The current article aims to highlight the key aspects of the business of fast-moving consumer goods (FMCG) companies primarily dealing in food & beverages (F&B), household care, personal care, and healthcare (over-the-counter or OTC) segments.
After reading this article, an investor would understand the factors that impact the business of FMCG companies and the characteristics that differentiate a fundamentally strong FMCG company from a weak one.
Key factors influencing the business of FMCG companies
1) Stable demand with low cyclicity:
From the perspective of the type of demand, FMCG products are usually divided into essential/non-discretionary and non-essential/discretionary segments.
Most of the products under household and personal care like toiletries and groceries fall under the essential category because consumers need to keep buying them irrespective of the state of the economy. On the other hand, segments like cosmetics and premium products etc. are non-essential because consumers can easily live without them during an economic down cycle.
The essential segment is a very large part of the FMCG industry and has a comparatively stable demand, which leads to stable earnings for companies. Whereas non-essential goods face a decline in demand during the down phase of an economic cycle.
Ratings criteria for the FMCG industry by CRISIL, February 2021, page 5:
Players in segments such as toothpastes, soaps, and detergents that are essential items, and therefore, in frequent demand, tend to have stable sales; those present in discretionary segments such as perfumes and cosmetics, on the other hand, often report declining sales during times of recession.
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Products in this industry are meant for frequent consumption and generally have inelastic demand dynamics, resulting in stable revenue and earnings profile for industry participants.
The stability of the demand for essential/nondiscretionary FMCG segments is true everywhere including India as well as overseas markets.
The credit rating agency, Rating and Investment Information, Inc. (R&I), Japan, has highlighted that the demand for essential items sees very low volatility.
Rating methodology for toiletries and cosmetics by Rating and Investment Information, Inc. (R&I), Japan, August 2019, page 2:
products are basically daily necessities, the fluctuation in demand is comparatively small.
Similar thoughts are expressed by the German credit rating agency, Scope, about non-durable consumer goods, which includes FMCG items indicating that these products face low cyclicity i.e. relatively stable demand across economic cycles.
Consumer products rating methodology by Scope Ratings, Germany, November 2022, page 6:
The average peak-to-trough cycle and observed volatility in revenue and profitability for non-durable goods companies are less than overall economic cyclicality. Further, we see consumer spending on essential food and beverages to be less susceptible to macroeconomic drivers and changes in consumer confidence.
Therefore, relatively stable demand across economic cycles attracts many players both domestic (regional as well as pan-Indian) as well as international (multinational corporations, MNCs) to the Indian FMCG market.
Advised reading: How to do Business Analysis of a Company
2) Ability to pass on the increase in input costs to customers:
FMCG players can pass on any increase in their input costs to their customers over a period of time; though it may not be an immediate increase.
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their better pricing power reflected in their ability to pass along the increase in costs over time.
In addition, FMCG companies, which deal in premium categories of essential products have an even better ability to pass on an increase in costs to the customers.
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FMCG player has better pricing flexibility in premium product categories and non-discretionary items where brand equity plays a crucial role.
This ability of FMCG players to pass on increases in input costs makes it an attractive industry for many business houses.
Advised reading: How to do Financial Analysis of a Company
3) Low capital intensiveness of the FMCG sector:
One of the key characteristics of the FMCG sector is that from the perspective of investments in plant and machinery, it is not a very capital-intensive sector.
This is because the machinery purchased to manufacture FMCG products can be used for many years without obsoletion. The reason is that usually, the manufacturing processes of FMCG products stay the same over long periods without any drastic changes.
Rating methodology for toiletries and cosmetics by Rating and Investment Information, Inc. (R&I), Japan, August 2019, pages 1, 2 and 3:
Capital spending burdens are generally small….drastic changes to the manufacturing processes are rare and much of the equipment for the production process can be utilized for many years.
Even for the niche products, which go out of fashion soon, the investment needed for manufacturing is relatively small because the production of FMCG goods usually needs small machines, which are not very costly.
Rating methodology for toiletries and cosmetics by Rating and Investment Information, Inc. (R&I), Japan, August 2019, page 3:
many niche products are non-essentials and their product life tends to be short, but the investment burden is comparatively light because the size of manufacturing equipment is small and the manufacturing processes can be outsourced easily.
