8477579 FMCG Industry

8/6/2019 8477579 FMCG Industry

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

- by Amritanshu Mohanty *

Part - I

Markets all over the world have been on a roll in 2003 and the Indianbourses are no exception having gained almost 60% in 2003. During thisperiod, while there are sectors that have outperformed this benchmarkindex, there are also sectors that have under performed. FMCG registeredgains of just 33% on the BSE FMCG Index last year.

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

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

The Indian FMCG market has been divided for a long time between theorganized sector and the unorganized sector. While the latter has beencrowded 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 isdominated by a handful of global players, India's Rs.460 billion FMCGmarket remains highly fragmented with roughly half the market going tounbranded, unpackaged home made products. This presents a tremendousopportunity for makers of branded products who can convert consumers tobranded products. However, successfully launching and growing marketshare around a branded product in India presents tremendous challenges.Take distribution as an example. India is home to six million retail outlets andsuper markets virtually do not exist. This makes logistics particularly for newplayers extremely difficult. Other challenges of similar magnitude existacross the FMCG supply chain. The fact is that FMCG is a structurally

unattractive industry in which to participate. Even so, the opportunity keepsFMCG 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 capitaconsumption of most FMCG products is much below world averages. This is the latent potentialthat most FMCG companies are looking at. Even in the much-penetrated categories like


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soaps/detergents companies are focusing on getting the consumer up the value chain. Goingforward, 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, foodproducts, confectioneries, beverages, and cigarettes. Typical characteristics of FMCG productsare: -

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. Priceand income elasticity of demand varies across products and consumers.

2. Individual items are of small value (small SKU's) although all FMCG products puttogether 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 thetechnical specifications. Brand loyalties or recommendations of reliable retailer/ dealerdrive 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 thissector from the others include the following: -

Part - III

1. Design and Manufacturing

1. Low Capital Intensity - Most product categories in FMCG require relatively minorinvestment in plan and machinery and other fixed assets. Also, the business has lowworking 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 formost products has been fairly stable. Modifications and improvements rarely change thebasic process.

3. Third-party Manufacturing - Manufacturing of products by third party vendors is quitecommon. Benefits associated with third party manufacturing include (1) flexibility inproduction 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 marketingfunction include the following: -

1. High Initial Launch Cost - New products require a large front-ended investment inproduct development, market research, test marketing and launch. Creating awarenessand develop franchise for a new brand requires enormous initial expenditure on launchadvertisements, free samples and product promotions. Launch costs are as high as 50-


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100% of revenue in the first year. For established brands, advertisement expenditurevaries 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 urbanconsumers and 35% of rural consumers. Alternatives like wall paintings, theatres, videovehicles, special packaging and consumer promotions become an expensive but requiredactivity associated with a successful FMCG.

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

Entry barriers are high due the nightmare logistics associated with distributing a FMCG and thelimited mass media options available to build a brand. Likewise, the intensity of competition frombranded and unbranded goods and the power of retailers make the FMCG a structurallyunattractive industry in which to enter and difficult industry in which to remain a competitiveplayer.

Blue-print for the Future

To offer a blue-print for an industry which is one of the most dynamic and demanding is likescheduling events in my life for the days to come. One thing in common between this two wouldalways 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


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2. Rural marketing3. Distributions4. 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 remainingas long as they stay confined within the organizational structures and mindsets associated withtoday's vertically integrated business model.

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

1. Operations issues get neglected from top-management two main business processes ofcustomer management and consumer management. It suggests that Operations issues get a lotless than 20% of the Executive Committee's agenda time. To compound the problem, only around10% of top executives in FMCG companies have direct personal experience in Operations. It ishardly surprising; therefore, that the commitment to drive radical change may not be as strong inOperations 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 tospread best practices across units or countries. Around 10% of FMCG companies have a globalOperations director with full responsibility for both operational improvement and strategicresource 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 FMCGOperations too internally focused and too technical. At the other end of the scale, seniorOperations experts are often attracted to other industries - such as electronics, automotive orengineering - 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 oforganizational separation and value chain de-verticalisation.

