UK: UNILEVER CHANGES ITS FORMULA.

UK: UNILEVER CHANGES ITS FORMULA. - A marketing calamity, which rocked the consumer goods giant to its foundations, was the catalyst for the radical restructuring now under way.

by Andrew Lorenz.
Last Updated: 31 Aug 2010

A marketing calamity, which rocked the consumer goods giant to its foundations, was the catalyst for the radical restructuring now under way.

September 1 will be an historic day in the life of Unilever, the Anglo-Dutch consumer products leviathan whose vast portfolio of brands includes Persil, Birds Eye and Walls. On that date, the three-man special committee - British chairman, Dutch chairman and the chairman-designate - which has run the group since Unilever was formed will be dissolved. Its place will be taken by a seven-person executive committee, vanguard of the group's most fundamental organisational reformation for three decades.

Appropriately, the date of the special committee's disappearance is also the day on which Sir Michael Perry, chairman of Unilever plc, is succeeded by Niall FitzGerald, an Irishman and the first chairman not to carry a British or Dutch passport. Of all the executives responsible for developing the new organisation, none has been more influential than FitzGerald.

Indeed, it is probable that without his insistence on the need for a shake-up the new structure would never have been born. FitzGerald could not have done it without the backing of Perry and of Maurice Tabaksblat, chairman of Unilever NV, or the support of executives below him. But if such a root-and-branch overhaul in a company the size of Unilever can have a single architect, it is the 50-year-old from Dublin.

That is what makes the changes so remarkable. For less than two years ago, FitzGerald, then head of the group's detergents business, was mired in the fiasco of Persil Power, the abortive launch of a new washing powder range which, the company hoped, would at last enable it to outflank Procter & Gamble's Ariel, its arch-rival in the European detergents business. Instead Persil Power proved to be a nightmare.

It was launched with an undetected flaw in its accelerator, a catalyst which was supposed to be the Ariel-conquering widget in the Persil packet.

In fact, as Procter was quick to expose, acting on a certain combination of dyes, it could ruin garments.

Although FitzGerald's people adjusted the accelerator component, the damage was done. Procter savaged the product until Persil Power itself was in shreds and in the process, the Cincinnati-based group succeeded in driving a wedge between Unilever in Britain, which wanted to keep faith with the revised formula, and the Dutch arm, which was taken aback by the public criticism and lost confidence in the product. The decisive moment came when Tabaksblat, on a visit to Beijing attended by the world's press, confessed that the company had made a mistake.

His impromptu 'nostra culpa' - ruefully nicknamed 'the Beijing initiative' by Unilever managers in London - cut the ground from under British executives.

Overnight the homely, trustworthy image of Persil, built up over decades, was deeply scarred. The brand, known on the continent as Omo, is still struggling to recover. Last year, the market share of Unilever's European detergents business, Lever Europe, slumped by 1.5 basis points to 20.1%, estimates Henderson Crosthwaite, the London stockbroker. It fell in 14 out of 16 European countries. In Britain, the impact of Persil Power was such that Lever's market share slumped to less than 28%, 3.5 basis points lower than in 1994 and almost 10 percentage points lower than in 1990.

For a while, the Power disaster caused acute tension between London and Rotterdam and unleashed considerable speculation about the position of FitzGerald, who had already been announced as Perry's successor. But, partly thanks to the innate strength of the organisation, partly because of the close relationship between FitzGerald and Tabaksblat, the Unilever leadership has turned Persil Power from a marketing calamity into a catalyst for much needed change.

'Every big organisation that is running into trouble needs a crisis to convince it of the necessity for fundamental change,' comments Thomas Bayne, chairman of PDP International, a product development organisation which specialises in the fast-moving consumer goods (FMCG) industry.

For Unilever's mediocre performance since the early 1990s was building up trouble for the future. Not that the group was in obvious crisis. Its financial position appeared secure; its recent results, while disappointing, looked respectable; its shares had generally outperformed the stock market; its product and geographical spread was so vast that it seemed impossible to conceive of an event so shattering that it would create widespread recognition of the need for sweeping change. But by causing a crisis in one of Unilever's heartland products, Persil Power rocked the giant to its foundations. If such a disaster could occur under the existing structure, then organisational change became imperative. The danger lay not in taking action, but in remaining inert.

The origin of Unilever's structural problems lay in the late 1980s, when its spectacular mid-decade growth began to flag. At first, the flaws were concealed by the momentum built up through a drive to eliminate low-return peripheral activities and the successful launch of several mega-bids.

