Hell Breaks

7/29/2019 Hell Breaks

1/17ITS ALL ABOUT MONEY, HONEY!

nalystral Munshi 5540 8651

[email protected])

ealing

91 22) 2685 0505

ndeepa Arora 5540 9033

en Patel 5540 8601

March 2004

HeLL breaks loose

But there is a reason to Smile!

Switch from HLL to Colgate


2/17

March 09, 2004 2

SECTOR RESEARCH(FMCG)

HeLL breaks loose- But there is a reason to smile!

hare Holding Pattern %

romoters 51.55

nstitutional Investors 26.94Other Investors 1.20

General Public 20.31

hare Price Chart

commendation

LL - SELL (Rs 157)

HeLL broke loose last week when Proctor & Gamble (P&G) initiated a price

war by cutting detergent prices steeply. There is a possibility of a similar war in

hair care segment. This will cause a significant dent in HLLs cash flows. A

surprise beneficiary of this price war could be Colgate. Colgate is a leading

player in oral care segment with meaningful competition from HLL. In this

segment, HLL will have not only lesser cash to fight but also a lesser cause as its

parent has exited the oral care category in select markets.

Incidentally, Colgate itself was at the receiving end when HLL cut prices sharply

some time ago. With parent support, Colgate launched new products to

consolidate its position, and is set to improve its financial performance also.Colgate, which runs an advertisement campaign with a smiling face will

have a reason to make its shareholders smile too. We recommend investors switch

from HLL (Rs157) to Colgate (Rs138).

Valuation

At Rs138, Colgate trades at 18x FY04 (Mar) earnings, whereas at Rs157, HLL

trades at 20x FY03 (Dec) earnings. We expect HLL to pass through an extended

phase of heightened competitive pressures which will restrict topline as well as

bottomline growth. Colgate on the other hand is likely to witness improved sales and

profit growth over the next few years aided by

a) Revival in volume growth

b) Further decline in adspend as competitive pressures ease

c) Lower tax outgo due to excise and income tax benefits on new manufacturing unit

at Himachal Pradesh

Over the longer term, decision by parent to make India a sourcing hub as the global

restructuring of manufacturing locations gathers pace, could act as a big trigger for

growth and a further re-rating of the stock. We expect HLL to under perform the

market and recommend a switch from HLL to Colgate for a long-term exposure to

the FMCG sector.

olgate - BUY (Rs 138)

hare Holding Pattern %

romoters 51.00nstitutional Investors 12.54

ther Investors 2.02

eneral Public 34.44

are Price Chart

Investment Summary

Colgate India Pvt Ltd (Rs 138)

(Rs mn) Sales % yoy EBIDTA % yoy OPM % APAT % yoy EPS P/E

03/01 11,991 1,229 8.5 625 4.6 30

03/02 11,609 (3.2) 1,374 11.8 9.6 698 11.7 5.1 27

03/03 10,569 (9.0) 1,662 20.9 12.9 887 27.0 6.5 21

03/04P 10,622 0.5 1,767 6.3 13.5 1,056 19.1 7.8 18

03/05P 11,047 4.0 1,991 12.7 15.6 1,316 24.7 9.7 14

03/06P 11,709 6.0 2,304 15.7 17.1 1,677 27.4 12.3 11

Hindustan Lever Ltd (Rs 157)

(Rs mn) Sales % yoy EBIDTA % yoy OPM % APAT % yoy EPS P/E

12/01 1,06,676 20,958 16.1 16,413 7.5 21

12/02 99,549 (6.7) 23,404 11.7 19.6 17,557 7.0 8.0 20

12/03 1,01,118 1.6 24,364 4.1 19.7 17,717 0.9 8.0 20

12/04E 1,00,107 (1.0) 22,920 (5.9) 18.6 16,462 (7.1) 7.5 21

12/05E 1,00,607 0.5 23,014 0.4 18.8 17,493 6.3 7.9 20


3/17

March 09, 2004 3



Flash back to the 80s

TheFirst Detergent War was fought in the 80s when a small manufacturer in

Gujarat aggressively marketed a detergent powder called Nirmanationally at one-

fifth the price of existing detergent brands. The launch changed the profile of the

Indian detergent industry.

HLL won the war, but shareholders lost

HLL launched Project STING (see Annex) as a strategy to win back market share.

The battle between HLL and Nirma has been well documented in Darden School of

Business, University of Virginia case study : Hindustan Lever Limited Contemplates

Indias poor. No doubt HLL won the battle, but as is evident from the chart below,

under performance with respect to BSE Sensex meant that share holders lost out.

The period of under performance coincided with the period of heavy fighting for

market share.

