P&G Shifts Management Incentives to Focus on Share

New Plan Allows Managers to Win When Rivals, Categories Slow

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BATAVIA, Ohio (AdAge.com) -- Procter & Gamble Co. is making a subtle but potentially important change in how it compensates top managers, one that will reward them for increasing market share even if industry sales slow and the company resorts to price cuts. The move has some speculating that P&G is girding for a period of slower growth, lower prices and bruising promotional battles over the next three years.

Under the old, three-year management incentive plan, dubbed the "Business Growth Plan," P&G executives were compensated based on organic sales growth, which factors out the impact of acquisitions, divestitures and foreign currency. The higher P&G's organic sales growth, the more managers made in the form of cash or stock. Under the new program, the "Performance Stock Program," P&G's top managers are compensated only in stock, but the top-line growth target changes to compensate them based on how P&G's organic sales growth does in comparison to peer companies.

In essence, P&G has redefined winning in relative rather than absolute terms -- so if it does better than the likes of Unilever and L'Oreal on the top line, managers hit their targets and reap rewards, even if everyone's organic sales slow.

While P&G plays down the significance of the change, it essentially positions managers of the world's biggest ad spender to win even if their categories slow, their prices decline and if what's already been a nearly three-year U.S. recession by official reckoning lasts another three. By essentially letting P&G managers win when their competitors lose, the new plan could also encourage bruising battles in rivals' biggest or fastest-growing categories and markets -- something that's already playing out in such markets as India, Brazil and Western Europe, where P&G is taking on entrenched competition from Unilever and Colgate-Palmolive Co.

The organic sales goal under the old management compensation plan was 5% compound annual organic sales growth, a P&G spokeswoman said. The new plan "will be consistent with our previously announced long-term growth targets of 1% to 2% ahead of the market." She noted that the new target doesn't necessarily mean P&G sees long-term potential for sales growth in its categories less positively than it did two years ago.

Though the new system wasn't in effect yet last quarter, it would have served P&G's managers better than the old one. P&G's organic sales growth, rounded up to 4%, came in lighter than many analysts expected. But the company did better on organic sales relative to competitors such as Unilever, Colgate-Palmolive Co. and Church & Dwight Co. than it generally has the past few years -- essentially tying them rather than lagging them.

P&G has terminated its old three-year incentive program, adopted just in advance of the September 2008 global financial meltdown, a year early. The company had hit only 42% of its overall financial performance targets during the first two years of that plan.

Neither the new nor the old plan were just about changing how P&G defines winning on the top line. The new plan gives equal weight to three other factors (similar to the old plan), including before-tax operating profit growth, core earnings per share growth and the rate at which the company converts earnings into cash. The one other change is the shift to "core" earnings per share, which strips out the impact of acquisitions and divestitures, lost federal subsidies for retiree health-care and potential fines for alleged violations of competition laws based on investigations under way in much of Europe.

P&G is changing the metric for its managers just as some analysts doubt it can hit its stated 4% to 6% target for organic sales growth in the just-begun fiscal year, particularly given that the company expects as little as 3% growth this quarter. P&G grew unit volume twice as fast as organic sales globally and cut prices or hiked promotion in such categories as batteries, laundry detergent and body wash in the U.S.

Morgan Stanley analyst Dara Mohsenian said in a note last week that P&G's sales guidance for this year looks too optimistic given that last year's momentum was fueled in part by comparisons to weak quarters the year before. She said most of its major innovations had already launched by last quarter and that the company's ad spending is likely to rise no more than single digits after a double-digit hike last year.

"I think it's really based on the volatility and the uncertainty in the consumer environment right now," Sanford C. Bernstein analyst Ali Dibadj said of the change in P&G's sales performance metric. "I also think it's because they're saying they're going to gain share. Some of that may come by slowing the category growth by introducing lower-priced products or taking some of their prices down or promoting more. They're optimizing share gain vs. category growth."

The old plan arguably encouraged P&G managers to hike prices. But given prospects for continued slow growth in the U.S. and consumers appearing to resist trading up, the new plan may be more realistic, Mr. Dibadj said. He added that with the biggest price gaps to private label, or other competitors, of anyone in its competitive set, P&G probably needed to reduce prices relative to the competition.

But while analysts, and even P&G, may believe that, it's not clear competitors do. Church & Dwight Co. and Colgate-Palmolive Co. are among companies that either have or say they plan to cut costs or hike promotion to deal with moves by P&G.

Unlike P&G, most other competitors base their compensation on broader metrics or profitability alone, such as total shareholder return or return on invested capital, said Mr. Dibadj. P&G was somewhat unique in adding a top-line metric in the first place in 2008, and in changing that to focus on relative performance.

But others have clearly adjusted pricing and strategy in response to a more conservative consumer, too. When he became Unilever CEO in 2009, Paul Polman focused on rekindling volume growth, even if it meant declining prices in some cases. With volume growing at a healthy pace, however, Mr. Polman has indicated that the company no longer plans for pricing to decline.

Even so, P&G managers won't really get rewarded for a truly bloody global price war, at least not one that ate seriously into P&G profits. Three-quarters of their long-term compensation still would be undermined by moves that reduce earnings or cash flow.

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