Sunday, September 20, 2009

"Challenges before the Indian FMCG Sector & Designing a Blueprint for Future"

Part – I

During this period, while there are sectors that have outperformed this benchmark index, there are also sectors that have under performed. FMCG registered gains of just 33% on the BSE FMCG Index last year.

At the macro level, Indian economy is poised to remained buoyant and grow at more than 7%. The economic growth would impact large proportions of the population thus leading to more money in the hands of the consumer. Changes in demographic composition of the population and thus the market would also continue to impact the FMCG industry.

Recent survey conducted by a leading business weekly, approximately 47 per cent of India's 1 + billion people were under the age of 20, and teenagers among them numbered about 160 million. Together, they wielded INR 14000 Cr worth of discretionary income, and their families spent an additional INR 18500 Cr on them every year. By 2015, Indians under 20 are estimated to make up 55% of the population - and wield proportionately higher spending power. Means, companies that are able to influence and excite such consumers would be those that win in the market place.

The Indian FMCG market has been divided for a long time between the organized sector and the unorganized sector. While the latter has been crowded by a large number of local players, competing on margins, the former has varied between a two-player-scenario to a multi-player one.

Unlike the U.S. market for fast moving consumer goods (FMCG), which is dominated by a handful of global players, India's Rs.460 billion FMCG market remains highly fragmented with roughly half the market going to unbranded, unpackaged home made products. This presents a tremendous opportunity for makers of branded products who can convert consumers to branded products. However, successfully launching and growing market share around a branded product in India presents tremendous challenges. Take distribution as an example. India is home to six million retail outlets and super markets virtually do not exist. This makes logistics particularly for new players extremely difficult. Other challenges of similar magnitude exist across the FMCG supply chain. The fact is that FMCG is a structurally unattractive industry in which to participate. Even so, the opportunity keeps FMCG makers trying.

Part - II

At the macro-level, over the long term, the efforts on the infrastructure front (roads, rails, power, river linking) are likely to enhance the living standards across India. Till date, India's per capita consumption of most FMCG products is much below world averages. This is the latent potential that most FMCG companies are looking at. Even in the much-penetrated categories like soaps/detergents companies are focusing on getting the consumer up the value chain. Going forward, much of the battle will be fought on sophisticated distribution strengths.

Structural Analysis Of FMCG Industry

Typically, a consumer buys these goods at least once a month. The sector covers a wide gamut of products such as detergents, toilet soaps, toothpaste, shampoos, creams, powders, food products, confectioneries, beverages, and cigarettes. Typical characteristics of FMCG products are: -

1. The products often cater to 3 very distinct but usually wanted for aspects - necessity, comfort, luxury. They meet the demands of the entire cross section of population. Price and income elasticity of demand varies across products and consumers.

2. Individual items are of small value (small SKU's) although all FMCG products put together account for a significant part of the consumer's budget.

3. The consumer spends little time on the purchase decision. He seldom ever looks at the technical specifications. Brand loyalties or recommendations of reliable retailer/ dealer drive purchase decisions.

4. Limited inventory of these products (many of which are perishable) are kept by consumer and prefers to purchase them frequently, as and when required.

5. Brand switching is often induced by heavy advertisement, recommendation of the retailer or word of mouth.

Distinguishing features of Indian FMCG Business

FMCG companies sell their products directly to consumers. Major features that distinguish this sector from the others include the following: -

Part - III

1. Design and Manufacturing

1. Low Capital Intensity - Most product categories in FMCG require relatively minor investment in plan and machinery and other fixed assets. Also, the business has low working capital intensity as bulk of sales from manufacturing take place on a cash basis.

2. Technology - Basic technology for manufacturing is easily available. Also, technology for most products has been fairly stable. Modifications and improvements rarely change the basic process.

3. Third-party Manufacturing - Manufacturing of products by third party vendors is quite common. Benefits associated with third party manufacturing include (1) flexibility in production and inventory planning; (2) flexibility in controlling labor costs; and (3) logistics - sometimes its essential to get certain products manufactured near the market.

2. Marketing and Distribution

Marketing function is sacrosanct in case of FMCG companies. Major features of the marketing function include the following: -

1. High Initial Launch Cost - New products require a large front-ended investment in product development, market research, test marketing and launch. Creating awareness and develop franchise for a new brand requires enormous initial expenditure on launch advertisements, free samples and product promotions. Launch costs are as high as 50-100% of revenue in the first year. For established brands, advertisement expenditure varies from 5 - 12% depending on the categories.

2. Limited Mass Media Options - The challenge associated with the launch and/or brand-building initiatives is that few no mass media options. TV reaches 67% of urban consumers and 35% of rural consumers. Alternatives like wall paintings, theatres, video vehicles, special packaging and consumer promotions become an expensive but required activity associated with a successful FMCG.

