The P&G Gillette Merger A Dream Deal

The P&G-Gillette Merger: A Dream Deal? AuthorsAuthors: RuchiChaturvedi N &PradipSinha,Faculty Member, Associate ConsultantICMR (IBS Center for Management Research).On January 28, 2005, Cincinnati-based P&G announced its investment deal to acquire Boston-based Gillette for $57 bn to become the world's largest consumer goods company. The annual sales of the combined entity would be $60.7 bn. Afterits purchase of Gillette, P&G would have 21 billion-dollar brands with a market capitalization of $200bn.According to the deal, P&G will be paying 0.975 for each share of Gillette, valuing the acquisition at a 20% premium to shareholders of Gillette. The shareholders of P&G are apprehensive of the company's share prices being diluted. To avoid such problems, P&G has promised to buyback its shares, worth $18-$22 bn, over the coming 12-18 months. P&G plans to pay Gillette 40% in cash and the rest 60% in stock. Marketing guru Al Ries feels that, "The extra 20% premium paid by P&G for Gillette's stock is going to make it 20% more difficult for the deal to pay dividends to stock holders". By acquiring Gillette, P&G will be adding the world's best shaving products to its portfolio. This is what P&G's CEO A G Lafley thinks is necessary to overtake their close competitors, particularly in developing countries.Both the firms' CEOs termed the deal as a friendly move, and added that it would benefit both the firms equally. According to analysts, the merging companies had many similarities a corporate history that is more than a century old, billion-dollar brands, and pioneering consumer product marketing initiatives. The merger was also said to have been based on a different model where innovation was the focus rather than scale. It was called a unique case of acquisition by an innovative company to expand its product line by acquiring another innovative company. Analysts described the merger as a "perfect marriage".Some analysts felt that regulatory concerns raised by the merger could relate to product overlaps between both companies, in order to determine whether the combined firm would have the power to set prices. There were concerns that strong overlaps in toothbrushes and toothpaste could result in regulators seeking some divestitures, although P&G would like to keep as many Gillette brands as it can. However, according to Christo Lassiter, a law professor and antitrust specialist at the University of Cincinnati, the deal would easily win regulatory approval, as P&G and Gillette mostly sold different products to different customers. Lassiter also said the government had realized that preventing US companies from expanding would make them vulnerable to foreign competition. So it has become tolerant of big mergers. Objections, however, were expected to come from European Union antitrust regulators in Brussels, as the deal would give the merged company added strengthin the overseas markets.A Compulsion Rather Than a ChoiceThe consumer goods industry grew rapidly from the 1950s through the 1980s. However, after this period, the industry's growth slowed down. Slow sales growth, increasing cost of inputs, emergence of private labels, lower margins, difficult price negotiations, and the increasing diversity of channels, choices and consumer types posed new challenges for this $2 tn plus industry.In recent years, major retailers had consolidated and manufacturers of consumer goods were facing pressure from them in pricing, delivery, and standardization conditions. Wal-Mart, the world's largest retailer, had expanded rapidly by adding 484 stores since 2000. By the end of 2004, it had 3,013 stores in the US. It accounted for about 8% of total retail sales in America, and its increasing presence in the rest of the world had put it in a position of strength. Over the years, it had built a reputation of passing costs on to suppliers. Wal-Mart's growing dominance had prompted competing retailers to merge. The emergence of the $11 bn combination of Kmart and Sears Roebuck as the third-largest retailer in the US market was driven by the need to gain purchasing clout over suppliers.They had been negotiating lower prices after their merger announcement in November 2004. The main players who competed in the consumer goods industry were renowned names like P&G, Colgate-Palmolive, L'Oreal, Kimberly Clark and Masco in the Household and Personal Products category. Other players in this category included Gillette, Revlon, Henkel, and Reckitt-Benckiser. Bic. Nestle, Unilever, Pepsico, Conagra Foods and Sara Lee dominated the Food Consumer products segment. Johnson & Johnson was a big player in the Healthcare category. Most players had been gaining size with acquisitions in the recent past. Competition had made promotional offers a norm in the industry, and advertising and marketing costs had increased due to stiff competition.A key development in the industry had been the successful emergence of private-label brands. Consumers didn't want to pay the highest possible price for goods just because of the brand name any more. In a recently conducted research, shoppers' willingness to buy branded goods had dropped by 12 percentage points, from 84% in 1997 to 72% in 2003. By 2009, this was expected to decline further to 66%. Consumer goods companies needed to handle this pressure from private labels, most of which were produced by big retailers.Retailers and suppliers were increasingly making use of information technology to efficiently manage their operations. Wal-Mart had demanded that suppliers should fit their packaging with Radio Frequency Identification (RFID) chips to help track goods through the supply chain. As retailers continued to put pressure on manufacturers for lower prices and private labels mushroomed, product innovation became extremely important.Why Gillette?The question that comes to mind is, why did P&G have to acquire Gillette? Moreover, why did Gillette have to sell off its business, notwithstanding its power-packed performance in the global marketplace? Acquisitions are not new for P&G. The company bought the hair care firm Clairol from Bristol Myers Squibb