The Detergent WarsHLL won the war, but shareholders lost

The Second Detergent War begins

We are about to witness what could be The Second Detergent War in India. It

started with Procter & Gamble (P&G) slashing prices of its 20gm Ariel sachets by

30% to Rs2 and Tide sachets by 50% to Re1. Hindustan Lever Ltd (HLL) followed

suit by lowering price of its premium Surf Excel sachet from Rs3 to Rs1.50. The

move by P&G was aimed at inducing trial of its brands and a gradual shift to the

brand as consumers experienced the benefit of a using a premium product. However,

sachets account for just 15-20% of the detergent volumes sold in the country.

Exhibit 1: Stock underperformance during 1987-1990

0

4

8

12

16

20

Apr-87

Jun-87

Aug-87

Oct-87

Dec-87

Feb-88

Apr-88

Jun-88

Aug-88

Oct-88

Dec-88

Feb-89

Apr-89

Jun-89

Aug-89

Oct-89

Dec-89

Feb-90

Apr-90

Jun-90

Aug-90

Oct-90

Dec-90

HLL Sensex rebased


4/17

March 09, 2004 4



P&G made its second move by announcing a huge 46% cut in the price of Tide and a

27% cut in the price of Ariel large packs. Two days later, HLL reacted by announcing

29% and 26% cut in large pack prices of its premium brand Surf Excel and midpriced

Surf Excel Blue (earlier known as Surf) respectively.

How much does HLL get affected?

The Indian detergent market largely comprises of three segments Popular, Mid-

priced and Premium. What the price cuts have done is effectively brought down the

huge price differential between the popular and the premium brands from 7x to 5x.

This move is likely to bring about a dramatic change in the consumer profile of each

segment. The impact would be felt by brands in all segments as mid-priced users may

upgrade to premium brands, while popular brands may face volume pressure as

customer upgrade to more affordable mid-priced brands. All leading national players

in the industry HLL, Nirma, P&G and Henkel as also the smaller regional brands

are likely to witness a huge realignment in their customer base.

HLL with its dominating presence in all the categories is likely to be the worst

affected, as

Detergents is the largest and the second most profitable business of HLL. The

stakes are therefore much higher for HLL than for P&G.

HLL also faces the additional risk of its premium brands eating into share of

its own mid-priced and its mid-priced brands eating into share of own popular brands.

On the other hand, P&Gs detergents are marketed by the 100% subsidiary

of P&G, USA. The parent would therefore easily be willing to absorb losses for a

few years for market share gains. The listed entity only manufactures for the 100%

subsidiary and infact would be a key beneficiary of any volume share gains that P&G

gets.

Caught between the devil and the deep blue sea

HLL, therefore finds itself on the point of a double-edged sword wherein

If it did not cut prices, there would be a big threat of losing market share in its

largest business

If it cut prices, that would not only put huge pressure on already shrinking margins

it also raises a question on the future strategy for its leading power brands Surf

and Rin.


5/17

March 09, 2004 5



Exhibit 2: Revised pricing structure of P&G and HLL brands

Original Price Revised Price Change Category realignment

Per Kg Per Kg % From To

P&G BrandsAriel 135 99 -27 Premium Premium

Tide 85 46 -46 Mid priced Popular

HLL Brands

Surf Excel 140 100 -29 Premium Premium

Surf Excel Blue 90 67 -26 Mid Prices Mid Priced

Rin Supreme 80 80 0 Mid Prices Mid Priced

Rin Shakti 40 40 0 Popular Popular

Wheel Active 26 26 0 Sub Popular Sub Popular

Wheel Green 20 20 0 Sub Popular Sub Popular

The key challenge for HLL would be maintaining the premium brand equity of its

Surf brand, a variant of which is now available at a price discount to a Rin variant.

Will consumers accept a Rin, which is more expensive thanSurf? Does this pricing

not go against decades of brand equity established in consumer minds? Wont the

Rin Supreme user upgrade to Tide which is certainly perceived as a more premium

brand than Rin? Managing the equities and positioning of long established brands,

therefore would be a big challenge for HLL.

The challenge of managing profitability

HLL has had a long history of facing several such marketing wars - be it in the oral

care, fairness creams, shampoos or ice-creams. And it has been able to fight thesewars without taking a big hit on its profitability in the past. But this time around, it

could be different due to a variety of internal and external reasons

The company faces low or negative category growth in almost all product

segments that it operates in.

Strong regional brands have strengthened their stronghold over local markets in

the past few years and have already been eating into existing market shares.

The challenge of managing brand equities

The price cut have led to three major realignments

a) Premium brands Surf Excel and Ariel now cost 25-30% less than before

b) P&Gs Tide has moved from the mid priced segment to the popular segment

c) Rin Supreme is now more expensive than Surf Excel Blue


6/17

March 09, 2004 6



Competition gnawing from all directions in all segments- There is increased

Competition not only from existing national players, and stronger regional players,

but also from a larger number of multinational companies eyeing the Indian market as

imports become more competitive in an era of lower protection.

