HLL's rural plan under trouble

Until recently, Hindustan Lever, a 51 per cent subsidiary of Unilever, was revered as a model of how to do business in the vast and complicated markets of rural India. Its sales, partly driven by acquisitions, had grown by over 12 per cent a year in the five years to 2000, and profits by 25 per cent. But this year profits are down, and share price has tumbled by 50 per cent at one point in August.The model is somewhat tarnished. Quarterly results published on October 28th showed after-tax profits down by 31 per cent, after a price war. Nirma, a local brand, and Procter & Gamble, Unilever's main global rival, have pushed cheaper detergents, forcing HLL to cut the price of its brands, such as Surf Excel. In the shampoo market, it acted pre-emptively, giving away a free bottle for each one purchased. The firm may have only itself to blame for the ferocity of the competition. Pursuing a strategy adopted by its parent in late 2000, over three years it slashed the number of its brands from 110 to 36 power brands, on which it lavished its attention. The strategy was, in one sense, a spectacular success. Operating margins grew from 13 per cent in 1999 to 21 per cent in the year 2003. Yet, says Raamdeo Agrawal, of Motilal Oswal, a stockbroker, HLL hit air pockets in business model. Its market dominance allowed it to raise prices even as its raw materials were getting cheaper. As a result, he says, margins grew at the expense of volumes. This attracted competition. This was at a time when FMCG sales in India were slowing, as for four years, 1999-2002, much of rural India suffered from failed monsoons, seriously denting spending power. A spokesman for Lever insists that this is a transitory phase, and that FMCG penetration in India is so low that the potential for growth remains huge. It has been investing heavily for the expected upturn. The market seems to be sharing some of the company's optimism. The recent results did not dent its share price, which reflects a price-earnings ratio of about 21. It still remains the biggest force, with a team, which is unlikely to make the same mistake twice. (The Economist)