Pricing Pressures 'Manageable' To P&G, But Threatening To Analysts

Procter & Gamble says retailer pressure for the firm to lower product pricing to compete with e-commerce and private label is a “real but manageable” problem, while an industry consultant says four megatrends are dictating product prices and changing the way consumers think about consumer health products.

Pricing pressures from retailers responding to e-commerce competition is a “real but manageable” problem that Procter & Gamble Co. expects to overcome through product launches and other innovation, though analysts see it as a large and growing threat.

P&G's strategy is to differentiate its brands other than through lower prices, says P&G Chief Financial Officer Jon Moeller. Line extensions and other innovations help conventional retailers protect their market shares against growing online consumer packaged goods competition, notably Amazon.com, while also providing e-commerce businesses with distinctive offerings.

“To the extent that we can bring innovation to the market, which helps grow the market, we lessen this problem for everyone,” Moller said on Nov. 15 at the Morgan Stanley Global Consumer & Retail Conference in New York.

P&G is developing products that allow retailers “in different channels to best serve their shopper with an offering that’s not a direct comparison to offerings in competitive channels, which also reduces some of the pricing pressure," he said. A current launch is a Clearblue pregnancy test line extension that sends data to users' smartphones (see sidebar below).

Moeller did not elaborate on how P&G will innovate or differentiate its brands, which include Crest oral care, Prilosec OTC frequent heartburn treatment, Vicks cough/cold products, Pepto Bismol upset stomach remedies and the Pantene and Head & Shoulders hair care lines. He previously has described P&G's strategy as competing in premium tiers and extending into the mid-price sector but not into the discount space. (Also see "P&G Keeps Direct-to-Consumer In Perspective, Retail Distribution Primary" - Pink Sheet, 26 Oct, 2016.)

The Cincinnati-based firm also has committed heavily to research and development, allocating $1.9bn to R&D, equal to 2.9% of sales, in 20916.

Still, P&G’s strategy to beat pricing pressure through innovation has skeptics, notably activist investor Nelson Peltz, head of hedge fund Trian Fund Management that purchased $3.5bn in shares of P&G stock in February, about 1.5% of total stock. Among his criticisms, Peltz says P&G is not getting adequate return on its R&D investment, characterizing its strategy as “broken.” (Also see "Ahead Of P&G Board Vote, Activist Investor Peltz Gains Endorsements" - HBW Insight, 26 Sep, 2017.)

Peltz has claimed victory in a proxy vote for a P&G board seat, but the firm says the results still are being tabulated and has not conceded that any of its candidates of the 11 seats received fewer votes than Peltz. (Also see "P&G Board Seat Swings To Peltz In Ongoing Vote Tally" - Pink Sheet, 15 Nov, 2017.)

Legacy Firms Are Own Worst Enemy

P&G is not alone feeling pricing pressure. Consumer health care peers Colgate-Palmolive, Church & Dwight Co. Inc. and Johnson & Johnson also face market-share competition from private label products and from online retailers. During a September investor conference, each of the firms said it is expanding e-commerce investments to compete with online start-ups. (Also see "Legacy Consumer Health Firms Invest To Compete In Start-Ups' Realm: E-Commerce" - Pink Sheet, 12 Sep, 2017.)

Mikey Vu, a partner at business consultancy Bain & Co. in Chicago, says the big firms’ lack of innovation and inability to trim pricing created the opportunity for numerous types of low-priced competition – both online and in discount stores – to find a strong foothold in the US in recent years.

Megatrends Shaping CPG Landscape

• Amazon.com gaining market share across consumer packaged goods;
• start-ups with disruptive sales and distribution strategies;
• national drug and grocery chains focusing on discount pricing;
• private label sales growth.

“Big companies spend a lot of money in inefficient ways and that’s one of the reasons they can’t reduce their pricing," said Vu, a specialist in corporate strategy, technology and digital strategy with expertise in pricing, private label and chain and inventory management

"If they actually went back to the drawing board and thought more about what they are spending their money on and redesigned their business model to be more efficient, they’d have room to reduce prices. But that’s really hard to do,” he said in an interview.

Amazon? 'Scary Proposition'

The “800-pound gorilla” among megatrends is Amazon, which already dominates e-commerce and is expanding its own private label offerings, Vu said.

“Amazon is an exceptionally scary proposition to everyone, both on the retail and CPG side," Vu said.