In the past, a speedily growing and highly profitablebusinesses (such as

personal product and toilet soaps) subsidized higher marketing investments in

other segments. Today, the core soap and detergent categories are de-growing and

margins are under pressure. In personal products the company has just managed to

push up growth to double digits levels aided by the power branding strategy. There

too margins remain flat. The beverages business continues to be impacted by an

adverse commodity cycle. The foods business is not mature enough - and would

need further investments for a few more years.

Likely impact on profitability

HLLs soap and detergent turnover in 2003 was Rs43.8bn, of which an estimated

Rs20bn is contributed by detergents. It is HLLs most profitable business after personal

products. The business contributes 42.6% to HLLs revenues and 48.5% to its EBIT.

However Revenues remained flat while EBIT margins in the business have been

shrinking and stood at 24.8% in 2003 as against 25.9% in 2002.

Exhibit 3: HLLs Soaps & Detergents business

Revenues (Rs mn) 43,794

% of revenues 42.6

EBIT (Rs mn) 10,883

% of EBIT 48.5

EBIT Margins (%) 24.8

We estimate that EBIT decline to range between Rs700mn - Rs1200mn, depending

on whether company is able to grow or maintain volumes or loses volume share to

P&G. The adverse impact on EPS could range from Re0.6-Re1.00. The company

would require a 15-20% surge in overall detergent volumes to maintain revenues and

profitability at current levels.


7/17

March 09, 2004 7



Exhibit 4: Price of 100ml shampoo packs

P&G Brands Rs

Head & Shoulder 64.0

Pantene 61.0

Rejoice 39.0

HLL Brands

Clinic All Clear 50.0

Sunsilk 41.0Clinic Plus 37.5

If P&G does decide to go ahead and cut prices of established shampoo brands like

Head & Shoulders and Pantene also, that would mean really really big trouble for

HLL. In a scenario like that, other competition like Colgate, Nirma and Cavincare

would also make moves to launch their own attacks. And that would mean a big dent

on HLLs Personal Products business the only business that is witnessing double

digit growth and expanding margins at present.

Shampoo war looming ahead - could add insult to injury

A much bigger threat could emerge if P&G decides to follow a similar strategy in

shampoos. It is very evident from the moves made in the last 2 years that P&G has

strategically decided to play the volume game in India. Its success in feminine hygiene

has encouraged it to imitate the strategy in detergents. Like detergents, shampoo too

is marketed in India through the 100% subsidiary Procter & Gamble Home Products,

which gives it significant leeway to take losses without being answerable to

shareholders. Currently P&Gs shampoo brands are sold at a 20-30% premium to

HLLs top end shampoo brand. But P&G has recently launched a mass marketshampoo brand Rejoice at a significantly lower price point (pitched against HLLs

Sunsilk and Clinic Plus)


8/17

March 09, 2004 8



The Return of the Tooth Fairy

The Toothpaste War of the 90s

Colgate Palmolive India Ltd dominated the Indian oral care scenario until the late

70s.Competition came in the form of Balsaras Promise in the early 80s and HLLs

Close up in the late 80s. Things really heated up when HLL aiming at increasing its

share in the oral care market launched an oral care marketing war in the mid 90s.

The success of Pepsodent, which was pitted Colgates largest brand CDC, hit hard

with Colgate losing significant market share during the period. 1999 to 2000 was the

most exiting period in the oral care history of India as a complacent market leader

was taken over by an aggressive competitors moves HLL emerged victorious and

strengthened its position as a strong No 2 with 35% market share. Colgate during the

period lost market share from over 60% to 47%.

The leader fight backs

An awakened giant retaliated by a slew of new launches such as Colgate Fresh

Stripe, Colgate Double Protection, Colgate Total, Colgate Whitening and

Colgate Herbal, Cibaca Top, gaining back a part of the market share loss. Colgates

sales grew by 8% yoy in FY01 and market share inched up to 49% aided by success

of Colgate Herbal and repositioning of Cibaca Top in the economy priced segment.

But by then new competition had arrived in the form of SmithKlines Aquafresh and

homegrown brands like Anchor. While Acquafresh could not garner significant market

share, domestic brands like Anchor and more recently Ajanta have positioned their

products on natural and vegetarian platforms and restricted market share gains for

both HLL and Colgate. The prolonged war between Colgate and HLL and their high

decibel advertising led to spiraling advertising costs, hitting margins hard. While HLL

subsidized its high decibel advertising by funding it through other more profitable

businesses, Colgates profitability took a big hit. Colgates adspend rose from a mere

9% of sales in FY96 to a peak of 20% of sales in FY02!

