Procter Takes A New Gamble

Procter & Gamble is quietly moving to a new sales and distribution system in India, which could emerge as a viable alternative to the Hindustan Lever model

It is a subject that is being discussed in hushed tones inside every fast moving consumer goods (FMCG) company today. Project Golden Eye the code name for Procter & Gamble's(P&G) latest initiative in rationalising its sales and distribution system isn't exactly an eyewash.

On the contrary, it raises fundamental questions about channel design and network strategy issues which are agitating the minds of a great many FMCG companies.

For long, Hindustan Lever's famed distribution system was the only benchmark available. In other words, increased reach meant increased volumes. So the more number of outlets you could bring under your distribution coverage, the better chances you had of making a sale and hitting critical mass.

 

So almost every year, every FMCG company prided itself on setting itself ambitious targets to expand distribution cover, appoint new distributors and plumb for volume growth. For almost a decade, P&G too, strained every sinew to match the Lever juggernaut. It pushed for growth not just in urban markets, but also tried very hard to establish direct coverage of rural markets.

But in its quest for reach, P&G, like many other FMCG companies, overlooked one critical factor: the cost of extending distribution cover. After failing to aggressively challenge Lever in soaps and detergents, P&G has rewritten its focus areas: laundry (Ariel), sanitary napkin (Whisper), and Vicks. What's more, it has junked its local strategy of extending Ariel across the price spectrum, and instead gone back to its original strategy of promoting top-end products.

While the process of redrawing the organisational boundaries was on, two things became apparent. One, 85 per cent of its sales came from the top 30 towns. Two, its current volumes did not justify a large distributor network. Even in a market like Mumbai, there were close to six distributors.

A large distributor network meant that no single distributor had large enough volumes to achieve an attractive return on investment. This resulted in each distributor trying to extend its reach to push up volumes. But with P&G's portfolio of high-margin, low volume products, merely extending reach only increased the cost of servicing, not the offtake per outlet.

Today, P&G is busy slashing its number of distributors down to one-tenth of its size and reworking the margin structure. And this has sparked off a debate among marketers whether it makes business sense.

In many ways, P&G's initiatives raise two clear issues. One, is a large direct distribution cover necessarily a strength for every marketer? Can an alternate model emerge in India which results in large cost savings and yet, is also effective in meeting marketing objectives?

More, not less

At the heart of the P&G's new system is the implicit assumption that lower reach does not lead to significantly lower offtake. "My marketing objectives tell me that our brands are over-distributed," explains a P&G manager. If sales analysis shows 95 per cent of Ariel or Whisper sales comes from 70 per cent of the outlets, then it counts for very little if distribution cover is actually reduced.

Given that the two prongs of FMCG distribution are cost and availability, P&G is likely to get a significant cost advantage, without losing out on availability by cutting down on reach.

Apart from reducing costs by knocking down direct coverage, how does P&G hope to achieve significant cost savings in its supply chain? That's where P&G has started rationalising its distributor network. The intent: cut down its number of distributors to about one-tenth of its current size. In Madhya Pradesh, for instance, P&G will now have just one distributor, who will operate like a super-stockist. "So if 5 distributors were handling Rs 6 crore of business, now that entire business will be consolidated under one distributor," says a sales manager with Marico, who has been closely monitoring the new P&G system.

Earlier, since each distributor was working with small volumes, it wasn't economical for P&G to replenish them frequently. As a result, the average inventories lying with the distributor would be significantly high, forcing them to tread on the company's margins.

That is a dangerous loop for any distribution system. Typically, channel design in any FMCG system is driven by distributor's economics. The key issue is: How effectively can you leverage your distributor? "For most companies, managing distributor inventory is not seen as critical to channel design. Primary sales is where companies hand off," explains a senior consultant. "So as long as the company has sold enough to the distributor, it is not interested, " adds he.

Now, a distributor evaluates a company on how he is faring largely on return on investment (ROI). Simply put, ROI in a working capital intensive business is the number of rotations (or the number of times that the distributor can turnover his investment in stocks) multiplied by the margin per rotation.

