L.G. Lafley was about to turn 62. He had been CEO of P&G, a 172-year-old company, for nine years now. In his years at P&G he had helped develop modern consumer-product marketing, and in the process had trained scores of managers who were now top executives in firms the likes of GE and Microsoft. He was no stranger to MBA classrooms and his 2008 book, The Game Changer that emphasized innovation, enhanced his reputation. However, in this time of economic challenge, the gospel that he preached had become a major issue with supporters and critics.
Many firms in the 2008–2010 recession found customers spurning their luxury products and brands for those more modestly priced. P&G had carefully nurtured its key brands in many categories with heavy advertising, so much so that its daytime television serials became known as "soap operas." Now these were becoming negatively affected, with sales of such brands as Tide, Tampax, Crest, and Pampers dropping 5 percent in the last six months of 2009, while earnings fell 7 percent. Lafley could hardly deny that P&G's national brands were losing business to store brands as pinched consumers shifted their spending, and this was affecting markups, gross margins, and net profit. Even with lower sales, gross margin could still be maintained if prices could be raised without demand being drastically affected. But this was not happening.
In his reign as CEO, Lafley had revitalized P&G's business. Late in the decade he was instrumental in the $57 billion acquisition of Gillette Co. This resulted in company sales more than doubling to $83.5 billion for the fiscal year ended June 2008. His strategy now was to move toward beauty and premium household products with higher profit margins.
Something else troubled him: Would consumers shift back to the higher priced P&G brands and their more profitable margins when the economy improved, or would they find these economy brands almost as good and stick with them? In early
2009, Lafley raised the quarterly dividend by 10 percent in keeping with the 53-year streak of increases. Some naysayers criticized this, but he maintained that this proud tradition should be continued. After all, it represented faith in the company's fortunes, recession or not.[23]
On July 1, 2009, 55-year-old Robert A. McDonald, chief operating officer, was appointed CEO. Lafley would remain chairman.
McDonald grew up near Chicago, and he dreamed of going to West Point. He took typing and speech classes to develop two skills he hoped would help him succeed should he be successful in gaining admittance. He wrote to his congressman to request admission to the U.S. Military Academy and graduated 13th in a class of 875 in 1975 with an Engineering degree. He became a captain in the 82nd Airborne Division. Jumping out of planes appealed to him because it added $110 to his $300 monthly salary. "That was a lot of money to me then."[24]
After five years in the Army he realized a military career would keep him away from his family too much, and he decided instead to pursue a management career at P&G.
The day of his P&G job interview, he dined with Mr. Lafley, who would become his mentor because they both served in the military prior to P&G, and their careers crisscrossed over the years. He rose quickly through the organization, managing brands including Solo detergent, Dawn dish soap and Tide detergent. In 2004, he became a vice chairman and chief operating officer, and for two years he worked to make the sprawling manufacturing facilities and transportation system more efficient.
P&G maintained a succession race for years with a promote-from-within model. For a huge firm with $83.5 billion in sales and 138,000 employees in more than 80 countries, the sheer size made it difficult to quickly respond to competitive threats such as lower-cost products. P&G's promotion model fostered intense competition as employees jockeyed for consideration. While the company liked the motivation this model inspired and the whole-hearted commitment of its ambitious candidates, it recognized a downside. Lafley feared that high-level executives passed over for a top job would leave the company while young enough to become CEOs elsewhere. This had been happening for years, and company executives wryly complained that "we're the training camp for other firms' executives."
When McDonald's promotion was announced, Susan Arnold, the president; announced her plans to depart in September. Persons also passed over for the No. 1 position included two vice chairmen, and they shortly left the company. It had also lost key executives the previous year: the global marketing officer, global design chief, chief technology officer, and chief legal officer, as well as the vice chairman of the global household-care division.
The competitive environment was at a critical juncture. Some were questioning whether the company had become too big for rapid growth. In May, P&G issued a sharply lower-than-expected earnings forecast for the fiscal year beginning July 1. Largely because of the recession with consumer buying patterns changing to a thrift emphasis, each business at P&G was seeking to reach more customers by widening the price range of its products. Some 23 brands each racked up more than $1 billion in annual sales. This brought certain profitability consequences that needed to be addressed. See the following box for the Evolution of Tide.