Takeovers of businesses in traditional areas such as Brooke Bond in foods were accompanied by diversification into personal products with the acquisitions of Chesebrough-Pond's, Elizabeth Arden and Calvin Klein.

On the back of this expansionism, Unilever's share price soared seven-fold in six years, far outperforming the stock market. However, says one veteran Unilever manager, 'We had a good run, but I think we probably slightly deluded ourselves as to why things were going so well'. Earnings per share were boosted not just by the takeovers, but by some smart financial management of the Treasury operations and the company's borrowings. Moreover, the period up to 1991/1992 was highly favourable to Unilever. 'From the mid-1980s to the early 1990s, most governments were business-friendly and the competition was not that tough because our main rivals had their own distractions,' says the manager.

Return on capital employed peaked in 1992 at 17.2%. Last year, it was down to 14.2%, the lowest rate for seven years. Operating profit margin reached its zenith even earlier, at almost 9% in 1990. David Lang, the highly respected foods analyst at Henderson Crosthwaite, says: 'Major initiatives were taken to raise returns and growth after the 1985-7 upsurge but, against a backdrop of much tougher northern hemisphere branded goods markets, little overall progress was achieved.'

Ostensibly, Unilever's operating profit, earnings and share price performance was still respectable. And some parts of the business excelled. The venerable ice-cream business in Europe, galvanised into action by the development by Mars of an ice-cream bar, enjoyed a renaissance. Although group profits were unchanged last year at £2.5 billion, that was after a £231 million exceptional cost-cutting charge. After the exceptional item, earnings declined from more than 83p a share to less than 79p, but that was still the second-highest level in the decade. The share price has outperformed significantly in recent years.

Yet the company is suffering by comparison with its peers - Procter, Nestle and L'Oreal. By last year, Unilever's non-executive directors were asking questions about performance drift. Despite recurrent rationalisation charges, the company was showing classic signs of organisation fatigue: lack of dynamism and an excess of bureaucracy. Its main distinguishing feature was confusion - of accountability, with second-guessing rife, and of responsibility. Head office had become a mish-mash of corporate, regional, co-ordinating and service duties.

'Extra levels of complexity were imposed on an already convoluted structure,' says Lang. 'Increasingly, Unilever managers found themselves responsible to two or more masters. Often they were faced with conflicting priorities.

Decision-making sometimes became constipated. Managers became frustrated and demotivated, not least because of the devaluation of operating company chairman status to which most aspired. At the top of the ladder, the move towards globalisation meant that senior management was spending too much of its time at 40,000 feet.'

When top executives were not in transit, they were being called on to make decisions that should have been sorted out much lower down the organisation.

Or they were in meetings. One observer says the diaries of senior managers had become so cluttered with committees, 'you wondered when they had time to sleep. Presumably, they slept in the meetings.'

Now Unilever has called a halt to this process of corporate self-absorption. The radical restructuring, being implemented under the banner, Shaping for Outstanding Performance, will abolish the system of worldwide business co-ordinators. Below them, the network of regional directors will be swept away. These two layers will be replaced by a single team of 14 business presidents, with operations grouped by product in Unilever's established regions of Europe and North America and in its industrial activities, and by region in the rest of the world.

Executive committee members and group presidents will meet in a new executive council, which will become the company's supreme policy-making body. The extent of the shake-up is embodied in the fact that half the 22 members of the council are new appointments to senior posts, and only around half are British or Dutch.

The scope of this reorganisation is, arguably, unprecedented in the history of the company. The speed of its introduction is certainly unparalleled.

The new regime will be fully operational by the end of this year, less than 10 months after its revelation in March.

Shaping for Outstanding Performance is the company's attempt to root out the structural detritus that has accumulated over decades. A booklet issued to senior managers to explain the motives, methodology and mechanics of the new regime opens with the simple question, Why change? The answer: 'In order to reach the level of performance that we expect, and are capable of, and that is needed to guarantee our future.' Among eight points made in the booklet are that, 'Our overall financial performance needs to be improved'; 'we need clarity of purpose and role; the board finds itself too involved in operations at the expense of corporate strategic leadership'; 'we must generate greater value from our operations in Europe and North America'; and 'we must focus more resource on growth opportunities in the developing and emerging markets'.

Apart from streamlining and crystallising Unilever's decision-making processes, the new structure represents an attempt to develop a truly global group by means that run counter to accepted multinational wisdom.

Unilever intends to globalise by devolution, not centralisation. While giving its executive committee total responsibility for overall strategic leadership, it is taking pains to devolve full operational responsibility, including regional strategy development, to the business group presidents.

