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A brand-name survivor in a Wal-Mart world
Private-label goods have just about killed the brand as we know it -- except for those that never stop innovating. Nobody does that better than Procter & Gamble.
By Jim Jubak
The brand is dead. Wal-Mart Stores (WMT, news, msgs) killed it. With help from Target (TGT, news, msgs), Costco Wholesale (COST, news, msgs) and Tesco (TSCDY, news, msgs).
Which is why I think you ought to buy shares of Procter & Gamble (PG, news, msgs), the "king of the brands" that just acquired Gillette (G, news, msgs) and its stock of brands. The owner of Pampers, Pantene, Bounty, Pringles, Folgers, Charmin, Downy, Crest, Clairol, Dawn and Olay knows that the traditional brand is dead, and it is the consumer company best positioned to grow in the post-brand world. P&G shares should be a core holding in the portfolio of long-term investors looking for solid growth with a minimum of risk. (Procter & Gamble pays a 1.9% dividend too.)
Let me show you how I get to that recommendation.
The traditional brand is dead, dead, dead
Start with the fact that private-label products accounted for more than 15% of retail sales in the United States in 2003, according to AC Nielsen, and for up to 40% in some European countries. Brands created by Wal-Mart, Target and other retail giants have knocked many second-tier brands off the shelves.
Take a hard look at the shelves of any of these stores the next time you shop. Increasingly, the pattern that you'll find in any product category is for the store to stock one or at most two brands -- and then only No. 1 and No. 2 in market share -- next to its own private-label brand. Shopping in Target last week for garbage bags, for example, I had a choice of buying brand name, Glad in this case, or price -- Target's own brand.
But that's not the end of the story. Private-label brands haven't just knocked lesser brands off the shelf; they've also redefined what it means to be a brand. That change has led to the death of the traditional brand.
Consider the choice consumers face in deciding whether to buy the top brand in a category or the store's private-label product. On price, the decision is simple: The store's private label is cheaper -- on average 25% cheaper. On basic quality, there's not much difference either. Store brands are no longer the lower quality knock-offs they once were. In fact, in some cases, they're produced in the same factories as the brand products are. And surveys show that consumers are increasingly comfortable with the quality of store brands.
So what can possibly justify paying a premium price for Pampers or Crest over the store brand? Innovation.
Over and over again, recent marketplace battles between the toughest and smartest brand powerhouses and store brands have been decided on product innovation. H.J. Heinz (HNZ, news, msgs), for example, was able to take back market share from store brands by creating new squeezable plastic bottles for its ketchup. P&G was able to win more shelf space at Wal-Mart for its Crest brand by creating an entirely new product category with the introduction of its Crest Whitestrips. The company is following the same path with its Olay face creams, positioning them as cheaper, but just as effective as a shot of Botox to differentiate them from private-label store brands.
In the world of traditional brands, consumers pay a premium price for the brand-name product because, to consumers, the brand name equals quality. In the post-brand world, consumers pay a premium price for the brand because of product innovation. Newness rather than familiarity sells.
Nobody does traditional branding better
In 2004, P&G had 16 brands whose sales exceeded $1 billion each. The company is the global leader in its four core product categories: fabric and home care (27% of sales in fiscal 2004, according to Standard & Poor's), beauty care (33% of sales), baby and family care (20% of sales), and health care (13% of sales). Only in snacks and beverages (7% of sales) do P&G brands, such as Folgers and Pringles, fail to command their markets.
The Gillette acquisition will just add to this brand strength: After it closes, P&G will own 21 brands with sales of more than $1 billion.
P&G sells those brands through a far-ranging and deep marketing system. Compare the marketing reach of Gillette and P&G in China, for example. Both companies sell their products in that market and Gillette's sales effort isn't exactly minor league: The company sells its brand in all the top Chinese cities. But P&G sells in the top 500 Chinese cities and in many rural areas, as well.
That's part of what makes the deal to acquire Gillette so attractive to me as an investor. P&G, with sales in the world's developing markets of $11 billion annually versus $2 billion for Gillette, will be able to push Gillette's products into markets that Gillette either doesn't reach or where it hasn't penetrated very deeply. And Gillette, which is especially strong in Brazil and India where P&G trails Hindustan Lever, a unit of Unilever (UN, news, msgs), will fill in the few remaining holes in P&G's global marketing map.
Buy P&G because it's a leader in product innovation
Although the company doesn't break out spending for product research and development from its Sales, General & Administrative category on the income statement, we do know that P&G employs 7,500 researchers. And the results speak for themselves: For the last eight years, P&G has introduced the No.1 or No. 2 new non-food consumer product in the United States every year.
And we can see how important innovation is from the example of the few categories where competitors are beating P&G at this game. The Clairol business, acquired in 2001, is one of the few areas where P&G has stumbled. The brand has lost market share and slipped further behind market leader L'Oreal (LORLY, news, msgs) in the hair-color business. It's not a coincidence that P&G's Clairol took a beating from L'Oreal in 2004, when that company out-innovated P&G by launching 130 new products.
