CFO Leaders: How To Manage An Economic Slowdown, HUL Style–By Srinivas Phatak

There Is No Silver Bullet

In the first quarter (April-June) of financial year 2019-20, HUL’s volume growth slowed to 5 percent. Some of it was base effect—growth in comparable quarters was very high due to sales recovery after demonetisation and GST. Some of it was slowing rural growth adding to a moderation in urban growth. Mostly it was due to a slowing economy—with first quarter consumption growth at a meagre 3.1 percent.

The company had warned investors at the end of the March quarter that “FMCG is recession-resistant and not recession-proof”.

Clearly, it saw the slowdown coming.

There is moderation to growth, Phatak says matter-of-factly but...

That preparation spans product portfolio, distribution, supply chain agility and, as a last resort, discounts, Phatak says.

1. Portfolio
Every part of HUL’s business, across home care, personal care and foods, has a product portfolio that straddles the pyramid either from a benefits point of view or from a price point of view. Phatak uses the hair care category as an illustration—it has six brands, Clinic, Sunsilk, Dove, TRESemmé and Indulekha—with prices starting from Rs 1 to Rs 432.

Not every pack will make money, Phatak says. “You will make more profit on certain packs, you will make less profit on certain packs. But in the aggregate, you’ll continue to have a -adding equation.”

This ensures product presence whether a consumer is down-trading in tough times or up-trading when spending power improves.

2. Distribution
HUL retails in over eight million outlets via 3,500 distributors. Over the past few years it’s been working on two distribution challenges—to disintermediate the distribution chain to achieve direct distribution. And, in at least urban areas, to build capabilities to service the customer in 24 hours. Right now the average time taken is 48 hours.

Phatak describes it as the ‘route to market’ challenge.

“The more and more you are directly distributing, you’re controlling the assortment, you’re controlling what actually goes on the shelf and therefore your ability to sell better to the consumer. Therefore, distribution becomes important.”

In-market execution remains strong with speed to market up 1.4x, improving service levels, lower inventory levels and expansion in coverage and assortment, according to a Jefferies research note listing key takeaways from the company’s Investor Day meeting in June.

3. Supply Chain Agility
Besides demand slowdowns, there is the risk of currency and commodity-price fluctuation, to name a few. Being able to quickly activate price/pack size changes across 40 brands in 12 categories, manufactured in 30 facilities, is critical, he says.

That mitigates inventory costs too.

4. Discounts, As A Last Resort
“If you need to give , give the to the consumer and not necessarily to the trade,” Phatak says based on learnings from previous downturns. That refers to discounts or an increase in pack sizes.

But only as a last resort, he insists.

“I would not do any of that. If you ask us, we will double up our efforts on market development. I’ll do more sampling; I’ll continue to drive more innovations. I’ll tell you why. When the turnaround happens, I’ll be the fastest to recover. The beauty of FMCG is that, you’re not the first to get impacted. But when you see a turnaround, you’re the first to benefit because people come back to products of everyday consumption.”

Watch HUL CFO Srinivas Phatak talk about managing a slowdown here...

The WIMI Wins

Even today, many parts of India are growing fast, Phatak notes. The move to segment the country into 14 geographies under WIMI allows for targeted resource allocation. So, for instance, in areas of central India, more investment in branding and marketing initiatives in say, village melas, could help capture benefits of relatively higher growth.

Each of the 14 clusters has an individual financial plan that Phatak and his team examine quarterly. It helps them determine and manage the “cost to serve” different clusters.

“If I had unlimited money, I can go and sell anything anywhere in the country, but I don’t. Therefore, how do you marry the sales and operating part of your business to your cost to serve?

This approach serves the company’s ability to determine geography-appropriate product mix, launch new innovations in specific regions and price them distinctly.

“Pricing is a big role for finance to play just given the complexity. Now, we use all of this modelling with the data and decide how you right-price a particular product and therefore, you’ll see that our similar packs across geographies will have different prices.” (emphasis added)

The Cost And Margin Focus

Improvements in two areas have and will help HUL withstand further bumpiness in the economy.

