MBA 502 Final Project Part I: Proctor and Gamble

By. Michael L. Baumwohl

I. Overview

Proctor and Gamble’s story began with a simple handshake between two men: William Procter and James Gamble (Proctor and Gamble, 2014). Their vision, a small soap and candle business, has grown since 1837 into one of the world’s largest consumer branded production and distribution companies in history. Today Proctor and Gamble (NYSE:PG), specializes in four major consumer product categories: Health and Grooming, Beauty, Fabric and Home Care, and Baby Feminine, and Family Care (2014).

P&G employs over 100,000 employees globally with 118,000 employed for the fiscal year of 2014. Looking deeper at PG’s 2014 annual report, we can see just how profitable branded consumer goods are (Proctor and Gamble 2014).

2014 generated 83 million in sales, 24% from beauty products alone. At an estimated 19.9 millions dollars in revenue, the Olay brand is one of Proctor and Gamble’s top facial skin care brands; generating over 8% of the global market share (Proctor and Gamble, 2014). The cosmetic industry is a highly profitable and lucrative business. As the numbers show, global consumers are willing to pay the price, for the looks of beauty.

II. Supply, Demand, and Market Equilibrium

Proctor and Gamble (PG:New York) sells branded consumer products all around the world. Having struggled to meet investor expectations, among heavy competition of consumer and cosmetic products, PG has made major changes to grow by downsizing.

PG hopes to reduce the supply of products sold to increase their demand (Paulson, 2015). In his Ted Talk, The Paradox of Choice, Barry Schwartz discusses how too much choice can lead to consumer “paralysis rather than liberation. (Schwartz, 7:44)” When consumer products are reduced, and choices are limited, consumers become more likely to be satisfied with their purchases (Schwartz, 2006). Proctor and Gamble’s reduction may therefore be advantageous for their company’s future success.

a.) Nearly a quarter of all of PG’s revue is from products sold in the cosmetic industry. According to the Wall Street Journal, Olay beauty products has recently discontinued items such as acne washes, facial scrubs, and skin treatments, and thus reduced a sixth of it’s product line to just 120 products. The Wall street Journal also reports that the cheapest of Olay products, its original moisturizer, is sold for $6 (NG, 2015). Wal-Mart, one of Olay’s largest retailers shows the same moisturizer being sold for $8.94 (walmart.com). We know that with the law of supply and demand, when demand increases and the supply remains the same, there is a shortage and thus a price increase. Given this information, we can calculate the price elasticity of demand for Olay moisturizer.

144-120/144+120/2 ÷ 6-8.94/6+8.94 = 18.1/-19.7 = -0.92

With this calculation we know that Olay beauty products have a unit elastic demand. The demand for Olay beauty products is unit elastic because, if the price elasticity, of demand is equal to 1, the percent change in the quantity demanded is also equal to the percent change in price. Therefore, a unit price elasticity of demand means that when the prices increase by 5%, the quantity demanded must decrease by 5% as well. Luxury goods, like automobiles and electronics, which have high elasticity; small changes in price can lead to major changes in demand from consumers – like Black Friday (Investopedia, 2006). What this means for Proctor and Gamble is that prices can be raised, the amount and variety of products is reduced, and demand for said products is increased. What this tells us is that, beauty products are considered essential items among American households, and changes in price do affect demand.

b.) Beauty is a highly profitable industry. With constant competition for the next best product on the market, two non-price factors that impact the demand of Olay Beauty Products are: competition and the role of retailers. Everyone gets older, so in order to stay in business, Olay needs to focus on rejuvenating ideas to attract new and youthful consumers. Although Olay’s success has not been dependent on this fact (NG, 2015), it’s competitors success is focused on innovation. Olay products must work, and work well, as to sustain consumer loyalty over the years. The demand curve for Olay beauty

products; however, may shift due to the price of generic products of the same type, of the same price, and or changes in consumer tastes and preferences. Competitors, of other makers of beauty products, are heavily dependent upon the prices of their products to that of Olay.

It is therefore the role of retailers and their distribution strategy that may also play a part in consumer preferences. Serena Ng of the Wall Street Journal also describes other non-price factors that affect demand. Her personal visit to CVS in New York City either had Olay products out of stock, or they were sitting behind antitheft panels, to which she described as a turnoff to shoppers (2015). It is understandable that companies like Olay don’t want lost revenue from theft, but they in turn lose revenue by alienating shoppers who are timid, shy, or made to feel like a criminal. It is similar to purchasing condoms from a counter clerk; it is embarrassing and discourages sales.

c.) All products including Olay need to be manufactured somewhere. With that said, two major non-price factors to the supply of Olay products are labor, and ingredients. Labor is a crucial element to every industry; without people things cannot be manufactured. Even if the industry relies on machines to produce a product from start to finish, people still must monitor and maintain the machines in proper working order. It is crucial to have all factories adequately staffed, and of course maintain employee moral. If people are not happy, they will not want to work, unhappy employees lead to high turnover and an instant decrease in productivity and less supply.

