A report by MSLGROUP India, a part of the Publicis Groupe

C O N T E N T S
TABLE OF CONTENTS 1. 2. 3. 4. Executive summary The rural economy The danger of drought and challenges for FMCG firms How FMCG firms dealt with earlier droughts Page 04 05 07 09 11

5. Recommendations

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Executive summary
Indias fast-moving consumer goods (FMCG) sector has in the past few years benefited from strong rural demand, boosted by an array of governmentrun employment and development programmes. For instance, in product categories like toilet soaps, washing cakes and health beverages, rural demand growth during 2001-2002 and 2009-2010 outstripped urban demand growth. However, this year, the monsoon has been weak and the India Meteorological Department (IMD) has warned of the possibility of a drought. As a consequence, the central banks recent monetary policy lowered growth estimates. The Central Government acted quickly, too announcing a relief package for five states. FMCG companies have in the past in 2002 and 2009, to be precise dealt successfully with droughts in India by adapting their marketing strategies to the situation. For instance, in 2009, the companies focused on expanding volumes across rural areas, avoiding price hikes to a large extent. In 2002, these companies focused on pushing select brands in their portfolios to deal with weaker rural demand. In this report, we analyse how FMCG companies could be affected by a drought this year and how they can learn from their earlier experiences to not just stay in the black, but also make further inroads into the rural marketplace.

Photo by runran on flickr

The rural economy

The rural sector is a key component of the broader Indian economy, comprising more than 600 million people and 52% of the workforce engaged mainly in agriculture and related activities. Indias Green Revolution, coupled with the government focus on the agriculture sector in its five-year plans, enabled the country to become the worlds largest producer of milk, jute and pulses. India also became the worlds second largest producer of fruits and vegetables. Yet, rural areas still accounted for 40% of the countrys nearly 407 million poor in the country, at the end of FY05. The Planning Commission defines the rural poor as those earning less than Rs 22.40 per day. Apart from that, the share of agriculture in the domestic economy declined to 21% at the end of FY03 from 29% in FY88, reported the Economic Times
THE INDIAN ECONOMY Sector 1996-97 2000-01 2004-05 2008-09 2010-11 23.4% 18% 19.2% 17.8% 17.6% 17% 19% 15.6% Agriculture 27.4% & Forestry Manufact- 20% uring and allied areas Services Others 45.6% 7%

50.5% 8.1%

52.6% 10.4%

54.2% 11.2%

54.7% 10.7%

Source: Union Ministry of Statistics and Programme Implementation; data based on current prices

The Central Government, in a bid to reverse the weakening trend in the rural economy, passed the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) in August 2005, which put in place what was primarily a job-focused programme. It provided a legal guarantee for 100 days of employment every financial year to the adult members of every rural household related mainly to unskilled manual work at a statutory minimum daily wage of Rs 120. The scheme has so far undertaken 146 lakh projects, 51% of them related to water and more than 19% to rural connectivity. The Central outlay for this scheme was Rs 40,000 crore ($8 billion) for FY11 and it helped to transform the rural economy by reducing the number of the poor and providing a stimulus for rural society to purchase an array of goods, ranging from soap and shampoos to television sets. By March 2010, the number of the rural poor had shrunk to 115 million.
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This transformation did not go unnoticed. Credit Suisse, in a recent report pointed, out that rural India is not solely about agriculture anymore and has made a transition from thatched-roof houses and muddy roads to factories and cellphones. The report highlighted that agriculture is now only about one-fourth of the rural GDP from being close to 50% a decade back. The rural population is rapidly shifting employment towards manufacturing and services. The report also stressed that rural consumption will continue to skew towards lower price points for FMCGs, two-wheelers, building materials/paints, and personal products.

