The rise of the superbrands

Consumer goods

Feb 3rd 2005 HONG KONG, NEW YORK AND PARIS
From The Economist print edition

Can Procter & Gamble's $54 billion merger with Gillette kick-start growth in the consumer-goods industry?

EVERY industry has its golden age. The makers of packaged consumer goods—quilted paper towels, tinned baked beans and other household essentials—enjoyed theirs around the middle of the 20th century. In the 1950s and 1960s, companies such as General Mills, Unilever and Procter & Gamble were delighting their customers with one innovative new product after another, from fluoride-enhanced toothpastes to fragrant fabric softeners and disposable nappies. But the industry's youthful vigour has ebbed away. Mr Clean, the bald, rugged sailor who fronts a line of domestic-cleaning products for P&G, turns 47 this year. (The chap has had a rejuvenating name change, however: he used to be called Mr Veritably Clean.)

One consumer-goods company that has fought as heroically as any against the onset of middle-age lethargy is P&G. In the past five years, the firm that was founded in Cincinnati in 1837 by William Procter, an English candlemaker and James Gamble, an Irish soap manufacturer, has boosted innovation, ditched losing brands, bought winning ones and stripped away some of the bureaucracy that has slowed its starch-shirted army of 110,000 “Proctoids”.

As P&G's share price has recaptured a little of its bounce (see chart 1), Alan (“A.G.”) Lafley, a dapper beauty-products specialist who became boss in June 2000, has grown bolder. On January 28th, he announced his company was buying Gillette—a maker of razors, shaving foam and other grooming products, as well as batteries and toothbrushes—for just over $50 billion. Stockmarket analysts and industry gurus whooped with delight. Mr Lafley called the deal a “unique opportunity” and a “terrific fit”. Gillette's boss, James Kilts (who will become a vice-chairman of the combined firm, and who stands to net more than $150m from the deal) said the merger would create “the potential for superior sustained growth”.

Even more fulsome in his praise was Warren Buffett, whose investment company, Berkshire Hathaway, owns nearly 10% of Gillette's shares. This “dream deal” would create “the greatest consumer-products company in the world”, he chortled, promising to invest more in the new firm.

The combined company will certainly be the biggest in its industry: it will have annual sales of more than $60 billion and a workforce that will top 140,000. But will it also be the best? Has Mr Lafley discovered among his shampoos, face creams and hair dyes an elixir of youth?

As Barbara Hulit of the Boston Consulting Group points out, the consumer-goods industry has found itself caught between slowing sales, rising costs and waning pricing power. Over the past five years, calculates Ms Hulit, the sales of the consumer-goods companies included in the S&P 500 index of big American companies have grown at a compound annual rate of just 4.7%. Meanwhile, their sales, general and administrative expenses have been rising by 5% a year.

Even with careful stewardship, the sales of mature brands tend to slip back towards their “natural” growth rate—population growth, plus inflation. P&G pioneered fabric softeners in the 1960s and scented sheets for tumble dryers in the 1970s. The industry introduced detergents as long ago as the 1930s. King Gillette founded the American Safety Razor Company in Boston in 1901. Ivory, a P&G-branded soap, traces its serendipitous history back to 1879, when James Gamble, son of the founder and a trained chemist, accidentally cooked up an unusually pure, floating soap in his laboratory.

Commodity prices have risen sharply recently, pushing up the cost of the foodstuffs, chemicals, packaging and energy that go into making the industry's products. There was a time when consumer-goods firms could pass rising costs on to their customers. But the spread of aggressive, big-box retail chains such as Wal-Mart (whose strategy is built around passing on savings won from suppliers to its shoppers), Carrefour and Costco has destroyed much of the industry's pricing power.

Meanwhile, retailers have begun plugging their own discounted, “private label” brands that compete with the pricier, higher-margin products from Unilever and P&G. As retailers have grown in clout, they have also squeezed the consumer-goods firms for more “trade spending”—the money the likes of P&G must stump up for in-store promotion, displays and eye-level shelf space. About 17% of the consumer-goods industry's sales disappear into such trade spending, says Ms Hulit.

Meanwhile, the complexity of advertising, marketing and distributing branded consumer goods has soared, further pushing up costs. P&G is the world's biggest advertiser, with a budget of around $3 billion last year. A decade ago, 90% of its global advertising spending went on television. Today, for some products only about a quarter of the budget is spent on television. The audience for traditional media is fragmenting, making consumers harder and more expensive to reach. So, along with other consumer-goods companies, P&G is finding that so-called “below-the-line” forms of marketing, such as in-store promotions, posters, coupons and sponsorship, are often more effective.

Hair today

The purchase of Gillette follows two other big acquisitions since Mr Lafley took the top job at P&G. In November 2001 he bought Clairol, a hair-dye company, for $5 billion. Two years later, he spent $6.9 billion on Wella, a German beauty firm. Less noticed, but perhaps more important to P&G's rejuvenation, has been Mr Lafley's willingness to jettison tired brands.

