Tag: Lawrence Hrebiniak

Has Procter & Gamble Made Some Bad Bets?

Last Friday’s quarterly earnings conference call put Procter & Gamble CEO Robert McDonald squarely in the hot seat, as some analysts openly blamed him for weak profits and a series of missteps, according to The Wall Street Journal.

Sales for P&G — the world’s largest maker of consumer packaged goods — increased 3%, compared to 8.5% for Unilever PLC and 6.5% for Colgate-Palmolive, the Journal reported, while its stock price has remained relatively unchanged compared to an increase of 13% for Unilever and 17% for Colgate.

Two unrelated issues are hurting P&G, says Wharton management professor Lawrence Hrebiniak. “The first is a strategic, product-mix issue. P&G has been focusing more and more on higher-end products, including beauty and cosmetics. These products are being hurt by down markets, especially in Europe. Some high-end products are doing well because of pent up demand and/or low interest rates — such as autos — but the same doesn’t hold for P&G’s stable of expensive offerings. The day of ‘rack ‘em, stack ‘em and sell ‘em’ at low cost that characterized the marketing of Tide and other commodities has changed, and the newer emphasis on the high-end isn’t faring well worldwide.”

A second, related issue is that growing emerging markets are looking for the low cost commodity products that P&G is emphasizing less and less, Hrebiniak adds. “Greater decentralization of structure and operations is needed to cater to local tastes and demands, but P&G seems weak in this regard. Perhaps too much centralization, coupled with downplaying the products that emerging markets are looking for, is hurting market share and the bottom line. McDonald and his team need to look carefully at strategic and operating issues — especially decentralization and getting closer to emerging markets — to turn things around.”

Some of the analysts on the conference call took the unusual step of blaming McDonald for the company’s woes, according to the Journal, which also pointed out that P&G saw a 16% decline in earnings, registered drops in market share in 55% of the categories and countries it operates in and plans to cut 4,000 jobs by 2016. P&G brands are available in 180 countries and range from Bounty, Crest and Pampers to Gillette, Tide and Pantene.

McDonald, who joined P&G in 1980, has been president and CEO since 2009 and chairman since 2010, and has been credited with spearheading a number of innovations at the company. What he hadn’t counted on, however, was a recession that has led to consumer demand for cheaper brands, and a backlash against the company’s decision to raise some of its prices at a time when other companies were holding steady. As Wharton marketing professor Stephen Hoch notes, “Consumers have turned much more price sensitive, and grocery retailers reinforce those behaviors [by] fighting to retain market share and continuing to push their store brands in order to reinforce a value image.” What P&G is mainly focused on, Hoch adds, is “retaining market share, since when you lose it — and they have plenty to lose as the top dog — it is not easy to get it back.”

Wharton management professor Louis Thomas says P&G’s current woes are because “its strategy over the years has been to build dominant market positions in product categories by starting price wars with competitors. In fact, P&G brand managers are given a strong incentive to defend market share and not profits. So brand managers routinely cut price, and thus margins, in order to hold market share.”

That strategy, Thomas says, has at least two limitations: First, “it is only effective as long as rivals are more financially constrained…. [But] many of P&Gs rivals, such as Unilever, are not financially constrained. In this case, P&G’s strategy simply leads to a prolonged price war, and because it is the bigger firm, it is hurt more than its rivals.” Second, this strategy is “vulnerable to innovation,” Thomas notes. “Other firms can introduce new and better products to limit the effectiveness of P&G’s price cutting. Unilever and Colgate have recently out-innovated P&G in many product categories.”   

What P&G needs to do, he adds, is “focus on improving existing products and introducing new ones [as well as] increasing advertising expenditures on these new products. This will allow prices/margins to improve and limit share gains by rivals. In the long run, firms simply cannot rely on price cutting to maintain their position in markets.” 

Innovation is key. “P&G has simply tried to raise prices without increasing differentiation,” Thomas says. ”This just leads to a classic prisoner’s dilemma where all firms lose in price wars. One way out is through product differentiation via innovation…. Aggressive pricing strategies have to go together with innovation for the industry leader if it wants to stay the leader. It’s like a strategic one-two punch.”

As for how much McDonald is to blame for the weak results, Thomas suggests that “the problems in certain categories like … shaving and detergents seem attributable to him. P&G was well ahead in those categories but rivals have gained as P&G slowed innovation.”

As for Hoch, “I don’t believe in the great man theory of leaders, and so I don’t see that McDonald is to blame exclusively…. Long term, I would absolutely not bet against P&G. This is not to say that they never blow it; they do. But they are still the class act in consumer packaged goods.”

