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Why P&G's $57 Billion Bet on Gillette Hasn't Paid off Big -- Yet

Five Years and One Recession Later, Company Says Value Is There but Hidden

By Published on . 6

BATAVIA, Ohio (AdAge.com) -- Just over five years ago on a Monday morning in late January, Procter & Gamble Co. shocked the business world with a $57 billion acquisition of Gillette Co., reshaping itself and its industry.

Though P&G was already beating most of its competitors handily on the top line and in market share, Chairman-CEO A.G. Lafley predicted that Gillette would add another full percentage point to the company's annual sales growth. Gillette Chairman-CEO Jim Kilts predicted the integration of what he called the two best companies in consumer products would become the stuff of Harvard Business School case studies as P&G reaped the benefits of "reverse synergies" from Gillette managers and practices and Gillette tapped P&G's beauty-care expertise. And he was holding plans for Gillette's first new razor system in seven years -- Fusion -- in his back pocket.

Stock since the Gillette deal
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HOW THE STOCK HAS FARED: Stock performance between the day before P&G announced acquisition of Gillette on Jan. 28, 2005 and market close on Feb. 11, 2010.
Five years later, though, things haven't exactly gone as planned. Most of the acquired Gillette businesses have been a drag on P&G's top line, not a boost. Most of Gillette's senior managers (with the notable exception of current P&G Vice Chairman Ed Shirley) have left. P&G's stock has lagged behind key competitors', including Colgate-Palmolive Co. and Unilever, which have beaten P&G 4 to 1 and 3 to 1, respectively, in the stock market. The recession buffeted Gillette's core business -- pricey razors and blades -- and efforts to expand the Gillette and Venus brands into adjacent categories have had mixed results, at best.

But P&G executives and some former Gillette managers say much of the deal's value is like an iceberg -- it's there, just obscured under water. Gillette, they say, has transformed P&G in ways that aren't always obvious but have made possible aggressive moves in key markets such as Brazil and India; a much stronger operation throughout Europe and an even stronger showing on U.S. retail shelves; a growing investment and expertise in sports marketing and faster internal decision making. And the best, they say, is yet to come.

In June, Gillette launches its first substantial razor system upgrade since Fusion -- ProGlide -- promising a performance enhancement similar to that from the launch of Fusion four years ago. It will be an acid test of whether Gillette's trade-up model can still work in what's, at worst, an intractable recession and, at best, a jobless recovery. P&G will ask for the same 10% to 15% price hike over Fusion -- or about $17 for a four pack of blades vs. about $15 now -- as it sought a decade ago for Mach 3's midlife makeover Turbo. But Matt Wohl, general manager-new product development for global grooming, said ProGlide performs as well or better on purchase intent scores compared to Turbo, which launched in 2002 following a much shallower downturn.

Innovations
The new system has seven key improvements centered on producing less tug and pull, including a thinner blade that requires about a third less force to cut through facial hair, along with blade stabilizers that keep the blades from producing microscopic wobbles that hurt performance, and a micro-comb that helps smooth the way. It all adds up to a significant decrease in irritation and an increase in closeness, said Stew Taub, research director-global Gillette male premium systems.

Meanwhile, to help deliver on some of the promise the combination seemed to offer for growth in deodorant, skin and hair care, P&G has taken a step away from the category-management model it's been working under since the 1980s and back, in a sense, to classic brand management. Mr. Shirley has recently put the entire Gillette mega brand into a single unit based in Boston rather than let individual category managers, many in Cincinnati, decide the fate of such products as Gillette body wash and hair care.

P&G's stock is up 12% since the day before the deal was announced in 2005. That's better than the S&P 500, down 8% over the same period (see chart). But it's worse than two of the three competitors most directly affected by the deal, including Colgate-Palmolive Co. (up 53%) and Unilever (up 36%). Realistically, few would have predicted the "Great Recession," which has swamped all other downturns in recent memory and hit Gillette's shaving and battery businesses particularly hard. Men were already starting to shave less before the downturn, and both men and women alike have fewer reasons to shave when they're unemployed or go out less often.