The second major non-price factor is the availability of ingredients. Although some may be synthetic and can be man-made in laboratories, others are natural and thus obtained from the Earth. Depending upon the season, or the availability of greenhouses in use, there is only so much organic material that can be grown, and all of which are dependent upon the natural limits of growth and time. It takes time for plants to grow and mature, even with bioengineering, time greatly affects supply. Without mature ingredients, products cannot be produced. There is a limit to how much supply is on hand.

d.) Although Proctor and Gamble has its hands in multiple consumer industries; the Olay brand is in the cosmetic industry. Introduced early in the twentieth century, the cosmetic industry is controlled by a hand full of Multi-national corporations. Globally the cosmetic industry is divided into six major categories with skin care accounting for 33.8% of the global market in 2008. In 2016 The United States is the biggest cosmetic market in the world, with an estimated total revenue of about 56.63 billion U.S. dollars and employing about 56,235 people in 2013 (Statista, 2015).

Serena Ng of the Wall Street Journal discusses further about PG’s revenue from the Olay brand:

“Boosting sales at Olay is [of] top mind at P&G. The skin-care line generates over $2.5 billion in annual sales and has an 8% share of the global facial skin-care market, but it has been a laggard in P&G’s portfolio. The brand’s sales in the U.S., the company’s biggest market, ha[s] declined annually since 2010,

according to Euromonitor International, creating a drag on P&G’s beauty division, which makes up a quarter of the company’s $76 billion sales (2015).”

e.) With 144 products generating 2.5 Billion dollars annually for Olay skin products, the demand is at Equilibrium. With the planned reduction in products however, I predict the effect decrease supply and increase demand until the new market equilibrium is achieved.

2.5 Billion is to 144 products, as X is to 120 products, the current amount Olay intends to sell.

X:120, 2.5:144

120X =360

X=3

I predict that with the reduction of 24 products from the Olay brand, Proctor and Gamble we will see an increase of .5 billion dollars in revenue. PG’s strategy to increase the demand by decreasing the supply, makes their products more desirable, and less in supply. Like high-end fashion, where limited quantities exist, consumers are willing to pay more for products that make them feel luxurious.

What we buy is intertwined with our self-worth. According to Vanessa Page of Investopedia:

“A person will buy luxury goods that he [or she] may not be able to afford. For consumers trapped in institutionalized poverty or those living paycheck to paycheck, a luxury good can go a long way in increasing self-esteem or providing a sense of belonging. In China, men use luxury goods to show off their success and flaunt wealth. Chinese women, like American women, tend to purchase luxury goods in order to give in to hedonistic tendencies (2015).” As a result, top-selling Olay branded products will meet the new demand curve,

and prices will reflect the new market equilibrium.

f.) With Olay’s expected increase in demand, I would focus Olay products primarily on online sales. Online retailers allow for wider access with fewer products on hand. Shan Li of the Los Angeles Times reports that as of June 30th 2015:

“Amazon.com surpassed Wal-Mart Stores Inc. as the world's biggest retailer on Friday after reporting a surprise jump in profit in the second quarter. The e-commerce giant said net income was $92 million, or 19 cents a share (2015).” With retail being sold more than ever online, Olay could also meet demand

instantaneously, with the simple click of the mouse.

According to Neil Patel, the psychological motivator for humans is the “pleasure principle (2014).”

“Our needs, wants, and urges can be as basic as the need to breathe, eat, or drink. But they can be as complex as the “need” for an iPhone 6 or some other cool new product.” The ability to purchase products online fuels our pleasure principle and takes full advantage of Instant Gratification – “the desire to experience pleasure or fulfillment without delay or deferment (Patel, 2014).”

PG can increase revenue while simultaneously decreasing losses from retailers by eliminating human error from inadequately stocked shelves, and having products removed from shelves where competitors place and price similar products.

