“Consumer products companies have got to be bolder” - Interview with Nik Modi, RBC Capital Markets

The consumer products sector is at an inflection point. Growth has become increasingly challenging as many companies struggle to adapt to consumer and retail changes. To better understand what companies need to do now, I caught up with Nik Modi of RBC Capital Markets. Modi is one of the top-ranked sell-side analysts covering the sector:

Andrew Cosgrove: Nik, a few years ago we argued that consumer products companies needed to disrupt their traditional approaches or risk being disrupted by changes in the market. What’s your view on the current state of the sector? Are companies being bold enough? 

Nik Modi: I like the fact that finally, after many, many years, some companies are starting to think a little differently. After the ’09 recession, we started recovering and the mood was, “okay, everything is going to be fine”. In fact, growth really hasn’t picked up. We’ve seen a very clear bifurcation between the winners and losers. That is a function of strategy, organizational design, and effectiveness of management. When I talk to the companies that have struggled, I’m finally hearing the need to make more decisive changes, or more disruptive changes. I like the fact that we’re seeing some companies starting to act with a greater sense of urgency.

 So, I think there are a lot of good things going on, a lot of pressure building. But, no, I don’t think they’re being bold enough. I have a big problem with the lack of delta in terms of compensation for high-performing management teams and low-performing management teams. And I don’t believe that boards of directors are doing enough to help companies make the disruptive changes required to win in the future.

Step One is always admitting you have the problem, right? The steps after that are always harder. I still don’t think many companies have correctly diagnosed what their problems really are. Is it really just marketing? Or is there something systemic going on, whether it be the actual quality of the product -- the need to take gross margins down because you have to put more ingredients in the product because that’s what the consumer requires in this day and age? Or is it the way you make decisions?

I think a lot of big global companies are still coming around to the fact that their competition is no longer just the other big multinationals. They have yet to realize that there’s a whole host of very credible, nimble, sophisticated local players in all these emerging markets.

Even before we started seeing the emerging market meltdown, most companies were probably under-delivering their plan on emerging markets. I think that’s been a function of this local competitive dynamic.

 Cosgrove: And that new competitive dynamic isn’t just a challenge in emerging markets. Look at the impact that digital first start-ups have made in mature markets, or the growth of craft beer, for example. So what are the three things you think CEOs should emphasize now?

 Modi: What’s becoming very evident for me is that the core competencies, the capabilities, the strategies, the initiatives that will help companies win in the future are almost diametrically opposed to what they have done in the last 20 years.

 First, CEOs have to focus on organizational design restructuring – really making sure they’re making the best decisions for the local markets. That might require descaling the business to some degree. Some companies are hesitant to do it because of tax implications. Others are afraid to do it because they want to scale up and that’s the only way they feel like they can get margin leverage.   But many of those that have that mentality are really losing it on the top line because they’re getting out-executed.

 Second: I still think there’s a huge opportunity to boost trade spending efficiency using big data. I don’t think enough companies are doing it. Some are starting to talk about it and a few are implementing systems. There’s a big opportunity there.

 Third: then comes supply chain reconfiguration. Over the last couple of decades, we’ve had supply chains consolidate in an effort to get margin. But we’re now in a new reality with geopolitical and cross-border currency wars where, if you don’t have local production, you’re really exposing yourself to a lot of volatility.

Those are the three big initiatives that I would implore companies to think about.

 Cosgrove: One challenge I hear from companies is that Wall Street expectations force them to focus on quarterly earnings. What’s the investment community’s appetite for change?

 Modi: You might be surprised. Even if CEOs acknowledge the need to invest in their businesses, they tend to say “Oh, we can’t cut our earnings numbers because the Street will punish us.” Well, you know what? I think the Street would actually give you a lot of good press if you said, “Hey, by the way: the world has changed around us quickly. We’ve been around 100 years and we want to be around 100 more, but we don’t want to just be “around.” We want to be dominant like we have been over the last 100 years. We need to make some investments in our supply chain.” Those kinds of investments build long-term competitive advantage; they are always valued that way. I think people tend to over-emphasize the near-term and under-emphasize the long-term.

Cosgrove: With growth being difficult, there has been a lot of focus on cost-cutting to drive shareholder returns. To what extent are the companies you cover getting the balance right?

Modi: I think that there’s too much emphasis on margin, unfortunately. Every company I cover can expand margins by a thousand basis points next quarter, but what does that mean for growth three to four years down the line? What does that mean for the innovation pipeline? What does that mean for product quality?

At a time when consumers are yearning for more taste and natural ingredients that typically cost more, companies want to get margin expansion? That’s impossible. Today, the reality is blind wins, product efficacy and recommendations; that’s how you build brands. It’s no longer just blasting people with ads on TV. The product has to speak for itself.

I would argue that many companies have allowed their product quality to deteriorate in the name of margin; that needs to reverse. I’m actually looking for companies to invest in their product at the expense of gross margin because I think invariably, that’ll help expand competitive advantage.

Ultimately, if companies do everything for the consumer, then they will invariably benefit their shareholders. I hear a lot of companies claim that the consumer is boss, but it really hasn’t been that way. The investment community has been boss, which is not the way it should be.

 Nik Modi biography

Nik Modi, Managing Director of Tobacco, Household Products and Beverages at RBC Capital Markets, LLC, Research Division.

 Andrew Cosgrove biography

Andrew Cosgrove is the Global Lead Analyst for the Consumer Products and Retail sector at EY. Andrew has significant experience in the Food and Beverage industry in both Europe and Asia. He is co-author of “Managing Profitable Growth in Emerging Markets: Scaling the Tail” published by Palgrave Macmillan.