Abhijeet Kundu, an FMCG analyst at Antique Stock Broking, said in a recent report: HUL and other leading players in the sector should grow their volumes by broadly 8% during FY13, led by the increase in the distribution network Also, the steps taken in terms of improving the quality of distribution network would aid growth in the coming years for these companies. In the food and beverages market, the share of rural markets is growing. Packaged fruit juices have traditionally been a very urban market product, but with growing health awareness among rural consumers we are witnessing a marked growth in demand. To cater to this, Dabur has expanded the distribution footprint for juices to cover smaller cities, George Angelo, executive director (sales), Dabur, told the Economic Times. Dabur is not alone. Nestle has extended its distribution reach to semi-urban and rural areas, adding 4.64 lakh new points of sale. In addition, HUL, the largest player in the domestic FMCG market, generated nearly half of its annual revenues from the rural hinterland. A strong rural focus has helped the FMCG sector over the past five years show an annual growth of 17%, compared to 11% in the last decade, according to a recent article in DNA Newspaper. In addition, a recent Nielsen report valued the FMCG market at Rs 1.46 lakh crore ($29.2 billion) at the end of March 2011. It is expected to grow rapidly, given the rural focus. Incidentally, the focus on the growing prosperity has also resulted in a growth in rural automobile demand.
RURAL SHARE IN AUTOMOBILE MARKET (IN %) Automobile Scooters Motorcycles Cars/jeeps 1995-96 25.2 45.8 7.4 2001-02 29.8 50.4 6.9 2009-10 32 55.4 9.3

The FMCG windfall

Rural consumers are a key consumer segment across a range of sectors for India Inc. The segment is particularly important for the FMCG sector. Apart from it being a key consumer, FMCG majors source several key inputs milk, sugarcane, coconut, wheat, cashew from the rural sector. Rural areas have benefited not just from the wider choice of products from household care and female hygiene to male grooming and toothpaste but also from the higher prices their produce commands.
FMCG GROWTH Product Toilet soaps Segment Urban Rural Sales Sales Growth (2001-02)* (2009-10)* (% 335.9 469.4 510.7 1,351.7 96.5 37 464.2 657.7 616.5 2,104.5 223.4 88.9 38.1 40.1 20.7 55.6 131.5 140.2

Washing cakes Urban Rural Health beverages Urban Rural

Source: The Great Indian Market, National Council of Applied Economic Research. * Figures in 000 tons

Analysts tracking the sector highlight that apart from the attractive price points for rural consumers (think sachets and combination offers), FMCG companies have ensured relevance for their marketing campaigns through themes easily understood by these consumers. Riding on this momentum, leading FMCG companies like Hindustan Unilever (HUL) and ITC have utilised their hinterland distribution muscle to push newer products. For instance, the sale of noodles, macaroni and soft drinks grew by 10% in volume terms and 12% in value terms in rural markets in the first 10 months of 2011, according to IMRB data reported in the Economic Times. This was much faster than the growth reported in urban areas in the same period.
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Source: The Great Indian Market, National Council of Applied Economic Research

A recent brokerage house report from Religare highlighted the trend of younger rural workers who have migrated to larger towns, remitting money to their families to enable them to purchase two- or four- wheelers. To take advantage of the opportunities, Hero MotoCorp Ltd, the largest player in Indias two-wheeler segment, has established a distribution reach across more than one lakh villages, which account for 45% of its rural sales. Indias largest passenger vehicle company, Maruti Suzuki, also saw the rural share of its vehicles rise from roughly 5% in 2005-06 to 26% at the end of 2011-12.

The danger of drought and challenges for FMCG firms

The IMD has indicated the possibility of a drought in 2012. Based on the rainfall distribution over the country and the outlook for the second half of the season, the south-west monsoon (June-September) is likely to be deficient (less than 90% of the long-period average), the department said. The country began August with a rainfall deficiency of 19%. While thats better than July, which began with a 29% shortfall, the agriculture department has already moved into drought-relief mode. On July 31, the Central Government announced a relief package of around Rs 2,000 crore ($400 million) for the five worst affected states Maharashtra, Karnataka, Rajasthan, Haryana and Gujarat.