As David Harding of Bain, a consultancy, points out, consumer-goods firms find it hard to boost growth by letting go of older, slower-growing brands. These brands have become so established in the minds of shoppers that they sell themselves, points out Mr Harding—customers buy them without thinking. That makes them a good source of profits. But they also eat up scarce management time and marketing talent on lines of business that are unlikely ever to grow much. At P&G, Mr Lafley has shed Punica, a German juice brand and Sunny Delight, an American one, Jif (peanut butter) and Crisco (pastry shortening). He has also got rid of P&G's BIZ, Milton, Sanso, Rei and Oxydol detergent brands. (The Oxydol sale must have especially hurt sentimental Proctoids: the soap powder was the proud sponsor in 1933 of “Ma Perkins”, one of America's first soap operas.)

The combined effect of these sales and purchases has been two-fold. First, Mr Lafley has given P&G's portfolio of brands a sharper focus on beauty and grooming products, where he spots more potential for growth. Second, by reinvesting cash from P&G's sales back into its strongest brands, Mr Lafley has bet more of the firm's resources on a smaller number of top “superbrands”, which are contributing more and more to the company's overall sales. In 2000, P&G owned ten brands each with annual sales of more than $1 billion. By 2004, it had 16 brands with sales over $1 billion. Together these earned the firm $30 billion of its $51.4 billion of sales that year. The purchase of Gillette, where Mr Kilts has followed a similar strategy, adds a further five superbrands. “P&G has done really well consolidating its brands down to a strong core,” says Uta Werner of Marakon Associates, a consultancy.

P&G is hoping that this growing stable of superbrands will help it to weather the industry's tough environment. Competition for the modern consumer's attention is ferocious. Steven Fredericks, the chief executive of TNS Media Intelligence, says that he adds an astonishing 400-700 new brands every day to the 2.1m brands that his New York company already tracks. These can range from a new face cream to a new model of car, or a film (which is now considered a brand). Advertising executives in Japan reckon the number of new beverages that enter the market each year runs into the thousands. Most perish almost instantly in the relentless battle for scarce shelf-space in Japan's small shops.

The superbrands should also help P&G to focus research and development spending on the most promising products. Like Gillette, P&G prides itself on its skill in adding incremental innovations to seemingly mature products, and then persuading customers to part with more money for them. Over the years, King Gillette's safety razor has added more blades, a lubricating strip, a high-tech handle and (triumphantly, last year) an exorbitantly-priced battery-powered version featuring “micro-pulse technology”.

P&G, meanwhile, has turned the humble floor mop into a “swiffer”, an “all-in-one, ready-to-use mopping system” that features an “action sprayer”, “premixed cleaning solution” and super-absorbent, triple-layer cleaning pads. Together, the two firms hope to transform yet more mundane household goods into technology-rich marvels. Since research suggests that the average supermarket shopper spends just a few seconds pondering each purchase and is unlikely to know the price of most items, P&G's and Gillette's push towards the frontiers of household-goods technology could prove profitable.

Another trumpeted benefit of the merger is the access Gillette will win to P&G's more evolved distribution network in developing countries, where the potential growth rate for the industry's products remains higher than in America, Europe or Japan. As the world's fastest-growing big market for consumer-goods firms, China will be critical to the success of the merger. P&G's long experience there should help it to push Gillette's lesser-known brands to the mainland's rising middle classes.

Chinese lessons

P&G has the best track record of any consumer-goods firm in China, says Tom Doctoroff, the head of greater China for J. Walter Thompson, an advertising agency that is part of WPP. This is because it has bothered to learn what sells in China and, importantly, how much consumers are willing to pay for their slice of western convenience and style—still relatively little.

In shampoo, for instance, P&G's Rejoice brand has won a 25-30% share of the Chinese market. Its Olay skin-moisturising brand is a market leader and has tripled sales since 2000. The overall skin care category should double to $3.4 billion by 2010, Laurent Philippe, the head of P&G's Chinese business, said recently. But Chinese consumers are wary of new products and prefer a trusted brand. So P&G is hoping to capture its share of that growth by extending the Olay brand across a range of categories (such as whitening creams) rather than by introducing rivals.

P&G has also been quick to understand the importance of advertising on China's national television network—long considered too expensive by other multinationals. In a country where people are, from long experience, suspicious of fine-sounding claims, China Central Television (CCTV) is a much-trusted broadcaster. Unlike in the West, where media are proliferating, CCTV still dominates the airwaves, and families all across China believe in it. As a consequence, products sold on CCTV also tend to be trusted. It must feel to P&G as if it has rediscovered in China the golden age of the American mass market.

Firms such as Wahaha, which sells water, milk and soft drinks, and Haier, a white-goods group, have become household names because they have spent money advertising on CCTV. P&G was the first foreign company to take CCTV seriously. Last November, it became the biggest overall spender in the national auctions for airtime held by CCTV, paying 385m yuan ($46.5m) for advertising slots. The slots will help P&G to develop its business in central and western China and second-tier cities.