Due to relatively small investment requirements, many companies become vendors/suppliers of large FMCG companies by manufacturing goods for them on an outsourcing basis. The easy availability of players making goods on an outsourced basis reduced the capital investment needs of FMCG players further.
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In general, such companies have relatively low capital intensity, which is also aided by considerable share of manufacturing being outsourced. Accordingly, companies tend to have low leverage.
Usually, companies factor in logistics costs as well as technological involvement while making outsourcing decisions.
If the source of raw material and the customer market are far away from the company’s own manufacturing plant, then an FMCG player may prefer to get the goods manufactured by any outsourcing player near the raw material source or customer market to minimize its logistics costs to move raw material and finished goods over long distances.
FMCG players tend to manufacture technologically intensive products in-house and outsource low-technology products, which brings in better control of sophisticated products and avoids the possibility of leak of technology to competitors.
Ratings criteria for the FMCG industry by CRISIL, February 2021, page 7:
Manufacturing is not capital intensive in the FMCG industry. Most companies have a combination of in-house production and outsourcing. The decision to outsource or produce in-house depends on issues such as transportation costs and access to raw materials. Typically, high-technology products are made in-house, while others are sourced from vendors.
Therefore, the consistent manufacturing processes, long life of plant and machinery, as well as easy availability of outsourcing partners, makes FMCG industry low capital intensive.
Advised reading: Asset Turnover Ratio: A Complete Guide for Investors
Moreover, this is not limited to fixed capital investments. FMCG companies also benefit from low working capital requirements.
FMCG companies mostly enjoy a negative working capital indicating that they do not need to invest their own money in inventory and receivables. In fact, the trade payables from suppliers and advances from customers are usually sufficient to meet all their working capital requirements.
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Generally, FMCG companies have negative working capital cycle, as extended credit period from suppliers and advances from customers/distributors are sufficient to fund working capital requirement.
In case, an FMCG company has a deterioration of its working capital position, then it usually indicates a red flag because the company might be using aggressive practices, which are not good for the sustainability of the business to earn higher revenue. For example, channel stuffing i.e. pushing too much inventory into the distribution channel to show higher revenue, which might not be saleable within a reasonable amount of time.
It may also be granted excessively generous payment terms to its customers (distributors etc.) to generate sales, which might make a recovery of the money difficult.
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A deviation from the general sector trend could reflect stress, as a company might be pushing inventory to its distributors or may have increased the credit period offered to its distribution partners to push sales, which could result in write-offs in future
Nevertheless, low investment requirements as well as stable demand for products lead to a large number of players competing in the FMCG sector leading to fragmentation and intense competition.
Advised reading: Inventory Turnover Ratio: A Complete Guide
4) Intense competition in the fragmented FMCG industry:
Indian FMCG industry provides a good scope for growth because the per-capital consumption of FMCG goods by the Indian population is still among the lowest in the world.
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FMCG products, India’s per capita consumption is still amongst the lowest, thereby providing long-term growth opportunities.
The growth potential of the Indian FMCG market attracts multinational corporations from developed countries because, due to existing high penetration and consumption, the scope of growth in developed countries is low.
Rating methodology for toiletries and cosmetics by Rating and Investment Information, Inc. (R&I), Japan, August 2019, page 2:
Although having high expectations for growth in advanced country markets is difficult, markets in emerging countries are following an upward trend, based on increasing populations and rising income levels that accompany economic growth.
In addition, the competition in the developed countries’ FMCG markets is also very severe.
Consumer products rating methodology by Scope Ratings, Germany, November 2022, page 6:
consumer goods sector is characterised by fierce competition for consumer spending, constantly shifting consumer preferences, and entries of alternative goods.
As a result, many multinational corporations (MNCs) as well as domestic players compete fiercely to gain market share in the Indian FMCG market leading to intense competition.
Rating methodology – fast moving consumer goods (FMCG) by ICRA, February 2022, pages 3 & 4:
higher competitive intensity with presence of large number of national as well regional players
A large number of players makes the FMCG industry very fragmented where even the largest players own a small market share. In India, the largest player owns less than 10% market share.
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The Indian FMCG sector is highly fragmented, with the largest player accounting for less than 10% of the domestic FMCG market.
