Fast-moving consumer goods (FMCG) makers are back to square one in FY22. Even though the economy is opening back up, with discretionary sales being allowed, consumer goods companies are dealing with a situation much like last year’s.
Companies are hiking prices, altering product portfolios, switching from traditional to e-commerce channels, and finding new ways to deliver products to buyers. Last year, many of these changes were a knee-jerk reaction to the pandemic. FMCG companies pivoted to rural areas in the second half of FY21, strengthening their base. But with rural areas faring just as bad, if not worse than urban areas amid the second Covid-19 wave, the rural advantage is weakening in FY22. However, some changes turned out to be more fortuitous than others, like leveraging e-commerce channels and distributing products through chemist stores.
In FY22, companies will ignore short-term margin improvement and cater to changing customer preferences. This will be by focusing on entry-level products over premium products, and food, health, and hygiene segments over beauty and personal care segments. Distribution-wise companies will focus on shoring up e-commerce channels, as traditional channels remain under pressure amid the lockdowns. With rural India hit hard in the second Covid-19 wave, FMCG companies focused on rural areas face a tough year.
Let’s look at some of the lessons India’s FMCG market leaders learned from Covid-19 and what it means for FY22.
Commodity pricing pressure eat into margins
India’s retail inflation reached 6.3% in May 2021. This was higher than analyst estimates of 5.3%. One of the reasons for this increase in retail inflation is the rising price of daily-use food products produced by FMCG companies. However, FMCG companies are caught in a pricing storm of their own.
After the first wave of Covid-19 in Q1FY21, the price of commodities used by FMCG companies rose steadily. FMCG companies noticed the rising prices as early as June 2020, but they went unaddressed till Q3FY21.
During the Q1FY21 conference call, Sanjiv Mehta, the CEO of India’s largest FMCG company, Hindustan Unilever (HUL) said, “We have seen some inflation in the quarter, especially in the month of June.” Mehta and former CFO Srinivas Phatak said with commodity inflation rising, HUL would be eyeing price hikes in vegetable oils, tea, and milk powder. Varun Berry, the CEO of Britannia Industries echoed a similar sentiment. In Q1FY21, the CEO of India’s largest biscuit company predicted that “gentle commodity inflation would continue.”
Like the rest of the market, FMCG companies expected commodity prices to moderate in 2021. But not only did commodity prices fail to moderate - they continued to rise. Take palm oil, a commodity used in the production of processed foods like biscuits and bread, vegetable oils, and home and personal care products like soaps, shampoos, and detergents. In May 2021, palm oil cost $1,100 (Rs 84,000) per ton, a rise of 120% YoY. The price of rice bran (used to produce edible oils), copra (used to produce hair oils), and high-density polyethylene or HDPE (a chemical used to make packages for FMCG products) are all up in 2021.
In response to rising commodity prices, all FMCG companies hiked consumer prices in the second half of FY21. Godrej Consumer Products and Wipro Consumer Care raised soap prices by 6-7%, Marico, Dabur, and Emami’s hair oil and value-added hair oil (VAHO) prices were raised by 5%. HUL raised skincare and haircare product prices by 8% and maintained price hikes for tea products. As commodity prices are still up in Q1FY22, FMCG companies will maintain if not add to these price hikes. However, even after the industry-wide increase in prices, save HUL, FMCG companies’ margins steadily declined in H2FY21.
With no let up in the rise in input costs, the price hikes might not help shore up margins in the coming quarters of FY22 for many FMCG companies. What’s worse is that sales of FMCG companies’ high margin products will also decline in Q1FY22 and Q2FY22 because of the pandemic and lockdowns.
Premium products take a back seat
FMCG companies’ premium products come with higher margins. Hence, companies engage in the promotion of these products, especially in urban areas where disposable incomes are higher. A simple upgrade from an entry-level product to a premium product increases the value that accrues to FMCG companies.
Due to the pandemic, the demand for premium products dropped. Consumers who preferred body wash settled for soap. With hair parlors and skin clinics closed, haircare and skincare were limited to ordinary coconut hair oils and skin creams, not value-added products like hair tonics and skin serums. With distribution limited to essentials, glucose biscuits’ sales rose and cream and digestive biscuits’ sales dropped.