New pricing strategy yielding results

The two large players in the industry called truce last year, realizing that while they

slugged it out fighting with each other, the smaller players were strengthening their

positions. The fight over market share and resultant high advertising and promotional

activity resulted in increase in product prices for consumers and lack of focus on

consumer need. Both the major players lost market share, while local competition

took advantage and gained market share by affordable pricing. A slowdown in FMCG

growth rates also restricted their ability to spend any further. Mutually consenting to

figh local players on the pricing platform, both Colgate and HLL cut product priceslast April. The lower realizations were expected to be compensated partly by cutting

down on promotions and freebies and partly by the higher volume growth driven by

improved product affordability.


9/17

March 09, 2004 9



Improving topline and lower adspend driving profit improvement

The strategy has worked well as is evident from Colgates topline growth improvement

seen in the last two quarters. September quarter sales were higher than June quarter

by 1.4%, while December quarter sales have jumped 9% over sales in September

quarter.

Meanwhile adspend has been brought down from a high 20% of sales in FY02 to

17.5% of sales in FY03 and 15% of sales in FY04. Operating margins saw a

corresponding improvement in FY03, and a marginal improvement in FY04 margins.

Colgates net profit has witnessed a 27% yoy growth in FY03 and a 21% yoy growth

in the first nine months of FY04.

1.4

9.3

(3.4) (3.3)

(6.0)

(4.0)

(2.0)

0.0

2.0

4.0

6.0

8.0

10.0

Mar-03 Jun-03 Sep-03 Dec-03

9.48.9

11.6

15.717.3

18.2 18.2

19.9

17.5

15.2

18.0

18.5

15.7

8.4 8.3 8.29.2

12.3 12.713.4

5

10

15

20

25

03/95

03/96

03/97

03/98

03/99

03/00

03/01

03/02

03/03

03/04

Adspend % OPM %

x1

Exhibit 5: Sequential sales growth

Exhibit 6: Will Adspend go back to pre 1998 days?


10/17

March 09, 2004 10



HLLs worries could make Colgate smile

The detergent price war started by P&G will erode HLLs margins and put pressure

on its cash flows. The detergent stakes are too high for HLL and at this point in time

it can ill-afford to divert any resources into the oral care biz. Also unlike P&G, HLL

may not find funding support from Unilever, who has exited from the oral care category

in certain countries such as US and Canada in line with its Path to Growth strategy of

focus on fewer brands. As HLL and P&G slug it out for the detergent market, benefits

will possibly accrue to Colgate. Colgate, by making a few right moves in the current

scenario, could effectively utilize this phase to strengthen its position in the category.

The timing could not have been better as a booming economy and strong agricultural

growth could trigger a long awaited rural demand revival and spur category growth.

On a strong footing globally

The parent - Colgate Palmolive has reported a record earnings growth during

2003. Worldwide dollar sales rose 6.5% to $9.9bn, an all-time record, global unit

volume grew 3.5% and operating profit increased 8%. Net income rose 10% to a

record $1,421mn and diluted earnings per share increased 12% to $2.46, also a

record. This is Colgates 31st consecutive quarter of increased gross profit, net income

and earnings per share. The parent continues to grow volumes and improve market

share in key markets of US, UK, Latin America and Asia. The parent expects the

strong volume growth and profit improvement to continue in 2004 driven by new

product innovations, improved productivity measures and aggressive global cost

savings activity.

Outsourcing could be icing on the cake

There is a rising parent interest in Indian operations and India is likely to emerge as an

outsourcing hub for the parent. In a recent international presentation made to consumer

analysts Colgate-Palmolive Executive Vice President, Mr Ian Cook talked aboutrationalization of manufacturing facilities as one of the key cost savings initiatives to

expand margins. The parent company has drawn up a 5-year plan of cutting down

toothpaste and bar soap manufacturing locations to 15 each and toothbrush

manufacturing locations to 8 globally. He also spoke of new manufacturing facilities

currently being set up in India for toothpaste and China for toothbrush. The Chinese

facility would be supplying toothbrush to 55 countries around the globe by end of the

current year. Such large-scale production would mean huge economies of scale in

procurement and manufacturing. Mr Cook also discussed Colgates global approach

to manufacturing, supply chain and procurement enabled by investments made inSAP. Sourcing organizations have been established in China and also in India on an

experimental basis for procurement of raw materials, product materials and indirect


11/17

March 09, 2004 11



materials too. Colgate Palmolive globally procures US$1bn of indirect materials every

year and expects 10-15% savings from this initiative.

Colgate Indias new toothpaste manufacturing facility in Himachal Pradesh would

entail investment of Rs500mn and would provide income-tax and excise benefit to

the company.The facilities are being set up for domestic consumption only at the

moment. However given that the new plant in India is being set up at a time when the

parent is actually looking at cutting down the number of manufacturing locations

worldwide, does give an indication that India could likely emerge as one of the 15

sourcing destinations post restructuring And when that happens, it would mean a

huge growth opportunity for a company that has been languishing under the weight of

low category growth.

Concerns

High reliance on single category

Colgates excessive reliance on a single category in India has been the biggest concern.

