At Heart of P&G vs. Peltz: The Future of Big -2-

By Sharon Terlep Features Dow Jones Newswires

Activist investor wants niche while consumer giant says big is best

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This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (October 9, 2017).

CINCINNATI -- Procter & Gamble Co., which has suffered through a decade of market-share losses and stagnating profits, hopes its redemption lies in a koala-shaped maxi pad.

Called the "Koala HuHu," the extra-long overnight pad launched this spring in China. Part of P&G's Whisper brand -- which is called Always in the U.S. and elsewhere -- it targets teenage girls with cartoon marsupials snoozing on the box, and is beating rivals despite commanding higher prices. To develop the product, the consumer-products giant abandoned its traditional global formula and for the first time created a major new line for a single overseas market.

"I had to change things," said Fama Francisco, who runs P&G's feminine-care division. For P&G, Koala is proof it can adapt within the world of its cornerstone brands such as Whisper, Crest toothpaste and Pampers diapers.

Activist investor Nelson Peltz, who wants P&G to radically revise its strategy, argues the success of Ms. Francisco's unit is the exception. He says the Cincinnati giant, hopelessly mired in the past, should shift to smaller, niche brands disconnected from its marquee products, pull in talent from the outside and split into three independent units.

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"All the action today is local. It's these small brands. It's what the millennials want," the 75-year-old investor said. "They want a brand with emotion, a brand that's got a story behind it, a brand that brings value to the environment or is organic."

On Tuesday, shareholders will get to chose from these competing visions in a proxy fight over whether Mr. Peltz, whose fund owns 1.5% of the company, should have a seat on the P&G board. In an era in which such battles have become common, P&G stands out as the largest company to face off against an activist investor.

Many the world's leading consumer-products companies, which once made the goods that stocked supermarket shelves the world over, have found it hard to adapt to rapidly shifting consumer tastes and the rise of smaller brands. The outcome of the Peltz-P&G battle will help determine the industry's future direction.

Company executives say P&G has learned from past mistakes and transformed itself into a leaner organization. They say the future lies in the same fundamentals that guided the company for 180 years: huge brands such as Tide and Gillette that spin off products so effective they dominate their category.

"Declaring big brands dead and buried just because there is new media and a new generation is wrong," said P&G's lead independent director, Jim McNerney, the former chief executive of Boeing Co. and 3M Co. "Our new world is big brands presented in different ways through different media."

Mr. McNerney argues that Mr. Peltz, who has had directorships at H.J. Heinz Co. and Oreo maker Mondelez International Inc., is trying to apply a formula that works in food, which is more susceptible to shifting consumer whims, but not for packaged goods such as diapers and dish soap.

"Either your dishes are clean or they aren't," said Mr. McNerney, who started his career as a P&G brand manager and has served on the board since 2003. "Or your car is fresh or it isn't. You win because you have a better-functioning brand because of R&D and chemicals."

Mr. Peltz, whose Trian Fund Management LP is one P&G's largest investors with a $3.5 billion stake, said he knows what shoppers want. "We are in a lot of companies and, whether it's Wendy's or Mondelez, we are living with what the consumer is thinking and doing." Mr. Peltz said. He added he doesn't want the company to abandon big brands altogether.

P&G's biggest rivals, by contrast, have been snapping up independent brands. Unilever PLC last year bought online razor seller Dollar Shave Club and cleaning-products maker Seventh Generation Inc., and said last month it was paying $2.7 billion for one of South Korea's biggest cosmetics companies. S.C. Johnson & Son Inc., maker of Windex and Glade, agreed last month to acquire cleaning-product brands Method and Ecover.

David Taylor, P&G's chief executive, said P&G is open to creating or acquiring new brands but believes the better strategy is to develop new products within the company's existing brands, such as Downy scented beads for laundry or Febreze air fresheners for cars. By adding to established brands, P&G says, it is able to leverage name-recognition and distribution channels already in place.

The two biggest proxy advisory firms have endorsed Mr. Peltz's bid for a board seat over the company's objections. As much as 40% of the vote will be by individuals stockholders, many of them retirees. P&G faces some investors and investment firms skeptical and frustrated after years of underperformance.

Stephen Yacktman, chief investment officer of Yacktman Asset Management, a money manager in Austin, Texas, with a $1.3 billion stake, said he was convinced the company needs a big shareholder on the board. "The argument that we've heard from P&G doesn't have a good ring to it," he said.

P&G's shares have lagged behind the S&P 500 and its competitors for the past 10 years, while rivals stole share in categories such as razors and diapers that P&G has dominated for decades. Long revered for an ability to meet consumers' desires with blockbuster products such as the Swiffer mop, P&G has struggled to invent a blockbuster hit. Its last game-changer was Tide Pods laundry packs in 2012.