The intense competition among the FMCG players creates a challenging business environment because the customers are highly price sensitive especially for an essential segment like toiletries.
Rating methodology for toiletries and cosmetics by Rating and Investment Information, Inc. (R&I), Japan, August 2019, page 2:
competitive environment is somewhat severe, however, because the bulk of consumers are price sensitive in both sectors.
Due to intense competition and price-sensitive consumers, FMCG companies are not able to earn super-profit margins. As a result, their profit margins are generally stable over the years.
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relatively stable demand and well-established competitive dynamics,…As a result, there tends to be limited scope for significant margin expansion over time.
Due to intense competition in almost all FMCG segments, players tend to grab market share from adjoining segments like economy players tend to “premium economy” products, which compete with premium products and put pressure on the demand and profit margins of the premium segment.
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To cover the gap between the popular and premium segments, the players have begun to launch new products at price points between the two segments, thus adding to the threat on demand for products in the premium segment.
As a result, price-based competition hurts industry players affecting their profit margins, especially during economic downturns.
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While sector players generally maintain pricing discipline, discounting during periods of muted demand, impacting profit margins is also a phenomenon.
To avoid competition, which is especially severe in more popular, economy, mass-market segments, many FMCG players focus on niche products where competition is lower.
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Presence in niche categories, where competition is fairly low, strengthens market position.
Many companies launch new products in the niche segment by way of in-house development; however, many companies buy established brands in the niche segments to improve their product portfolio.
In addition, tough price-based competition also takes its toll on companies and during downturns, many players sell out to larger players. As a result, the FMCG industry frequently goes through mergers and acquisitions.
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Acquisitions in the FMCG industry tend to outnumber those in other industries
The intense competition in the FMCG industry forces the players to continuously evolve their product portfolio to stay relevant in forever-changing customer preferences, which requires a continuous investment by companies in product development.
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The high competitive intensity in the sector mandates steady investments in new product launches, advertising, and marketing to maintain stable market position and profitability.
Nevertheless, the investment required in the FMCG industry for new product development is low when compared to other industries like the pharmaceutical industry.
Rating methodology for toiletries and cosmetics by Rating and Investment Information, Inc. (R&I), Japan, August 2019, page 3:
Although investments should be undertaken frequently to introduce new products or revamp packaging with an eye to maintaining or expanding market share, such investments are not very extensive.
Therefore, a low investment requirement by FMCG players in manufacturing, working capital, and product portfolio development increases the competition significantly.
Further advised reading: How to analyse New Companies in Unknown Industries?
5) Branding as well as sales, marketing and promotion expenses are essential in the FMCG industry:
Even though the FMCG industry provides hundreds of products from numerous competitors in each segment; however, at the end of the day, all the products in any one category are functionally non-differentiable. For example, every shampoo will clean hair and every liquid soap will wash hands.
Therefore, to differentiate their functionally-similar products from each other, all competitors indulge in massive branding exercises so that customers can differentiate their products from competitors and can associate with the product/brand.
Rating methodology for toiletries and cosmetics by Rating and Investment Information, Inc. (R&I), Japan, August 2019, page 1:
Even so, differentiation is difficult in terms of function of the products. Customer continuity and stability is thus relatively low. Competition among manufacturers is comparatively intense, and companies bear a heavy burden for marketing expenses, including sales promotion and advertising costs
In India, most of the FMCG players spend a very significant portion (12%-15%) of their revenue as advertisem*nt and marketing expenses.
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to support or enhance brand visibility, industry players incur sizeable (12-15% of revenue) investments towards advertising, marketing, packaging and distribution costs.
Despite spending on branding in mainstream media by way of large advertising spends, FMCG companies also need to spend money in retail stores to get shelf space so that their products are available to the customers near their homes.
Rating methodology for toiletries and cosmetics by Rating and Investment Information, Inc. (R&I), Japan, August 2019, page 5:
Given that product differentiation is difficult, it is necessary to secure retail store shelf space by spending on sales promotions, if a company seeks to maintain and expand sales.
FMCG companies spend on branding because it is assumed that established brands can command premium pricing and can earn a higher profit margin.