"It depends on how you define a good deal," said Deutsche Bank analyst Bill Schmitz. "If you've got a model that's built around trade up and trade up dies on you because of a recession, that's a problem."

As with virtually every deal in its history, P&G delivered on most of its economic benchmarks, particularly earnings, by over-delivering on cost savings, Mr. Schmitz said. Mr. Kilts, a noted cost-cutter, helped instill a discipline even tough P&G managers had never experienced before.

Even so, operating margins Mr. Lafley projected would hit 24% to 25% by the end of last decade only reached about 22%. Spiking commodity costs, slower growth in higher-margin beauty and personal- care businesses (including some from Gillette,) and a higher mix of business from developing markets all played a role.

Basically, like almost every deal in P&G history save the 1999 Iams acquisition, Gillette has disappointed in delivering on its organic sales growth target through its first five years. But it might just be too soon to tell.

Key pieces of P&G's 1985 acquisition of Richardson-Vicks, such as Olay and Pantene, didn't really take off until five years later in the case of Pantene and nearly 15 years later in the case of Olay. The 1997 acquisition of Tampax foundered on the top line for more than five years until the launch of Tampax Pearl in 2002.

Ali Dibadj, a Sanford C. Bernstein analyst who worked on the P&G-Gillette integration as a consultant with McKinsey & Co., likewise gives the deal a mixed review, with cost cutting being the clear standout.

Sales growth has been a challenge, he said, in large measure because of the recession and because "Fusion is pushing the envelope on what a razor can do" in terms of performance and getting men to trade up. Similarly, efforts to expand Gillette and Venus more broadly into personal care have been slower than expected. But he said P&G did get distribution gains for Gillette, and vice versa, in key emerging markets.

Executive talent
P&G did learn a lot from Gillette both in terms of cost efficiency and executing promotional programs at retail, Mr. Dibadj said. "A lot of the senior management obviously did not stick around, but the people who did stick around, e.g. Ed Shirley, are extraordinarily high quality. So I'd say it's still a positive on the skill set from a management perspective."

Executives of some competitors are less forgiving, contending P&G overpaid for Gillette and under-delivered on expected synergies such as the expansion of Gillette and Venus into adjacent categories. No one, however, disputes that P&G got perhaps the most-coveted brand in package goods with the Gillette men's shaving business.

One big and still relatively untapped payout from the deal is giving P&G access to the half of the consumer market it largely didn't serve -- men -- Mr. Shirley said. "That's really formed the potential for Gillette to explore the full potential of the strongest male brand in the world," he said.

"Before we engaged in the conversations with P&G, we tried to launch a male skin-care line of our own," Mr. Kilts said. "We just didn't have the technology or the understanding. ... Part of it had some traction, but it was really underwhelming. ... The same with the deodorant business. We just did not have the wherewithal and technology to be competitive."

Admittedly, the jury is still out on the degree to which P&G will be able to tap the potential of that combination. Male personal care is growing, but at least in the U.S., rival Unilever claims to have captured most of that growth, having accounted for 66% of growth in men's personal care, excluding razors, over the past five years, said Kathy O'Brien, VP-personal care for Unilever, citing Nielsen data.

Gillette has launched upgraded deodorants, a new body-wash line and a new hair-care line since consummating the deal in October 2005. While the deodorants have gained shelf space at club stores and the body wash has stuck (see related story, P. 9), Unilever's Axe has grown faster in each category, particularly hair care, where it soundly beat Gillette despite the latter's head start. Edge, first under rival SCJ and sold earlier this year to Energizer, has been taking share from Gillette in shave prep, too.

But the game is far from over. Part of the ProGlide launch is an ambitious four-item expansion of Gillette's shave-prep business, including a warming pre-wash, a cooling after-shave lotion and, in a fairly bold gambit for U.S. males, a moisturizer with UV protection.