The consequences of ignoring distributor ROI can be disastrous. Take the recent example of a leading FMCG company which attempted to benchmark its distributor economics with Hindustan Lever. The findings were startling.

The distributor margin for the company was 6 per cent while it was 5 per cent for Levers. Distributor stock levels for this company was an average of 4 weeks, while for Lever it is 2 weeks. Assuming that the distributors gave no credit to the market, the company's distributor ended up rotating his stock 13 times (52 weeks over 4 weeks) as against a Lever distributor who rotated his stock 26 times.

Now, given that the distributor aimed to hit a return of 30 per cent (the risk-free rate of return was 30 per cent if the distributor invested in the money market), the margin that had to be kept aside to achieve the above ROI was 2.5 per cent. The corresponding figure for a Lever distributor was 1.2 per cent.

This effectively meant that the amount of money that the company distributor could spent on distribution (buying vans, investing in salespeople etc.) was 3.5 per cent, while the Lever distributor could spend 3.8 per cent on distribution.

The writing on the wall was clear: despite its lower distributor margins, Lever was successful in getting higher distribution. So even though the FMCG company in question spent Rs 14 crore more by way of higher margins, it ended up with poorer distribution. The reason: it fundamentally did not manage distributor ROI.

The result can be disastrous. Even in healthy FMCG distribution systems, poor ROIs usually result in distributor drop-outs of around 10 per cent. The result? It leaves vacuum in distribution, leading to obvious share losses.

Recently a leading FMCG company in the household insecticides business could not find any distributors to service its key wholesale market in Begum Bazar for nearly three months, leading to a significant share drop. The company simply couldn't get any distributors to buy into the economics of the business.

The other fall-out is that the distributor will stop extending credit in the market, resulting in retailers not picking up stocks. Gaps in distribution are then inevitable.

Competing on size

Now, for P&G, by moving to a superstockist set-up, it could now replenish its distributors more frequently and hence reduce their average stock-level. Not only is its system complexity lower, it can also look at building stronger relationships with its superstockists. By ensuring a better return on investment, P&G will now be in a position to make the distributor invest more in IT and distribution infrastructure. Sources in P&G say that they will now be able to replenish stocks every three days.

Moreover, P&G hopes to make significant cost savings through the increased throughput available to the superstockist. By offering him more volumes and reducing the distribution reach (hence his cost of operations), P&G is now trying to shave off distributor margins by a full 2 per cent. This saving will then be channeled into brand building advertising. A larger advertising kitty will undoubtedly help it to fight competitors, particularly Levers, on mass media without being beaten on share of voice in media.

Additionally, with a limited number of distributors, P&G will also not need to invest in C&F agents. The superstockist will be expected to invest in storage and warehousing space, so that the stock transfer from the company can take place as soon as the stocks are shipped into the warehouse.

In the final scheme of things, P&G has another reason for reducing the distributor's margins. That's because of the peculiar distributor psychology at work. As in the earlier example, as soon as the company is able to reduce distributor stocks from 4 weeks to around 2 weeks, at 6 per cent margin, the distributor begins to earn almost 60 per cent rate of return. "That can be the starting point of trouble," says a senior manager.

The key is to keep the distributor's ROI in a band between 30 per cent to 40 per cent. The moment it falls below 30 per cent, the distributor is inclined to undercut in a bid to recover his money. On the other hand, if ROI is as high as 60 per cent, the distributor is tempted to aim for a higher turnover by undercutting the distributor in the next territory.

Of course, the only brand that will continue to need wide distribution cover is Vicks cough drops. The reason is simple. Vicks' competitive set is other impulse-driven confectionery. But for P&G to extend direct distribution cover for a single brand like Vicks is simply far too costly. So it has chosen to adopt wholesale distribution for the Vicks line. "If you don't have a portfolio to support a massive distribution thrust into the hinterland, there is very little point in aiming for direct distribution," avers a senior manager with an FMCG company.

However, for its future product launches, it is apparent is that P&G has chosen to focus on key urban markets. "Reducing cover is in line with future plans," affirms a sales manager at P&G. The era of jostling with Lever across the length and breadth of the country is over. Focus is P&G's new name of the game.