Something of that sort has happened during the past two decades in the consumer packaged goods CPG industry. Two of the most influential strategy ideas are so widely held, so intuitively appealing, and so seemingly pragmatic that they are very hard to give up. Yet they can also be very dangerous to follow. Both of these misleading ideas have to do with consolidation: Since the s, the conventional wisdom has held that shareholder returns accrue most to companies with huge brands and the scale to compete in emerging markets.
Many CPG leaders have assumed that their chances of winning, in every region and every product segment, were enhanced by size. More salespeople, a bigger distribution footprint, a bigger advertising budget — these were the ingredients of success. This perception gave rise to the second misleading idea: For years, experts predicted that most consumer packaged goods segments would end up like carbonated beverages, razor blades, and diapers — with just two or three big rivals, a handful of niche players battling over the scraps, and a few private-label brands for value consumers.
Together, these two myths add up to a consolidation mentality that has dominated business strategy in this industry. CPG leaders have assumed that their job was either to make their company as large as possible or to position it for eventual sale to a giant conglomerate.
In this way, many previously solid CPG companies began to lose their way on the path to profit. But in reality, the industry is much more diverse and dynamic than the conventional wisdom would suggest. Most CPG categories — including staples such as food, personal care products, and cleaning supplies — are in a constant state of evolution. They move from consolidation to fragmentation, and some can cycle back, time and time again.
In such an environment, there are many ways to prosper, with each successful company finding its own path: But none of the paths taken involve growth for the sake of scale alone. Instead, they require the kind of growth that leads to profitability. This in turn requires coherence.
Highly coherent companies have three to six major distinctive capabilities, all of which are integrated into a single system that is used throughout the company. This type of strategy and management execution allows companies to be efficient in their activities, disciplined about their portfolios, and differentiated in the eyes of customers.
Because of the consolidation mentality, many executives of CPG companies have overlooked the value of coherence. They have focused on sheer size and scale instead.
But size and scale are no longer as critical as they once were — at least not in the mature markets of industrialized nations. We recently compared the financial performance of three dozen consumer packaged goods companies in North America and Europe, over a year period starting in The most consistent CPG successes were all coherent firms.
Coherence seems to be particularly important in consumer products companies, where there is always a temptation to react opportunistically to changing markets, with brand extensions, new products, or acquisitions. Why does it make such a difference to resist that temptation? In their book The Essential Advantage: A coherent company — for that matter, a company that is simply more coherent than its competitors — can focus its investments on relatively few capabilities, increasing its mastery of those critical areas.
A coherent company also makes more prudent portfolio decisions, applying the lens of capabilities as it decides which products or services to acquire and which to divest. Finally, a coherent company provides more opportunities for its people and gives them a clearer understanding of where the company is going and how their work fits in.
There is some truth to this — a smaller company, especially one with a hit product, always has a better chance of showing dramatic growth because of its small revenue base. Even so, if the advantages of size, international penetration, scale, and retailer satisfaction were really so great, one would expect bigger companies to do better than the vast majority of their smaller peers.
Instead, they are on par with most smaller companies and far behind a few in the important area of total shareholder returns. The history of the industry suggests that size was indeed a vital element in the past. But its impact has been eroded. One important factor in this was the rise of digital media. A generation ago, when network television was the most effective way to get a branding message out to consumers, players with scale could get the best deals for airtime.
Newer outlets, including infomercials, custom-designed Internet sites, and social media such as Facebook offer better options. Creativity and promotional skill are supplanting sheer size as the determinant of marketing success. Many CPG companies are delivering their own branded experiences through websites or mobile phones — an approach known as private-label media. Outsourcing and alliances have also helped erode the value of scale. These capabilities can be offloaded to outside partners that can do the job as well as the largest rivals in a market, often at a lower cost.
Nowadays, a smaller CPG company that needs that information can outsource the function to a specialist firm. Shopper attitudes have also changed. There, the near-term advantage is to the swift, because emerging-market consumers are still developing brand loyalties. Scale also provides an advantage there because the retail infrastructure is not as advanced as it is in industrialized nations, and therefore large manufacturers can provide reliable delivery at a lower cost than their competitors can.