Gross savings are up from 4 percent of turnover in 2014 to 7 percent in financial year 2018-19.

In about the same period, the company’s EBITDA margin has increased by 800 basis points—from 15 percent in FY13 to 22.9 percent in FY19.

After perusing the company’s latest annual report, Edelweiss Securities makes some useful observations regarding costs:

1. HUL has not cut advertising spends. In fact, the company’s ad spends as percentage of revenue rose from 10.7 percent in FY17 to 11.7 percent in FY19. This makes HUL one of the biggest ad spenders (within the ad industry), the Edelweiss report notes.

2. Major expenses which saw cost rationalisation are freight cost, royalty and miscellaneous expense.

• Freight cost: From 4.7 in FY16 to 4.1 in FY19—as percentage of revenue
• Royalty: From 2 in FY16 to 1.8 percent in FY19—as percentage of revenue
• Miscellaneous: From 7.9 in FY16 to 7.1 in FY19—as percentage of revenue

3. HUL maintained its industry-leading working capital position over the year.

• It boasts negative working capital.
• The cash conversion cycle further reduced (improved) from negative 54 days in FY16 to negative 77 days in FY19.
• There’s been a rapid decrease in inventory days—down from 63 in FY16 to 50 in FY19.
• And, payable days have gone up from 131 to 142.

Menaka Doshi: Is there continuing room for EBITDA margin improvement?

Srinivas Phatak: Just let’s wind back. There are three divisions and it is important to understand where I have seen the biggest change in margin expansion. I’ve got three divisions; one is home care business. Second is beauty and personal care and third is foods and refreshments. Home care business, it’s about a third of our total business, we used to make low single-digit margins and today, we have moved the needle to the range of about 16 to 17 to 18 percent.

Menaka Doshi: That is through premiumisation?

Srinivas Phatak: Through multiple things—a whole reconfiguration. We have invested back into product quality, we’ve gone into a very different portfolio which sells in different parts of the country and the whole WIMI strategy and, therefore, how you’re making those choices. Clearly, there is premiumisation—whether it is Surf or whether it is liquids. A complete rejig of supply chains—where do you source from, where do you sell to—a lot of work has happened there. That is where we have moved almost 8-9 percent in absolute margin increase.

Menaka Doshi: That’s the bulk of your margin expansion?

Srinivas Phatak: If you say, 700-800 basis points, close to 300 or 350 comes from this part of the business. Second, if you look at our beauty and personal care business, it has had very good growth. It has a margin profile of 25 percent, give or take, 200-300 bps here or there. Again, a very healthy space to be in. Our foods and refreshments business, which used to be close to double digit, has moved to 15-16 percent. So, the whole space of how you’re playing the portfolio has really helped. But again, I talked about our savings agenda going up from 4 percent to 7 percent (of turnover) is again a big enabler.

Menaka Doshi: How long can you continue to extract savings?

Srinivas Phatak: What typically happens is—you get newer abilities and newer capabilities to unlock some of this. At the end of the day, can we sustain 7 percent of savings forever? Of course not. The question today is, many things which were not feasible earlier, are feasible today.

Menaka Doshi: Where has the 7 percent savings coming from? Can you give me a real life illustration of what has worked best for you.

Srinivas Phatak: Supply chain counts. Let’s take our non-material suppression costs. Factory, distribution, supply chain.

We are changing the footprint of our factories, we are doing more automation in the factories, we are able to bring in more technology into the factories. The number of kilometers that goods are travelling on the road is coming down, its fascinating when you have the capabilities that you are creating, they will unlock this.

Menaka Doshi: What proportion of your margin expansion has come from savings and how much has it come from things like premiumisation?

Srinivas Phatak: Every year, I get about 20 to 30 basis points of margin expansion from premiumisation.

But, he offers as a parting shot...

Watch HUL’s Srinivas Phatak talk about managing costs here...

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