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Being a consumer-facing sector, branding plays an important role in consumer purchase decisions and a strong brand position generally allows premium pricing of products over that of weaker players.
In addition, strong brands act as an entry barrier to new competition because the new players have to spend a large amount of money to launch their brands and give promotional discounts to gain customers.
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In addition, stronger brand equity acts as an entry barrier, where new entrants have to make sizeable investments for customer acquisition, promotion and branding to challenge incumbents.
Strong brands of FMCG players increase profit margins because established brands generate their own demands and in turn require lesser advertisem*nt and sales promotion expenses.
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Strong brand equity and brand loyalty entails lesser spending towards advertising and promotional activities, resulting in better profitability.
Due to their established brands, MNCs focus on mass-market products where they can use their brands, pricing power and economies of scale to generate profitable sales despite intense price-based competition.
Consumer products rating methodology by Scope Ratings, Germany, November 2022, page 4:
While many participants limit themselves to national or local markets to use their comparative advantages, multinationals provide mass-market products, taking advantage of their economies of scale to establish pricing power and usage of its branding.
In the FMCG industry, it becomes essential for the companies to protect the value and perception of brands because any dilution in the brand equity can lead to immediate loss of customers and profit margins as there are numerous competitors selling products, which can serve as ready alternatives for the customers.
As a result, whenever a brand faces any issue like perception or product safety, then it may prove to be a very costly affair for the company as it might have to spend a substantial amount of money on rectification measures to avoid a loss of sales and profits. This is because a discounted sale would hurt the brand image and would affect its sales and profit margins in the future.
Rating methodology for toiletries and cosmetics by Rating and Investment Information, Inc. (R&I), Japan, August 2019, page 6:
If problems occur with regard to aspects such as product safety, however, not only will profits or losses deteriorate rapidly as customers refrain from purchasing a company’s products because of the damage to its brand, substantial expenditures to correct the problem can be expected to mount up as well.
Therefore, companies try to avoid any such step, which may damage the brand image. Even when excess inventory gets accumulated in the retail channel, then companies prefer to take back branded inventory and accept a disposal loss instead of selling it at a discount.
Rating methodology for toiletries and cosmetics by Rating and Investment Information, Inc. (R&I), Japan, August 2019, page 3:
discount selling could damage the brand. To prevent damage to their brands, the standard trade practice for manufacturers is to accept returned cosmetics and other goods, and there is a possibility this will result in a disposal loss.
Maintaining large established brands with significant customer acceptance has been one of the key requirements for any successful FMCG company, which used to take considerable time and investment. However, nowadays, due to digital marketing channels, brands are relatively quickly made and destroyed.
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Established brands also serve as an entry barrier, but their importance has declined of late as digital marketing opens new channels….The perception of the value and sustainability of a brand can change more rapidly today than in the past, reflecting the impact of digital marketing and communications.
Still, owning established consumer brands is one of the key features of successful FMCG companies.
Advised Reading: Credit Rating Reports: A Complete Guide for Stock Investors
6) A well-established distribution channel is a big advantage for FMCG companies:
Most of the FMCG business is about distributing small-ticket goods to every neighbourhood shop in the country. For any company to succeed in this quest, a deeply penetrated large distribution channel is a must.
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A wide reach of the distribution channel lends competitive advantages to FMCG players.
Establishing a large, reliable distribution channel requires a lot of time and investment because it needs a long-term relationship with channel partners established through strategies like channel incentives and financing as well as supporting the counterparties through tough times.
Therefore, new players who might have developed products with better features; however, find it difficult to reach customers rapidly because establishing a large, cost-effective distribution channel takes a lot of investment and hard work.
As a result, a large, operationally efficient distribution channel acts as an entry barrier to new players in the FMCG industry.
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Entry barriers can exist in the form of investments and efforts involved in building brands and expanding the distribution network, besides manufacturing infrastructure.
An established distribution channel can help existing FMCG players to rapidly launch any new product as it can use the existing distribution.
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A wide distribution network supports quick ramp-up in production/sales in case of new product launches, as companies can leverage their existing distribution channel.
Ratings criteria for the FMCG industry by CRISIL, February 2021, page 6:
Companies that can use the same network to distribute new products benefit from a head start.
