How the Global 50 largest fmcg companies are turning defence into attack

The world’s largest fmcg companies are on the defensive. In the face of soaring inflation and global volatility, their game has gone from one of attack, to one that has simply aimed to hold on to volumes.

That’s been no easy feat amid such unprecedented pressures. Fmcg companies had only just recovered from covid when inflation spiked to a 40-year high in 2022 – pushing up costs of commodities, logistics, energy and labour. What’s more, Russia’s invasion of Ukraine created yet more volatility on the global stage.

Against this backdrop, you might expect the Global 50 to have suffered. Yet their overall revenue growth last year was the highest in a decade. Although this was largely driven by price, volumes have held up too.

So how have the Global 50 managed to remain so resilient? And, now the game looks set to move back in their favour, are these consumer giants ready to go back on the attack?

The industry’s biggest players have certainly performed better than feared in the circumstances. “In a pretty turbulent market, most indications suggest many have outperformed their wider markets and have shown the ability to navigate that disruption with their strength of brand and global reach,” says OC&C managing partner Will Hayllar.

Indeed, overall revenues across the 50 companies in the index grew 10.9% in the last completed financial year, up from 9.3% in the previous period and 1.1% before that. With little impact from M&A, this was driven by organic growth, which was up 11.4% across the companies that detail organic figures.

Notably, these suppliers were able to push through rapid price increases to mitigate their soaring costs: price/mix growth stood at 10.7%.

“Large investment grade companies have shown a strong degree of resilience as they have been able to pass through quite rapidly the price increases that were needed with only modest volume attrition,” says Moody’s senior VP Paolo Leschiutta.

As Moody’s senior analyst Lorenzo Re points out, this was helped by the sheer heft of these companies and their brands, which gives them an edge in retailer negotiations. Essentially, they are less likely to face delisting than smaller brands.

Dannatt adds: “Weaker brands have found it more difficult to hold their own through this environment and have faced bigger volume elasticity as consumers selective choose to trade up into products their really value or care about.”

The uniform need for all players to recover pricing also helped, says Rothschild global head of consumer Akeel Sachak. “Everyone has taken pricing in this cycle and therefore relative pricing remains where it was previously and so nobody has really suffered,” he says.

“There is no real talk about having to give back that pricing and pricing elasticity of demand has been much lower than anyone anticipated.”

That latter part is the crucial. Against these prices rises, there has been little damage to volumes, which rose 0.8% across the Global 50. That figure is in line with much of the previous decade. Volume growth has largely been close to 1% – the only obvious outlier was the Covid-driven 3.4% volume growth of 2021.

It serves to illustrate the resilience of the top consumer goods companies in the face of wider downtrading to private label and cheaper brands. In Europe, private label value share has risen from 34.6% in 2021 to 36.4% 2022, fuelled by the discounters taking share across major markets.

Not only has the global 50 have stood firm against this threat, but OC&C found own label was not the winner across all categories. Brands have taken back share in Europe in areas such as beauty, beer & cider and baked goods. And even in areas where private label won share, such as the UK laundry detergent market, the largest brands were still able to win share at the expense of smaller players.

This is telling, says OC&C partner Claire Dannatt. She believes it is “a testament to the brand loyalty and strength that lives in those big companies that you can have record price growth go through without much volume backlash down into private label or into other cheaper alternatives”.

There are some wider market conditions on their side, too. Despite the inflationary volatility, consumer confidence and employment have held up against the headwinds. “Accumulated savings plus low unemployment has actually meant fewer consumers have faced the sort of constraints that force them to re-evaluate their consumption baskets,” says HSBC head of consumer staples research Jeremy Fialko.

Then there is the fundamental nature of the fmcg sector. “Consumers need to eat and drink and spend on personal care, so it’s a more protected part of consumer spending on average,” says OC&C’s Hayllar.

This is reflected in share prices. Shares of food and drink players were up 7% in 2022, and tobacco shares were up 21%. That compared with an average fall of 1% in share prices – and double-digit slumps of 39% in tech stocks and 23% in automobiles. 