6 rules of highly effective companies in the post-brand world
And finally, it's not just that P&G has a huge base of traditional brands and a superb track record of product innovation that makes the stock a great long-term buy. The evidence is that P&G gets the post-brand world and has put strategies in place to exploit the new environment. That's no mean achievement for a company that has cut its teeth on the traditional brand. I'd break down the company's strategy into six rules that make a playbook for the post-brand consumer products company.- Consumers will pay a premium for products that offer improvements over either private-label products or the brands they have bought for years.
- Product innovation must be constant with noticeable (or at least marketable) improvements year in and year out. Tide detergent goes from a powder to a liquid to a tablet that incorporates Downy fabric softener. Great, says the consumer, but what have you done for me lately? In today's market, a company can't count on much in the way of customer loyalty and instead must constantly "sell" the customer on product value. Especially when the product sells at a premium price.
- Product innovation must be designed to constantly "up-scale" consumer preferences. Selling coffee is not as profitable as selling cappuccino (and selling the cappuccino "experience" is even more profitable). Selling clean and cavity-free teeth isn't as profitable as selling whiter teeth (and selling dentist-white teeth is even more profitable.)
- This upscaling of consumer tastes can't be limited to just the most-affluent consumers. By moving the top of the scale, a company gains the room to move every other consumer segment a rung up the ladder. Constant product innovation gives the company a steady stream of not-quite-new products that have built significant economies of scale and can now be offered at slightly lower prices to consumers down the spending ladder. Pricing should be structured to make each step up a bit more profitable for the company and to encourage a final step up to the newest product.
- These strategies of innovation and pricing can be used to penetrate developing economies and to gradually move the most-affluent consumers in those markets up the product/pricing ladder. A strategy of constant innovation also allows a company to offer less affluent consumers in developing markets a constant stream of new-to-them products, even if they're actually older products at low price points. The days of selling generic and unchanging products to less affluent consumers in developing markets are ending.
- As growth rates in mature consumer markets in the United States and Europe slow, using innovation to capture an increasing share of developing markets will be key to growing company earnings. It's especially critical for consumer-products companies where growth rates are tied to population growth and household formation. This is one area where Procter & Gamble lags its global rival Unilever. Procter & Gamble has a 37% market share in the mature developed economies and a market share below 20% in the developing markets. That trails Unilever's 27% market share in developing markets. The Gillette acquisition directly addresses this lag by opening up new markets to P&G and for Gillette's products, as well.
The world is P&G's oyster -- eventually
In the short run, the Gillette acquisition will dilute earnings per share at P&G. And if cost savings are slower to materialize than promised -- and they almost always are -- you can expect Wall Street to throw a hissy fit. I'd even expect some difficulties in putting the cultures of the two companies together. I wouldn't be surprised to see a negative story or two or more before the integration is accomplished. So, maybe you'd want to wait until something like that dings the stock price. But if you're a long-term, patient and fairly risk-averse investor, you should certainly use any drop on news like that as an opportunity to build a position in these shares.
The world of consumer products is moving in P&G's direction. In the long term, that will pay off for the company and for those who own its stock.
In my next column, I'm going to use this post-brand model to do a long-overdue update to my 50 Best Stocks in the World portfolio. If the brand is dead, how does that change the way we think about stocks such as Intel (INTC, news, msgs), Sony (SNE, news, msgs), Charles Schwab (SCH, news, msgs) and Walt Disney (DIS, news, msgs)?
New developments on past columns
Vicious cycle: Rising oil prices, falling dollar
Well, it doesn't look like the United States can expect any help with its trade deficit from the economies of Japan or the European Union. Both went from weak to weaker growth as 2004 drew to a close. Slower growth means fewer purchases of U.S. goods and services by consumers and companies in these developed economies. The culprit in both cases: high oil prices. First, the European Union: With Germany and Italy posting unexpected declines in gross domestic product (GDP) for the last quarter 2004, growth in the European Union dropped to 0.2% in the last quarter of the year. The German economy shrank by 0.2% and the Italian economy by 0.3% in the quarter. The numbers are even worse news than they seem for the U.S. trade deficit. Exports remained strong, particularly for the export-driven German economy, despite the rise of the euro versus the dollar, but domestic consumption fell off, which means less buying of U.S. goods in Germany. The consensus by economists is moving toward projected growth of just 1.5% in the European Union for 2005. That's weaker than the earlier forecast of 2%, which wasn't especially robust to begin with. Things could be worse in the European Union, however: It could be Japan. The Japanese economy actually dropped into recession in 2004, with GDP falling 0.1% in the fourth quarter after a decline of 0.3% in the third quarter and a fall of 0.2% in the second quarter. Thanks to strong growth in the first quarter, the Japanese economy actually grew by 2.6% for all of 2004. For 2005, the Organization for Economic Cooperation and Development is now projecting growth of 2.6% for Japan. That's down from earlier projections of 4% GDP growth. The new projections put U.S. economic growth at 4.4% and European Union growth at 1.8% in 2005. The growing spread between growth in the United States and the rest of the developed world could well push the U.S. trade deficit in 2005 above the record levels set in 2004.
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in none of the equities mentioned in this column. He does not own short positions in any stock mentioned in this column.
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