All this has translated into strong results: the group's sales in China have grown by 25% for three consecutive years, to nearly $1.8 billion at the end of 2003. Profits, meanwhile, have risen by an average of 140% a year. Already, that growth has elevated China to P&G's sixth-biggest market in 2003. It could eventually claim second place behind America.

Old Europe

In Europe, the merger of P&G and Gillette could trigger a series of takeovers or brand sales among rivals. Europe's consumer-goods firms are already struggling with the strength of the euro and rising commodity prices. As in America, there is also increasing competition from supermarkets' own brands, which are taking more shelf space. Suddenly, the two biggest European players, Unilever and L'Oréal, are looking less like giants.

Unilever, an Anglo-Dutch company, is Europe's biggest producer of consumer goods. It has been struggling to get into better shape for several years. In February 2000 it announced its “Path to Growth”, an efficiency drive that has saved about €4 billion ($5.2 billion) in costs. It also reduced its portfolio of brands from 1,600 to around 400. But it has failed to meet targets for sales and profits. The company's sales declined by 3.8% and its net profits were down 16% last year, according to estimates by Merrill Lynch, an investment bank. Last September, the company issued its first-ever profit warning. It will unveil its latest strategy on February 10th.
Some of Unilever's brands are known around the world. They range from Dove skin products to Surf washing powder to Hellmann's mayonnaise—the world's top-seller. It is also a leader in personal care. Unilever's Axe range of deodorants (sold as Lynx in Britain, Ireland and Australia) is reckoned to be the world's most popular grooming product. It was launched in America only in 2003.

P&G is already Unilever's biggest rival in health and personal care, which represents almost half of Unilever's business. Gillette competes with Unilever as a producer of toothpaste, deodorant and cologne. As a combined force, they stand a better chance of attacking Unilever's strengths. Emerging and developing markets, such as India where Unilever has a strong, local operation called Hindustan Lever, have traditionally been the company's forte. But P&G has been catching up. With the addition of Gillette, it will almost be on a par with Unilever in many areas outside Europe and America.

Brazil could be an early test of the contest to come. Unilever controls a quarter of the Brazilian market for toothpaste, and P&G's product is hardly known. But Gillette has about a third of the market for toothbrushes. The merged firm can combine its effort, perhaps to launch a joint brand of toothpaste in the Brazilian market, says Lauren Lieberman, an analyst at CSFB, an investment bank.

For L'Oréal, which was founded in 1907 by a French chemist who invented a new way to colour hair, the merger could be good news—at least while P&G is distracted by making the deal work. L'Oréal has faced fierce pressure from P&G in its core hair-care market.

History suggests that rivals will try to adjust to the new competitive landscape, perhaps quickly. Unilever's acquisition of Bestfoods in 2000 triggered a wave of consolidation. Kraft, an American food company, bought Nabisco, the maker of Oreo cookies and Ritz crackers, and Pepsi bought Quaker Oats. In 2001, Nestlé paid $10.3 billion for Ralston Purina, an American pet-food company.

Even before the latest merger there was plenty of gossip about possible deals. Reckitt Benckiser, a British household-products company, was recently courted by Colgate-Palmolive, an American maker of toothpaste. P&G has also been seen as a potential buyer of Beiersdorf, a German skin-care company, and Henkel, a German maker of laundry detergent. Henkel says it does not feel especially threatened by the P&G merger as its products barely overlap with those of Gillette. Beiersdorf, on the other hand, sells lots of men's grooming products similar to those made by Gillette. But it insists it can do well on its own.

Scale or strength?

Others may now be interested in buying these companies. But Sylvain Massot, an analyst at Morgan Stanley, an investment bank, says European consumer-goods groups will first have to decide whether size is really so important. The jury is still out on whether firms focused on a few core brands will inevitably lose out to cross-category giants. Advocates of size think that a big company can leverage scale to cut costs, use these savings to invest more in advertising and innovation, and so gain even more scale.

But there are also diseconomies of scale. Giant firms can find it more difficult to move quickly, and their costs can balloon. In particular, mergers take discouragingly long to complete. P&G is still far from finished integrating Wella, for example, and may need many months, if not years, to do the same with Gillette. In any case, strong brands are more important than scale, argues Klaus-Peter Nebel, a spokesman for Beiersdorf, a company less than one-tenth the size of the new P&G. (Beiersdorf's skin cream, Nivea, is one of the strongest brands in the industry.)

Indeed, some of the most successful consumer-goods companies over the past decade have tried to become leaders in just a few product categories, relying on focus rather than scale. Reckitt Benckiser, for instance, is thriving with a limited product range. L'Oréal sold its pharmaceutical business to focus on hair and skin care. In the food industry Danone is selling only water, biscuits and yogurt, but is a world leader in all three.

Mr Lafley's latest deal is aimed at capturing the benefits of both scale and focus, creating a business that is both larger and more reliant on a smaller portfolio of stronger brands. Barring objections from American or European competition authorities, P&G's acquisition of Gillette should achieve this. Whether the new merged firm will then be able to rekindle the consumer-goods industry's dreams of youth remains to be seen.

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