengniu, by no means at the centre of the problem, still found itself in difficulties. The chief culprit was Sanlu, a cut-price producer that had been adding melamine to milk to boost its apparent protein levels. But the practice spread to dairies that supplied both Mengniu and Yili with almost disastrous consequences. Even though the company immediately recalled the products involved, it suffered mass de-listings by supermarkets and found its export markets in Malaysia, Singapore, Taiwan and the Philippines suddenly closed. The company’s shares took a hammering on the Hong Kong Stock Exchange. Only an injection of capital from state-owned COFCO Ltd., China’s largest food importer and exporter, plus with private equity cash in return for 20% of the equity, kept Mengniu afloat.
But the storm passed: by the end of 2009 Mengniu was again one of the top 20 global dairy companies, a year later made number sixteen in the world and, both in volume and value terms, number one in China. In 2011, sales reached a new high of just over $6 billion, with 90% in liquid milk products, 9% in ice cream and 1%. In liquid milk, UHT accounted for a steadily declining 61% with the more strongly branded beverages making 25% and yoghurt 14%. Milk Deluxe, Champion, Future Star, Fruit Milk Drink and Youyi C all enjoyed strong double-digit growth, moved from 17% in 2008 to 27% in 2012. It was this strong, branded portfolio that decided Arla to take a 6% stake in mid-2012, a closer cooperation it is hoped will increase Chinese five-fold by 2016. Nor need these sales come at Mengiu’s expense: the company’s market shares in all main product categories are still below 30%, leaving plenty of room for further organic growth through nationally advertised brands and superior NPD capability.
The next big question is how aggressive the company will be in looking beyond China once homeland growth flattens out. It will certainly have the scale to make significant acquisitions and both the technical and the branding capabilities to do so. We should watch that space: by 2020, China is likely to be should be the world’s number one economy, with India at number three and Russia at number five by PPP.
Expansion from Other Areas of the Value Chain
It is often forgotten today that one of the main stimuli for brands and branding was the never-ending struggle between producers, middlemen and retailers for a greater share of profits. Before the emergence of modern brands in the mid-19th century, the key player in the value chain had been the middleman, whose access to capital and credit gave them the ability to strong-arm the subscale pre-industrial manufacturers of the day. But the scale of industrialization enabled the early mass production barons to reverse this position and encroach upon the banking and credit facilities previously controlled by the merchants, thus largely squeezing them out of the picture.
Branding was born both to compete with other manufacturers more effectively for sales and to squeeze better profits from the retailer and it did so by talking directly to the consumer about superior quality. The process was enhanced by packaging, which protected products from adulteration by retailers and provided a better canvas from which to communicate brand identity. Middlemen were now much more transporters and distributors, and were squeezed even there as companies saw the merchandising benefits of delivering direct themselves. Branding strategy was so successful that we now tend to see it as the natural preserve of the manufacturer. The recent crumbling of that edifice, as evidenced by the remarkable rise of retailers’ private labels from the 1990s onwards, should not have come as the shock that it did Had manufacturers looked more carefully, they would have seen that the economics and technologies which underpin branding were changing.
This shift of brand power from manufacturer to retailer does illustrate that there is no natural and permanent locus of branding in the value chain; from the industrial perspective, the locus of branding can be different. Any player in the value chain -producer, distributor or retailer - could be the predominant force in the right circumstances. Occasionally, the middleman became the brand owner himself: two such example
s being bananas and port wine.
For its entire history, Chiquita has been an expert in the transportation of bananas which largely grown by independent farmers. By transporting bananas for many producers and retailers, it was able to lead the value chain by unlocking benefits of scale: the larger the warehouses and refrigerated ships, the cheaper the bananas. The little Chiquita label gives assures the consumer that his bananas are not only good value, but trustworthy. Which gives the company the power to squeeze at both ends, growers and retailers alike. Sherry and port are very similar cases: Harvey’s in sherry, and Sandeman’s in port, also hold the whip-hand.
Brands that flow to the product from the middleman has breathed new life into the role and function of the middleman and almost certainly changes the developed market manufacturer-retailer dynamic The rise of the Chinese economy as supplier to the western world presents new opportunities for a new kind of competitor which follows this model. Li & Fung is a very good example.
Li & Fung
Li & Fung is a Hong Kong company whose roots go back to the early 1900s, when it became one of the first Chinese-owned export companies in a market dominated by foreign-owned trading houses. Li & Fung began by exporting porcelain and silk products, mostly to the US, but soon expanded into jade, bamboo, rattan furniture, fireworks and handicrafts. It filled a valuable and hence profitable role: in most cases in those days, American buyers spoke no Chinese and Chinese manufacturers spoke no English, so the company could charge high commissions. But the Second World War was forced the company to cease trading for several years. Then the 1949 communist takeover of China delivered a second and almost fatal blow, cutting off all suppliers in the Chinese hinterland. So Li & Fung reoriented itself to source from the Hong Kong itself, where the manufacture of labour-intensive products - toys, plastic flowers, garments and electronics – had begun. Li & Fung became Hong Kong’s largest exporter of these new products.