World Class Faculty & Research / October 28, 2015

A Consumer Goods Behemoth Faces Pressure

SMITH BRAIN TRUST — Is it time for the biggest consumer products group in the world to be broken up? Procter & Gamble may account for more than half of the market for laundry care in the United States (Tide, Gain, Downy), more than two-thirds of the market for razors and blades (Gillette), and 15.5 percent of the beauty and personal care market (Pantene, and on and on). That's added up to a market capitalization of more than $200 billion. But P&G’s sales have dropped by nearly 9 percent since 2012, and analysts are impatient.

In one survey, nearly two-thirds of institutional investors said they thought the Cincinnati-based giant would be more profitable if it were divided. The company reported mixed results last week, stressing that its "organic sales" — a measure that excludes acquisitions and divestments and currency-price moves — fell by 1 percent in the quarter. On a broader measure, it saw a 12 percent drop in sales (partly, to be fair, because it was hit hard by the strong dollar). Revenue per share was also up, but that did not quiet the skeptics.

The company has thrived in the past by charging a premium price for premium brands. By one estimate, its products cost on average about 30 percent more than those of rival companies. But more consumers are treating consumer goods like interchangeable commodities — and P&G has been slow to adjust. Procter & Gamble has been streamlining aggressively, having sold or eliminated 100 brands to concentrate on a core of 65. But advocates say that if it were operating as two or three smaller companies it might be even more nimble.

Procter & Gamble also has been slow to take advantage of new sales platforms. For instance, the Financial Times reports that it came up with the idea for an online subscription shaving club before the upstart Dollar Shaving Club did. But Dollar Shaving Club beat them to market and is now a disruptive competitor. And P&G relies heavily on TV advertising, even as consumers' attention has fragmented across multiple platforms.

"There are sound reasons, and some empirical evidence, for why spun-off companies do better than their parent companies," observes Smith School finance professor David Kass. "The managers in those new companies wouldn't have to go through several levels of approval for investments and strategy and funding, as they do now." At the same time, those managers would be given a stake in the new companies, aligning their financial interests more closely with those of their shareholders.

But Procter & Gamble's brands face problems that run deeper than bureaucratic sclerosis, Kass says.  "It's basic economics that manufacturers like Procter & Gamble could raise their prices when their goods were relatively inexpensive," Kass says. That's because, up to a certain price point, people don't pay much attention to price increases of a dime or two. At those levels, the demand for things like razors and detergent is "inelastic," to use the economic terminology. People will buy what they want despite small price moves. However, Kass adds, "Procter & Gamble has raised its prices to the point where demand is becoming elastic."

"Exorbitant" prices for Gillette razors, for example, are leading people to look for lower-cost substitutes. Executives might be inclined to say price sensitivity is a temporary blip, caused by the recent recession. But with the economy steadily improving, it appears that price sensitivity is the new normal. To bring prices into line with those of its competitors, P&G will have to make its manufacturing processes significantly more efficient. Its new CEO, David S. Taylor, who previously ran the global beauty, grooming and health care unit and begins his job Nov. 1, will have to decide whether the current conglomerate can make those moves, or whether smaller companies could execute that plan better.


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