However, the FMCG industry faces forever changing consumer preferences, which makes even established FMCG companies keep tweaking their distribution channel to meet the changing customer preferences.
For example, currently, many customers prefer to use e-commerce channels to buy products from established FMCG players. Therefore, incorporating an online/e-commerce channel has become a must for serious FMCG players who wish to grow.
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To maintain their reach, FMCG entities also need to adapt to underlying trends in customer buying behaviour. For instance, FMCG companies have begun to focus on alternative distribution channels like e-commerce due to the steady increase in mobile internet penetration and smartphone usage.
Changing consumer preference for the online/e-commerce channel has the potential of reducing the importance of owning a large distribution channel. This is because the e-commerce players like Amazon, Flipkart etc. provide a readymade distribution system. New players can use it to reach customers even in far-flung areas, which was other very difficult to do without spending a huge amount of investment.
Advised reading: Detailed Analysis Of A Company: A Framework
7) Diversification helps the business model of FMCG companies:
Diversification by FMCG companies along the lines of product segments, manufacturing bases, geographical reach, suppliers, customers as well as distribution channels helps reduce the risk in their business model.
Product diversification protects a company in case any product or segment or any particular brand is not doing well or if the customer’s preferences undergo a change. A presence in many products spread across different categories helps the company to report relatively stable revenue and earnings.
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Segment or product diversification mitigates the impact of change in consumer preferences, product obsolescence, slowdown in a specific segment and weakening of an individual brand…entity with a diversified product portfolio is generally expected to have a relatively stable top-line growth and profitability against a company dependent on a specific product segment.
A diversified product portfolio with a range of products in a category at different price points helps the company maintain its revenue during an economic recession as customers tend to step down on the pricing range i.e. opt for cheaper products when their buying power declines.
Ratings criteria for the FMCG industry by CRISIL, February 2021, page 5:
domestic market is extremely price-sensitive….The price sensitivity necessitates prudent product management, especially during a recession. A diversified portfolio, with products at a variety of price points, helps mitigate risks associated with any one segment.
A company with its customers spread across different segments and geographies is protected from an abrupt impact on its business if any one customer segment (like rural vs. urban) witnesses a decline in buying power.
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diversified revenue mix between rural and urban India can also mitigate the adverse impact of an uncertain monsoon in the rural market as well as an economic slowdown in the urban market… mitigate any potential changes in customer preferences in a particular region
A geographically diverse customer base (like domestic vs. exports) helps the company to maintain its sales even if its business in any country is not performing well.
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Those with products that have a strong export potential also have an advantage, especially during downtrends in the domestic market.
Companies with a diverse manufacturing setup in terms of their own manufacturing as well as outsourcing plants, and with plants spread across different geographies are better placed. This is because it protects their business from regional disturbances like natural calamities, social and political disturbances etc.
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An issuer with manufacturing footprints or contract manufacturers across regions is better placed to mitigate event risks, including natural calamities or operational disruptions.
In addition, companies with manufacturing units at diverse locations also benefit from easier access to raw materials, as well as closeness to customers, which in turn reduces their logistics costs and makes their operations more efficient.
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Further, manufacturing facilities tend to be well spread out because of the need to provide timely delivery of products to trade channels, manage transportation cost, and access to raw materials.
Diversification along regions and product lines brings a strong advantage to the business model of FMCG companies. Even companies that have one or a few brands can reduce the business concentration risk if their business is sufficiently diversified along geographies and product lines under the brand.
Consumer products rating methodology by Scope Ratings, Germany, November 2022, page 8:
Companies with only one brand can still be strongly diversified across geographies and product ranges.
Companies with a diversified supplier base benefit from a higher bargaining power because they can choose among different suppliers for the best terms, which is not possible if a company is dependent on a single large supplier for its raw material.
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An entity with a wider supplier base might have better negotiating power with suppliers and mitigate supplier concentration risks to an extent.
Advised reading: How to do Business Analysis of a Company
8) Large size of operations with an established market position helps FMCG players:
FMCG companies with a large size of operations benefit from multiple aspects. These companies, due to their large size benefit from economies of scale where costs like manufacturing expenses, advertisem*nt expenses etc. are spread over a large number of products and thereby have a lower per unit cost of production. It leads to a higher profit margin.