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Starbucks Moves to the Express(o) Lane in China

Starbucks is on a caffeine-fueled growth spurt in Asia. According to a report from the company newsroom, Starbucks plans to go from around 500 stores to at least 1,500 stores over the next three years, and predicts that its operations in China will be its second largest, outside of the U.S., by 2014. Starbucks coffee stores are currently located in 48 Chinese cities.

The company has had mixed success with expansion, however. Although it has strongly rebounded from flat sales in the U.S., it faces continuing resistance in Europe — where “fickle regional palates” and a sagging economy have weighed down performance, according to a recent New York Times article. Starbucks has yet to make a profit in France, the article adds, and “even in the parts of Europe where the company does make money, sales and profit growth lag far behind results in the Americas and Asia.”

Given this uneven track record, and continuing uncertainty over the global economy, how successful will Starbucks be in China?

“It has already been proven that there is a segment of consumers [willing to buy] premium coffee – given the huge success that Starbucks enjoys in big cities of China,” says Wharton marketing professor Qiaowei Shen. “In recent years, the number of coffee shops – national chain stores or local independently owned stores – that target high-income white collar [consumers] has been increasing dramatically. This is another piece of evidence to show that there is demand for high quality premium coffee, and the potential demand is likely to grow in the future.”

Also, according to Shen, the assumption that Chinese consumers tend to favor tea over coffee “may not be true for the young generation in China who grew up with Western food and drinks — such as McDonalds, KFC and Pepsi.”

At the same time, Shen adds, “Starbucks needs to be cautious about its expansion plan. The goal of tripling the number of stores in China within three or four years indicates that Starbucks is not only going to add new stores in the first-tier and second-tier cities, but is also expanding to third-tier or even smaller cities….. For large cities, the concern with proliferating stores is within-chain cannibalization, when the expansion rate exceeds the rate that the pie grows. For the new markets – third-tier or smaller cities — the concern is whether premium pricing is sustainable in less Westernized and economically less developed places. On the other hand, the aggressive expansion plan could potentially fend off some competitors and strengthen Starbucks’ foothold in the Chinese market.”

Wharton management professor Lawrence Hrebiniak is also enthusiastic about the expansion — with a few caveats. “China looks very good for Starbucks,” he states. “Coffee sales are up significantly as traditional tea drinkers [opt] for the newer form of caffeine. Sales are booming — revenue is up 38% — and margins are high, 35% versus 22% in the U.S.” When the company raised prices last year in China, he adds, “demand actually went up, a sign of a luxury good. Chinese customers seem to be enjoying the socializing at Starbucks’ sites, much like the original craze in the U.S. In addition, coffee sales forecasts show predicted increases of more than 50% by 2015.”

So, is there anything at all to be concerned about? “Perhaps,” he says. While the projected rate of growth is very robust — 200% in only three years — not all cities in China are alike. “Smaller cities with lower income levels may not react as strongly as their larger counterparts. Lower economic growth may affect the smaller markets more than the larger ones. And management attention definitely will be taxed somewhat as the top planners try to grasp and control such rapid growth.”

A “slightly slower, incremental approach” may be in order, he suggests. For example, the company should avoid undertaking too many initiatives simultaneously, such as openings, marketing programs, management controls and so forth. “This can tax even the best management team. China looks good and deserves a commitment to expansion and growth, no doubt about it,” he states, but “taking things a bit slower and opting for a less hectic growth program to avoid the problems of a too-large, complex change” may prove more successful, he notes.

For his part, Wharton marketing professor John Zhang suggests that Starbucks may not be moving fast enough. “The fact of the matter is that the U.S. would have a good year if its economy grows by 3%, and China would have a bad year if its economy grows by only 8%. Given the size of the China market and the projected high growth rate — 7% to 8% — for the coming decade, investors if anything may question why the company does not aim to grow faster. For instance, KFC already has more than 3,000 restaurants in 650 cities in China and is adding a new one every day. In comparison, Starbucks is definitely not turbo-charging its growth.”

There is “no question that the American brand is a big draw,” Zhang adds. “More importantly, consuming a cup of bitter-tasting, very expensive and foreign liquid is a sure way for someone to stand out as one of the sophisticates in China. Indeed, given the popularity of the brand” there, Starbucks can surely ride on the swelling middle class and fast urbanization in years to come. The risk lies in opening stores too slowly and losing the rare window of opportunity.”