But as these markets evolve and mature, and as competition increases, these markets will probably start to favor coherence as well. From Consolidation to Fragmentation The value of consolidation, like the value of size, was more substantial in the past than it is today. In the s, a company with a loosely configured portfolio pursuing an incoherent growth strategy could maintain adequate shareholder performance for years, until it was eventually purchased by another company.
Those days are gone. In recent years, the CPG industry has undergone a sea change in its structure. Some product categories are consolidating, but many are fragmenting instead: They are splitting the customer base among more, rather than fewer, competitors. When retail outlets were still highly fragmented, a manufacturer could gain an advantage by having a bigger sales or distribution force to knock on more doors and get products on the shelves.
Now there are fewer retail brands, but a greater number of megastores and outlets. In some cases, this situation favors consolidated manufacturers. But more often, small, coherent manufacturers find that retail consolidation works in their favor. Simply by getting accepted at Walmart, a CPG company with one or two popular products can gain access to 30 percent of the U.
With another one or two big retail distribution wins, the company can reach 50 percent or more of its target market. Getting this access is easier than it may seem, because although most big retailers routinely limit the number of products they carry, they place less emphasis these days on product breadth and more on category-specific differentiation based on superior shopper and consumer insights.
That would mean giving up some of their negotiating power. They need to score with big retail buyers through distinctive capabilities in innovation, product development, and packaging. Think of the chocolate lover who is drawn to a highbrow brand such as Vosges, Lindt, or Ghirardelli, or the connoisseur who insists on freshly baked bagels to go with a high-end form of Nova salmon.
Consumer engagement also tends to spread virally; if a large number of people in a community buy specialized pots and pans at Williams-Sonoma, sooner or later their neighbors will look for similar cookware at Walmart or Target. This type of dynamic tends to push a category toward fragmentation, as different groups gravitate toward different competing brands.
Before , there were just a handful of producers. Then new regulations allowed small-scale breweries to operate, and breweries proliferated. About 1, beer companies operate in North America today. The same dynamic spread from beer to other food and beverage categories. By , the top two or three brands in any food category were just as likely to lose market share as to increase it over the subsequent four years. Fragmentation is also common in many personal care and beauty segments.
But it had only Hairstyling products are even more fragmented than shampoos, with the top three products barely accounting for a quarter of all revenues. Private-label products often gain a foothold here. Adding to the complexity, the perception of brand value differs across geographies. In Germany, more than 60 percent of consumers resist buying branded toilet paper: They do not believe it is any better than the cheaper private-label variety. There are, of course, categories that have consolidated in just the way the experts predicted.
Carbonated beverages Coke and Pepsi have more than 70 percent of the market between them , breakfast cereals Kellogg and General Mills , shaving products Gillette and Schick , and pens Sharpie and Bic all have only a couple of major brands, plus a few local or niche brands, and private labels.
These consolidated categories also offer unique scale advantages in product development, manufacturing, and distribution. But they do not represent the bulk, or even the majority, of consumer product categories. Moreover, as time goes by, some of these categories are also likely to fragment. Coherence at Alberto-Culver In the face of these realities, why do so many consumer products companies maintain the consolidation mind-set and pursue a strategy of incoherent growth?
In part because it feels natural to executives who grew up in the business during the past 30 years. Most of the large companies in this category evolved through ad hoc mergers and acquisitions. A baked goods company might acquire two others, each with a small frozen foods sideline, and become a conglomerate with a frozen foods division.
Ultimately it would end up with a diverse portfolio of relatively unrelated products. Companies that develop in this fashion naturally tend to organize themselves around their brands, typically their most visible managerial distinction. Without stepping back and looking at the portfolio in light of capabilities, a CPG company will struggle to be coherent. Each product line in its wide-ranging portfolio inevitably requires its own capabilities to thrive, and few of these capabilities overlap with those needed by other products.
Consider, by contrast, the high level of coherence that Alberto-Culver has achieved. This relatively small company has outperformed the market since and commands a high valuation multiple. Its strategy works because Alberto-Culver has a tightly defined product mix — 80 percent of its revenues come from beauty products for hair and skin care — and a system of interconnected capabilities, giving it an advantage in its categories. The same is true of the product development staff; they know hair care deeply.
A second differentiating capability relates to brand building. For example, it was the first company to convert products used in salons into mass-market packaged goods. Like any other CPG company with limited resources, Alberto-Culver also manages some capabilities that are not differentiating.