3. Huge Distribution Network - India is home to six million retail outlets, including 2 million in 5,160 towns and four million in 627,000 villages. Super markets virtually do not exist in India. This makes logistics particularly for new players extremely difficult. It also makes new product launches difficult since retailers are reluctant to allocate resources and time to slow moving products. Critical factors for success are the ability to build, develop, and maintain a robust distribution network

Part - IV

3. Competition

1. Significant Presence of Unorganized Sector - Factors that enable small, unorganized players with local presence to flourish include the following:

2. Basic technology for most products is fairly simple and easily available.

3. The small-scale sector in India enjoys exemption/ lower rates of excise duty, sales tax etc. This makes them more price competitive vis-à-vis the organized sector.

4. A highly scattered market and poor transport infrastructure limits the ability of MNCs and national players to reach out to remote rural areas and small towns.

5. Low brand awareness enables local players to market their spurious look-alike brands.

6. Lower overheads due to limited geography, family management, focused product lines and minimal expenditure on marketing.

A general assessment of this would lead to the conclusion that FMCG is not a Structurally Attractive Industry to Enter.

Entry barriers are high due the nightmare logistics associated with distributing a FMCG and the limited mass media options available to build a brand. Likewise, the intensity of competition from branded and unbranded goods and the power of retailers make the FMCG a structurally unattractive industry in which to enter and difficult industry in which to remain a competitive player.

Blue-print for the Future

To offer a blue-print for an industry which is one of the most dynamic and demanding is like scheduling events in my life for the days to come. One thing in common between this two would always be the risk of uncertainty involved is very high.

Any draft on these topics would certainly always involve issues like distributions, channel-conflict, optimizing operations (supply chain) and if not the last, rural marketing.

Part - V

This blueprint will delve 4 basic concepts and why it could be of major reckoning in the future. These are: -

1. Excellence in operations - through Value Chain De-Verticalisation

2. Rural marketing

3. Distributions

4. Brand managers to Business managers

1. Excellence in operations - Value Chain De-Verticalisation

Excellence in Operations remains an illusion for most FMCG companies. This will be remaining as long as they stay confined within the organizational structures and mindsets associated with today's vertically integrated business model.

According to a McKinsey report based on problems and opportunities relating to operational excellence, the study comes out with the following findings: -

1. Operations issues get neglected from top-management two main business processes of customer management and consumer management. It suggests that Operations issues get a lot less than 20% of the Executive Committee's agenda time. To compound the problem, only around 10% of top executives in FMCG companies have direct personal experience in Operations. It is hardly surprising; therefore, that the commitment to drive radical change may not be as strong in Operations as it is in the other two business processes.

2. Organization structure of many MNC's makes it's tough to optimize decision-making or to spread best practices across units or countries. Around 10% of FMCG companies have a global Operations director with full responsibility for both operational improvement and strategic resource allocation.

3. Most of the top quartile talent is siphoned for handling marketing or finance functions.
Operations functions are short of management talent. High potential generalists often find FMCG Operations too internally focused and too technical. At the other end of the scale, senior Operations experts are often attracted to other industries - such as electronics, automotive or engineering - where Operations is both more highly regarded and more highly rewarded.

Part - VI

These problems are not new. What is new is that a potential solution - the combination of organizational separation and value chain de-verticalisation.


Multinational FMCG companies that are able to achieve organizational separation - and functionally organized national companies -

This effectively means outsourcing your supply chain activities to a third party. Typically this will involve selling the existing Operations assets and activities, including procurement, manufacturing, primary distribution, and process R&D, to a financial buyer, a third party manufacturer or a joint venture with other FMCG companies. In essence, this leaves an 'asset light' FMCG company and an 'asset heavy' supply company.

How will it create value?

From the perspective of the FMCG Company, the supply company of its will now be in a position to address the above-mentioned operational issues. A strongly incentivised management team often directly accountable to the capital markets - will be better able to attract and motivate talented operations managers, focus 100% of its attention on Operations issues and build operational skills. And operational excellence will translate directly into bottom-line impact.

Thus de-verticalisation allows the management of the FMCG company to focus entirely on customer and consumer management - the main engines of growth - while sharing in progressive Operations cost improvements through either an equity stake or 'open book' supply contracts. From the financial perspective this would also help the FMCG Company get a quantum leap in return on capital employed.

Industry examples

A few FMCG companies have already outsourced manufacturing to some degree - including Sara Lee, Nike and several beverage companies - or begun establishing themselves as specialized players. But compared to industries like automotive and electronics, where much of the industry value chain has already changed owners, FMCG is some way behind. One reason has been a lack of willing buyers of Operations assets.

Part - VII

However, there certainly is a trend at present and a visible scope in the future wherein private equity firms, raw material suppliers and specialist manufacturers, constrained by growth in their traditional markets, are now actively exploring the FMCG de-verticalisation opportunity.

One big challenge remains in managing the interfaces between the two companies - for example, product development, forecasting and order processing. However, the lesson from multinationals that have successfully implemented organizational separation - and those that already make extensive use of co-packers or third party logistics providers - is that this challenge is far less daunting than it may at first appear. E-enablement technologies aid to disaggregate the value chain without losing the connectivity between its component parts. About the new product development process - that can be addressed by retaining a pilot plant in-house".

