"I
began my career," says Peter Klein, "selling drugs on the corner of
Haight and Ashbury in the 1960s." True enough: The drugs in question
were over-the-counter medications like Vicks and Nyquil, and Klein was
selling them to pharmacies (including one at that famous location) as a
management trainee for Richardson-Merrell Inc. It was a good beginning
for an ambitious young man with no flowers in his hair, though not for
the reasons he thought. For just as the Age of Aquarius was dawning,
the sun was setting on the last great period of growth for the
consumer-products industry. Industry leaders would take time to react,
but by the early 1980s, they were battling for market share -- and Wall
Street's approval -- with countless turnaround plans, re-engineering
schemes, adjacent expansion strategies and, above all, acquisitions.
The wave of transactions, which continues to this day, involved many of
the biggest and best-known companies in the world. Richardson-Merrell,
for example, became Richardson-Vicks Inc. and then a part of Procter
& Gamble Co., which won it in 1985 after Unilever put it in play
with a hostile bid.
Klein had long since moved on by then, preferring to climb the
ranks at Johnson & Johnson, Gillette and Sterling Drug Inc. before
becoming a consultant in the early 1980s. But throughout his long
career -- and especially in the last decade, when he held the top
strategy and business development jobs at Nabisco and then Gillette --
he has been involved in one way or another in much of the action as
this huge, mature sector has tried to reconfigure itself in a changing
world. Klein's role has never been a highly public one; that's for
CEOs. Instead he has stayed in the background, in that vital spot where
strategy meets execution. "So," he says, beginning an interview with
typical humor, "this is Tonto, coming out of the tent."
If Klein is Tonto, the Lone Ranger would have to be Jim Kilts, the
disciplined, analytical consumer-products executive credited with
turning around dozens of brands over the years, from Kool-Aid to Post
Cereal. The relationship dates back to 1982, when Kilts was at General
Foods Corp. and hired Klein as a consultant. Kilts went on to work at
Kraft Inc., ultimately becoming executive vice president of worldwide
food operations at Kraft's then-parent, Philip Morris Cos. But what he
(and, by extension, Klein) is best known for are two consecutive home
runs: fixing up Nabisco and selling it to Philip Morris for $14.9
billion in 2000, and then fixing up Gillette and selling it to P&G
for $54 billion in 2005.
Gillette's sale to P&G was the largest-ever consumer-products
transaction, making P&G the world's biggest consumer-products
company, with combined annual revenue of more than $63 billion. It's
also a giant test case of the ability of an acquirer to combine
seemingly complementary businesses, take advantage of diverse
geographic strengths and make huge scale pay off.
The Nabisco sale was a coda to the over-reaching $31 billion
leveraged buyout of RJR Nabisco Inc. by Kohlberg, Kravis Roberts &
Co. in 1989. Because Nabisco was combined with Kraft, recently spun out
of Altria Group Inc. (as Philip Morris is now known), it was also a big
step in the unwinding of the 20-year strategic tie-up between food and
tobacco.
At both Gillette and Nabisco, Kilts was hired as the chief executive
officer and quickly brought in Klein as one of his key recruits.
Klein's job was nearly identical at both companies: He was in charge of
drawing up the strategic plan, which defined the company's goals and
documented how to achieve them. Dealmaking for him has always been part
of a bigger picture. Now a consultant again (his Rye, N.Y., firm is
called PK Associates LLC) he regularly tells his clients to be wary of
the "zeal to deal." By that he means making key M&A decisions in
the heat of the moment, instead of taking a longer-term approach and
seeing deals as an extension of a plan.
It's the kind of common sense that executives in an industry under
pressure often manage to forget -- and Klein's industry offers many a
case in point. Take, for example, Kellogg Co.'s acquisition of Lender's
Bagels for $455 million in November 1996. Three years later, the
attempt to move into the broader breakfast market was deemed a failure.
Kellogg sold Lenders to Aurora Foods Inc. for $275 million, 60% of its
original price, and the company took a $170 million hit to its earnings.
The desperation to deal comes from the simple fact that the industry
is not growing. For the past 25 years consumer-products companies have
struggled to keep pace with the overall economy and have grown at less
than 1%, simply tracking population growth in developed countries.
As a consultant at Marketing Corp. of America in the early
1980s, Klein saw the transition unfold. Companies shifted attention
away from product development and focused on grabbing market share,
usually through more advertising and more acquisitions. Consolidation,
Klein believes, exacerbated this shift and created a vicious circle.
Senior managers departed as their companies were acquired, leaving
fewer executives with experience in product development. Meanwhile,
companies were having trouble recruiting young talent; many of the best
and brightest went into the roaring financial services sector.
And the best-known brands in the supermarket weren't getting any
younger. Saltines date back to 1876, Coca-Cola to 1886, Juicy Fruit gum
to 1893, Kellogg's Corn Flakes to 1906, Hellmann's mayonnaise to 1912,
Land O'Lakes butter to 1921, Birds Eye frozen foods to 1930, Ragu pasta
sauce to 1946, Häagen-Dazs ice cream to 1959 and Gatorade to 1965.