The weak results attracted an earlier activist, Bill Ackman, in 2012, which led to the departure of the CEO the following year. Mr. Ackman, whose Pershing Square Capital Management LP owned as much as 2% of P&G as he pushed for management change, sold the last of his stake in 2014.

Sales growth was tepid when Mr. Taylor took over in November 2015. The 36-year P&G veteran soon admitted the company was in need of a global overhaul. An electrical engineer by training, the soft-spoken executive pledged to cut $10 billion in costs, mostly by streamlining its supply chain and bureaucracy, and to focus efforts on top brands.

"There is no question that we were losing share" in part because of missing big trends in China and in the Gillette business, said the 59-year-old executive. "We've been very transparent about the issues." Mr. Taylor and his team argue those problems are in the past.

The same month Mr. Taylor assumed the CEO job, Ms. Francisco took over P&G's feminine-care unit, a global $4 billion division that oversees brands such as Whisper and Tampax tampons. The P&G line commands 30% of the global market, three times its closest rival.

In her first weeks, the 28-year P&G veteran replaced nearly all of her unit's leaders with new managers, mainly from within P&G.

In China, P&G was losing share to regional brands. There, she said, P&G's Whisper brand was viewed as dowdy, and its marketing focused almost entirely on functionality. Online sales were a low priority, and store displays were cluttered and bland. "This is what we were selling," Ms. Francisco said, grimacing as she held up a nondescript box. "This is a really boring pad."

P&G had missed China's exploding middle class, which was willing to splurge on their children. Consumers were also shifting rapidly to online shopping.

Her team came up with a new pad for Whisper, the Koala HuHu, which isn't sold in the U.S. Previously all new P&G products had to be global. The Koala, the longest pad on the market, is imprinted with a koala cartoon with ears and paws folding over to become adhesives, which required re-engineering production. HuHu in Chinese is equivalent to Zzzzz, and the pads were meant to be used while sleeping.

To get to market quickly, P&G used a local Chinese supplier, another practice the company disliked in an effort to capitalize on its global scale. A P&G team of designers and engineers worked with the supplier, which had never developed a major product for the company, to retool its machinery and set up its factory for the Koala HuHu.

The company also started selling organic cotton pads as well as Tampax tampons, which are rarely used in China but were just starting to take off. In the U.S., P&G added higher-end products including extra-compact tampons and fashionable incontinence underwear.

The efforts stopped P&G's share losses both in China and at home. Its global share of the feminine-care market is up 0.3% in the past six months after losses in 2015 and 2016, according to Nielsen data supplied by P&G.

Ms. Francisco said she made use of a new organizational structure P&G has implemented over the past two years. At first, she had to share sales teams with other P&G units selling unrelated products, which meant salespeople were scrambling to meet targets set by other executives. Eventually, with her own sales team, Ms. Francisco was able to persuade Chinese retailers to overhaul their in-store displays.

Across P&G, global unit leaders now have control over sales teams and can unilaterally make decisions on product investments and supplier contracts, executives say. Previously, sales staff reported to regional heads instead of executives running brands, and such decisions required a nod from layers of management -- a corporate structure nicknamed "the thicket" by frustrated executives.

"When something went wrong, it wasn't clear who or where" was responsible, said finance chief Jon Moeller. "Now, there is no place to hide."

Trian says P&G still has too many executives making decisions at the corporate level.

Several retailers and suppliers say doing business with P&G often takes longer and requires more bureaucratic finesse than working with its rivals.

In dealing with Boxed, an online bulk seller of grocery and consumer goods, P&G was slower than Unilever and S.C. Johnson to agree to switch to lower-cost packaging designed for e-commerce, people familiar with the situation said. The P&G team was eager to make the change, but it took more than a year to get approval from higher-ups.

"When you are not No. 1, you are willing to make the bigger and bolder bets," said Boxed founder and Chief Executive Chieh Huang. "I think that might be a reason they haven't moved as fast as some other companies."

P&G lost market share globally in all its reporting segments for the fiscal year ended June 30. In each segment, the losses narrowed from the previous year, but trouble spots remain.

The company's share of the global baby-care market, which includes diapers, training pants and baby wipes, fell to 25% in the latest year, down from 30% a year earlier. For years, P&G has been working to jump-start its Olay skin-care line, but the brand's share fell to 6% last year from 7% the year before.

Mr. Taylor said it would take time for some of his efforts to bear fruit. Meanwhile, he has made fighting off Mr. Peltz a personal mission. When discussing the activist's criticisms at his office in downtown Cincinnati, Mr. Taylor kept his voice even while restlessly bouncing his knee. "I'm getting fired up," he said. "I'm not mad, though. I'm determined."

(END) Dow Jones Newswires

October 09, 2017 02:47 ET (06:47 GMT)