For much of the 1980s, food and packaged goods companies could do no wrong. Merely to take part in the industry seemed to guarantee stellar financial performance. Between 1981 and 1990, the top quartile of the industry generated shareholder returns of over 30 percent per year. Even the laggards in the bottom quartile turned in a compound annual return of 26 percent. Understandably, it wasn’t easy for companies achieving annual shareholder returns of over 20 percent to come to grips with the fact that they were at the bottom of the barrel.

Back down to earth

More recently, however, industry performance has come crashing back to earth. Top quartile returns to shareholders so far this decade are well below the bottom quartile returns of the 1980s (Exhibit 1).

The reasons for this slump are legion. In the early to mid 1980s, tremendous margin expansion swept the industry. The nominal cost of ingredients fell; manufacturers realized customers were prepared to pay a good deal more for quality branded products; and general inflation was higher than food inflation, making it easy to pass real price increases on to consumers.

But when conditions deteriorated in the late 1980s and early 1990s, food producers found it much harder to earn superior returns. A steep decline in performance was followed by a rash of announcements about layoffs, facility consolidations, overhead cuts, and the like. Such measures, however, are largely tactical, designed to prop up short-term earnings. In order actually to create wealth, it is now imperative that food and packaged goods companies grow.

Three main options present themselves: acquisition, expanding internationally, and expanding existing businesses. In the current environment, all are difficult.

Limited options

In the wake of the aggressive acquisition programs of the past, the number of potentially attractive takeover targets has dwindled in both the United States and Europe. If co-ops, highly diversified companies, and private firms are excluded, there is no more than a handful of US food companies in the $500 million to $5 billion range that are genuine acquisition candidates.

Even if a major company did emerge as an acquisition prospect, today’s high prices would rule out any guarantee of improved shareholder returns. As the industry consolidates, major acquisitions are becoming steadily more expensive: in 1994, for instance, Johnson & Johnson had to pay 20 times the operating income of its takeover target, Neutrogena, to clinch the deal. Given such prices—double the mid-1980s norm—it is difficult to see how acquisitions can ever pay off with higher shareholder returns, no matter what the economic benefits of consolidation may be.

International expansion is hardly a safer bet. Encouraged by vibrant markets at home, packaged goods companies stampeded across borders. By 1993, 15 of the largest US consumer packaged goods companies had won more than half of their revenue growth from international markets in the previous five years. An overseas growth rate of 16 percent during this period overshadowed the 6 percent gained at home, while international operating profits rose by 18 percent a year, compared with 11 percent in domestic markets. But how much of this growth actually produced economic profit is questionable.

We looked at the international operating income generated by the 15 large US-based consumer companies and subtracted a cost of capital charge on their international assets. On this basis, Coca-Cola did very well. But taken as a group, the other 14 companies only broke even internationally. Though some of these companies are undoubtedly making investments that will attract future rewards, it is still surprising that blue-chip packaged goods companies have not on the whole been creating value.

Many companies have an equally dismal record of growth from existing businesses. A survey of salesforce effectiveness among leading US packaged goods companies revealed that only one in four had achieved genuine unit-driven growth over the previous five years.¹ Most growth derived instead from higher prices or acquisitions. Fully a quarter of the companies surveyed experienced real declines in revenue, and just under half of these saw negative unit growth.

Evidence suggests that many of today’s companies are simply not equipped to exploit opportunities for growth. Often, they spend their limited budgets ineffectively; in some cases, as much as 40 percent of a development budget was expended on unproductive projects. Management systems were evidently not able to put a stop to these projects quickly enough.

In addition, senior executives rely too heavily on the brand management system for ideas. While it provides terrific execution, CEOs are dissatisfied with its performance in other areas critical to growth, such as strategic market development and the crossfunctional activities involved in bringing a product to market.

Growth opportunities

Just because the bonanza is over, it does not mean packaged goods companies must stagnate. All three strategies—acquisition, international expansion, and growing existing businesses—still hold opportunities, though companies will have to be more focused than in the past if they wish to capture them.

Companies should concentrate on smaller deals at the business unit or category level—not just because of the dearth of big takeover targets, but because smaller deals create more shareholder value. The reason is simple: large acquisitions take a long time to assimilate, so that releasing substantial value through economic synergies is a slow process. When S.C. Johnson bought Drackett from Bristol-Myers Squibb, for example, it predicated its bid on absorbing the business fully and achieving 100 percent attrition. It accomplished these objectives within four months and created value in year one.

When expanding internationally, companies should concentrate on specific categories or markets and avoid spreading themselves too thinly. The best international margins are enjoyed by single-category businesses or worldwide brand dominators such as Coca-Cola, Wrigley, and Kellogg.

The second-best strategy is to focus on selling a broad range of categories to a limited group of markets. Heinz takes this approach, deriving about two-thirds of its international revenue from just four markets. Companies with a multi-category presence across many markets, such as Sara Lee, Procter & Gamble, and CPC, have earned more modest returns. CPC was the top performer in this class, with a margin of about 12 percent.

At the bottom of the scale, opportunistic or inconsistent strategies seem to reap the worst rewards.

Kick-starting a stagnant home market will entail managing an organization to encourage innovation. That means the right people in the right jobs, the right management processes, and the right environment to foster growth.

We studied a number of cases where a flat business suddenly took off and achieved double-digit growth. There were striking parallels between these winners. After setting stretch targets for growth, the best managers concentrated single-mindedly on obtaining the deep fact-based consumer and competitor insight they needed in order to determine how to reach their objectives. Senior managers were heavily involved in selecting, and keeping the organization focused on, the key product ideas and technologies.

The managers who achieved these outstanding results were almost always new to their job, though well-grounded in the functional aspects of packaged goods. They were disciplined thinkers who trusted their own intuition—as others also did. While they were collaborators and good crossfunctional integrators, they were also willing to take risks and manage them carefully.

Achieving profitable growth in the packaged goods industry will continue to be a tough challenge. Success will be the preserve of the companies that recognize this and implement best practice in the pursuit of shareholder returns.