For P & G, it’s a Hamletian dilemma

It has given the world washing powder, disposable nappies and soap operas. Now Procter & Gamble wants something in return: more time from investors to prove that the largest consumer group on the planet — with a market capitalisation of more than $200 billion — should not be broken up.

Against a backdrop of increasingly frugal consumers and stiffer competition the group, home to dozens of global brands from Tide to Pantene and Gillette, has seen market share in some of its core product areas fall sharply in recent years, with sales slipping 8.8 per cent since 2012 according to Bloomberg. And despite an ongoing $10 billion cost cutting programme, including the sale of nearly 100 brands, the pressure for more structural change is growing.

AG Lafley, pulled out of semi-retirement to be chief executive in 2013, was given the task of providing P & G with a new direction but the stock has since fallen 7 per cent. The question now is whether it can revive sales or has to take more drastic action, the most extreme option being splitting the company up.

“It’s hard not to be disappointed in the stock, not only from a profit standpoint but also execution standpoint,” says Valerie Newell, chairman of Riverpoint Capital, a Cincinnati-based advisory firm that manages $2 billion including P & G stock. “They have a lot ahead of them in terms of executing strategy [to re-establish growth]. There is a lot of validity in splitting the company up, it’s not out of the question at all.”

A survey of 62 institutional investors carried out by Bernstein analyst Ali Dibadj in June showed that 66 per cent said they would like to see the company broken up. Dibadj estimates that such a move would add between 9 and 18 per cent to the company’s valuation.

The tension over the future of the group may resurface when P & G issues first-quarter earnings. Analysts estimate that sales slipped a further 18 per cent to $17.1 billion between July and September. Jon Moeller, P & G’s chief financial officer, firmly believes that the company should remain intact to take full advantage of the economies of scale offered by centralised administrative and supply chain functions.

“I have probably done, or contemplated, more splits or spins than any sitting finance manager in the US,” he tells the ‘Financial Times’. “It’s not a structure I’m adverse to. But it is a structure that is very difficult to create value in.”

The responsibility of proving to investors that P & G can increase its top-line without breaking up will fall to incoming chief executive David Taylor, a company veteran of 35 years, who replaces Lafley next month. But time is not on his side.

P & G traces its roots back to 1837. More than 65 per cent of Americans still shave with Gillette while about half of the US fabric care market is dominated by Tide, Bounty and Downy.

But in the fiscal year ended in June, global volume fell in four of its five segments — beauty, hair and personal care, grooming, health care, and baby, feminine and family care. Only fabric and home care delivered increases.

The trouble at P & G had begun in 2009 as sales growth was hit in the wake of the financial crisis. Then chief executive Robert McDonald was criticised for losing market share and not getting a cost-cutting plan together quickly enough. Sales have dropped every year since 2013.

While rivals such as Colgate-Palmolive and Unilever acknowledged that the shift to more commoditised consumer goods is here to stay, analysts say that P & G put its head in the sand believing it was a temporary blip. The group is not alone in trying to pick its way through the huge shifts in the way people shop and what they want to buy. But the impact has been greater on P & G as it was slow to realise that the consumer has fundamentally changed and that the company’s premium pricing policies may no longer apply.

“For years, P & G has got consumers to pay more and more for products that are [now] viewed as commodities. The company needs to realise the world has changed, and it needs to take bolder actions to adapt,” says Dibadj.

In the US, where P & G makes 40 per cent of its sales and 60 per cent of its profits, its prices are on average 30 per cent higher than its rivals, according to Stephen Powers, an analyst at UBS. Critics argue, however, that it is not just about pricing and that P & G also needs to be agile enough to respond much more quickly to market changes. For P & G, it is a two-pronged problem: decision-making is still too centralised in Cincinnati for such a global company and many of those decisions involve too many people in the process.

“The company has become overly self-confident and very inward looking, and as a result has a high level of self-righteousness in a world that is changing fast,” says a former employee.

The US market for male grooming started to change in 2012. It has for many decades been owned by Gillette, with Energiser’s Schik a distant second, competing over the number of blades per razor and innovations such as “flexball” technology to help justify higher prices. But both were outmanoeuvred by the Dollar Shave Club — an online subscription razor delivery service — when it launched in 2012 to sell simple razors at lower prices.

