The Rs 48,000 crore FMCG industry may, once again, be in for a big let-down in 2005. Despite the much-talked about revival, price swings on the input side are likely to make it difficult for growth in profitabiltiy to come by, predict industry analysts.
The upside, however, is that the year will see companies pushing a ‘back to basics’ approach, with focus on improving distribution and reach and broadening the consumer base with ‘smaller’ packs.
The critical challenge for most FMCG companies in 2005, forecast analysts, would be to manage the supply side as sharp swings in commodity prices are expected to impact profits like never before.
“There’s no upside for the sector. While growth in demand will remain sluggish, from the supply side it would be critical to watch how costs are affecting profitability,” says an FMCG analyst at ICRA.
Not surprisingly, then, an upward price trend is being predicted. “I am not expecting anything to move for the FMCG sector in 2005, though prices will see an uptrendand it has already begun to happen,” says Ernst & Young national director (transactions and advisory) JS Desai.
Dabur India CEO Sunil Duggal thinks otherwise.
Inflationary pressures, he says, have begun to recede a bit. Besides, in Dabur’s case, pressures have also eased as the company has managed cost efficiencies in bulk buying and taxation planning.
PricewaterhouseCoopers leader for retail and consumer industry N V Sivakumar is far more optimistic. “The sheer size of the market coupled with the growing middle class makes India a dynamic market, promising tremendous opportunities for FMCG companies,” he says.
While a focus on cost efficiencies may help to a certain extent, a unanimous view is that a bleeding topline will call for a price revision in most consumer products. So, if 2004 marked highly visible price wars, 2005 may well see a reversal of the strategy.
“Given the pressures on profitability, the sector will no longer see aggression on pricing. Prices will only go up,” says Mr Desai.
According to him, the trend has already started with premium players turned price warriors—HLL and P&G—starting to take selective price increases on some products.
“India is a price-sensitive market where volumes move with prices,” he adds. Pointing to the soft drinks story in the country, he says the sector saw real growth only when the prices were brought down. But how long could they sustain such pricing?
“Price reductions will definitely come to a close. Another round of price reductions beyond this will make margins unattractive,” says Mr Duggal.
Used to gain marketshare primarily by HLL and P&G, the price war strategy did take its toll. According to a study conducted by Assocham, on account of intense competition, only five out of 12 FMCG companies managed a double-digit CAGR from 2000 to 2004. Year-on-year growth rate of HLL’s profits came down from 22.45% in 2001 to 4.22% last year, while its CAGR sales growth was a paltry 0.02% last fiscal.
Barring a few categories like edible oils, which analysts expect will grow fast, demand growth in most categories is expected to remain sluggish.
“While edible oils sector will continue to grow faster owing to huge consolidation happening in the sector, basic FMCG categories like soaps, shampoos, toothpaste and the like will not see any substantial growth this year,” says Mr Desai of E&Y.
Agrees Icra analyst, “The edible oil sector has shown profitable growth owing to higher prices, but growth is difficult to come by in other categories.”
The high-potential food, sector, is also looking up. “Categories such as biscuits, chocolates, and tea have begun to do well,” adds the Icra analyst.
The big opportunity for the growth starved sector, forecasts E&Y’s Desai, will come by adopting a rather simple strategy. “For most companies, realisation will be quite clear: go back to basics.” According to him, growth will come essentially by expanding rural reach, and within that in areas with populations of below 20,000 people. “Initiatives to drive the rural market like ITC’s e-choupal and HLL’s Shakti will build a momentum,”
“Low unit packs (LUPs) will become increasingly important for FMCG companies in the year ahead,” says Mr Duggal.
Emphasis will also be on innovation. “Companies are increasingly giving importance to innovation in all spheres of their operations,” says Mr Sivakumar of PwC.
“Two kinds of companies will survive: those who innovate and those who look beyond urban, and P&G and ITC have done that,” says Abhijeet Virmani of Positron Advisory Services.
According to E&Y’s Mr Desai, FMCG companies may also need to question their transition from ‘selling’ to service sector unless they create a distinct stand-alone business model.
Regional brands, which have also been facing pressure ever since big majors started competing with them on their pricing plank are expected to make a comeback. “Regional players will continue to enjoy their advantage...Nirmas and others will make a comeback,” says Mr Desai. Agrees PwC’s Sivakumar: “Regional players will continue to grow in volume/margins leveraging on their lower overhead costs.”
While encouraged by tax incentives, most FMCG companies have announced plans to set up production units in the northern states of Uttaranchal and Himachal Pradesh, the true impact will be felt only after a few years. “While it will lead to lower tax incidence, however, it has to be realised that capacity expansions which are being taken out today will happen over a period of time and not in the next year,” says the analyst at Icra.
Amidst this pessimism, the buzz that India is being preferred as a low-cost manufacturing base by many global majors—including Unilever—is expected to open new vistas of growth.
“India is also emerging as a sourcing destination for global FMCG companies after proving itself in terms of quality and production capabilities,” says Mr Sivakumar of PwC.