Current conditions are ripe for more consumer goods companies to
end up in PE portfolios. Ongoing consolidation among retailers, the
deepening penetration of private-label offerings and widespread
product proliferation will likely result in carve-outs,
public-to-private deals and rollups of orphan brands. Major
consumer packaged-goods companies are divesting non-strategic
businesses. For example, Kraft Foods's announced sale of its frozen
pizza division was part of the company's post-merger portfolio
rationalization preceding Kraft Food's 2010 acquisition of
There is also the ever-lurking presence of investor activists
who are buying positions in laggard consumer packaged-goods
companies and pressing management to boost shareholder returns
through asset sales, among other means.
But making money in consumer goods companies has been hard for
PE investors. Too often, these investments end up
disappointing—it's as if the contents of the container are not
what the pretty packaging suggests. A brand may look to an investor
like an underachiever that can be turned around when, in fact, it
is performing at its strategic full potential.
The consequences of confusing one for the other show up most
clearly in the lackluster performance PE funds have
Because everybody is a consumer, many PE investors think that
making money in the sector should be easy. In fact, consumer goods
deals perform roughly in line with supposedly more complex
industries like health care and technology. According to Bain &
Co. data, median returns from PE-owned consumer goods companies
between 1995 and 2009 were a full 5 percentage points below that of
companies in all sectors.
The challenge for PE funds to earn solid returns in consumer
goods is apt to become even more daunting, as they battle major
changes that have accelerated since the downturn. The engines that
they have long relied on to power their returns are sputtering.
Economic growth is tepid in a tenuous recovery, and assets prices
and acquisition multiples are already high and show little
potential to expand. Meanwhile, nearly all PE funds have become
more specialized and have embraced the idea that they must be value
creators to succeed. Thus, competition to identify and land the
most attractive assets will increase.
Clearly, PE acquirers have their work cut out for them to spot
companies where their active ownership can materially improve their
competitive position. To do that, they need to be mindful of
important traits that make the sector distinctive. Scale is
important in consumer goods as it is in most product and service
industries, but it is not sufficient by itself. A consumer goods
company may be a market-share leader but not make much money, or it
may occupy a small niche and command premium margins. Equally
important for setting a consumer goods company apart is the power
of the brand. Customers are loyal to, and willing to pay more for,
brands they trust.
It is in the interaction between the latent advantages of scale
and the strength of a brand where the best PE opportunities can be
found. To spot them, PE acquirers need to take a rigorous
analytical approach. One framework that we call "high road-low
road" is a powerful tool for sizing up how much opportunity a
consumer goods investment presents.
The principal insight of "high road-low road" is that the
primary driver of success in consumer goods company is a product's
so-called premiumness-that is, the percentage sales in the category
that command a premium price to private label. In categories where
that percentage is about 60 percent or greater, high-road brands
are more valuable and the potential for boosting margins-and
shareholder value-tends to be much higher.
In fact, it is better to be a follower in a high-road category
than a leader in a low-road category.
In high-road categories (think of razors or baby food), a
brand's ability to reap large profit margins enables its owners to
sustain major investments in innovation and marketing, leading to
higher prices and profitability—a self-reinforcing strategy, if
executed correctly. In low-road categories (think of frozen
vegetables or canned tuna), products tend to be commodities with
thin profit margins. Leading brands in low-road categories can
achieve superior economics by gaining scale and relentlessly taking
out costs, as a leader in an industrial business would do.
The qualities that characterize high-road and low-road brands
influence where PE funds can expect to find attractive
Brands in high-road versus low-road categories face different
economic realities that require them to pursue very different
strategic options. PE investors need to be on the lookout for
brands that offer the potential to execute several broad winning
The first path to winning returns is to pick up "hitchhikers."
Big consumer goods companies want to hold on to their high-road
leaders, putting their top-shelf brands off limits to potential PE
buyers. But the acquirer of a strong follower in a high-road
category can make very healthy margins by prudently tending the
brand's market position and keeping a tight rein on costs.
That's what The Blackstone Group and Lion Capital did when they
joined forces to restore iconic status to the slumping Orangina
soft-drink brand following its carve-out by Cadbury in 2006.
The popular thirst quencher had long enjoyed top market
positions in its category, but management had been investing in
other brands in its portfolio at Orangina's expense. Following the
$2.6 billion buyout, however, the new PE owners moved quickly to
refocus the company by stepping up spending for marketing and shelf
Then, under the leadership of a new CEO, Orangina streamlined
operations and engineered a series of small, successful
acquisitions in France and the Ukraine. With Orangina's fizz
restored, the PE owners sold the brand to Suntory, in 2009, for
$3.9 billion, generating a sparkling 30 percent annualized return
PE owners can also breathe new life into low-road brands, but
again, they need to match their strategy to the realities of what's
possible. Consumer goods companies are often eager to divest
poor-performing assets, but PE investors would be wise to follow
the dictum "buyer beware." These companies face very long odds of
success. They operate in a market where competition revolves around
price, but they lack sufficient scale to be a cost leader.
That places them in a virtual "dead end"; our work shows that
only one company in 100 navigates its way to a healthier strategic
position from this starting point. Two paths to success on the low
road are to attain low-cost leadership in a category by building
scale or by focusing on a well-defined niche.
The first promising low-road strategy is to back a solid budget
brand that is a scrappy "rival" in a category that lacks a clear
PE investors hunting in this space look for companies that are
potential acquisition platforms. By assembling other brands to the
core holding and smoothly integrating them, they can build
significant value by creating a runaway category leader with scale
advantages that are difficult for competitors to match.
For example, when Centre Partners acquired Bumble Bee Seafood
from Con Agra in 2003, the canned-fish products manufacturer had a
household-brand name in its commodity category. Pursuing a strategy
to improve Bumble Bee's procurement strength while driving down
costs, Centre engineered a reverse merger of Bumble Bee with a
leading Canadian seafood company, significantly increasing its
market clout and returning capital to its limited partners in the
process. Then, when the economy tanked in 2008, Centre reacquired
the growing company at an enterprise value of $600 million. In late
2010, Centre exited Bumble Bee a second time through a $980 million
sale to Lion Capital, the UK-based PE firm.
The second winning low-road strategy is to acquire a promising
niche brand with premium potential. PE firms that have successfully
executed this approach typically get involved early in the life of
the target company. They provide funding that helps a young
organization with a novel brand that has done well in a few local
or regional markets make the leap to national scale—the point when
it achieves a growth record and scale that makes it attractive for
a major consumer goods player to acquire.
VMG Partners, a San Francisco-based PE firm, followed this route
to high returns through its 2007 acquisition of Waggin' Train, a
producer of all-natural treats for pets. Waggin' Train's whole-meat
snack products caught on with the small segment of dog owners who
care passionately about their pets and are willing to pay extra to
indulge them. With the product category growing at more than four
times the rate for pet treats overall, VMG Partners and company
management helped build brand awareness and push Waggin' Train
products beyond mass retail and club stores into grocery and pet
retail outlets. Sales took off and last September, VMG Partners
earned its own treat by selling Waggin' Train to Nestle Purina Pet
As these examples demonstrate, PE funds that invest in consumer
goods can succeed only by taking to heart what travelers on any
journey understand: You cannot reach the destination you desire
unless you know what road you're on.
Charles Tillen and Martin Toner are partners at Bain &
Co., based in the firm's Boston and New York offices, respectively.
David Harding is a Boston-based partner who leads the firm's Global