Colgate Indias oral care business accounts for 94% of its turnover and more than

98% of profits , as against a diversified product range of oral, personal, household

surface, fabric care and pet nutrition businesses globally

Turnover Contribution

Personal

Care

5.3%

Others

0.5%

Oral

Care

94.2%

Profit Contribution

Oral

Care

Personal

Care

1.6%

Others

0.2%

Personal care biz turned around last year, but reported losses again in H1 FY04

Colgate has expanded non-oral care product portfolio in the current year and launched

a wide range of liquid hand washes, shower gels, bar soaps and talcum power under

the Palmolive aromatherapy range. While the new launches would enable the company

to expand the earnings base, initial brand building efforts could impact margins. The

personal care business, which had turned around and made a nominal profit of Rs31mn

in FY03, reported a loss of Rs64mn in H1 FY04.

Exhibit 7:Segment turnover and profitability


12/17

March 09, 2004 12



Case A: Hindustan Lever Limited Contemplates Indias poor[1]

Project STING At 9:30 a.m. on a Monday morning in June 1987 the top managers of HindustanLever Limited (HLL), the Indian subsidiary of the giant multinational Unilever PLC were havingan important meeting. Having gathered from all regional offices to the HLL headquarters inBombay these managers were discussing the launch of Project STING -- the Strategy to InhibitNirma Growth. For a company like HLL that had a reputation and performance history that wasunbeatable, it was fairly strange that top management would waste their precious timediscussing strategies to inhibit the growth of a small time entrepreneur like Nirma. However,over the past decade Nirma had risen from nowhere and had overtaken HLL in the detergentsector. So far HLL had ignored rural India, but Nirmas recent success in this disorganizedsector had brought HLL back to the drawing board. Reconsidering their approach and deciding

how to regain dominance in Indias detergent market HLLs executives were going to d iscussthree questions that morning.1.Strategy - Should HLL enter the rural Indian market?2.Marketing and Distribution - Considering the logistical hurdles of this market how shouldHLL plan its entry?3. Design - What kind of product should HLL introduce to combat Nirma?

Hindustan Lever Limited

Hindustan Lever Limited or HLL was the Indian subsidiary of Unilever PLC, one of the worldslargest multinational corporations. Founded in 1930 and based jointly in the Netherlands andthe United Kingdom Unilever sold its products in approximately 150 countries. Predating thecreation of Unilever, Levers products first came to India as early as the late 19th century whenIndia was a part of the British Empire. The first Lever product to be introduced in India was

Sunlight soap. This foreign product was affordable and available to the British citizens inIndia and only a small section of the Indian well-off urban population. Thus setting a trend forthe profile of clients that HLL would develop.

In a truly multinational spirit Unilever was aware that success in India involved having localmanagers who understood both the Indian way and the Unilever way. After a series of exclusivelyforeign managers, Mr. Prakash Tandon became the first Indian Director in 1951.By 1955 Unilever had a well-trained local taskforce with about 65% of all managers beingIndian. HLL was among the first foreign subsidiaries to offer Indian equity at that point and had10% of Indian participation. Unilever gradually divested its stake in HLL and by 1982 it heldonly 52% equity in the company. By the late 1970s HLL had gained the reputation of being arole model for companies that want to succeed in India[2] and was one of the most soughtafter places to work at in the country. With products ranging from food and beverages to homeand personal care products HLL was considered Indias largest household Packaged Mass

Consumption Goods (PMCG) Company.

Looking specifically at the Indian detergent industry, HLL was the undisputed leader.Traditionally, Indians had used bars or tablets of soap to wash their clothes. Clothes washinghad involved scrubbing a wet garment with soap and then beating it with a club (similar to abaseball bat) or against a stone. HLL changed everything by introducing the revolutionary Surfwashing powder in 1959. By introducing a washing powder they encouraged people to movefrom the club to the bucket. Part of their marketing strategy involved demonstrations of howclothes are washed in buckets with a washing powder. Surf was an immediate success andoccupied the top spot in the national detergent market. While the concept of a detergent wasevery Indian housewifes solution to grueling hours of clothes washing, only a fraction of themcould afford Surf. Bright blue in color and packaged in a large colorful carton (like the breakfastcereals in the United States) Surf was too expensive for rural India.