in 2001 for $4.9bn, and the German hair care firm Wella AG in 2003 for $7 bn. The companies acquired by P&G in the past were producing product(s) that matched P&G's product line. However, this deal is different. While P&G's strength lies in women's personal care products with brands such as Olay®, Always®, Tampax®, Cover Girl® and Max Factor®, Gillette's strength is in the men's grooming category with an entire range of Gillette and Braun products. According to Lafley, "This combination of two best-in-class consumer products companies, at a time when they are both operating from a position of strength, is a unique opportunity". Added James M Kilts, CEO, Gillette, "This marks the realization of a historic next phase of great opportunity for Gillette and also for P&G. It brings together two companies that are complementary in their strengths, cultures and vision to create the potential for superior sustainable growth." Refer to Table 1 for a comparison of both the companies.According to reports, Gillette's stocks has climbed 50% since the beginning of 2003 and profits too jumped after the firm focused on premium products, like its Mach3 razors, and employed long-term contracts with retailers. Generally, a stronger company acquires a weaker company, but this is not the case here. Both the firms are strong and competitive in their own segments, and are coming to combine their forces a unique and unusual combination.The acquisition would add about 20% to P&G's sales. This is significant in an industry where sales growth is difficult to achieve. According to an interesting comparison,P&G's acquisition of Gillette would be similar to adding Colgate's sales to P&G's. Gillette had a net income of $1.39 bn in 2003, while P&G had $6.48 bn. The combined company forecasted operating margins of around 25% by the end of 2015, in comparison to margins of 19.1% in 2003.Taking Gillette's growth potential into account, P&G had increased its long-term sales-growth estimates to 5-7% a year, that is, approximately $500 mn each year. According to a research report from Citigroup analyst Wendy Nicholson, the razors-and-blades business would account for 7% of sales and 12% of operating profits of the merged entity. Sales of men's grooming products in the US totaled $3.5 bn in 2004, and were expected to touch $8 bn by 2007. After the deal, health and beauty products would account for half of P&G's portfolio of products. Major gains could also come from bargaining with retailers on prices that would boost margins.The companies expected cost savings of $14-16 bn from combining back-room operations and new growth opportunities. This would make the merger profitable in the third year. One of the areas of cost savings would be eliminating jobs. Both companies would also benefit from adapting each other's technologies and joint research and development. For example, in the area of RFID adoption, P&G and Gillette were early participants and much of their initial investment was likely to have been completedWhy Gillette? Contd...Together they would have even more resources to enable intensive collaborative supply chain initiatives in a more cost-effective way. The merger would also bring down the advertising and media costs owing to greater bargaining power. P&G had already been using its buying power to negotiate for the lowest prices. It had spent $5.5 bn on advertising in 2004more than any other company, according to Advertising Age magazine. Gillette had spent about $600 mn on marketing.The two companies had representation on a global scale with their products being marketed around the world. Also, both companies were looking at developing markets. According to Lafley, Gillette would give exposure to P&G in emerging economies like India and Brazil, while P&G would distribute Gillette products in China. (Refer to Table II for comparison of geographic sales of P&G and Gillette). Analysts felt that P&G and Gillette could bring new products into the market more quickly, and learn from each other's strengths. However, according to marketing guru Al Ries, "a merger that broadens a company's product line just makes the company bigger without producing any marketing advantages".Undoubtedly, the $57 bn deal will redefine the Fast Moving Consumer Goods (FMCG) industry. The deal will give P&G the strength to compete with the Netherlands-based Unilever, and will make it the world's largest consumer and household goods company by both market capitalization and revenue growth. Though company officials feel that the deal would give P&G high bargaining power with retailers like Wal-Mart, according to Nirmalya Kumar, Professor of Marketing, London Business School, the impact may not be very significant, as Wal-Mart does not negotiate prices with P&G as a whole, but separately for each product.According to some business analysts, the deal will create an enterprise which will be unmatched in geographical reach and competition. It will give P&G the much needed boost to further strengthen its product categories where at present it has negligible presence. The deal will help P&G unite some of the world's leading and finest products under one roof and provide the company with an additional hold in the upcoming market of men's shaving products, an area where its biggest rival Unilever does not have a presence at all. According to a former UK-based Gillette employee, "The deal will help Gillette in improving its inventory days." Though Gillette has strong brands, it is operationally insufficient when seen from market standards. At present, Gillette operates at 120 days with the standard (CPL) of 80-90 days. The deal will help Gillette overcome this inefficiency.Integration IssuesKilts would be the vice-chairman of P&G, and would lead the integration for a year. The merger would result in around 6,000 job cuts, equivalent to 4% of the two companies' combined workforce of 140,000. Most of the downsizing will take place to eliminate management overlaps and consolidation of business support functions. Although managing cultural issues is very important in mergers, especially cross-border ones, in this case, such problems were