P&G (PG) and Gillette

Gillette

P&G acquired Gillette in 2005 for $57 billion in stock.  The idea, as I understand it, was not only to acquire an attractive business in itself but also to use the Gillette brand name for PG to expand into men’s health and beauty products.  More or less, PG’s a big chunk of PG’s extensive women’s line would be repackaged, reformulated a bit if necessary, and sold under the Gillette label.

Unfortunately for PG, millennial men decided to stop shaving about ten years ago.  The big expansion of new Gillette product categories hasn’t happened.  And PG announced two months ago that it was slashing the price of its higher-end shaving products by up to 20%, effective late last month.

It’s this last that I want to write about today.

pricing

The Gillette situation reminds me of what happened with cigarette companies in the 1980s.  I’m no fan of tobacco firms, but what happened to them back then is instructive.

the iron law of microeconomics

The iron law of microeconomics: price is determined by the availability of substitutes.   But what counts as a substitute?  For a non-branded product, it’s anything that’s functionally equivalent and at the same, or lower, price.  The purpose of marketing to create a brand is, however, not only to reach more potential users.  It’s also to imbue the product with intangible attributes that hake it harder for competitors to offer something that counts as a substitute.

cigarettes

In the case of cigarettes, they’re addictive.  It should arguably be easy for firms with powerful marketing and distribution to continually raise prices in real terms.  And that’s what the tobacco companies did consistently–until the early 1980s.

By that time, despite all the advantages of Big Tobacco, it had raised prices so much that branding no longer offered protection.  Suddenly even no-name generics became acceptable substitutes.  This was a terrible strategic error, although one where there was little tangible evidence to serve as advance warning.  As it turns out, in my experience there never is.

The competitive response?  …cut prices for premium brands and launch their own generics.  There certainly have been additional legal and tax issues since, and because I won’t buy tobacco companies I don’t follow the industry closely.  Still, it seems to me that tobacco has yet to recover from its 30+ year ago pricing mistake.

razor blades

The same pattern.

Over the past few years, Gillette’s market share has fallen from 71% to 59%.  Upstart subscription services like the Dollar Shave Club (bought for $1 billion by Unilever nine months ago) and and its smaller clone Harry’s (which I use) have emerged.

Gillette has, I think, done the only things it can to repair the damage from creating a pricing umbrella under which competitors can prosper.  It is reducing prices.  It has already established its own mail order blade service.  On the other hand, Harry’s is now available in Target stores.   Unilever will likely use the Dollar Shave Club platform to distribute other grooming products.  So the potential damage is contained but not eliminated.  Competition may also spread.

The lesson from the story:  the cost of preventing competitors from entering a market is always far less than the expense of minimizing the damage once a rival has emerged.  That’s often only evident in hindsight.  Part of the problem is that once a competitor has spent money to create a toehold, it will act to protect the investment it has already made.  So its cost of exit becomes an additional barrier to its withdrawal from the market.

 

 

 

Warren Buffett’s bid for Unilever (ULVR)

(Note:  ULVR is an Anglo-Dutch conglomerate with what is for Americans a very unusual corporate structure.  I’m using the London ticker.)

Late last week word leaked of a takeover offer Kraft Heinz (KHZ)–controlled by Warren Buffett and private equity investor 3G Capital–made for Unilever.  Within a day, KHZ withdrew its offer, supposedly because of a frosty reception from the UK government.  Not much further information is available.  In fact, when I checked on Monday evening as I was writing this, there’s no mention of the offer or its retraction among the investor releases on the KHZ website.  Press reports don’t even seem to acknowledge that Unilever is one set of assets controlled by two publicly traded companies.

In any event, two aspects of this situation seem clear to me:

–Buffett’s initial foray with 3G was Heinz, where the Brazilian private equity group quickly established that something like one out of every four people on the Heinz payroll did absolutely no productive work.  Profits rose enormously as the workforce was trimmed to fit the actual needs of the company.

Buffett subsequently joined with 3G in the same rationalization process with Kraft.

For some time, achieving stock market outperformance through portfolio investing has proved difficult for Berkshire Hathaway.  Tech companies are basically excluded from the investment universe; everyone nowadays understands the value of intangibles, the area where Buffett made his reputation.

The bid for ULVR shows, I think, the Sage of Omaha’s new strategy–acquire and rationalize long-established, now-bloated firms in the food and consumer products industries.

Expect a lot more of this, with any needed extra financing likely coming from Berkshire Hathaway.

–the sitting pro-Brexit UK government is showing itself to be extremely sensitive to evidence that contradicts its (questionable) narrative that Brexit is good for the UK.  That seems to me to not be true in the case of UVLR.

Sterling has fallen by 15% or so since the Brexit vote, creating problems for firms, like UVLR, which have revenues in sterling + euros but costs in dollars.  Since the Brexit vote, and before the revelation of the bid, UVLR ADRs in the US had underperformed the S&P 500 since last June by about 20 percentage points.  Yes, UVLR has been a serial laggard, but most of the recent stock price decline can be attributed, I think, to the currency decline brought about by Brexit.

The idea that a venerable British firm would fall into American hands, with layoffs following close behind, appears to have been more than #10 Downing Street could tolerate.

That attitude is probably also going to remain, meaning that weak management teams in the UK need not fear being replaced–and that Buffett will likely have to look elsewhere for his next conquest.