III. Production and Costs

Proctor and Gamble is known for making a wide range of consumer products, many of which we use today. Olay, one of PG’s most known brands, requires extensive

costs and production to put their products on the shelves.

a.) Inputs for production can be divided into four categories: Land, Labor, Capital, and Entrepreneurship (Nickolas, 2015). Land is used to produce goods and generate a profit, Labor is the amount of work performed and needed to create the goods and services, Capital is any tool, building, and machine, used to produce a good or service, and Entrepreneurship combines them all to earn a profit.

(*Mortimer, 2012)

The inputs used to produce one case of Olay’s Active Hydrating Facial Cream – Original, can be seen by simply looking at the ingredients. We can see a glimpse into just how much capital, labor, and entrepreneurship is required to make one case. The Ingredients are as follows:

Water/Eau, Glycerin, Cetyl Alcohol, Petrolatum, Cyclopentasiloxane, Stearyl Alcohol, Isopropyl Palmitate, Dimethicone, Carbomer, Sodium Hydroxide, Stearic Acid, PEG-100, Stearate,

Fragrance/Parfum, PEG/PPG-18/18 Dimethicone, Titanium Dioxide, EDTA, DMDM Hydantoin, Iodopropynyl Butylcarbamate, MDM Hydantoin, Red 4.

(*Olay.com)

Capital is far more than just the money needed to produce a product; it is also all of the various pieces of the puzzle to make the picture complete. The packaging and the case which houses the product must be manufactured somewhere. The design on the box costs money – the ink, and the designers must be factored into the cost and production equation as well.

Labor is so much more than just workers on an assembly line, it includes: scientists, researchers, a marketing team, advertisement, project management teams, models and actors, creative teams, designers, HR teams, factory workers, and the thousands of employees who build the product in laboratories to those that stock Olay products on the shelf. It is truly amazing to think of how much teamwork creates something, from start to finish.

With regard to entrepreneurship, ideas must constantly be evolving and ever changing to keep beauty current. We know with certainty that we will age and we will die; therefore creativity is needed to market Olay, from each generation to the next. Ideas are born from experience and unique for those serving on PG’s board of directors. They understand their products, and can bring personal insight to the table. Their insight and thirst for innovation however must always be mindful of the fixed and variable costs that stifle Research and Development.

The fixed costs, and variable costs for all of the inputs needed to produce Olay, are many. The fixed costs would include rent for the buildings used for production, the cost of the operation, and the machines used to produce the products. The variable costs would be wages, utilities, and the ingredients used to make Olay beauty products. Since may of the ingredients used to make Olay are based upon their market price, the stock market is a crucial factor in variable costs. Labor laws are also major variable costs, as 14 states increased their minimum wages on or after January 1st 2016 (Jamieson, 2015). The true cost of beauty however, is another matter entirely.

b.) As sure as the seasons are changing, so does the demand and relevance of a product. Many factors impact the inputs for Olay’s production three of which are: market volatility, varying costs of labor, and capital, and cultural views of beauty. Olay’s line of beauty products rely on the ingredients used for production, many of which vary in price. Petroleum, an active ingredient in Olay’s Active Hydrating Cream, is dependent upon the cost of oil. According to Grant Smith and Moming Zhou of Bloomberg Business:

“Oil is down about 13 percent this year as turbulence in global markets adds to concern over brimming U.S. stockpiles and the prospect of additional Iranian barrels. Markets could “drown in oversupply,” sending prices even lower, according to the International Energy Agency (2016).”

In a chart presented in the same article, we can see just how much volatility crude oil has had within the last month. If oil prices drop, then the cost of production drops as well. Olay can then be produced much cheaper. If crude oil is selling at $6 a share vs. $38 a share, the cheaper costs of production allows for adequately staffed factories, payable wages, and salaries, and minimal to no

lay offs. In order to stay in business, Proctor and Gamble would need to be vigilant of the ever-changing prices of their ingredients, and account accordingly, of the costs of labor.

Its been said that beauty is in the eye of the beholder, and from an economic standpoint, we can’t help but agree. Beauty is profitable and also culturally relevant. In the video 100 years of beauty in 1 Minute – Episode 1:USA (Nina), we can see a glimpse of how a woman’s beauty has evolved over time.

(*Colbert, 2014)

If one generation views beauty as with the use of make up and products, Olay is sure to be successful. As a woman ages however, they become less dependent upon beauty trends and Olay may profit from a woman’s insecurities rather than through her confidence. Either way, the generation, and the age of the consumer are major factors upon the inputs of cost, labor, and entrepreneurship. If women were to collectively decide that beauty no longer mattered, Olay would be out of business, and all inputs needed for production would become irrelevant.

c.) There is much uncertainty when it comes to business. The production decisions that I would make based on the analysis of the factors of impacting the choice of inputs of: market volatility, the varying costs of labor, and capital, and the cultural views of beauty, would be a complete restructure of Olay’s production goals

and greatly reduce labor costs. With beauty standards varying from culture to culture, it’s naive to assume that beauty standards are the same globally, and to mass-produce on that assumption.