The rural poor could not afford Surf and so continued to use bars and clubs. Surf was expensiveto begin with, and with the early 70s came a rise in the price of crude oil and a massiveincrease in the cost of raw materials. Surf doubled in price from 1974-75 and so became evenmore unreachable for the rural people. At this time a host of new medium sized competitorscame into being but HLL maintained dominance.[3]

Annexure


13/17

March 09, 2004 13



The Rise of Nirma In 1969 Karsanbhai Patelts life typified that of millions of other Indians. Heworked as a chemist in a factory in Ahmedabad in the western state of Gujrat. Earning ameager salary on which he was desperately struggling to make ends meet. At the same timeKarsanbhai recognized that there was a vacuum in the rural Indian market for an affordabledetergent. There were low quality soap bars that did not wash very well and were very time-intensive or there were up-market detergent brands that washed very well but were tooexpensive. Karsanbhai recognized the need for an affordable detergent and concluded that agood product would create its own market. On the basis of this rather simplistic but accuratebelief, Karsanbhai started conducting experiments in his kitchen. His efforts finally yielded apale whitish yellow powder that he named Nirma, after his then one-year-old daughter Niranjana.In no time he began producing small quantities of washing powder and selling them to hisneighbors. He packaged his product in small pouches with neither colorful decorations nordesigns. Every morning Patel got onto his bicycle and went from door-to-door selling his

washing powder. Soon wholesalers and distributors from different neighborhoods, towns,cities and states of India started arriving at Karsanbhais doorstep to buy and redistr ibuteNirma. Karsanbhai took on no responsibility for delivery or distribution; but his product wassoon available at every corner of India. Once Nirma arrived on the rural market things changedfor Indias poor -- they had an option.

By 1977 Nirma was the second largest volume seller in the country. Despite this, no othercompany took Nirma seriously. The marketing gurus of the world believed that Nirma was aregional product that was seeing temporary success and that its bubble would soon burst.They predicted that at such a low sale price, the margins Karsanbhai was making per unitwould not sustain his business for long. Moreover, HLL completely ignored Nirma and believedthat it was no threat at all. HLL considered themselves a superior company with a superiorbrand, and there was a strong belief that the only clients worthwhile pursuing were the Indian

middle class and elite. Since Nirma was not in their market segment, HLL did not considerthem a threat. The general belief was that rural Indians were poor and the rural sector was toodisorganized to bother with.

Understanding the Rural Market In India, HLL had disregarded a huge market segment thatdue to its sheer volume held great promise and potential. By ignoring the lowest rungs ofsociety HLL was in danger of being toppled from the leading position. The question is why hadHLL ignored the rural markets? In order to understand the dilemma facing HLL at this time it isimportant to know how traditional business is conducted, especially as far as multinationalcorporations are concerned. C.K. Prahalad and Stuart Hart help us to understand this bylooking at the market as a pyramid.[4] The Top tier of the market consists of about 75-100million people who earn more than $20,000 a year (See Exhibit 1). This group consists of theelite/ middle and upper-income people in our societies. Most of these people live in the developedworld and a few in the developing world. The second and third tiers consist of the rising middle

classes, living mostly in developing countries and earning between $1,500 and $20,000 a year.Prahalad and Hart estimate that between 1,500-1,750 million people live in Tier 2 & 3. Finally,we come to the bottom of the pyramid, Tier 4, which consists of around 4 billion, people whoearn less than $1,500 a year. Most of the people in Tier 4 live in the developing world, howeverthere are some who live in urban inner city areas in both the developed and the developingcountries. [5]

Typically, MNCs have focused on the first tier as it allows for the highest margin of returns. Inmany cases the second and third tiers of the pyramid have also been focused on, however, thepeople at the bottom of the pyramid have usually been ignored. While those in Tier 4 have beenignored for a host of reasons it is interesting to notice that by concentrating on the top three tiersMNCs have marketed to only 30% of the worlds population. MNCs have ignored Tier 4 becauseit has always been assumed that those living in Tier 4 do not have any disposable income and

so cannot afford the products produced by the MNCs. Nirmas success in rural India dispelledthe myth that rural consumers are poor and do not have the disposable income to buy consumergoods. However, the additional reason that MNCs were wary of Tier 4 markets was becausethese markets constituted what is called the disorganized sector where a lack of infrastructureand development hinder effective mar keting and distribution of products. Finally, due to highoverhead costs most MNCs are not able to price their goods in the manner that local companies


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can thus, refraining from entering the rural market due to their inability to be price competitive.The Case of Rural India Looking specifically at India it is easier to understand what working inrural markets entails. In the early 1980s the total population of India was around 750 million ofwhich 70% lived in rural areas.[6] Thus Indias rural population, which was comprised of 525million people, was equal to almost twice the population of the United States of America.Indias rural market comprised 12% of the worlds population. With an estimated annualgrowth rate of 1.7%, India was the second most populous country in the world. By the year 2010its population was expected to reach 1.15 billion.[7] The sheer size of the rural Indian marketwas the greatest attraction for entering it.

Despite the sheer size and potential volume of business in rural areas, HLL stayed away fromthe rural Indian market for the simple reason that it was physically very difficult to penetrate. Thenature of rural markets has always been very complex and rural India presented a number of

unusual challenges for HLL. In India the rural client group lived in approximately 570,000villages spread across the Indian countryside. Approximately 90% of Indias rural populationlived in small way-out villages with populations of less than 2000. Most villages neither hadelectricity nor running water. Access to telephones and the Internet was unheard of. Due to alack of infrastructure, only 45% of the villages could be reached by road, and few of these wereall weather roads.

