United States: Growth in Consumer Goods: There’s More Than One Way to Skin a Cat

Originally published January 26th, 2005

Despite the enormous buying clout of mega-merchants like Wal-Mart, Target and Carrefour, fast-moving consumer goods (FMCG) companies have actually outperformed retailers in the capital markets over the past decade. From 1994-2003, the mean annual total return for the top 25 U.S. and European FMCGs was 11.8% compared with 9.6% for the top 25 retailers, a nearly 25% difference. Consumer products makers also earned 74% of the 50 companies’ combined economic profit over that timeframe.¹

How did they do it? Through massive cost reductions and disciplined product portfolio pruning. For example, Unilever, the Anglo-Dutch consumer goods giant, has shuttered more than 100 factories, cut its workforce by 33,000 and pared its number of brands from 1,600 to 400 since 2000.² Procter & Gamble, Cadbury Schweppes and Nestlé have gone through similar cost-cutting and portfolio restructuring initiatives. The products and brands that survived have the strongest consumer franchises and the largest appeal to retailers.

Today, however, as investors look increasingly for top-line growth, many consumer goods makers seem to be reversing themselves by adding costly new products to their portfolios. In addition to developing line extensions for product categories they already participate in, FMCGs are increasingly introducing new products into "adjacent" categories – product categories that are similar to the ones they already cater to and that are often sold in the same supermarket aisle.

For example, Kraft Foods’ Nabisco, known for its cookies and crackers, rolled out a low-fat wheat chip, Ritz Chips, in 2003 to steal sales from the potato chip aisle. More recently, the makers of Huggies (Kimberly-Clark) and Pampers (P&G) have introduced lines of toiletries for babies and small children to leverage their diaper franchises. Why the focus on adjacent markets? By moving into neighboring categories, these companies and others have sought to significantly reduce the risk of innovation by launching new products that are close to their core businesses – products they think can capitalize on their brand names, consumer understanding, distribution systems and shelf space access.

While the wheat chips and children’s toiletries appear to have been successful introductions, our experience in advising several FMCG companies suggests that adjacencies are not a panacea for sluggish growth. They often disappoint. Consumer goods makers frequently overestimate their knowledge of the adjacent segments and the potential advantages they bring to the new product category – i.e., the value of the brand, distribution system and other assets. Think of Dryel, P&G’s home dry-cleaning kit. After a promising introduction in 1999, sales of Dryel plunged in its second year once its promotional budget dried up and rival kits from Dial and Clorox hit the market.

In other cases, consumers do not benefit enough from the company’s entry into a category because the new products lack superior features or fail to provide superior value. Two classic examples: BenGay aspirin and Bausch & Lomb mouthwash.

Furthermore, in almost all cases, consumer products companies grossly underestimate the response of competitors, which quickly introduce a rival product of their own, cut prices or increase spending to protect their turf – all of which erode margins and shrink the profit pool for everyone in the category. One FMCG that recently recognized this and made the smart decision to scrap a costly launch in the UK was Gillette with its Gillette Complete men’s skincare line.

With new entry into adjacent categories increasingly in vogue (and admittedly a number of recent successes to point to), attention is being diverted from other, potentially more lucrative opportunities for growth. Leading consumer goods companies know this and pursue multiple avenues simultaneously. The breadth of options can be illustrated by the matrix in Figure 1.

Along the horizontal dimension, we look at the relatedness of a business to the company’s existing businesses. In-market growth is about getting more new or existing products into categories and to consumers already served. Adjacent growth represents entry into reasonably related products and services to existing and/or new consumers. New platforms – also sometimes referred to as "far from the core" or "unrelated diversifications" – are products/services and/or consumers that are not at all similar to those of the company’s current businesses.

The vertical dimension captures whether the growth is achieved through build or buy activities. The in-house development of a new product is typically a "build" activity, while the acquisition of another company or business unit is a "buy."