With various skin tones, varying amounts of sun exposure, and even various standards for beauty i.e. burkas

vs. bikinis, I would eliminate the mass production of Olay beauty products all together. By restructuring the company into small laboratories, and production teams, Olay could focus on target markets using locally sourced ingredients, all around the world. Labor would also be localized, and distribution would be decreased in both production time and distance of distribution.

Beauty standards in the Middle East may care more about the eyes and less on the complexities of the face, whereas Hollywood California may desire beauty products that harden the skin with synthetic estrogen, similar to that of Botox. By targeting beauty standards into culturally relevant markets, large labor costs associated with mass production are eliminated, and the money can be spent employing educated Biochemists, Doctors, Marketing Specialists, and Sociologists. Profits are then maximized in the markets that are most vulnerable, and employment is offered to educated professionals and the local communities. As David Taylor steps in as PG’s new C.E.O., his decision to grow PG through downsizing (Paulson, 2015) might be the right step for PG’s stock to continue soaring.

IV. Market Structure

a.) Procter & Gamble Co., (NYSE:PG) is an American multinational consumer goods company currently headquartered in downtown Cincinnati, Ohio (Wikipedia, 2014). Ali Ackerman Orr of Consumer Goods Technology has ranked the top 100 publically traded Consumer goods companies for the year of 2013. The top ten are as follows (2014):

1          Nestlé SA                                            $103,734       2.69%2          The Procter & Gamble Company     $84,167          0.58%3          Unilever PLC                                      $68,550          1.07%4          PepsiCo, Inc.                                      $66,415          1.41%5          The Coca-Cola Company                  $46,854          (2.42%)6          Imperial Tobacco Group                   $45,614          (2.42%)7          Anheuser-Busch InBev SA               $43,195          8.64%8          LVMH Moët Hennessy Louis Vuitton           $40,126          8.05%9          JBS S.A.                                             $39,316          6.43%10       Mondelez International, Inc.                        $35,299         0.81%

Although many consumer goods companies likes Coca-Cola focus on limited types of products, Proctor and Gamble’s focus on beauty accounts for 24% of their total income. The Olay brand is Proctor and Gamble’s top facial skin care brand; generating over 8% of the global market share (Proctor and Gamble, 2014). A comprehensive look at the U.S. market however, leaves much room for Proctor and Gamble to improve.

“[For] the fiscal year ending in April 2014, Nair depilatories accounted for 27.1 percent of that segments total sales. Olay Regenerist and Olay Regenerist Micro-Sculpting achieved 8.9 percent and 7.3 percent of the facial anti-aging product market, respectively (Statista, 2016).”

Online sales however, after calculating the Herfindahl-Hirschman Index are another matter entirely.

HHI = s25.9^2 + s11.8^2 + s5.0^2 + s4.1^2 + s4.0^2 + s3.7^2 + s3.7^2 + s3.7^2 + s3.3^2 + s3.1^2 + s3.0^2 + s3.0^2 + s2.3^2 + s2.2^2 + s2.1^2 + s1.7^2 + s1.6^2 + s1.5^2 + s1.4^2 + s1.3^2 + s1.3^2 + s1.2^2 + s1.1^2 + s8.1^2

HHI = 670.81 + 139.24 + 25 + 16.81 + 16 + 13.69 + 13.69 + 13.69 + 10.89 + 9.61 + 9 + 9 + 5.29 + 4.84 + 4.41 + 2.89 + 2.56 + 2.25 + 1.96 + 1.69 + 1.69 + 1.44 + 1.21 + 65.61

(* Mazur Group, 2014) HHI = 1043.27

With a HHI score slightly above 1000 we can now better understand the level of competition in the online market of beauty products.

“The U.S. Department of Justice considers a market with a result of less than 1,000 to be a competitive marketplace; a result of 1,000-1,800 to be a moderately concentrated marketplace; and a result of 1,800 or greater to be a highly concentrated marketplace (Investopedia, 2003).” An HHI score of 1043.27 for Beauty and Skin care products is a moderately

concentrated marketplace.