Store brands or private brands have been around a long time. They offer astute shoppers lower prices than nationally advertised brands. While the quality may be somewhat less, it is usually entirely acceptable. They offer the retailer a better markup because the store is not burdened with advertising and other distribution costs. In this present recession, with some of the highest unemployment since the Great Depression, many shoppers switched from national brands to store brands. This affected P&G particularly hard because its big brands had long dominated due to heavy brand advertising over decades. The price differential with store brands became more attractive than ever, both to the consumer and to the merchant.
Store brands became an easy sell. Consumers had become more knowledgeable than ever, and many were now skeptical of advertising claims. High drug prices and particularly the differences in generic prices to the brand name drugs, encouraged this new acceptance of unbranded goods. Lafley was to moan, "People who switch might find private labels give them 95 percent of the satisfaction of a P&G brand, and they might decide that's good enough."[25]
A new product generally takes some sales from similar older products. This may be due to technological improvements, a better price, or something else that makes it more attractive to the buyer than existing products. Then, most people are attracted to the selling pitch—"New!"
More often, producers are tempted to add features that boost the price of the new product. If this cannibalizes, so much the better. Even if the new product yields a lower profit margin, the manager can rationalize that "if we do not introduce this advanced razor or toothbrush or detergent, someone else is likely to do so in the near future, and we will be out more profit." But the decision is not easily made.
In P&G's dilemma in bringing out new products of somewhat lower quality and lower price to meet the changed consumer demand, the best hope was that the lower-priced product would be more competitive and have an acceptable rate of cannibal-ization. And the other hope is that consumers would switch back to the higher priced brands as the economy improves. But will that many consumers switch back?
The more similar products that are carried in a particular product category, the more costs that are incurred. A lean inventory and product line is generally the most profitable. The decision to carry a leaner stock and assortment should be weighed against the greater attractiveness of a wider assortment and more choice given to consumers. However, not every consumer is attracted to a wide assortment. Some see such as confusing, and making shopping more time consuming. But certainly the inventory investments are not minor when P&G brings out lower-priced versions of more than 20 top-selling brands in its product stable in order to complement its major brands and to be competitive.
McDonald announced his organizational plans upon assuming office. In a town-hall style of meeting at the company's Cincinnati headquarters, he told employees that he planned to reduce the levels of management between entry-level positions and the chief executive to seven levels from the present nine levels. He wanted to "create a simpler, flatter and more agile organization. This is a priority because simplification reduces cost, improves productivity and enhances employee satisfaction."[26] He also announced that he would not replace himself as chief operating officer and would assume the title of president, eliminating another high-profile job opening.
McDonald faced some of the legacies of Lafley's tenure. He sold Crisco shortening, Folgers coffee, and other sluggish food brands. Lafley had invested heavily in the beauty business, capturing brands like CoverGirl cosmetics and Pantene shampoo that became the biggest contributor to sales and profit gains in the last years of his tenure. He made a giant acquisition with Gillette that gave P&G a major stake in men's grooming in developing markets. But what about other Gillette businesses, such as Braun appliances and Duracell batteries? Are these getting too far from P&G's core? Robert McDonald faced such decisions in his early months on the job.
We have discussed earlier a key concern about this policy if followed rigidly. Some of a firm's most capable executives who fail to win the promotional lottery will feel bitterly disappointed and likely move to top-level positions in other firms. Whether this leaving the ship outweighs the motivational advantages of promotion from within is worthy of study. There may be some advantages to bringing an outsider into the organization.
P&G presented a number of challenges, many of these aggravated by the difficult economic times. The decision on succession further complicated the issue. The major issues and their scope and priority are worthy of debatable attention.
By Fall 2009, McDonald was ready to make some hard decisions mostly involving acquisition and divestiture candidates. Since taking over in July, he had been trying to shake up P&G's slow, process-heavy culture. He paid particular attention to Braun small appliances, Iams pet food, Duracell batteries, and Pringles potato snacks; items on the fringe of P&G's declared emphasis on beauty, health, and nonfood household staples. McDonald charged the managers of these businesses to prove their brands' prospects or face divestment.
For example, Duracell, which P&G acquired when it bought Gillette in 2005, was struggling against cheap private-label batteries and fluctuating commodity costs. So, even though Duracell would post about $2.5 billion in sales, batteries were not likely to be profitable in the near future. Similarly, Iams, with an estimated $1.8 billion in sales was struggling to improve its profit margins. As one of the most expensive brands in pet foods, it was proving a tough sell in the recession, and market share continued slipping. Why would one firm be interested in buying another firm's loser? See the following box for a discussion of this issue that bedevils both the buyer and seller in many instances.