HLLs decision to stay away from the rural markets was not limited to the physical challengesof the land, but also by the so-called social and cultural challenges of the people. In trying tosell their product in rural areas HLL would be dealing with a client group that had never beforebeen focused on by multinationals. Banners and leaflets alone would not be effective sinceonly 43% of rural Indians could read. Moreover, India was a country where 15 recognizedlanguages were spoken along with over a few hundred dialects so any media campaign would

have to be effectively translated. HLL would have to tackle the challenge of marketing a productin the absence of conventional marketing and advertising tools. Since only 57% of the ruralpopulation was reachable by mass media HLL could not depend only on television or radio toget their message across; they would have to be innovative.

Nirma Overtakes Surf: The War of the Bubbles While it may seem that Nirma was of inferiorquality, housewives of rural India were not objecting. Karsanbhais product was in high demand.

At one-third the price, as long as Nirma washed almost as well as Surf, the consumers did notmind. Going from 0% of the market share in 1976 to 61.6% of market share in 1987 Nirma hadpushed HLLfrom the top. At the same time, until 1989, Surf remained between 2.5 to 3.6 timesas expensive as Nirma.

HLL was astounded by the growth of Nirma. HLL had a very clearly defined idea of what thespecific ingredients of a detergent should be and what ratio they should be mixed in. According

to HLL, Nirma was a low quality product. HLL commented that Nirma did not contain anywhitening ingredient, had insufficient active detergent, had no perfume and was rough on theskin. The rumor was that Nirma contained lower levels of active detergents and more fillers andsoda ash. Despite all these factors Nirma had outperformed Surf in the market. Looking at thefollowing figures in Exhibit II the rate of growth of Nirma is astounding. [Now here lets talkabout the design of each product: their chemical makeup, etc.

By 1984, Nirma occupied the position of No. 1 brand in Asia leaving Surf far behind.[9] Everybodywas shocked, most of all HLL. The key question is: how was Karsanbhai able to achieve suchtremendous success in an arena that had been dominated by HLL for so many years?Karsanbhais response to this was that he saw an opportunity where others had not botheredto look.

He said, I found a massive market segment that was hungry for a good-quality product at anaffordable priceso I decided to keep my margins very low, and was happy if I could netbetween three and five percent profits really came from the huge volumes we generated.[10]Karsanbhai was a genius to have recognized the opportunity provided by this rural market andhe was able to successfully give them the product that they wanted at the price that they wanted.

A New Business Model - The Nirma Way[11]


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One of the starkest differences between Surf and Nirma was the price. While the contents ofthe product may differ Karsanhbhai was able to produce such a low cost detergent. There aremany areas where he controlled expenditure. Aware that soda ash, the main raw material forhis product, was abundant in Gujerat, Karsanbhai set up shop in the vicinity. To keep a leanorganization Karsanbahi outsourced all the administrative functions. He contracted tasks likeselling, accounting, technical production capabilities and distribution. All this gave him theflexibility to negotiate price during slow periods.

Till 1985 the Nirma ingredients were simply mixed by hand thus requiring neither machinerynor capital investment. Due to the scale of his product and the simple non-mechanizedproduction process, Nirma gained a number of tax and excise benefits for not using electricity.Since Nirma was a small-scale local venture, they did not have to pay excise duties that werelevied on multinationals.

Another area where Nirma saved millions was in labor costs. Being a cottage industry Nirmawas not compelled to abide by minimum wage rules. To maintain low costs Karsanbhai usedcontract workers who were paid Rs. 85 per ton (In 1985 $1 U.S = Indian Rupee 12.368)[12] formixing raw materials and then bagging them into 1000 bags of 1 kg each. Payment was madeaccording to work done and since labor was not permanent no additional overhead for benefitsetc. needed to be paid. It was not until the mid 80s that Nirma started to mechanize theirproduction process, however by then they were an already well-established name. In 1989Nirmas labor costs for 8000 workers was estimated to be between Rs 15-20 per person dayin comparison to HLL who paid their semi-skilled workers approximately Rs 30-40 per personday. (In 1989 $1 U.S = Indian Rupee 16.225)[13]

When setting up a distribution system Karsanbhai was extremely aware of the importance of

keeping costs down. Once demand for Nirma had outgrown his ability to deliver on bicycle hemoved on to vans and then later to trucks. Nirma had neither a field sales force nor owned adistribution network. Karsanbhai negotiated prices with truck and van suppliers on a dailybasis. As sales grew Karsanbhai eventually hired stockists (those who stocked additionalquantities of the goods) as commission agents. On the one hand it helped him avoid centralsales tax and the stockists were responsible for all transportation, octroi,[14] handling anddelivery costs. There was also a strict system of protocol and distribution depended onprepayment for stocks so as to minimize risk for Nirma.