As such, the new organisation signals the end, so far as the group is concerned, of centrally-driven expansion. The new Unilever will grow as much by local pull as by global push. It is setting out to turn its variegation, its innate diversity, into a source of competitive advantage. 'We used to think of ourselves as a European business with interests in North America and outside,' says one executive. 'In the new organisation, Europe is just another region and it has to justify its existence along with all the rest.' With so much of world economic growth coming from Asia, that new equality should play a decisive part in restoring Unilever's flagging momentum.

The obvious danger in devolving so much freedom of action, however, is that the new centrifugal Unilever will spawn a number of regional baronies which create duplicate bureaucracies, wasting resources instead of liberating them. The end result would be fragmentation.

But powerful mechanisms are in place to prevent this and ensure that the regional groups use rather than abuse their new freedom. Each president will report directly to Tabaksblat and FitzGerald, the joint chairmen.

The executive committee will be responsible for agreeing business plans with the 14 groups, monitoring their implementation and intervening if the plans are not met: 'not interfering, but intervening decisively if there is a major deviation from plan,' says the Outstanding Performance document. The key interface between committee and presidents, between strategic direction and operating freedom, will be a new annual plan contract, with four components: strategic, investment, and human resource matters, and operational targets.

The drive for competitive advantage will be strengthened by a second major reform, introduced alongside the structural change. On 1 January, the company installed a new measure, trading contribution, which will form its fundamental yardstick for gauging its financial performance and enhancement of shareholder value. Lang says: 'We rate Unilever's fresh financial approach equal in importance to its new organisational structure in terms of its ability to change deep-rooted behavioural patterns. It represents a decisive shift to value management.'

Trading contribution will form the base measure of performance for each of the 14 business groups, and will be the key criterion for determining bonus payments under a new management incentive system. The system is derived from the concept of Economic Value Added (EVA), now used by many leading US firms including Coca-Cola and AT&T to assess returns to shareholders.

Like conventional performance measures, Unilever's trading contribution emphasises growth, cash flow and business mix, being calculated on after-tax earnings with an adjustment for working capital inflation and replacement cost depreciation. Where it departs from the norm is in also taking account of capital efficiency, via a capital charge struck at 1% above Unilever's estimated 6% cost of equity capital. That also links the financial plan to the share price.

The combination of the new organisation and EVA-type financial measurement should provide the force to re-orientate the group. 'Unilever is determined to generate more shareholder value from Europe and North America to release resources for fast-growing developing and emerging market investment,' says Lang. 'Major change is inevitable.'

Extensive streamlining is likely in the new European and US groupings of food and drink, and household and personal care. In particular, Unilever will cull its rump of small regional brands, most of them in European foods, which account for about £4.5 billion of annual sales or about 14% of the group total of more than £31 billion. In foods, Unilever will focus on three global growth products - margarine, ice cream and tea-based drinks - while developing smaller areas such as frozen foods and culinary (convenience) products. Other refinements will include, in personal products, a focus on growing fragrances while cutting back on cosmetics. But the speciality chemicals operations, including Quest and Unichema, often tipped for disposal, may well be retained, at least in part. At 12%, margins being made here are currently the highest in the group.

Successful implementation of the structural and financial reforms will bring huge benefits for shareholders, Lang believes. 'A step change in profitability is possible. Trading profit margins could improve by 1.5%-2% to raise earnings by an extra 20p a share.' That would be a rise of more than 25% on last year's earnings of 78.6p a share, a remarkable achievement for a group of Unilever's size.

That potential quantum leap in performance highlights how, if the new structure and systems take root, Unilever will be transformed. As a result of the changes, even those most sacred of cows, the twin head offices and the two executive chairmen, could ultimately disappear. This eventuality, distant but real, is definitive evidence that Unilever is in the throes of a corporate revolution.

Andrew Lorenz is business editor of the Sunday Times

Unilever Executive Council the supreme policy making body comprising:

Executive Committee of

the Board Business Group Presidents

Chairman NV Food & beverage Europe

Chairman plc Home & personal care Europe

Category director, foods Ice cream & frozen Europe

Category director, home &

personal care Foods North America

Personnel director Home & personal care North America

Financial director National Starch and Crosfields

Strategy and technology

director Lever Industrial International & Diversey

and category director,

industrial Africa

Central Asia & Middle East (inc. North Africa)

Central & Eastern Europe (inc. Turkey)

South East Asia & Australasia

Latin America

North East Asia

Quest & Unichema.

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