To be sure, consumer-products companies in the 1980s were trying to
innovate, just as they are today. In 1984 Klein was hired by Oscar
Mayer Foods Corp., where Kilts had recently become a general manager,
to evaluate one of its new products -- stuffed frozen hamburgers. Klein
suggested scrapping the frozen burger idea since Oscar Mayer was
spending money to learn things about the frozen-food business that
industry leaders had known for decades. Instead, he suggested extending
Oscar Mayer's brands of deli meats and cheeses. The result was
"Lunchables," packaged school lunches consisting of crackers, cheese,
deli meats and desserts, which soon became a billion-dollar business.
But Lunchables was an exception -- the more so, since most
innovations come from outside the big companies. "More than 80% of new
products fail," says Klein, who studied marketing and finance at
Syracuse Univerity, earned an M.B.A. at Harvard and has no doubt that
stuffed frozen burgers would have failed too.
Klein continued his consulting career at the Cambridge Group, which
he joined in 1991. And he continued to work on the buying and selling
of several supermarket aisles' worth of brands, divisions and
companies, including Pine Sol, Gatorade, Tropicana and Mennen. Jim
Kilts was a big client, but not his only one.
That changed in 1998, when Kilts was hired as the CEO of Nabisco. It
was almost 10 years after the "Barbarians at the Gate" buyout. KKR had
exited in 1994, but the separation of Nabisco from RJR, one of the
original objectives of the deal, was still hung up in the world of
tobacco litigation. Nabisco itself was struggling. A heavy debt load
limited financial flexibility, its distribution system had been damaged
by cost cuts and it lacked an international division, which KKR had
divested to pay off debt. "This put the company at a major disadvantage
because it was operating in a global market," says Klein.
Kilts hired Klein as vice president of strategy, corporate planning,
e-business and marketing services. Klein drew up a strategic plan and
then got to work on item No. 1: turning around the biscuit division,
whose profits were falling fast, despite popular brands like Ritz
crackers, Wheat Thins, Fig Newtons and Oreo cookies.
Seeking to increase productivity, the previous executives had
restructured the biscuit division sales force. Originally, one sales
person drove the trucks, stocked the shelves, set up displays and
maintained a relationship with the store manager. Under the new system,
a different person was assigned each function. The system was rolled
out nationally before it was tested on a much smaller scale. Many
senior people in the sales force responded to the change by quitting.
"They changed their distribution system and got it all wrong," says
Klein. After studying what went wrong, Klein and Kilts brought back the
original structure and rehired some of the senior sales people who had
quit.
The marketing plan also suffered from mismanagement and neglect. In
the five years before Klein joined Nabisco, the unit's advertising
budget had fallen to historical lows. Klein discovered that several
viable brands, including Snackwells, Ritz crackers and Fig Newtons, had
been all but ignored. Nabisco then decided to invest $50 million in
marketing, increasing the advertising-to-sales ratio by 50%.
Shrewd acquisitions played a big role in the turnaround
plan. Klein's team identified gaps in the product line, and in
September 1999, Nabisco bought Favorite Brands International Inc. out
of bankruptcy for $475 million -- a deal that was within the company's
limited means. Favorite brands had been a hodgepodge of companies
thrown together, but never fully integrated. Its brands included
Jet-Puffed marshmallows, Trolli Gummi candies and the Sathers &
Farley's candies.
"We saw hidden value in Favorite Brands," says Klein, explaining
that the brands, especially Trolli, complemented Nabisco's Life Savers
unit. Previously undermarketed, the brands could be sold through the
stronger Life Savers distribution system. The deal also made possible
the introduction of Gummi Savers, now a significant product in the $700
million chewy-candy sector.
Nabisco was also eyeing United Biscuits, but here it lacked the
financial firepower to proceed alone. After initially competing against
a team consisting of French food company Groupe Danone and financial
partners Paribas Affaires Industrielles, or PAI, Cinven Ltd. and DB
Capital Partners, it teamed up with them and bought United Biscuits in
a joint venture. Along with a stake in the JV, Nabisco was able to buy
outright some of United Biscuits' holdings in China, Hong Kong and
Taiwan. (Danone, meanwhile, bought its operations in Malaysia,
Singapore, Scandinavia, Finland, Poland and Hungary.) The deal turned
out to be a cost-effective way to restore some of Nabisco's
international reach, since most of United Biscuits operations were in
Europe.
The turnaround was progressing, but Nabisco's stock remained
depressed because of its relationship to parent RJ Reynolds (still its
majority owner), which was facing billions of dollars in potential
tobacco liabilities. Raider Carl Icahn had already made several
attempts to buy Nabisco before Kilts and Klein joined the company. In
2000 he made another, offering a hefty 40% premium to the company's
stock price. The board of directors put Nabisco on the auction block.
Klein became immersed in the process, facilitating the development of
the prospectus, working closely with the investment bankers on the deal
and working on the management presentations to prospective buyers.