First signs
The Reserve Bank of India (RBI), in its monetary policy unveiled in the end of July, scaled down the countrys gross domestic product (GDP) growth rate for 2012-13 to 6.5% from its earlier projection of 7.3%. That was partially due to the uncertainties arising from a weaker monsoon. The RBI also raised its estimate for year-end inflation to 7% from 6.5%. However, Planning Commission Deputy Chairman Montek Singh Ahluwalia struck a more pessimistic note, estimating growth at 6% on the back of the weak monsoons impact on farm growth and muted industrial expansion. If we factor in agriculture, which would not be strong ... [growth] would be closer to 6%. I dont think we have sufficiently strong industrial turnaround yet, Ahluwalia told PTI. Credit rating agency CRISIL, meanwhile, cut the growth target to an even lower 5.5%. Apart from government officials, many senior executives also voiced concern on the emerging drought-like situation. Adi Godrej, chairman of Godrej Consumer Products, told PTI in late July: The rise in overall cost of living and concerns over the decrease in social spending may have some impact on growth in rural FMCG sales in the short run. The Society of Indian Automobile Manufacturers (SIAM) also lowered its growth forecast for small cars to 9%-11% for FY 13, from 10%-12% earlier. A deficit in the monsoon is a big cause of concern for tractor manufacturers. Generally, tractor buying starts from May till the end of festivities. We are expecting an adverse second quarter as far as sales are concerned, Sanjeev Goyle, senior vice-president (marketing), Mahindra and Mahindra, told DNA.

Photo by sushmita balasubramani on flickr

How FMCG firms dealt with earlier droughts

DROUGHT YEAR ECONOMICS Year of drought FY 1988 FY 2003 FY 2010
Source: Economic Times

Rainfall deficit (%) -15 -20 -19

GDP growth (%) 3.5 4 7.4

Agriculture growth (%) -1.1 -6.6 1

2009
In 2009, the rainfall deficit across was 19%. In mid-August that year, the then Union Finance minister Pranab Mukherjee declared 161 districts as drought-hit. He said that the country was facing the biggest drought of the century because of the weak monsoon. For FMCG companies, it was a difficult environment, given the importance of rural consumers. The global economic turbulence due to the US sub-prime crisis was also taking a toll on consumer sentiment in urban areas. However, FMCG firms managed to deal with this situation by highlighting how they could help Indians look younger, make their teeth whiter, kids stronger and toilets cleaner. They rewarded the loyalty of their customers by not raising prices despite input costs rising in the drought-ravaged economy. One item sugar typified the cost pressure. Its price almost doubled in a year to reach Rs 40 per kg in the National Capital Region. This trend was also highlighted by Sunil Alagh, former managing director of Britannia Industries and a veteran of the FMCG industry, in an interview with CNBC TV18. He pointed out that every FMCG company would be hit in terms of operating margins due to rising costs, but in terms of demand most players would offer lower-priced or lowerweight products, which would help maintain the sales momentum. Sure enough, as V Srinivasan, FMCG analyst at Angel Broking, told MSLGROUP India: FMCG companies dealt with the drought of 2009 by focusing on volumes; price hikes were at a minimum. A similar strategy could be played out this year too, depending upon the overall health of the rural economy. The financial performance of HUL is a good indicator of FMCG firms registered a rise in net profits despite raw material costs rising.

Photo by mckaysavage on flickr

HUL FINANCIALS Parameter Net Sales Raw materials consumed Operating profit Operating profit margin (in %) Net Profit Financial year ended march 2009 17,523.8 5,252.3 2,548.4 14.5 2,202 Financial year ended march 2010 20,239.3 6,697.4 2,656 13.1

firms to ensure their prices were competitive. Once again, HULs financials are a good indicator of how the sector managed.
HUL FINANCIALS Parameter Financial year ended december 2001* 10, 667.55 3,202 1,714 16.1 1,641.3 Financial year ended december 2002* 9954.85 3,238 1,955 19.6 1,755.68

Net Sales 2,496.5 Raw materials consumed Operating profit Operating profit margin (in %) Net profit

Source: HUL balance sheet. All figures in Rs crore, except where indicated

The FMCG firms approach was lauded by industry bodies. The [FMCG] sector has coped well with recent challenges and grew by 15% over the last year, said industry chamber FICCI in a press statement.

