Tough choices for consumer-goods companie

Over the past half century, the consumer-packaged-goods (CPG) industry has achieved enviable growth in both revenue and shareholder returns. At first blush, continued growth seems a sure thing—after all, the burgeoning economies of emerging-market countries are fueling an unparalleled boom in global consumption. And given that global CPG companies are selling more of their products to more people in more parts of the world, shouldn’t revenue growth –and, with it, healthy returns—be theirs for the taking?

If only success were that simple. A look back at recent decades of developed-market based CPG companies shows that they have consistently managed to grow, but not always profitably. And today, a series of large-scale trends is causing industry upheaval, forcing companies in mature markets to make tough choices about where to play and how to win. Investment in emerging markets isn’t foolproof: growth, although strong, is uneven, with certain markets and categories far outpacing others. Severe resource constraints are causing volatility in commodity costs. Digital technologies are affecting every part of the value chain, and in sometimes unpredictable ways. New—and newly acquisitive—competitors are emerging. And regulatory risk is rampant as government exerts ever-greater influence over the industry.

Given how fundamentally these trends will transform the industry over the next decade, we believe the strategic choices that CPG manufacturers make in the next few years will be more consequential than those they’ve made in the recent past. Every company will respond to the trends differently. Some companies may choose to keep their focus on core franchises with the hope of delivering stable, even if not stellar, earnings; others may opt for more assertive but riskier moves. In this article, we discuss each of the aforementioned trends, the kinds of choices they will require companies to make, and the actions every company should take regardless of its specific strategic choices.

Changes and choices

In recent decades, CPG companies have posted better returns than other sectors. Between 1967 and 2012, the industry’s 7 percent annual growth in total return to shareholders (TRS) outpaced the S&P 500’s 6 percent. But it hasn’t been a smooth and steady road. In our analysis of the CPG industry since 1967, we see four distinct eras, with one in particular—the period from 1985 to 2000—accounting for the bulk of value creation. The years 1967 to 1985 marked a golden age of growth, a time when sales of food, beverages, and household and personal products soared. Americans doubled their consumption of soda (from an average of one serving a day to two), for example, and cheese (from half an ounce a day to a full ounce). However, revenue growth came at the expense of margins, which declined by almost 300 basis points.

Margins shot up—largely thanks to declining input prices—during what we call the era of expansion (1985–2000), allowing CPG companies to finance forays into new global markets. A wave of mergers and acquisitions followed in the years 2000 to 2007, but the success of these deals was mixed; revenue increased but TRS growth dipped. Then, during the Great Recession and the subsequent recovery, the industry grappled with a tough economy and persistently high commodity costs, limiting both revenue growth and value creation.
How CPG companies fare in the current era remains to be seen: will they sacrifice margins for revenue, as they did during the golden age of growth? Will they be able to grow profitably, as they did between 1985 and 2007? But what’s already evident is that the industry is on the cusp of sweeping change, presenting companies with a range of strategic choices. We believe the five most influential changes, and their implications for CPG companies, are as follows.

Granular growth, globally

By 2025, a staggering 4.2 billion people will be part of the consuming class. For the first time ever, the number of people with discretionary income will exceed the number still struggling to meet basic needs—a phenomenon that may well be the biggest opportunity in the history of capitalism. Another golden age of growth could be in the making. Consumption growth, however, isn’t even; it’s happening much faster in certain categories and markets. Some emerging-market cities have higher growth potential than entire countries. In Shanghai, for instance, the skin-care category will grow three times as fast in absolute terms as in all of Malaysia, based on 2010–20 compound annual growth rate (CAGR).

This uneven growth presents tremendous potential for companies—whether they are multinationals or local players—to quickly become industry shapers, if they choose to play in the fastest-growing subcategories in the fastest-growing markets. For example, The Coca-Cola Company, recognizing Chinese consumers’ preference for pulpier juices, launched Minute Maid Pulpy—which became the company’s first billion-dollar brand developed for and in an emerging market. Local companies, too, are making winning choices: our research shows that in the fastest-growing CPG categories in China, Brazil, and Mexico, eight of the top fifty companies are headquartered in emerging markets. These local entities—companies like Mexico’s Grupo Bimbo—are venturing outside their home markets and skillfully leveraging their emerging-market know-how, favorable cost positions, and proximity to a rapidly expanding customer base. As a result, their sales growth in emerging markets (19 percent CAGR in the 2009–12 period) far exceeds that of US-based CPG companies (5 percent).

Emerging-market companies’ budding success on the global stage introduces a new element to strategic planning. We believe CPG companies should take a more data-driven approach to understanding how competitors will grow in each market, and how their own strategic positions will change as a result. They will then be able to predict critical inflection points for particular products in particular cities and regions. McKinsey research has found that consumption growth in each product category follows its own distinct variant of the classic S-curve pattern. Companies that invest just as a category enters the “hot zone” will likely generate the most value. Better insights into competitor evolution, and how it will affect the microeconomics of product categories in each country and globally, will become increasingly important.

Not all growth is coming from emerging markets; companies must identify and invest in pockets of growth in developed markets as well, particularly as growth in emerging markets slows. In the United States, for example, the spending power of certain demographic groups, such as baby boomers and Hispanics, is significant and growing. The “value” segment, which flourished during the recession, continues to appeal to a broad swath of consumers. These and other “niche” opportunities in developed markets can hold as much growth potential as entire countries. Colgate-Palmolive, for one, has launched products targeting Hispanics; P&G has introduced new products and brands to compete in lower price tiers.

No matter what investment decisions a company makes, one key to success will be its ability to allocate resources quickly to the businesses that will yield the highest returns. In our experience, companies often underestimate both how big a shift they need to make and how big a shift emerging-market players are already making. The growth of Anheuser-Busch InBev—from a national beer player in Brazil to the world’s biggest brewer and a top 5 CPG manufacturer in less than a decade—shows just how quickly the game can now change.