This shift away from premiumisation affected FMCG companies’ revenue mix and hence margins. Take the case of HUL, which sells premium products under its beauty and personal care segment (shampoos, soaps, moisturisers, deodorants). This segment contributed 44% of revenues quarterly before the first wave of the pandemic. At the end of Q4FY21, its revenue share dropped to 36%.
With lower sales, premium products’ margins decreased as well. As raw material costs rose and the second wave pinched discretionary spending in Q4FY21, premium products’ margins declined sequentially. In the March 2021 quarter, HUL’s beauty and personal care products’ (besides Lifebuoy soaps and Closeup and Pepsodent toothpaste, HUL’s beauty and personal care portfolio falls under premium products) margins fell by 170 basis points QoQ, compared to a 220 basis points and a 230 basis points increase in home care and food products’ margins, respectively.
FMCG companies haven’t pulled back from their efforts to sell premium products in FY22, despite the second wave. Britannia’s target in FY22 is to gain market share in the milk and glucose biscuit markets through its brands Milk Bikis and Tiger. The biscuit maker is taking Milk Bikis to the Madhya Pradesh, Jharkhand, Chhattisgarh, Bihar, Haryana, and Rajasthan markets. However, Parle, the market leader in glucose biscuits (through Parle G), is priced 30% lower than Britannia’s biscuits. Varun Berry said Britannia will not lower its prices to gain market share. Rather, the company will increase advertising spends in H1FY22 to increase its brand’s awareness.
The decline in premium product sales led to a 12% drop in revenues for Godrej Consumer sequentially in Q4FY21. Over 80% of the company’s revenues come from premium products like mosquito repellent (GoodKnight), and 20% from haircare and skincare products. In the Q4 earnings call, Godrej Consumer’s Managing Director Nisaba Godrej said that the non-premium category has headroom for growth in Q1FY22 and Q2FY22, given its strong demand during Q4FY21.
Marico’s premium products (VAHO, hair serums, male grooming products, etc.) saw poor sales since the first wave. In Q1FY21, premium product volumes dropped by 30% YoY, compared to an 11% drop in volumes of entry-level hair oils. As the economy recovered in Q3FY21 and Q4FY21, premium product volumes rose steadily.
The growth in volumes of Marico’s premium products didn’t translate into revenues as sales declined in Q4FY21. Premiumisation is unlikely to pay dividends until the second wave and the resulting economic distress is over. Saugata Gupta, the Managing Director of Marcio made no qualms about the FY22 outlook, stating during the Q4FY21 earnings call, “Taking cognizance of the fact that the pandemic has severely hit the consuming class this time around, we believe it is the premium, indulgence based categories that will be more affected this time.” Needless to say, with the pandemic becoming worse in Q1FY22, premium product sales will continue to remain low. This will hit urban-centric FMCG companies like HUL, Nestle India, and ITC worse than others.
E-commerce and rural markets recover after the pandemic
FMCG companies distribute goods through three channels - traditional trade (unorganised outlets like kirana stores), modern trade (organised outlets like department stores), and e-commerce. During the national lockdown in Q1FY21, traditional and modern trade plunged and only e-commerce distribution survived in urban areas. This allowed urban-focused companies to come out of Q1FY21 relatively unscathed with revenues flat on a YoY basis. However, rural FMCG companies’ (Marico, Dabur, and Emami) revenues declined by 11-26% YoY.
As India gradually unlocked in Q2FY21, the momentum in rural sales outpaced urban sales. This was because rural areas opened up quicker than urban areas and the incidence of Covid-19 cases was lower. Disposable income in rural areas rose in Q2FY21 and Q3FY21 due to normal monsoon, reverse migration from urban to rural areas and government subsidies like the expansion of the rural jobs guarantee program and the increase of the minimum support price for crops.
FMCG companies with a strong rural base suffered in Q1FY21 due to low demand. However, these companies’ revenues recovered sharply in H2FY22.