As consumer goods companies pin their hopes on the development and launch of new products into adjacent categories, we believe many of them underestimate the remaining potential for profitable growth in in-market categories. For example, many marketing departments claim that initiatives to serve Latino/Hispanic or African-American consumers already exist. However, we have also found that these companies often support such initiatives insufficiently, skimping on people and funds. Leading consumer products companies take a much different posture. In 1999 and 2000, for example, PepsiCo created senior-level advisory boards for the African-American and Latino/Hispanic consumer segments and invested substantially in tailoring products, distribution, and messages for these markets – with great success.

Similarly, many consumer goods makers have not made the most out of their marketing investments. FMCGs could get more bang for the investment buck if they were to more closely integrate business strategy development and marketing investment planning, and consequentially allocate larger portions of their budgets to those brands and geographies with more top-line headroom, higher profitability, stronger consumer responsiveness and lower competitive threat. Furthermore, sophisticated marketing science approaches can help systematically identify those consumers within each product market who are inclined to buy and/or use their products more often. By following through with a targeted marketing investment plan, companies can reap significantly higher sales growth out of the same budget.³

We also think there is considerable potential for top-line growth in creating fully integrated retailer strategies – collaborations between consumer goods companies and retailers to jointly serve their customers better. P&G, for example, has helped make Wal-Mart a destination for health and lifestyle information by cosponsoring "Speaking of Women’s Health," a program that highlights P&G products (among others) at conferences and community events, in-store education centers and on a national TV series. The program has reportedly yielded P&G $5 in increased sales for every dollar invested.⁴ Just recently, Estée Lauder inked a similarly creative deal with Kohl’s to outfit its stores with beauty departments for the first time. The departments feature Lauder-trained sales staff, beauty counters and new cosmetics and skin care lines exclusive to the retailer. Such moves help retailers differentiate themselves, while consumer goods makers build profitable volume with key accounts.

Another avenue for profitable growth that consumer product companies have underutilized is large-scale acquisition. True, many FMCGs have acquired small start-up companies and/or noncore business units of their competitors. And many experts agree that acquiring a series of small businesses is a way to learn over time how to better make and integrate acquisitions. But most of the brands and businesses for sale today are being shed by consumer products giants that are restructuring their portfolios. How many winners are likely to be found among those?

While clearly not a game for everyone to play, there may be substantial benefits in large-scale acquisition. The big plays we have in mind, however, would not be aimed at consolidation within a product category. The concentration within any one FMCG category is already quite high, and government antitrust officials are unlikely to approve further consolidation.

Instead, select FMCGs should seek to acquire big in order to reach familiar consumer segments with a wider range of products and to leverage distinctive capabilities. We think the basis for recapturing an acquisition premium may have shifted. Specific product category knowledge may be less important for creating value with an acquisition than the ability to apply valuable core competencies to a combined portfolio. For example, companies that are excellent at restructuring tired product/brand portfolios and cutting costs may be able to replicate their successful initiatives on a much larger scale after buying another big company. Marketers who have figured out how to reach African-American and Latino/Hispanic consumers with their products may be able to apply their capability to a whole different set of categories. A company that is excellent in integrating strategy development with marketing investment planning can infuse this competency into another company in which strategy and marketing planning are less coordinated.

With this perspective, PepsiCo buying Quaker Oats and Kellogg buying Keebler make a lot of sense. Why is it that we aren’t seeing more such moves? After all, since those acquisitions were announced just over four years ago, PepsiCo and Kellogg have outperformed their global peers in annual total returns by 4.0% and 8.6%, respectively. Perhaps it’s because consumer goods makers are too focused on developing new products for adjacent categories. Now they must quit dabbling and pursue a broader range of growth avenues with sufficient investments behind each avenue. Multiple approaches to accelerating organic growth in categories already served and major acquisitions show significant promise.

Uta Werner is a Partner in Marakon's New York office. She can be reached at uwerner@marakon.com.