Low profit margins

It’s not universally good news, though. The industry has had to take a hit on margins, as it absorbed some of the impact of cost inflation.

That’s reflected in Global 50 profit margins falling to their lowest level in the past five years – from 19.1% in 2021 back to 17.8% last year. Only 17 of the 50 companies were able to grow both revenues and margins.

Most significantly, spiking commodity costs and wider inflationary cost inputs resulted in gross margins falling from above 47% pre-Covid down to 43.6%.

To some extent, this was mitigated by cost cutting. The operational cost cutting undertaken by companies – most notably to marketing spend and SKU counts – improved margins by 0.8 percentage points.

Still, Bernstein analyst Bruno Monteyne says it is “debatable” how good shape consumer goods companies are in. “Companies significantly cut market spend because gross margins were under pressure and they have still not fully recovered so far in 2023,” he says.

In particular, he notes performance was far from consistent across the global 50. Key players like Danone, Unilever and Henkel have lost market share and volumes in Europe. Food and drink players have seen the most significant EBIT margin decline of the Global 50 – 1.7% – given their higher structural cost base and lower ability to drive operating cost improvements.

By contrast, some sectors benefited from a pandemic recovery. Covid was still depressing out of home, leisure, China and travel retail sales in 2021 – making for some favourable 2022 comparisons.

Beer and spirits players were key beneficiaries of these conditions. They delivered a 14.7% jump in sales, boosting overall Global 50 growth. Volume growth reached double digits at Pernod Ricard and Diageo, while Heineken, Carlsberg and AB InBev all achieved volume growth due to structural tailwinds that have started to slow in 2023.

And this year could bring more turbulent conditions. On the plus side, wider macroeconomic headwinds have started to ease.

Inflation in key global markets has begun to normalise in the second half of this financial year. Meanwhile, the vast majority of commodity inputs have drastically eased since their peak in the wake of Russia’s invasion of Ukraine last year.

That should give most Global 50 players the opportunity to recover the margin they were forced to give away last year. OC&C highlights the strong margin rebound in 2008 after a wave of inflation, which went from a 0.4 percentage point margin compression to a 0.9 percentage point expansion the following year.

Moody’s Re expects a similar pattern to emerge this time around. “Companies did not pass through the entirety of cost increases they experienced, so most companies will want to retain the benefit from declines in commodity prices to restore gross margin, which is still below 2021 levels,” he says.

But consumer goods companies aren’t out of the woods yet. Their recovery may be limited by long-term hedging arrangements, which mean lower input costs take a while to filter through to the bottom line. There is also the impact of continued inflation in inputs such as labour and the cost of borrowing, which are typically harder to recover.

This is crucial, considering gross margins need to be rebuilt to fund investment in growth. That investment will be vital if brands are to avoid becoming mired in downtrading and longer-term volume declines.

“Growth will still be the number one priority for these businesses,” says OC&C’s Dannatt. “A lot of them will be worrying about how to manoeuvre from a world of price-led growth back into a world of volume-led growth, which is not an easy pivot to make.”

“A big cut in marketing costs helps you manoeuvre through one or two years while holding on to reasonable profitability, but it is not sustainable for these businesses longer term,” she adds. “A profit-focused strategy around cutting costs or despeccing propositions is extremely short-termist and you quickly start to see revenues suffer.”

HSBC’s Fialko adds: “Most of the management teams are quite conscious of negative sales volumes and will want to ensure that this trend is reversed soon. In most cases we expect that the recovery in margins will be more gradual than the declines.”

“Margin recovery is necessary but insufficient,” agrees Hayllar. “These companies need to focus on the future and you tend to find that those companies what are growing are those that succeed in getting propositions out which appeal to consumers in the long run.”

So the consensus is clear: companies will have to once again invest in areas that were cut back last year, such as marketing and research & development.

While this could result in further pressure on net margins, investors stress the bottom line-focused era of zero-based budgeting is not a blueprint for this next cycle. “Zero-based budgeting is not so fashionable these days,” Sachak notes. “There remains an appreciation of cash flows, but the imperative for big fmcg remains how can we sustainably grow our business in the long run.”