De-verticalisation

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

This effectively means outsourcing your supply chain activities to a third party. Typically this willinvolve selling the existing Operations assets and activities, including procurement,manufacturing, primary distribution, and process R&D, to a financial buyer, a third partymanufacturer 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 positionto address the above-mentioned operational issues. A strongly incentivised management teamoften directly accountable to the capital markets - will be better able to attract and motivatetalented operations managers, focus 100% of its attention on Operations issues and buildoperational skills. And operational excellence will translate directly into bottom-line impact.


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Thus de-verticalisation allows the management of the FMCG company to focus entirely oncustomer and consumer management - the main engines of growth - while sharing in progressiveOperations 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 inreturn on capital employed.

Industry examples

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

Part - VII

However, there certainly is a trend at present and a visible scope in the future wherein privateequity 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 multinationalsthat have successfully implemented organizational separation - and those that already makeextensive use of co-packers or third party logistics providers - is that this challenge is far lessdaunting than it may at first appear. E-enablement technologies aid to disaggregate the valuechain without losing the connectivity between its component parts. About the new productdevelopment 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 theIndian FMCG sector is busy putting in place a parallel rural marketing strategy. Among the FMCGmajors, Hindustan Lever, Marico Industries, Colgate-Palmolive and Britannia Industries are only afew 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 andhelp FMCG companies to log in volume-driven growth. That should be music to FMCGs whohave 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 tonneslogged 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: lowerincome group is expected to shrink from over 60 percent (1996) to 20 per cent by 2007 and thehigher 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 majorlimitation here is this: most FMCG players just do not have the critical size for going all out for


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rural marketing. That is why most FMCG players are expected to concentrate both on rural andurban marketing: focus on urban markets for value and focus on rural markets for volumes. Oneresult-oriented marketing strategy here is this: offer value-additions to existing lines to lure theurban consumer and alongside offer the rural consumer wide-ranging choices within a singleproduct 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 prospectsmaximum value for money spent. Certainly, reaching out to 3.33 million retail outlets is an uphilltask. The only way out for Indian FMCG players: put in place an aggressive cost structure thatwould 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 costworks 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 prospectswhen they perceive there is a latent demand. For instance, Hindustan Lever's Rin, Surf and Luxare 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 itsurban market was shrinking due to an industrial slowdown. Its Operation Bharat that focused onpersonal 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 profitsevery three years and log in double-digit revenues every four years. Britannia with its Tiger brandof biscuits and Colgate-Palmolive with its low-priced and conveniently-packaged productsdesigned 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 ofdistribution. Integrating operations with your distributors and channel partners is a Herculeantask. 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 theopportunity for a company/supplier to reduce distribution cost by reducing intermediariessuch 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 otherhand the contribution of chemist outlets and paan outlets has been increasing. This hasbeen a result of both SKU's (sachets) and hardware (mini dispensers) being specificallydesigned 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 necessitatedthat yesterday's Brand Managers be transformed into Business Managers who understandconsumers 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, agenerous dose of below-the-line and above-the-line activities and constant promotions and


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schemes in the market. Consumers who have become demanding yet inscrutable in terms ofattitudes, outlook, moods and behaviour have rendered conventional Brand Management toolsobsolete.

Part - X

This makes it all the more important for Brand Managers to develop strong consumer insights andconstantly innovate. This requires immersing oneself in the consumer's life space andunderstanding her to open up new opportunities. These opportunities are hidden in seeminglyinsignificant 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 whichorganization are re-inventing or discovering. Its no denying that the FMCG space will be for timeto come, remain a glamorous sector, but also be testimony to new innovations and excellencethrough-out the value-chain.

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

8477579 FMCG Industry

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