The rural market wasn’t the only market to give FMCG companies wind in their sails. E-commerce momentum continued even after the lockdown. A report from management consultancy company Nielsen said e-commerce spends rose 17% QoQ in Q2FY21 to Rs 1,184 per customer, and the number of items ordered was up 23% to 3.8 items per order.
Expecting this rural and e-commerce momentum to continue, Lalit Malik, the Chief Financial Officer at Dabur said this during the Q2FY21 earnings call, “We have seen a steady recovery in demand sequentially with some channels and geographies, like e-commerce and rural, growing at a fast pace...we are hopeful that H2 would be better than H1.”
The momentum in rural and e-commerce sales proved vital for the domestic FMCG industry. In Q3FY21, Nielsen said the FMCG market’s value grew by 7.1% YoY (compared to a 0.9% growth in Q2). As economic conditions improved in Q4FY21, the industry’s value grew by 9.4% YoY. As the trend from H1FY21 indicated, this growth was led by e-commerce distribution channels and rural areas.
The main positive for the FMCG industry is the double-digit growth of the traditional trade channel. The modern trade channel, through department stores, has still not recovered since the first wave of the pandemic. FMCG product sales through traditional and modern trade channels will remain under pressure in the first half of FY22 as economic activity will take time to recover. Analysts estimate that traditional trade will recover by Q3FY22, with modern trade unlikely to recover to pre-Covid levels in FY22.
Rural remains under pressure, e-commerce and chemist shops the next frontier
The second Covid-19 wave affected rural areas worse than the first wave. FMCG companies strengthened their rural base through wider distribution, product launches, and increased marketing in rural areas. However, even this won’t help rural-focused FMCG companies because of the severity of the second wave.
FMCG companies are split on the pace of recovery of rural areas post the second wave. Varun Berry said Britannia will see a fall in rural sales because of distribution bottlenecks. Direct sales to traditional trade outlets like kirana stores all but stopped in Q1FY22. The biscuit maker is only distributing products to wholesalers and via telephone sales. Mohan Goenka, director at Emami said the rural market was “badly impacted” in April and May. This was because labourers left factories in April and 90% of its wholesale market was closed because of lockdowns.
Others expect rural areas to remain resilient post the second wave. Sameer Shah, the Chief Financial Officer of Godrej Consumer expects the second wave’s impact on rural areas to be made up by a good monsoon season and reverse migration from urban to rural areas. Mohit Malhotra, CEO of Dabur said the government’s fiscal stimulus to rural workers will help demand conditions. These incentives, he expects, will set rural on a recovery path only in Q2FY22.
While FMCG companies’ hopes on rural sales are dampened because of the second wave, their hopes on e-commerce are high. HUL plans to gradually increase premiumisation through e-commerce channels, starting with its beauty and personal care segments. Sameer Shah of Godrej Consumer said e-commerce is still firing on all cylinders despite the second wave, and e-commerce sales are expected to grow. Marico’s e-commerce sales hover at 8% of total sales. Saugata Gupta said this share will be ramped up in the next 3-4 years, driven by premiumisation.
FMCG companies will also increase distribution via chemist stores in FY22. This is because chemist stores are less prone to lockdowns and are open longer. However, premium products with high margins cannot be distributed through chemist stores.
Emami will add 20,000 chemist stores in rural areas. Godrej Consumer increased its distribution via chemist stores by 20% in FY21 and will bolster this further in FY22. HUL’s chemist distribution increased post its acquisition of Horlicks and its merger with GlaxoSmithKline Consumer Healthcare. This distribution will be limited to beauty and food products and FMCG companies with a weak portfolio (ITC, Tata Consumer) will be unable to make piggyback off chemist stores.
Margins are not a concern for FMCG companies despite high input costs. Their priority is changing customer preferences post-pandemic. Companies with a heavy beauty and personal care portfolio will see lower sales in Q1FY22 due to lockdowns. This category will only recover by Q3FY22, provided there is no third wave. Non-premium products will see strong sales in H1FY22.
Rural areas will not replicate their FY21 success in FY22, due to distribution disruptions. Chemist stores and e-commerce channels will continue their momentum in FY22. FMCG companies learned a lot in the last twelve months, but whether they’ll put this in practice remains to be seen