2. Rural marketing

Rural marketing has become the latest marketing mantra of most FMCG majors. True, rural India is vast with unlimited opportunities. All waiting to be tapped by FMCGs. Not surprising that the Indian FMCG sector is busy putting in place a parallel rural marketing strategy. Among the FMCG majors, Hindustan Lever, Marico Industries, Colgate-Palmolive and Britannia Industries are only a few of the FMCG majors who have been gung-ho about rural marketing.

70% of the nation's population, that means rural India can bring in the much-needed volumes and help FMCG companies to log in volume-driven growth. That should be music to FMCGs who have already hit saturation points in urban India.

Not just rural population is numerically large, it is growing richer by the day.

Food grain production touched 200 million tonnes during fiscal 1999 against 176 million tonnes logged during fiscal 1991. Not just improved crop yields; tax-exemption on rural income too has been responsible for this enhanced rural purchasing power.

Consider this statistics from a National Council of Applied Research (NCAER) survey: lower income group is expected to shrink from over 60 percent (1996) to 20 per cent by 2007 and the higher income group is expected to rise by more than 100 per cent.

Value-volume trade-off

Rural marketing could open the doors of paradise, but the path is paved with thorns. One major limitation here is this: most FMCG players just do not have the critical size for going all out for rural marketing. That is why most FMCG players are expected to concentrate both on rural and urban marketing: focus on urban markets for value and focus on rural markets for volumes. One result-oriented marketing strategy here is this: offer value-additions to existing lines to lure the urban consumer and alongside offer the rural consumer wide-ranging choices within a single product category in a bid to generate high volumes.

What should the FMCG players do now?

They should not only price their products competitively, but also offer their rural prospects maximum value for money spent. Certainly, reaching out to 3.33 million retail outlets is an uphill task. The only way out for Indian FMCG players: put in place an aggressive cost structure that would enable them to offer low-price and value-for-money products. But then, FMCG is a low-margin business with a high cost of raw materials. Consider the case of Marico: its material cost works out to a high of 59 per cent on sales. Therein lays the rural marketing paradox.

However, customer-centric and market-savvy FMCG companies have always chased prospects when they perceive there is a latent demand. For instance, Hindustan Lever's Rin, Surf and Lux are available even in India's most obscure villages.

Hindustan Lever had given shape to its rural strategy a few years ago when it perceived that its urban market was shrinking due to an industrial slowdown. Its Operation Bharat that focused on personal care products made the most out of surging rural incomes.

The result was there for all to see. The company has been able to clock in double-digit profits every three years and log in double-digit revenues every four years. Britannia with its Tiger brand of biscuits and Colgate-Palmolive with its low-priced and conveniently-packaged products designed for the rural masses have been other pioneers in rural marketing.

Part - IX

3. Distribution

One of the age-old problems that FMCG has been facing not only in India but globally is that of distribution. Integrating operations with your distributors and channel partners is a Herculean task. Few ways to reduce pain involved in this link: -

· Reducing supply chain costs by reducing intermediaries - Organised retail chains have set up systems for inventory management and quick servicing, thereby offering the opportunity for a company/supplier to reduce distribution cost by reducing intermediaries such as wholesalers/distributors and supplying directly to the warehouse of retail chain.

· Increasing sales by driving channel width - The relative share of grocers to FMCG sales has dropped from over 50% in the early 90's to 35% in the late 90's. On the other hand the contribution of chemist outlets and paan outlets has been increasing. This has been a result of both SKU's (sachets) and hardware (mini dispensers) being specifically designed to facilitate entry to these outlets and increase consumer interface.

4. Brand Managers To Business Managers

Tough market situations and a more aware and savvier demanding consumer have necessitated that yesterday's Brand Managers be transformed into Business Managers who understand consumers and can innovate and be flexible to move with the consumer.

Gone are the days when brands could be made to gallop with a big budget media plan, a generous dose of below-the-line and above-the-line activities and constant promotions and schemes in the market. Consumers who have become demanding yet inscrutable in terms of attitudes, outlook, moods and behaviour have rendered conventional Brand Management tools obsolete.

Part - X

This makes it all the more important for Brand Managers to develop strong consumer insights and constantly innovate. This requires immersing oneself in the consumer's life space and understanding her to open up new opportunities. These opportunities are hidden in seemingly insignificant behavioural patterns, which open up wide new opportunities for the brand.

Developing strong consumer insight basically requires one to

a) Align oneself to the challenge, in terms of correctly identifying the key issues and objectives.
b) Leverage all that one knows and understands from available sources.
c) Immerse oneself in the consumer's life space.
d) Connect this insight to a usable platform/ idea.
e) Executing it in a format that solves the challenge he started with.

The above four are by no means an exhaustive list of new and radical approaches which organization are re-inventing or discovering. Its no denying that the FMCG space will be for time to come, remain a glamorous sector, but also be testimony to new innovations and excellence through-out the value-chain.

A spate of new product launches, new schemes, brand extensions and new marketing initiatives across companies indicate that only the fittest ideas survive "Only the Paranoid Survive ", the famous line by Andy Grove seems relevant to this space.