As for the competition that Starbucks faces in China, Shen cites McDonald’s as one candidate, “but probably not the major one [because] McDonalds’ coffee is much cheaper and attracts different segments of consumers…. Currently, major competition comes from similar coffee chain stores from Taiwan and Japan, with some well-known brands. Competitors also include bakery stores that serve high-quality coffee. Many independently owned local coffee shops also are starting to populate the large cities. They typically have a very unique style and beautiful atmosphere,” attracting the same type of consumer that Starbucks is targeting. “The local competition,” Shen adds, “is intensifying.”

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Warren Buffett’s Big Secret

When Warren Buffett announced last week that he had finally chosen a successor to one day take over the reins of Berkshire Hathaway — but didn’t actually say who that person is — some investors and other interested parties weren’t happy.

Buffett’s comments came in his annual letter to Berkshire shareholders, in which he covered a number of topics, such as the company’s recent performance, continuing doldrums in the housing industry, and the status of recent investments, including both winners and losers.

But his discussion of the succession issues is what led media coverage of the letter. Not only did Buffett choose not to name the heir apparent, but he also noted that there were two unnamed backup candidates, according to an article in The Wall Street Journal. Furthermore, the Journal pointed out, the only details he offered about the chosen one is that “the person ‘is an individual to whom [directors] have had a great deal of exposure and whose managerial and human qualities they admire.’” 

Articles in both the Journal and The New York Times noted that an earlier heir apparent, David Sokol, was knocked out of the running when he resigned over allegations of insider trading. The Times, however, went on to suggest that “in searching for clues into Buffett’s successor, the letter perhaps heaped the most explicit praise on” Ajit Jain, head of the company’s reinsurance operations. Two other current executives — Tad Montross and Matthew Rose — have also been mentioned as possible successors.

While Buffett has been generally unforthcoming on the topic of succession — and repeated in his letter that he has no plans to step down — it looks like some investors are losing patience with the waiting game. Berkshire’s share performance has lagged the broader market recently, and according to the Journal, some investors suggest that Buffett’s failure to resolve the succession issue is one of the reasons.

KnowledgeToday asked Wharton faculty for their take on Buffett’s handling of the succession question.

According to Wharton accounting professor Wayne Guay, “when you have an 81-year-old CEO who is not sure when he will choose to retire, investors will obviously be concerned about succession planning…. This is even more important for Berkshire than the typical firm, given Buffett’s high profile and the perception that Buffett is Berkshire Hathaway. Comparisons could be made to the succession planning that took place at Microsoft, Apple and other firms with high profile founder CEOs.”

However, Guay adds, in general, firms “will not announce a successor until it has been set in stone with all the I’s dotted and T’s crossed. It is very bad to announce a successor and then have to rescind the announcement if the heir apparent cannot reach a formal agreement with the firm. Failure to reach an agreement with the chosen successor would then mean that the firm has to move down to its second choice or third choice, and investors will likely conclude that those lower choice successors are not as good as the top choice.”

From his reading of this week’s coverage in the Journal, Guay says “it does not appear that a formal agreement has yet been reached with the successor because of the mention of a couple of ‘alternative’ successors waiting in the wings. By waiting until the successor has been set in stone, Berkshire can then announce that they have appointed the best person to run the firm.” Keeping the issue “close to the vest now [means that] no one will know whether, in fact, they got their first choice or not. I think this is a common strategy for announcing successors. When a successor is finally announced, it is generally always sold to the public as the best choice to run the firm.”

Wharton management professor Lawrence Hrebiniak, however, wonders if Buffett “is losing it just a bit. Company performance has been down slightly of late. People certainly haven’t forgotten the David Sokol fiasco and how Buffett was duped for a while by his friend. And now [we have] the ballyhooed notice of the secret choice of successor where even the successor doesn’t know who he is and when he might be tapped for the job. When will Buffett retire, and will his choice of successor still be the right one for the company at the time? How will the supposed group of successors now interact or work together? Clearly with uncertainty and perhaps even with a bit of paranoia as they search for clues about Buffett’s decision. This, in my opinion, isn’t good succession planning. I know Buffett is a bit different than most CEOs, but this is off base, even for him.”  

Wharton management professor Nicolaj Siggelkow suggests that since Buffet has not announced he is retiring anytime soon, “it’s not clear why he should have revealed any name. If he retires in five years, the successor might be quite a different person than the one he is currently thinking of. I see this announcement mainly as saying: ‘We have a credible contingency plan should something unexpected happen to me. Not only do I know who would succeed me, but the board has already signed off on this decision as well, i.e., there won’t be any time of uncertainty.’”  

With an unknown retirement date, “it’s really not clear what would be gained by identifying the person now,” Siggelkow adds. “The internal politics at Berkshire would change: People would deal differently with this person and others might become less motivated. At the same time, the person would get much more external attention without really having much more internal control. None of this strikes me as particularly helpful.”

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