Wednesday 28 January 2015

Unilever chief executive slams short-term profit mentality - the options for NAMs...

News that Paul Polman has criticised the traditional City benchmark of shareholder value raises important issues for NAMs.

As you know, 'shareholder value' is the value delivered to shareholders because of management's ability to grow earnings, dividends and share price, all driven by wise investment decisions and a healthy return on invested capital.

In practice, this means generating a steady ROCE of 15% per annum, a level that gives a company autonomy, freedom to make longer term decisions, and 'independence' of the City, who are essentially in the reward-for-risk business. The City will tend to leave successful companies alone to 'get on with the good work'...

'Acceptable' Returns
When it comes to type of business, branded suppliers need to generate between 5-10% Net Profit, and retailers 3-5% Net Profit, and because retailers rotate much of their capital (i.e. stock) faster than suppliers, both types of companies can deliver ROCE's of 15%+, all things being equal.

The problem has been the global financial crisis driving down net profits below these levels, and in turn the ROCE and thence the share price. This means greater pressure from the City to increase the bottom line, fast. And all in an increasingly high risk environment.

As you know, profit can be increased either by driving sales or cutting costs, or a mix of both, with cost-cutting being the fastest route in the short term. Hence the product content reductions/compromises, range rationalisations, sell-off of brands and properties, savings in working capital via extended trade credit, pulling forward commercial income and all the other issues that have come to haunt us all in recent times...

The ideal formula
The City are a vital source of funding and will only be encouraged to back off if the ROCE reaches, and is maintained at, acceptable levels.

Polman is right in that the starting point has to be the (savvy) consumer, via a combination of Product, Price, Presentation and Place that is demonstrably better than alternatives, made available to them however, whenever and wherever they choose to buy, resulting in a degree of satisfaction that causes them to willingly return for more and hopefully tell their friends... And all at a level of profit that satisfies the money men...

NAM action
However, in the short term, NAMs need to work in the here and now. They need to reassess their own finances - and those of the competition- but especially the financial health of their customers, in order to try to appreciate the degree of City pressure on all stakeholders.

Within this commercial reality, make an assessment of their relative competitive appeal to retailer and consumer, and strip out anything redundant.

Then check the cost to the business of each element of the offering and translate it into the incremental sales each represents to the retailer in terms of value. Then go in and make every pound count...

Alternatively, why not try asking the City to politely get out of the way...? 

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