Amazon's approach is to continue reducing prices, attract more customers and build scale as it continues growing and reducing prices. “They have free will to set prices where they want. They continue to reduce prices and attract more shoppers. If you are a large CPG and you are looking at that, you can 100% expect Amazon to turn around and put pricing back on you,” he said.

Amazon already is offering its own CPG brands, including Amazon Elements vitamins, minerals and supplements launched in February 2016, and is expected to extend the Elements line into OTC drugs in the near term. (Also see "Perrigo's Next Private Label First Lands With Second Thoughts On Outlook" - Pink Sheet, 3 Oct, 2017.). It also has launched CPG lines not branded with the Amazon name, Mama Bear baby food, Happy Belly snacks and several fashion labels.

P&G CFO Jon Moeller: “To the extent that we can bring innovation to the market, which helps grow the market, we lessen this problem for everyone.”

The ecommerce giant also will have the Whole Foods natural food grocery chain to market its lines following closing of a $13.7bn purchase it announced in June, a deal currently under regulatory review. (Also see "Amazon Pays $13.7bn For Whole Foods: Health And Wellness Industry News" - HBW Insight, 19 Jun, 2017.)

Vu expects Amazon will bring its competitively priced lines into Whole Foods, a strategy that will bring value-shoppers who so far have shunned the higher prices associated with the chain into the stores. “That’s scary because that pulls traffic away from retailers these large CPG companies rely on,” he said.

Amazon also employs other price-reducing techniques, including “Discount provided by Amazon” that cuts Prime service customers' prices at checkout with Amazon making up the difference. The service is used on products from "Fulfillment by Amazon" vendors, which store products at Amazon warehouses and count on the firm for distribution. (Also see "Navigating Amazon: E-Commerce Giant Critical For OTC Drug Sales" - Pink Sheet, 4 May, 2017.)

Subscriptions, Discount Also Disruptive

Another trend is the rise of small CPG firms that exclusively market and ship discount-priced products direct to customers online.

This sector includes Dollar Shave Club, which Unilever acquired in 2016., Brandless Inc., a recently launched online platform with off-brand products for $3 or less, and Hello Products LLC, a niche line of toothpastes free of synthetic ingredients in non-traditional flavors. (Also see "Legacy Consumer Health Firms Invest To Compete In Startups' Realm: E-Commerce" - HBW Insight, 15 Sep, 2017.)

Vu said big players are seeking to purchase these brands for a stake in the boutique brand market. According to media, P&G has purchased San Francisco firm Native, which markets aluminum-free deodorants direct to consumers.

Additionally, “hard discounters” in the US, primarily comprising German firms Aldi and Lidl US LLC, are taking CPG market share. Aldi and Lidl launched in the US in recent years after conquering the retail landscape in Europe.

Aldi has 1,600 US stores and plans to open 400 more by the end of 2018, according to Bain, which also says Lidl's US launch is "in the early days" and it likely will add up to 500 stores in the next five years.

The German firms have "been really able to capture a descent portion of the market share in the US and convinced the American shopper that there’s a lot of value there, not just cheap stuff. Right now they’re mainly in food, but you can see them pulling in certain specific personal care, beauty and OTC categories,” Vu said.

Private Label On Par With Brands

Private label preceded e-commerce, subscription services and discount drug/grocery chains as a disruptor of national brand pricing, and currently is having as much influence.

A large breadth of private label products are “finally winning with consumers” in a range of categories. Sold by conventional and online retailers, they commonly are priced at 15% to 20% below national brands, Vu said.

“Europe’s always been ages ahead of America in adoption rates of private label,” he said. While US consumers previously considered private label as cheap imitations of national brands, more are “opening their minds, they’re not seeing private label as a knock-off, white-label product anymore.”

Additionally, millennials are drawn to niche brands, including private label, not associated with large companies. “Our latest research shows that 85% of American shoppers are reasonably opened to the idea of buying private label over major national brands,” Vu said.

In a research note published in May, Barclay analyst Lauren Lieberman said CPG firms are stymied by limited pricing power and a “fragmented, fickle” consumer. Other factors in play since the early 2000s –consolidation of retailers and supplier consolidation – also have been amplified in recent years by “a growing mistrust of big brands, lower barriers to entry facilitated by the rapid nature of technological advances in digital marketing and e-commerce, and declining volumes year after year,” Lieberman said.

“While in the past, stronger brand loyalty rendered iconic brands somewhat sheltered from disruption from smaller players, today’s consumer is far more curious and accepting of the ‘kitschy’ or ‘local’ and in fact, also more mistrusting of big labels,” she wrote.

From the editors of The Tan Sheet.