For those of you who are not aware of Procter & Gamble Co.'s (PG) plan to cut costs by $10 billion from 2012- 2016, I will here present a brief summary. The company plans to save $10 billion through the following plan:
- Reduce cost of goods sold by $6 billion
- Reduce overhead costs (which are costs not related to the sale of goods) by $3 billion
- Reduce marketing expenses by $1 billion
Is it realistic?
As an external analyst, it is difficult to guess whether the expectations of management are realistic or not. Intuitively, it almost seems too good be true, but more impressive accomplishments have been made before. In 2008, Unilever - a competitor of P&G - managed to increase its operating margin from 8.5% in 2004 to 13% in 2005 and 17% in 2006. Unilever realized this thanks to a restructuring plan called "One Unilever", in which it adopted a single SAP system, transformed its Human Resources department, established a single supply chain, and outsourced transactional finance to IBM.
As you can see in the below graph, sales, general and administration costs decreased from around 38% of revenue in 2003 to less than 25% in 2011.
Reducing costs of goods sold
The plan of Procter & Gamble, however, is different. While Unilever primarily focused on lowering overhead costs, PG expects to benefit primarily from lower costs of goods sold. This is pretty ambitious, as it actually has lower COGS than two of its three closest competitors.
Management, however, argues that given the company's scale, it should have even lower costs, which I believe is a valid point. Since the COGS of its competitor Colgate makes up only 42% of revenues, compared to 50% for P&G, I think it is fair to assume that P&G is capable of bringing this level down by a couple of percentage points. The $6 billion reduction in cost of goods sold is expected to come through manufacturing cost efficiencies. To be more specific, management has identified the following areas where it can improve:
- Improving process reliability
- Reducing capital cost per unit of volume
- Simplification and standardization of the manufacturing platform
The problem with estimating a $6 billion reduction in costs of goods sold is that management (in making those calculations) made the assumption of revenues growing by 5% y/y. But as I have previously argued, this is most likely infeasible. Even CFO Jon Moeller didn't believe that those numbers were realistic when he represented them back in February, as they do not take into account currency fluctuations and the geographical price mix.
Here is what Jon Moeller had to say about whether the $6 billion reduction was realistic or not.
In terms of the $10 billion program, I'd say a couple of things. First of all, we've tried to very transparently lay out exactly how that number was calculated, and you've rightly described how that's calculated. So, if you have a different view in terms of what happens with the top line or any component of it, we've given you all the pieces and you can model that any way that suits yourself.
Since Jon Moeller is basically asking me to change my calculations, I think I should. The first thing I have to do is to replicate the assumptions of management. Since it plans to save $6 billion over the next five years and hasn't precisely outlined how much it plans to save each year (or at least I haven't been able to find those numbers), I'll had to make a guess on this rate.
I have assumed that the company will save the same amount in costs of goods sold each year, or $1,200 million a year over a five-year period. In the table below, you can see the calculations I assumed management made in comparison to my expectations. My conclusion is that I think the company will save $5,560 million, rather than $6,000 million in costs of goods sold, this of course assuming the only unrealistic assumption management made was expected revenue growth.
Savings of overhead costs and advertising expenses
Management plans to save around $3 billion in overhead costs through the following changes:
- Eliminating duplication of work
- Simplifying through digitization
- Optimizing the number of business units and functions
- Optimizing the global footprint
A concrete example of what it plans to do is reducing non-manufacturing enrolment by 1,600 workers in 2012 and 4,100 in 2013. P&G, however, recently announced that it is ahead of schedule, and plans to reduce enrolment by around 10% this year, compared to the original estimation of 3% for 2012, and 7% for 2013. In the table below you can see my updated (revised) estimates for the reduction of enrolment.
As you can see in the table, I expect P&G to save a further $89 million than originally estimated. However, as I interpret the following quote by CFO Jon Moeller, P&G has chosen not to go through with the $1 billion savings in advertising:
We have chosen for the next fiscal year to prioritize resumption of developed market growth over efficiencies in advertising.
Adding it up
So if we assume the numbers that Procter & Gamble originally presented are true, except for the following three changes:
- 1% revenue growth instead of 5% (decreases savings by $440 million)
- Further reduction in jobs that originally outlined (increases savings by $90 million)
- No reduction in advertising expenses (decreases savings by $1,000 million),
then P&G will save $10,000 - 440 + 90 - 1,000 = $8,650 million.
So to conclude, I do not think that Procter & Gamble can save $10 billion. But I do think margins will improve over the coming years, especially if commodity costs decline (which is the main reason why Procter & Gamble is having problems to begin with).