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How Procter and Gamble's 'gummed-up' bureaucracy is holding it back

Nicole Sinclair
Markets Correspondent

Monday’s news that activist investor Nelson Peltz would kick off a proxy fight for a board seat at consumer giant Procter & Gamble (PG) comes amid significant cost-cutting at the company.

P&G, the biggest household and personal care company in the world, has spent the past five years cutting $10 billion in costs and shedding more than half of its brand portfolio. Last year, P&G even announced that it would cut another $10 billion in costs.

But that’s not enough for Peltz’s hedge fund Trian Management, which announced his $3.3 billion stake in P&G on Feb 14 and has said it’s disappointed by P&G’s performance.

AP Photo/Steve Helber

As a board member, Peltz would push for faster changes at the company behind Pampers, Tide, Crest, and Gillette. Peltz has already hinted at what’s holding P&G back, and it all comes down to one word: bureaucracy.

Bureaucratic bog-down

In his SEC filing, Peltz pointed to an underlying issue of bureaucracy.

“P&G’s challenges stem in large part from its organizational structure and culture, which can be highly resistant to change,” according to the filing. “Trian believes the job of a highly engaged shareowner in the boardroom is to foster a true sense of ownership among directors and inspire the board to take decisive and timely action to create sustainable, long-term value for both the company and its shareholders.”

Bernstein analyst Ali Dibadj added that the company has been slow to respond to changing consumer behavior relative to its peers. Dibadj says too many of P&G’s decisions have to go through the top levels of the company, and that the problem has persisted after CEO David Taylor took the helm in November 2015.

“The bureaucracy and gummed-up-ness of the company is the issue. They just aren’t able to get things done,” Dibadj told Yahoo Finance.

Forgetting about the consumer

P&G’s bureaucracy has made it difficulty for the company to rapidly meet consumer demands.

“Though P&G has long called the consumer ‘boss,’ it clearly lost sight of that mantra for too many years,” Barclays’ Lauren Lieberman wrote in a recent note.

Case-in-point? P&G’s strategy around diapers in China, which happens to be P&G’s second largest market. The company entered the market focusing on “mid-tier” pricing, according to analysts, as part of a one-size-fits-all strategy, even as key growth drivers in the region and category came from “super premium.”

P&G at last rolled out its premium tape diaper product last year and it fell flat with consumers, because it was designed with US consumer preferences in mind, according to analysts.

“Rather than realizing that Chinese mothers are more focused on the texture (soft) and comfort (loose) of a diaper, the existing diaper is designed for a tight fit to prevent leakage,” according to Lieberman. While a new diaper is slated to launch in August, the time to get to this point was long and well behind peers, according to analysts, reflecting the lack of agility at the company.

The company is also slow to make its prices competitive with peers. Bernstein conducted a “price gaps” analysis in the US, which showed that in categories including fabric care and grooming, P&G pricing remains significantly higher than peers.

And in some categories, like shampoo, P&G misdirected focus on the lower-end price tier, according to Dibadj, while stronger growth came from the higher end.

This has all translated to disappointing performance, according to analysts. Trian sites that P&G’s market share is down in 68% of the top 20 country-category pairings, as organic sales lag peers, as shown in the chart below.

And the impacts of this slower pace at P&G has been exacerbated by the rise in e-commerce and Amazon (AMZN), particularly as big-box stores like Walmart (WMT) have run a new price-comparison test, fueled by e-commerce pressure, putting pressure on packaged goods.

‘They have a long way to go to make it less complex’

While P&G made a big deal when it slashed more than 100 brands, Dibadj said the changes haven’t been extreme enough.

“They have a long way to go to make it less complex,” Dibadj said. “While they cut the majority of their brands, these were small brands, only about 15% of sales. Meanwhile, with the facade of scale, they’ve created a lot of complexity.”

And while P&G (whose stock is up 4% year-to-date versus the market up 10%) has made some efforts to better respond to consumers, much more needs to be done, according to analysts.

“We believe that to be able to sustainably grow in line with the market, let alone gain share, it will take more than just a step up in advertising or just one product cycle per category given how out of synch P&G’s brand portfolio has become in many key markets globally,” Lieberman wrote.

The first step in transforming the company

Peltz’s efforts to speed up change may be the first step in transforming the company to get results to match peers, according to Dibadj.

“I think the stick of a potential breakup, given past pushes by Peltz, will get folks to move a bit faster,” Dibadj said. “At this point, pushing for a breakup of P&G is an uphill battle met with a lot of resistance. I can imagine Peltz having some patience. But over time, the break-up may be the way to unlock the full potential of the company … You’ll eventually get to the point where the complexity is too interwoven.”

At the very least, Peltz is expected to invoke change, even if he hasn’t disclosed specific details.

Peltz’s past experience with Pepsi — where he took a stake in 2012 — may provide a hint of what’s to come at P&G. While Peltz advocated for a spin-off of the snack business and then a merger with Mondelez (MDLZ), analysts say the “stick” of a potential breakup prompted operational improvements at Pepsi, causing the stock to outperform and metrics to improve without that action.

“His track record of improving companies is clear,” Dibadj said.

Nicole Sinclair is markets correspondent at Yahoo Finance

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