Source: Company balance sheet. Figures in Rs crore, except where indicated. *HUL changed its accounting year to end in December during this period

2002
Seven years before the drought of 2009, a rainfall deficit of nearly 21% led to a major drought. The IMD officially acknowledged 2002 as the first ever all-India drought year since 1987. Nearly 29% of Indias geography was classified as suffering from drought-like conditions and another 10% from severe drought. The difficult operating environment for FMCG companies and the steps they took were highlighted by MS Banga, the then chairman of HUL, in his annual note to shareholders in the balance sheet for 2002-03. He pointed out that broad economic growth had slowed to about 4%, well below the 6% level achieved during the latter half of 1990s. Overall demand for FMCG products continued to be difficult with the agricultural sector declining nearly 3%, which severely affected rural demand. In addition, competition had intensified across categories. Banga stressed on the need to cut costs across the supply chain, given the rise in raw material costs. In addition, HUL decided to focus on its 30-odd power brands, broadly referring to devoting its marketing strategy and corporate resources on key brands such as Wheel, Brooke Bond, Lux, Rin, Lifebuoy and Fair & Lovely to survive the slowdown. The difficult conditions were also acknowledged Godrej, of Godrej Consumer Products, who in an interview with www.equitymaster.com time highlighted the broad slowdown in topline growth for FMCG firms. He also highlighted later that Indian consumers showed a distinct preference for value-for-money offerings and the need for FMCG
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Photo by Phillie Casablanca on flickr

Recommendations

FMCG companies have not yet felt the impact of the drought on their performance this year. In the recently-declared results for the June 2012 quarter, leading companies (Nestle India, Godrej Consumer, Marico and HUL) grew net sales between 10.8% and 39% year on year, while their net profit grew between 15% and 112%. Analysts at brokerage houses pointed out that they benefited from strong volume growth, coupled with earlier price hikes. However, the Business Standard newspaper pointed out that the impact of a weak monsoon would be felt only later in the second half of calendar year 2012, when the impact on farm output and rural income and demand would be clear. There is always a lag effect in FMCG, said Kaustubh Pawaskar, FMCG analyst at Sharekhan. Apart from drought relief measures, media reports indicated that the government may allocate additional funds for the MGNREGA to provide a measure of security to rural incomes. Analysts and marketing strategists suggest that as the rural economic situation evolves, FMCG companies may have to take the following into account.
THE WAY AHEAD Suggestions Expand distribution network, ensure enhanced sampling of products. Impact
Will help you get new

consumers in rural areas.

Will help offset weakness in

sales. A drought-like situation, would hit sales in one region, but this strategy will help you achieve customers in new markets and sustain the sales momentum. Adapt to fluctuations in input costs.
While price hikes may be

difficult for consumers to absorb, prudent hikes may be resorted to. However, if you can absorb part of the input hikes, try and pass them on when the economic situation improves. This will help build a consumer base with long-term loyalty.
Expand the concept of

Launching more value-formoney products/sub-brands across categories. Remember, even the urban 10

sachets. Lower price points helped FMCG companies deal with the drought in 2009.

Suggestions consumer would check expenditure when food and other prices rise.

Impact
This could be relevant in

the current scenario. Marico, for instance, has lowered the price of Parachute oil in response to weakening of key input costs. Analysts expect this will help Marico maintain sales momentum. Experts stress that savings for companies, in terms of lower advertising and promotional costs could be passed on to the consumer. This would help build long-term relationships with consumers.

As Jagdeep Kapoor, managing director, Samsika Marketing Consultants, told MSLGROUP India: FMCG companies should not get overly perturbed by an expected drought. They need to be aware of the emerging developments in the broader environment, but try and go about business as normally as possible.

Take a holistic view of advertising and promotional budgets.

Photo by Benjamin Chun on flickr

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