Financial results for the third quarter of 2013 indicate that the fortunes of Colgate-Palmolive Hill’s pet care unit are being turned around, while those of Procter & Gamble continue to slide in the wake of a string of product recalls.
Procter & Gamble and Colgate-Palmolive face similar problems. Mars and Nestlé are consolidating their grip on the global dog and cat food market, largely through intensive efforts to build share in emerging markets. Moreover, these companies enjoy economies of scale that Procter & Gamble and Colgate-Palmolive can only dream of. In 2012, Mars and Nestlé accounted for almost 50% of value sales in the global dog and cat food market, up from 48% in 2008. On the other hand, a plethora of small and medium-sized players are fragmenting the premium end of the market (particularly in North America), the segment in which Procter & Gamble and Colgate-Palmolive have traditionally derived the bulk of their sales.
In 2008, Procter & Gamble and Colgate-Palmolive both accounted for 6% of global sales, but their shares began to slide in 2010. However, by 2012, the latter had arrested its decline, while Procter & Gamble’s difficulties have only intensified. The latest sales figures show that these trends have continued into 2013.
Recall Woes Hurt Procter & Gamble
A spate of recalls has hit Procter & Gamble’s pet food sales hard. It issued two voluntary recalls for its super-premium Natura brand during the first quarter, while recalls for its Iams and Eukanuba brands were issued during the summer. Suspected salmonella contamination was the cause of all of these recalls.
Some have pointed the finger at efforts to cut costs in the manufacturing process as the cause of these problems, but such assertions are merely speculation. Margins in the pet food market are much higher than in most areas of the packaged food market (particularly for such super-premium brands as Natura), and the argument that a straight line can be drawn from cost-reduction measures to these incidents is specious. Moreover, such rivals as Colgate-Palmolive have also been cutting costs aggressively, without any negative impact on product quality.
Net sales at Procter & Gamble’s healthcare division, which includes pet food, fell by 1% year-on-year during the three months to the end of September. The company attributed this decline to the negative impact of the Natura recalls. Healthcare sales had risen by 6% year-on-year during the previous quarter.
Sell-off Speculation Builds
This has led to renewed speculation that Procter & Gamble will seek to exit the pet food market. AG Lafley was reappointed as CEO in May this year, and in August he commented that the company was ready to offload business units in “unattractive sectors”. However, the pet food market hardly fits this description – global real value sales of pet food exhibited a compound annual growth rate of 2% over the 2008-2013 period, compared with 1% in home care and 2% in beauty and personal care, two of Procter & Gamble’s mainstays.
Nonetheless, Procter & Gamble is very weak in key emerging markets – it accounted for just 1% of value sales of dog and cat food in the rapidly expanding Latin American and Eastern European markets in 2012. Its global market share in dog and cat food slipped from 6% to 5% between 2008 and 2012, and it is inevitable that this figure will fall again this year.
Under Attack from Emerging Brands in North America
Procter & Gamble remains strong in the premium segment of the North American dog and cat food market, accounting for 19% of value sales in 2012. However, this figure stood at 24% as recently as 2008. It is poorly positioned to fight off the challenge posed by such emerging brands as Blue Buffalo and Natural Balance, which offer natural and holistic ingredients and have seen sales surge in recent years.
Sales Surge at Hill’s, but Margins Dip
The contrast with Colgate-Palmolive is stark. Its Hill’s pet care unit saw organic sales expand by 6% year-on-year during Q3, with volume gains in the US and Russia partly offset by volume declines in Japan. However, higher raw and packaging material costs, as well as increased investment in customer development initiatives and advertising, saw its operating profit decrease by 6%, to US$138 million, during the quarter. Its profit margin fell by 250 basis points, to 25.3% of net sales.
New Launches Find Success
The company credited much of its growth to the successful launch of a new natural pet food brand, Hill's Ideal Balance, in the US, in addition to the global launch of Hill's Prescription Diet Metabolic (which targets owners seeking to manage the weight of their pet) and the re-launch of Hill's Science Diet with natural ingredients and an improved taste.
With regard to Hill's Prescription Diet Metabolic, the company noted in an October 2013 conference call that “In Europe, our distribution is already above the target we had set for ourselves for the end of this year”. It also reported that its sales of wet dog and cat food and pet treats were particularly strong. It also has a host of innovations still in the pipeline, with such SKUs as Science Diet Small & Toy Breed Lamb Meal & Rice Recipe, Ideal Balance Grain Free Cat and Ideal Balance Hairball for cats due to be launched in the near future. With these and other launches, the company is hoping to rebuild its margins during 2014.
Distribution Strategies a Key Differentiator
Colgate-Palmolive deserves a lot of praise for adapting (albeit rather belatedly) to a strong shift in consumer preference to natural products in dog and cat food. Unlike Procter & Gamble, which bought its way into this segment via the acquisition of Natura in 2010, Colgate-Palmolive opted to reorient its existing research and development and branding strategies, taking into account both changes in consumer preference and the positioning of its emerging rivals. Moreover, while Procter & Gamble tried to broaden the distribution of Natura products (even selling it in garage forecourts), Colgate-Palmolive focused on building relationships with specialist retailers, particularly pet superstore chains like PetCo and PETsMART in the US.
Procter & Gamble’s distribution strategy appears to have alienated some consumers as it reinforced in the minds of at least some the notion that the Natura brand had been diminished by its association with a behemoth like Procter & Gamble. The recent recalls have only served to heighten these reservations.
Stick or Twist?
Is Procter & Gamble prepared to make another effort to turn around its declining fortunes in pet food, or will it seek to exit the market? 2013 could well see Colgate-Palmolive leapfrog Procter & Gamble to become the second largest player (behind Nestlé) in the North American premium dog and cat food market (its value share stood at 18% in 2012), and with the likes of Blue Buffalo continuing to expand rapidly (increasing its share from 3% to 8% between 2008 and 2012), Procter & Gamble needs to act fast.
In the event of a sale, interested parties could include private equity funds and such rivals as Mars, which is relatively weak in the North American premium segment. A spin off could also be an option. This would perhaps provide these brands with greater room for manoeuvre, while at the same time allowing Procter & Gamble to maintain an interest in a lucrative market.