Asked whether Gillette has been a good deal for Procter & Gamble Co., the latter's Chairman-CEO Bob McDonald gives an unqualified yes. But he also noted it would be interesting to look at the decision by another company not to combine with Gillette.

It's no secret that company is Colgate-Palmolive Co., though never officially acknowledged by either side by name.

Gillette was in repeated merger talks with Colgate more than two years before then Gillette Chairman-CEO Jim Kilts approached P&G, say people close to the companies, with Colgate ultimately rejecting the deal twice.

First, the rejection came down to price, or valuation, in a proposed merger of equals, with Colgate rejecting what ultimately looked like a cash transfer that would have addressed Gillette's less-than-5% market capitalization advantage, these people say. By the time P&G bought Gillette less than three years later, the purchase price valued Gillette at about double what its shareholders would have gotten in the combination with Colgate at a time when Colgate was just entering a restructuring induced largely by a marketplace drubbing from P&G.

By the time the second wave of discussions came in 2004, following Colgate missing a quarter's earnings target and suffering a steep share-price decline, the cultural differences were likely even more of a factor. Gillette proposed an outright acquisition rather than merger of equals. A person close to Colgate said that was unacceptable, especially given suspicions that Mr. Kilts would quickly flip the combined companies to another buyer.

Colgate has little reason to weep. Its stock has risen four times faster than P&G's in the past five years, and it's been beating P&G on the top line for more than two years.

But it does raise the question of whether a Gillette-Colgate merger would have worked better than P&G-Gillette. While Peter Klein, Mr. Kilts' longtime adviser at Gillette and Kraft, gives the combination with P&G an unqualified endorsement, he gives a definite maybe when asked whether Gillette-Colgate would have worked better.

One key goal in the merger -- to tap "reverse synergies" by incorporating as much as possible of a Gillette culture widely seen as a rival to P&G's for success in package goods -- has had mixed results.

All but one of the most senior managers from Gillette ultimately left the company, some despite considerable efforts and wooing by A.G. Lafley and current Chairman-CEO Bob McDonald.

Privately at least, some veteran P&Gers looked down on the marketing skill set of the incoming Gillette people. Some of the incoming Gillette people found the P&Gers remarkably resistant to new ideas.

Deutsche Bank analyst Bill Schmitz has contrasted a Gillette culture where "giving it the old college try" was acceptable, to a P&G culture where no defeat or loss of market share is really tolerated. "It's not a culture. It's a cult," said one former Gillette executive who tried to stick it out but ultimately left. But not all P&Gers drink the Kool-Aid, or they at least take it with a substantial grain of salt. And in the case of two senior Gillette executives who were much prized by P&G, either family or personal illness was the reason for their departures, not cultural incompatibility.

The rest of the Gillette people have either left or adapted. Some have done the latter quite nicely, including the company's top executive in Germany, its top media executive in China, and most notably P&G Vice Chairman Ed Shirley, a career Gillette executive who's now vice chairman of over a third of P&G's business: beauty and grooming. At 53, Mr. Shirley is three years younger than Mr. McDonald, and as such has probably the best shot at one day being CEO.

He's been spearheading a reorganization of his businesses along male and female consumer lines rather than the traditional category and brand structure. And he's made inroads in what looked to be a huge problem when he took charge -- beauty businesses that, despite steep acquisition prices or heavy ad investments, were losing momentum and share to global rivals. Organic sales growth of the P&G beauty business has steadily risen on Mr. Shirley's watch to 4% last quarter, which, while still lagging such rivals as Colgate-Palmolive Co. or Unilever's personal-care business, has lately been beating another key rival: L'Oréal.

"Culturally, it was a challenge," he said. "But ... I saw it almost as sport that I'm not going to let some of the long-lived cultural aspects get in my way. "

"A lot of the people who left were going to retire and leave anyway in the short term," said former Gillette Chairman-CEO Jim Kilts. "And I think we seeded the company with some great talent down in the organization, so time will tell."

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