This imperative will be complicated by other market pressures, though. Retailers are beginning to push back on pricing. There is intensifying regulatory scrutiny of competition and profit levels among grocery suppliers. And the threat of own label isn’t going anywhere.

“Private label is going to be more necessary for the grocers to compete with the discounters, so consumer goods companies have to offer good quality products at a premium to private label that is not excessive and pushes customers away,” says Moody’s senior VP Roberto Pozzi.

There will also be pressure to increase promotional intensity as costs come down. 

There will also be pressure to increase promotional intensity as costs come down and it remains to be seen whether companies have, according to Sachak, “learned from the mistakes of the way they promoted historically” as they got “completely carried away with promotional behaviour”.

OC&C notes consumer preferences have rapidly shifted over the past few years, which has reshaped category norms as well as retail and supplier relationships. As such, suppliers will need to understand the changed nature of category dynamics and how elasticities have been altered by the significant increase in pricing.

Premiumisation

One important dynamic will be how premiumisation plays following last year’s rapid price increases. Driving consumers up the value curve – either to more premium branded products or into their ranges from cheaper local brands – has been a key driver of industry growth in recent years.

Dannatt is optimistic. “Consumers are now fundamentally different than in previous large-scale economic squeezes,” she says. “Where a proposition really resonates with them and they attach strong emotional value to it, they are willing to spend significant sums on those products, so brands need to build those propositions and emotional connections.”

Still, even if consumers are willing, whether they are able to spend is a different matter. “You certainly see historically that premiumisation slows in a period like this as consumers, on average, have less ability to trade up,” says Hayllar.

There have been some signs of consumers cutting back this year on premium goods – particularly in the US, which has affected sentiment around spirits makers like Diageo. On the more positive side, super-premium goods have held up better than expected, shrugging off concerns around a slowdown in China. Sales of LVMH’s high-end champagnes and wines, for example, jumped 24% last year.

This suggests consumers in many markets are not feeling the level of pain normally associated with periods of economic volatility. It also points to an uneven spread of pain, with wealthier consumers benefiting from savings and strong employment.

Given these dynamics, suppliers will need to think carefully about geographical strategies and individual market conditions. China, for example, is heading into deflation, inflation is normalising in the US and it remains stubbornly high in parts of Europe.

Then there’s the impact of the sell-off and scaling back of businesses in Russia. Companies will need to carefully consider the weight they place on protecting volumes in difficult markets in Europe, while weighing up potential softness in demand in the US against the confidence they have in the Chinese economy.

Another factor to consider is M&A. It has had very little impact on growth in recent times – a freezing of the capital markets dropped Global 50 deal activity to a quarter of average levels. But as conditions stabilise, that all looks set to change.

Major fmcg groups will likely continue to seek growth assets to bolster their portfolio. And OC&C suggests changes in the value of supply chains could result in new M&A approaches as groups target more capability-led acquisitions – targeting areas such as AI and technology or ESG.

“There has been a very significant change to the value chain and source of advantage that raises questions about what is right to own in-house or outsource,” Dannatt says. “For example, manufacturing is a good example where co-manufacturing could give suppliers more agility to respond to market trends than owning production facilities.”

The strategic questions facing the globe’s largest fmcg players in a post-inflationary landscape are only intensified by the scale of change many leading players are going through themselves.

Rothschild’s Sachak notes leadership changes at Reckitt Benckiser, Danone, Unilever and PepsiCo, among others. Meanwhile, activist investors pushing for change remain on the shareholder register of a number of these businesses.

“The different leaders at the helm of these businesses will do different things as they’re not weighed down by the baggage of their predecessors,” he predicts.

Emerging from a crisis brings industry opportunity, but it also threatens the status quo. The fmcg giants have relied on their brand strength and scale to ride out turbulence, but sitting back and expecting to prosper in more benign conditions is not an option.

The post-inflationary world is a different place to the pre-Covid market – and will require a very different approach. Those that prosper will be those able to pull the right mix of levers now to strengthen their brand and market position and position themselves for the next phase of growth. It’s time to go from defence to attack mode.