Quality is (and has always been) our mantra, the crux of our investment philosophy. Whether a company makes excellent returns today or has the potential to do so in the future, we believe it is the factors that allow a business to defend these returns that makes or breaks its ‘quality’.
But as we have previously said, when facts change, we should change our minds…
While we might be tempted to make like ostriches and bury our heads in the sand, the reality is that there is an undeniable shift in power from brands to consumer, a structural shift in how consumers communicate with brands and how they relate to them. Our research suggests Unilever’s stronghold is weakening, and its moat eroding. There are a number of reasons why this is the case.
The advertising landscape is changing – let’s face it, mega brand owners like Unilever have had a bit of an easy ride. But linear TV, the technology which has for years driven brand loyalty, is being replaced at warp speed. The prime real estate of evening TV advertising is losing eyeballs, despite TV still accounting for around 40% of the advertising market. Incremental advertising dollars are being spent on ‘new world’ platforms: YouTube in fact is now a more watched format than US TV, with more than 1 billion hours of content consumed per day. A quarter of the planet’s population is now on Facebook. The reach of platforms like Instagram with its 800m active users, is just breath-taking, and frankly unprecedented. The barriers to reach, target and influence consumers are a lot lower than what they used to be, and the productivity of one advertising dollar on these platforms is in general higher than on traditional channels. Challenger brands are therefore accessing huge audiences at low cost, and their growth is gathering pace.
The following is a powerful illustration of how low barriers to entry have sunk: 20-year old Kylie Jenner had 98.7 million followers on Instagram at the time she decided to launch her own beauty product (she has 103 million followers today). She decided to test a single product under the brand Kylie Cosmetics, with a single landing page and relying solely on her own channel to reach her audience. The Kylie Cosmetics page quickly gathered 14.6 million followers and achieved $420 million in retail sales in just 18 months. It took Tom Ford cosmetics (owned by Estee Lauder) six years to achieve this sales number. If this isn’t an eye opener, I don’t know what is.
The customer’s voice is king! Not only is this allowing smaller brands to proliferate and take share from big brands, but it is also giving consumers a powerful voice, robbing brands of control over the message. For instance, only 6% of the interactions on social media are generated by accounts that are officially associated with Chanel, the luxury brand. Chanel simply doesn’t control its own brand message on the most influential social media platforms. When you no longer control the conversation, things can go wrong fast, as illustrated by the Dove advert mishap3. The shift in power is palpable.
Distribution is another component of the moat that is changing dramatically, and undermining the power companies like Unilever used to wield. Traditional physical distribution channels, like retailers and shopping malls, are themselves going through a traumatic period of mass closures and reinvention. In the face of the inexorable rise of online shopping, power is again shifting to the consumer as price transparency increases and choices are narrowed down to a small screen, with the help of filters and sorting options. And with the rise of private label champions Aldi/Lidl, the disrupters have completely changed the landscape and reframed the customers’ decision to have some radical implications on how purchasing decisions are made, to the detriment of incumbent brands.
We know from our holding in specialist ingredients company Kerry Group that local brands are gaining market share at the expense of big multinationals. Craft almost everywhere is growing faster than the market. In fact, according to Euromonitor, small branded goods companies with less than $1 billion in sales have been growing at approximately 4x faster rate than larger manufacturers with sales over $3 billion.
Why? Simple, innovation. They are small, smart, and nimble. They have data in spades, and although unsettling at times, are able to predict consumption patterns. Big brands in contrast often don’t even have a CRM because of cumbersome legacy systems.
So how are they reacting? By acquiring concepts they were unable to develop organically. Think about Dollar Shave Club, the start-up founded barely seven years ago in a garage, which Unilever bought for $1 billion. Unilever’s spending spree has just begun, and it is having to pay eyewatering multiples to acquire growth.
If that wasn’t enough, the last couple of years have seen shareholder activism gathering pace. Financial orientated management teams are succumbing to margin fanaticism at the behest of shareholders. And why not? After all, Warren Buffett and 3G paid a super-premium price for Heinz in 2013 and have made a handsome profit while aggressively ripping costs out of the business. While we see the merits of approaches such as the Zero Based Budgeting (ZBB), the Buffet/3G approach is not always the best, as it can lead to chronic under-investment at a time when brands need the most support. Heinz sales were down -16% in the UK last year.
Post the Kraft Heinz bid on Unilever earlier last year, CEO Paul Polman has vowed to redouble efforts to improve the margins by rolling ZBB across the entire organisation.