While advertising did not appear as a cost in his initial budgets, by the late 70s as televisionsslowly started to spread into rural India, so did the Nirma ad campaign, with its simple messageand catchy jingle. By the early 80s Nirma became synonymous with good quality and low-price. The stockists were also responsible for promotions and they funded 50% of promotionalexpenditure for their goods. Nirmas sales reached a rate of growth that was two to three timesthat of the industry in general. As a result of all the above measures Nirma survived andflourished on what looked like a miniscule margin per unit.

The HLL time-line In 1977, with a 12% market share, Nirma was the second largest volumeseller of detergent in India. Surf was the leader with 33%. Still, for a long time HLL did not thinkthat Nirma could ever present a potential threat. The general belief between marketing gurusand within HLL was that Nirmas bubble would soon burst. They did not believe that Nirmacould survive on the miniscule per unit margins they were making. In addition, being amultinational, HLL had tremendous overhead costs and therefore had never considered itselfcapable of providing a low cost detergent to compete with Nirmas low priced product. For thisreason HLL had traditionally stayed away from the rural and low-income market. Finally, at thetime HLL had two detergent producing factories, both of which were having productivity andindustrial relations problems. So HLL decided to wait and watch.

However, by 1985 Nirma was outselling Surf by 3 to1. While Nirma had a market share of 58%Surfs had dropped to 8.4%. From nowhere, Nirma had risen to become one of the largestselling detergent brands in the world.[15] Nirma had not only increased its share of the pie, buthad increased the size of the pie itself. Moving into a so far untapped market, Karsanbhai wasresponsible for expanding the detergent market 10 times. To HLLs surprise, consumers were


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starting to compare HLLs high quality Surf powder with Nirma. HLL researchers reported thatpersistent use of Nirma caused blisters on skin and damaged clothes by weakening fabric inthe long run. According to HLLs Research and Development team these side effects were dueto the high soda ash content in Nirma. Despite these criticisms, Nirma was being perceived asa much cheaper and fairly comparable alternative to Surf. This jolt in consumer confidence andthe massive decrease in sales forced HLL to recognize that Nirma was here to stay. Nirmawas successfully toppling the giant from the bottom of the pyramid. Finally, in 1986 Nirmastarted testing a new detergent bar that would be directly marketed as a challenge to Rin, HLLs leading and most profitable detergent bar at the time. At this point HLL recognized that it wasnot just a question of Surf, Nirma was systematically undermining HLLs dominance in theindustry and for the first time HLL got a glimpse of what could be the beginning of the end oftheir detergent business. It was time for HLL to react.

[1] This case was written in July 2002 by Research Associate Pia Sabharwal Ahmad under thesupervision of Professor Michael E. Gorman, Professor of Technology, Culture &Communications and Systems Engineering at the School of Engineering and Applied Science,University of Virginia, and Patricia H. Werhane, Ruffin Professor of Business Ethics, DardenSchool of Business, University of Virginia. This case was written as a basis for class discussionrather than to illustrate effective or ineffective handling of an administrative situation. Copyright 2002 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rightsreserved. To order copies, send an e-mail to [email protected]. No part of thispublication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmittedin any form or by any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of the Darden School Foundation

[2] Hindustan Lever: Role model for Multinationals, Financial Times, August 1, 1997

[3] Charlotte Butler, Hindustan Lever Limited: levers For Change, Case registered at LondonBusiness School in 2000. Page 40-41.

[4] C.K. Prahalad & Stuart Hart, Strategies for the Bottom of the Pyramid, 1999. Seen at http://www.wri.org/meb/wrisummit/pdfs/hart.pdf

[5] C.K. Prahalad and Stuart L. Hart, The Fortune at the Bottom of the Pyramid. Seen at http://www.changemakers.net/library/temp/fortunepyramid.cfm

[6] See Appendix 1 for Map of India.

[7]Population statistics taken from the following sites http://www.undp.org.in/report/IDF97/

idftab.htm, http://mohfw.nic.in/popindi.htm, http://www.library.uu.nl/wesp/populstat/Asia/indiac.htm, http://www.eia.doe.gov/emeu/cabs/india/indiach1.htm, http://www.cs.colostate.edu/~malaiya/india.html#Populations%20in%20the%20Sub continent

[8] Charlotte Butler, Hindustan Lever Limited: levers For Change, Case registered at LondonBusiness School in 2000. Page 47.

[9] One Man Show Rivals Multi Nationals, 2000, Responsive Database Services, Inc., Businessand Industry, Rodman Publishing Corp., Happi-Household & Personal Products Industry, Vol.37, No. 2; Page 26.

[10] Karsanbhai Patel A Clean Sweep, June 27, 2002. Seen at. http://www.indiaprofile.com/people/karsanbhaipatel.htm


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