virtually absent given the geographic proximity of the two firms' headquarters at Cincinnati and Boston.However, P&G is considered a promote-from-within company, and already had a lotof executive talent at the top. Therefore, absorbing Gillette's management to their satisfaction could be difficult. According to some analysts, P&G's ability to handle this massive cultural assimilation would decide the success or failure of this acquisition. According to Lafley, three potential categories that could help the combined company grow would be oral care, women's hair removal and male grooming. P&G could useits "technology transfer" ability (which refers to its drive to take technology from one brand and use it in another) for Gillette's products. Opportunities for productintegration could also be possible in the $10 bn women's hair removal market that was growing at a rate of 8% per year. For example, it could apply some of its technology used in Olay skin care to Gillette's women's razors. A major focus area could be the invention of new products. In addition, P&G could promote Gillette brands together with compatible P&G products (Refer to Table III for potential products for co-promotion).According to some analysts, P&G's acquisition of Gillette will result in anoverlap/clash of some brands or products. P&G's Crest toothbrush, Old Spice, Secret and its battery will clash with Oral-B, Right Guard, SoftnDri and Duracell brands of Gillette. This will be a cause for concern for both companies.Future OutlookSome analysts felt that the P&G-Gillette merger was a defensive move by P&G to check the growing power of retailers. In the retail industry, there has been a struggle for power between vendors and retailers, and retailers have taken the upper hand recently. However, other analysts disagreed, explaining it as an aggressive move for achieving growth rather than a balancing act. Some analysts felt that the deal was a right move as it aimed at product diversification. Davis Dyer, a corporate historian and author of Rising Tide, a history of Procter & Gamble, opined that acquiring Gillette would round out a personal care product range that tilted heavily toward women. He felt that it was more important, given the fact that P&G's recent acquisitions of hair care brands Clairol and Wella AG had reinforced that imbalance. According to analysts, the P&G-Gillette deal created merger pressure for competitors in the industry. They also added that P&G would have at least some time in hand before its rivals catch up with it. Most of the competitors were in bad health, and needed to reformulate their strategies in light of this deal. So P&G could focus on integration without having to bother too much about competition.Unilever, P&G's archrival, had been under fire from investors for missing earnings targets, and had been forced to rethink its 2005-2010 strategy in light of low sales, changing consumer trends and price wars. The struggling Anglo-Dutch firm was already under pressure to improve its performance. It may need to acquire other firms to keep in pace with P&G. Unilever products included Calvin Klein fragrances, Birds Eye foods, Hellmann's mayonnaise, Lipton tea and Dove soaps. The Company announced on February 10, 2005 that although it had a 6% earnings growth for the third quarter, its business was hurt by strong competition and weak demand. Sales of its Ben and Jerry's ice cream and Lipton tea had fallen. The company said it was well into a five-year plan that included focusing on a smaller number of global brands and selling businesses that did not earn enough, putting the savings into promoting the core brands. P&G's entry into the male grooming market posed a further challenge to Unilever. Its Persil and Omo brands were already fighting a price war with P&G's Ariel and Tide in the laundry sector.On January 28, 2005, Colgate-Palmolive (Colgate) announced that their fourth-quarter earnings had fallen by 23%. Colgate was cutting about 4,440 jobs and closing a third of its factories, reducing profits by 9 cents a share. Reuben Mark, the Chief Executive, planned to use savings from the revamping exercise to increase advertising and protect Colgate's lead over Crest, P&G's toothpaste brand. Colgate-Palmolive's toothpaste and Speed Stick deodorant would be battling with P&G's Crest toothpaste and Gillette's Right Guard deodorant. Shares of UK's Reckitt Benckiser and French pen and razor group Bic had moved up after P&G's Gillette deal on speculation that Colgate-Palmolive could be interested in these companies. However, the company announced it would not be engaging in any M&A activity for quite some time. Analysts said that the company was too busy with current restructuring to make any acquisition moves.Future Outlook Contd...Some analysts felt that the dark merger `cloud' might have a silver lining for competitors. Glenn MacDonald, Professor of Economics and Strategy at Washington University's Olin School of Business in St. Louis said, "When industries consolidate, that typically leads to more profits. Further, no merger ever goes as quickly or as smoothly as predicted and so competitors can take advantage of the disorganization that happens during a merger." He added that competitors could launch new products or strengthen their supply chain relationships during this time to gain an edge. Analysts feel that the consumer goods industry was ripe for consolidation. Many felt that a P&G-Gillette combination could be a transformative deal for the industry because of Gillette's growth potential. They also forecasted that this deal could lead to further consolidation in the industry. The costs of product innovation were quite high for razors, and some analysts feared that consumers might be getting fed up with ever-increasing prices for razors. Gillette had admitted in the past that it feared competition from low-cost rivals, particularly in its Duracell electric-battery segment. As for the argument of synergies, Bethany McLean of Fortune Magazine commented, "Personally, I think synergies are a lot like UFOs. Lots of people claim to have seen them, but few can actually prove they exist."。