In addition, a large FMCG player naturally has a diversified customer profile spread across different geographies as well as a diverse product profile spanning across many categories, which stabilises volatility in its business performance.
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A large scale of operations enables economies of scale, drives cost and manufacturing process efficiencies, supports meaningful diversification across different product categories and geographies, leading to stronger bargaining power with various stakeholders in the value chain
Large FMCG companies earn better profit margins because due to the large sales volumes of their products, distribution partners agree to work with them at lower commissions/margins. As a result, the company can retain a higher share of the profitability of the value chain.
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A consistently high market share has several advantages. It ensures a stable relationship with and better control over the distribution channel. Also, the company does not need to offer very high margins to the trade since this is compensated for by higher volumes.
Large FMCG companies have a relatively higher profit margin because usually they own large established brands, which are cheaper to maintain.
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Established products with a large market share also have lower marketing and advertising expenses as it is cheaper to maintain an established brand than to create a new one
Large FMCG players can survive economic down phases better because their comparatively higher market shares across product categories and geographies protect them from adverse development in any one category/geography.
Consumer products rating methodology by Scope Ratings, Germany, November 2022, page 4:
companies with strong market positions are more resilient during economic downturns. Such companies are not only large with high market shares but are also favourably positioned in supply and distribution chains, with a low dependence on any specific distribution channel or customer.
Due to their large and established market share, large FMCG companies have a higher purchasing power with their suppliers. As a result, they can get an assured supply of raw materials at a cheaper price, which positions them favourably in a market with intense price-based competition.
It makes a large FMCG company, the most price competitive and its competitors have to follow its pricing actions.
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This bolsters purchasing power with key suppliers and makes it easier to be a price-setter among competitors.
However, please note that being a price-setter does not mean that large FMCG companies have any superior pricing power over the customers.
As discussed above, the customers are very price sensitive and if any company attempts to raise its prices exorbitantly, then the customers have a readily available choice of many alternate products and brands in the market due to a very fragmented FMCG market with numerous players.
Therefore, the large size of operations of an FMCG company gives it cost competitiveness over its competitors and not pricing power over its customers.
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large market share does not necessarily translate into price protection…Market leaders, for instance, may be challenged by smaller players taking advantage of new technologies or a higher flexibility in meeting market needs, putting pressure on market prices.
In fact, the FMCG industry is forever evolving and nowadays, smaller companies can produce goods very cost-effectively by using new standards of automated manufacturing and integrated distribution channel. It puts further pricing pressure on established market players.
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factory automation and integrated supply chains allow smaller company brands to be highly responsive to consumer demand and effectively provide bespoke products at mass-production prices.
Therefore, even though large FMCG companies enjoy many competitive advantages due to their large size of operations; still, they are not able to command excessive profits due to intense price-based competition from smaller players.
9) Regulatory, environmental and social risks for FMCG players:
FMCG companies, which depend on imported raw materials like edible oil are impacted by govt. policies about import duties because any change in such policies may significantly impact the profit margins of those FMCG products, which have a low-profit margin.
For such companies, very efficient sourcing of raw materials becomes essential.
Ratings criteria for the FMCG industry by CRISIL, February 2021, page 7:
Efficiency in management of raw material costs is an important consideration for FMCG companies, especially in the case of products that depend on commodities such as sugar, cereals and oil…For items such as edible oil that are largely imported, effective risk management systems in procurement are critical,
Additionally, FMCG companies operating in categories, which are heavily regulated like tobacco, alcohol etc. face a significant risk of adverse regulations.
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A regulated product category (such as tobacco products and alcoholic beverages) is considered relatively riskier
Apart from regulatory risk, FMCG companies also face environmental risk because their manufacturing processes as well as packaging material harm the environment.
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FMCG companies remain exposed to the impact of changes in environmental norms with respect to treatment of manufacturing residual discharge/waste…restrictions on usage of different grades of plastics for packaging and finding environment-friendly solutions
Any strictness in the environmental regulations may increase the manufacturing/selling costs for FMCG companies due to increased compliance costs.
Operations of FMCG companies are people-intensive both in manufacturing as well as distribution & sales. In addition, their products are used by a large section of the regional population, which exposes them to social risk.