What we know based on the HHI calculations, is that the Beauty and Skin care Product Market structure is also monopolistically competitive. In order to have a perfectly competitive market structure:

“All firms [would] have equal access to raw materials, capital, labor and technology. A perfectly competitive industry, therefore, has no single market leader or monopolistic firm (Gilani, 2016).” Unlike perfect competition, monopolies are controlled by “a single producer or supplier of a product or a service [with] no close substitutes (Gilani, 2016).” Monopolistic competition is the best of both worlds. “The industry comprises many firms, which offer substitute products, and many buyers. Although the products are substitutes, they are differentiated on the basis of physical attributes, image, advertisements and accompanying services (Gilani, 2016).

The Beauty and Skin care Market is a great example of monopolistic completion, in that there are wide ranges of: products, companies, skin tones, and age ranges each company targets. Some of Olay’s competitors however, account for a much larger percentage of online revenue. Avon accounts for 25% of the entire market share. Mary Kay’s sales, which are second in margins, aren’t capturing as much revenue as Avon. It is clear that a few firms dominate the market structure of this industry.

Although many competitors exist, Avon is spearheading this monopolistically competitive market. As online sales become more commonplace, it is Avon who is at the forefront of digital marketing. With Olay sales accounting for only 5% of the online market share, PG needs to develop an online branding strategy to compete with Avon’s dominance and future plans to expand into international markets (Turner, 2016).

b.) Proctor and Gamble’s revenue is significantly impacted by a monopolistically competitive market structure. Although a 5% market share is noticeable, it is 80% less than that of Avon. The market dominance by only a few firms creates minimal profit margins for the Olay product line. The transition from CEO A.G. Lafley to David Taylor comes at a time where PG has struggled to deliver increased returns to shareholders (Paulson, 2015). In an attempt to grow by downsizing, Net Sales, and Net Earnings have only slightly increased each year.

*(Proctor and Gamble, 2014)

PG’s performance on the New York Stock Exchange isn’t impressive either. Share prices have dropped by 19% since the beginning of 2015. “Over the past five years shares of Procter & Gamble have gained 19% while the Dow Jones Industrial Average (DJIA) has increased 54% and the S&P 500 has grown by 71% (Paulson, 2015).”

(*Google Finance, 2016)

Unlike Avon, Proctor and Gamble’s multi arms in consumer product categories: Health and Grooming, Beauty, Fabric and Home Care, and Baby Feminine, and Family Care allow for a diversified portfolio. With multiple industries, beyond that of the Olay line to generate Revenue, Proctor and Gamble can sustain despite a 5% hold on the online market share without bankrupting the entire company. If Proctor and Gambles hopes to make good on its promise of higher returns to investors, they need a new plan.

c.) PG’s attempt to grow through downsizing is effective. As the supply decreases, the demand will increase, but only to an extent. This reduction strategy will only be effective short term, because there are only so many cuts in product inventory, until there is nothing left to sell. Therefore, PG needs an aggressive strategy in order to expand their Olay brand into densely populated and international markets. Trefis team at Forbes writes:

“Avon Products, the direct selling company of beauty, household, and personal care products, experienced a rough year in 2014. The company’s sales declined by 12%, to $8.6 billion, as it faced a weak economic environment and underwent restructuring in its operations. Avon faced a grim economic environment, especially in the Latin American region (which accounts for over 50% of its revenues) and North America (which accounts for more than 10% of its revenues). Internally, the company underwent major management restructuring and attrition of its representative base. Avon has been on a downhill journey since 2011 (its last profitable year) as its direct selling model is losing market share to retail outlets and online shopping (2015).”

Avon’s focus is solely concentrated on cosmetics, and has 90% of it’s sales out side of the United States of America (Trefis team, 2015). With 50% of Avon’s sales concentrated in South America, Avon’s target market is too big to ignore. Proctor and Gamble as a company, acts like an adoptive parent, merging new companies into its portfolio. A corporate merger of Avon, with the Olay product line, would account for over 30% of the online market share of Beauty and Skin care products.

Avon’s innovative online marketing strategy has proven successful, as it has given them dominance over the market; yet their limited resources cannot rejuvenate investor dissatisfaction and declining share prices. It would be a wise investment for Proctor and Gamble to purchase the entire Avon product line, to not only increase their online market share, but also expand into international markets with the Avon team. Avon’s experience with consumer reception, in each international market, to different product lines, creates a financial and knowledgeable powerhouse unlike any other cosmetic company. Although competitors may still have their advantage in retail sales, the merger of Avon with the Olay product line would be the defining standard, for the business of beauty - globally.

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