Gillette — which has seen its dominant share of the US market slip by 4.2 percentage points since 2009 — had looked at creating a similar subscription service but delayed, finally launching Gillette Shave Club this summer. As of September Gillette had 21 per cent of the online shaving market compared with Dollar Shave Club’s 54 per cent, according to Slice, which tracks online shopping.

One person familiar with P & G notes that although Gillette had the shave club idea before its upstart rival, it was second to market. “It’s not about big eating small any more,” he says. “It’s about fast eating slow”.

In emerging nations it is also about understanding the local market and not assuming that a product that works well in one country will necessarily work well in others. In China, seen as critical for future growth, P & G admits it misread the audience for its Pampers nappies, aiming them at mid-market consumers when demand was much stronger at the top end. In response, it says, it is upgrading some products and introducing a premium-brand nappy.

While affluent Chinese parents may be choosing high-end nappies, many emerging market consumers are opting for home-grown brands across various categories. Amid the broader economic slowdown growth in the fast moving consumer goods market in China slipped from 12 per cent in 2012 to 4.4 per cent in the first quarter of 2015, according to Bain & Co and Kantar Worldpanel.

As well as becoming more frugal, and discerning, consumers have also become a little more difficult to find in one place. P & G, the world’s largest advertiser with an annual budget of $8.3 billion, has traditionally relied on television to connect with customers. But the changes, accelerated by a more fragmented media, is moving the company far from its soap opera roots.

Mark Pritchard, P & G’s global head of brands, says that even though digital technology has been developing over the past two decades, it is only now creating profound change.

As a result P & G is cutting $500 million out of its marketing spend, part of a ruthless paring back that has seen it axe 22 per cent of its non-manufacturing headcount a year ahead of schedule. On top of the marketing cuts it expects to trim a further $700 million this fiscal year to add to the $7 billion it has reduced over the past five years.

At the same time it is streamlining its domestic supply chain by investing in new multiple-product manufacturing plants and six distribution centres to get its products more swiftly to supermarket shelves. And as it expands overseas and seeks to mitigate the pummelling that the strong dollar has had on its profit, it is adding 18 factories in developing countries by 2017.

Analysts and investors believe Taylor has about a year to produce signs of a sustainable recovery in sales growth before investor patience wears thin. Riverpoint’s Newell says the new chief executive’s first few months could be what she calls “a kitchen sink quarter” — where the company spends more in a bid to build momentum.

Powers argues that P & G needs to do three things to revive its fortunes: sell more of its products over a wider range of prices, not just the high end; increase advertising spend and address the imbalance between domestic and emerging markets. While China, Brazil and Russia are tough markets right now, they are where the growth will be over the long term, he says. P & G’s sales are heavily skewed towards developed markets but emerging economies now account for 32 per cent.

“Its strategy has been to go where the consumer is more ready for [it], and it needs to be a bit more proactive in trying to plant the flag in the long run,” Powers says.

If progress is not swift under Taylor, calls for a break-up are likely to get louder, particularly if activist investors find a way to quietly build up enough of a stake to be influential, as Bill Ackman’s Pershing Square managed in 2012 before selling last year.

Dibadj insists the management should consider a split while top-line growth remains elusive. And he argues that despite its divestitures and increased efficiency, P & G’s stock has underperformed its peers and that costs still remain higher than those of its rivals.

He sets out two scenarios for the group’s future: splitting P & G into two companies comprising beauty and the rest; or three entities made up of beauty, grooming and health care, and fabric, baby and family care.

His estimates suggest such a break-up could add between 9 per cent and 18 per cent to P & G’s valuation. But others argue that while it is worth considering the viability of splitting such a large company, for now, with the focus on better integrating the business across categories, it is not a priority.

But investors remain unhappy. “The leadership drove the P & G bus into the ditch,” declared shareholder Karen Meyer — to applause — at this month’s annual meeting. “What assurances can you provide me as a shareholder that these directors, vice-presidents and presidents and the leadership that drove the bus into the [ditch] are the same ones that can get us out?”

It is a question Taylor is likely to be asked again when he takes control of the group in November. His answer could determine whether investors will give him more time.

— Financial Times