Any product quality issues, employee/labour issues as well as brand perception issues may hurt the business of FMCG companies.
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maintaining healthy employee relations and retaining talent…is essential for disruption-free operations. This apart, there could be quality concerns that FMCG entities could face in certain product categories which could adversely impact their brand, or risks that an entire product category could face out of the social considerations that pertain to health consciousness (aerated drinks) or equity (fairness creams)
A hit on the brand of an FMCG company can have a very significant impact on its business.
To assess the vulnerability of an FMCG company due to adverse developments affecting its brands, an investor may look at the share of intangible assets on its balance sheet. A higher share of intangible assets reflects a higher dependence on brands.
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we monitor and assess intangible assets on the balance sheet to recognise a company’s potential vulnerability to changes in brand perception and/or to the emergence of alternative brands and products that may better meet consumer needs.
Advised reading: How to study Annual Report of a Company
Summary
Overall, the FMCG industry provides an attractive business environment with a stable demand across all phases of economic cycles with low volatility in demand. The revenue and profit margins of FMCG companies are relatively stable because the companies can pass on increases in input costs to customers over time. In addition, the Indian FMCG industry offers a growth opportunity because, in India, the per-capita consumption of FMCG products is one of the lowest in the world.
Manufacturing FMCG products is not a very capital-intensive process because the manufacturing equipment can be used for a long operating life as the manufacturing processes stay constant over the years. In addition, FMCG companies enjoy a negative working capital cycle because the credit period from their suppliers and advances from their customers are sufficient to meet their working capital requirements.
Due to these business characteristics, many global as well as domestic companies are attracted to operate in the Indian FMCG industry, which makes it a fragmented sector with the intense price-based competition. Declining growth prospects in the FMCG industry of developed countries force their MNC players to look towards India for growth.
As a result, the Indian FMCG industry faces intense competition from numerous manufacturers for functionally similar products. Therefore, players spend a lot of money on advertisem*nts to create brands to achieve differentiation in the customers’ minds for their products from their competitors.
Large established brands with an established market share are an essential feature of successful FMCG companies, which also act as an entry barrier for new players because creating a new brand involves an investment of significant time and money.
Large established distribution channel of existing FMCG players, which is operationally efficient, forms another entry barrier for new players because creating a trust-worthy and cost-effective distribution system takes a lot of time and investment.
Nevertheless, the emergence of e-commerce players that have their own distribution system has provided an opportunity for new players to reach customers across the length and breadth of India, which was very difficult to achieve for new players previously.
Diversification by FMCG companies into different product categories and customer segments brings stability to their revenues and profit margins. Similarly, geographically diverse manufacturing as well as customer base, protects it from event risk, economic, political and social risks of any one region. A diverse supplier base increases the bargaining power of FMCG companies and increases their profitability.
Large FMCG companies with an established market share benefit from economies of scale and efficient utilization of expenses like manufacturing and advertisem*nt costs. This in addition to better bargaining power with suppliers leading to an assured supply of cheaper raw materials increases the cost competitiveness of their operations and increases their profit margins.
However, the large size of operations does not provide any superior pricing power over customers because the intense price-based competition in the industry offers numerous choices of alternate products to the customers.
In addition, FMCG players face regulatory, environmental and social risks, which the companies need to handle carefully for succeeding without losing local goodwill.
Therefore, an investor should always keep in mind these multiple aspects of FMCG companies to understand the true picture of their business position.
- Stable demand with low cyclicity
- Ability to pass on an increase in input costs to customers
- The low capital intensiveness of operations
- Intense price-based competition in a fragmented industry
- Large established brands are a big competitive advantage for existing players
- A well-stabilized, cost-effectively and efficient distribution network is a big strength
- Diversification helps a lot to reduce risk in the FMCG business model
- The large size of operations with established market share is a big advantage; however, it does not give any superior pricing power
- Regulatory, environmental and social risks need to be managed carefully.
We believe that if an investor analyses any FMCG company by considering the above parameters, then she would be able to assess its business properly.
Regards,
Dr Vijay Malik
P.S.
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Disclaimer
Registration status with SEBI:
I am registered with SEBI as a research analyst.
Details of financial interest in the Subject Company:
I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.