In late 2009, P&G sold its pharmaceutical business in its continuing of a back-to-basics strategy. It sold its prescription-drug unit to Warner Chilcott, a niche pharmaceutical maker for $3.1 billion in cash. In so doing, P&G gave up a business that contributed more than $2 billion a year in sales, but it gained a cash infusion to help grow its core businesses of laundry, home care, and personal care products. Instead of prescription drugs, the company will now focus on over-the-counter, health-care products.[27]
Suppose this turns out to be another Folgers. Should heads roll?
P&G, the world's biggest advertiser, was spending about $8.7 billion annually on mass media advertising and promotions. McDonald's appointment raised concern in advertising circles about how this management change would affect advertising budgets.
Already, it had been pressuring media companies for price breaks. Indeed, the recession was hurting the rest of Madison Avenue rather badly, with General Motors, the second-largest ad spender in the United States, slashing its budget and warning of more cuts to come.
P&G announced an organizational change for its brand management by bringing together teams of experts to work on given brands under one leader. P&G had started this strategy in 2007 and dubbed it "the brand franchise leadership model." This design "will simplify our business, lower our costs and improve capability by eliminating thousands of individual contracts and generating much more holistic advertising and mar-keting."[28] The aim was to reduce the number of ad companies it dealt with to only two.
Going into 2010, the economy remained weak. While the stock market had recovered some of its losses and manufacturing was slowly reviving, the job market was little changed and unemployment was around ten percent in most areas with home sales still in the pits. Consequently, there was little to spark consumer optimism, and a return to higher-priced brands. CEO Robert McDonald, some of whose products were twice as expensive as competitors', disputed the notion that consumers had abandoned premium products. "The idea that this economy is causing everyone to trade down is overly general and too broadly applied," he defended, noting the success of some of his higher-priced products by the end of 2009. But the cost of increased marketing and other "innovations," such as more absorbent diapers, had driven costs up and profits down. Cutting prices doesn't come easily for P&G, and it planned a 30 percent increase in "significant" product innovations for 2010.[29]
Invitation to Make Your Own Analysis and Conclusions
On balance, do you think the promote-from-within model is desirable both for the firm and the individual? Are there any conditions you would like to see imposed?
Does the size of P&G give it a powerful advantage over its competitors? Why or why not?
Would you like to work for a firm that has a firm policy of only promoting from within?
Discuss the importance of market share in P&G's various businesses.
Do you see any danger of major retailers, such as Walmart, opting to drop the higher-priced national brands? Why do you think this?
Do you think house brands of golf balls will ever strongly compete against the national brands?
How much of a price premium do you think national brands ought to command over private brands? Justify your position.
Can you criticize McDonald's handling of his first few days on the job as CEO? What advice would you offer him?
Do you have any criticisms of "town-hall meetings"?
You are a trainee at P&G and have been assigned to Robert McDonald to help him with his transition to CEO in the early days. He has asked you to draw up plans and goals and priorities for his first 2 weeks on the job. Now is your chance to impress the big boss and perhaps gain a mentor.
Debate the promotion from within policy.
Debate McDonald's plans to reduce executive levels.
Debate the budgetary issue of increasing advertising during bad economic times in order to build up demand, versus cutting back on advertising to protect your bottom line.
How has McDonald's transition to CEO been? Have there been any publicized problems?
As the economy has emerged from recession, has P&G regained its former luster? Have its major brands regained their pricing power?
How is Lafley spending his retirement years?
[23] Christopher Steiner, "The Tide Changes," Wall Street Journal, June 8, 2009. p. 29.
[24] Ellen Byron, "P&G Chooses a New CEO as It Adapts to Era of Thrift," Wall Street Journal, June 9, 2009, pp. A1, A16.
[25] Steiner, ibid.
[26] Ellen Byron and Joann S. Lublin, "Appointment of New P&G Chief Sends Ripples through Ranks," Wall Street Journal, June 11, 2009, B3.
[27] David Holthaus, "Steamlining, Procter & Gamble Shedding Its Pharmaceutical Unit," Cleveland Plain Dealer, August 25, 2009, pp. C1, C4.
[28] Suzanne Vranica, "Girding for a Leaner P&G," Wall Street Journal, June 10, 2009, p. B6.
[29] Ellen Byron, "P&G Meets Frugal Shoppers Halfway," Wall Street Journal, January 29, 2010, pp. B1–2.