In June 2000, Nabisco was sold in a complex deal. Philip Morris
bought Nabisco Holdings, the food unit, for $14.9 billion. Nabisco's
parent company RJ Reynolds, meanwhile, assumed any tobacco liabilities
associated with the deal along with $11.8 billion in cash that was on
Nabisco's balance sheet.
Philip Morris wanted Nabisco to combine with its Kraft unit, which
it had captured in a hostile deal in 1988 as a bulwark against its
tobacco liabilities. For Kilts and Klein, this was familiar territory.
As senior vice president of strategy and development at Kraft in the
late 1980s, Kilts was in charge of defending Kraft from Philip Morris'
original tender offer, helping to get the price up from $90 a share to
the $106 a share Kraft eventually fetched. After the deal was done
Kilts was in charge of integrating Kraft with Philip Morris' existing
food business -- his former company, General Foods, which Philip Morris
had captured in 1985. Klein worked on that integration as well, helping
to combine the two North American sales forces.
In 2000 the task would be to integrate Nabisco with Kraft. Klein
stayed on to help, working with Irene Rosenfeld, then a rising star at
Kraft and now chairman and chief executive officer of the company.
Klein oversaw a Nabisco steering committee, which suggested ideas for
integration, but Kraft was responsible for the ultimate plan. The
hardest part for Klein was watching Life Savers, a unit he helped
build, be dismantled. To get regulatory approval for the Nabisco deal,
either Altoids or Life Savers' breath mints unit needed to be divested.
Philip Morris decided to sell the Life Savers unit.
"It was a difficult decision, hard to comprehend," says
Klein, who recalls being told that Altoids was a global brand with
significant growth opportunities. Klein disagreed. Less than 10% of its
sales were outside the U.S., he says. And while Klein was unsure
whether Altoids had any new products it its pipeline, he knew that Life
Savers sure did. Also by selling almost half of the Life Savers unit,
which had been bigger than Altoids to begin with, it would become
smaller and lose some of the benefits of scale.
After Nabisco, Klein planned to get back into consulting. But Kilts,
who had been hired in 2001 as CEO of Gillette, once again knocked on
his door.
Gillette, like Nabisco, was a major turnaround play. The company had
missed analyst's forecasts for 14 straight quarters. The way Klein saw
it, the biggest problem was that the company had become very insular
and inefficient. It would pay bills in 15 days but take 120 days to
collect debt. Sales meetings were held 10 to 15 days after the books
closed each month, not daily. There were few staff meetings or
quarterly reviews. Managers were not held accountable and didn't strive
to meet performance objectives; few even knew what exactly was expected
of them. The board of directors only paid out between 20% and 40% of
its bonus pool each year.
As vice president of strategy and business development, Klein once
again developed a three-year strategic plan for the entire company.
Gillette hadn't created such a plan since 1992. "No one was planning
for more than one year in advance," says Klein. The problem, he says,
"was more or less self-inflicted."
Klein and Kilts began by redefining the company's organizational
structure, laying out clearly defined rules and responsibilities. They
didn't replace most executives, though there were some musical chairs.
Weekly staff meetings created a venue where managers could be held
accountable to each other, not just to Kilts and Klein. Reorganizing
made a big difference. By 2005 the board of directors doled out about
95% of the bonus pool to employees.
With the organization functioning, Kilts and Klein turned their
attention to revamping the business. A major challenge was recovering
from a badly bungled acquisition. Gillette had paid KKR close to $8
billion, including assumed debt, for battery maker Duracell
International Inc. in September, 1996. But according to Klein, key
people from Duracell were lost after the acquisition, and Gillette
focused on selling its high-end Ultra brand to the exclusion of some of
its better-known, more midmarket brands, like CopperTop and Duracell
Plus.
Under the new plan, Duracell would focus on all three brands and
look to grow the business' margin faster than the battery business as a
whole. To do this, executives were given quarterly and annual goals,
which Klein and Kilts ensured were met. The other objectives outlined
under Klein's three-year plan included: to expand the company's market
share in the razor business, to grow Oral- B's manual toothbrush
business and to improve its electric razor business. Across the board,
Klein and Kilts found that Gillette executives had focused on high-end
products to the exclusion of its bread-and-butter businesses.
The three-year plan helped improve the company's business and its
stock performance. Nevertheless, Gillette was still overly dependent on
razors and blades. And with about $10.5 billion in 2004 sales, it was
dwarfed by consumer-products giants such as Unilever and Procter and
Gamble.
Klein believes that larger companies have many competitive
advantages. They have more power when it comes to procurement and
research and development. They also can invest in areas that are out of
reach for smaller competitors. Frito-Lay's extensive distribution
system and Anheuser-Busch's advertising campaigns are examples. Larger
companies can also exert more pressure against retailers, especially
behemoths like Wal-Mart Stores Inc., for shelf space but can also work
with them as a global partner.
In one of the many presentations Klein uses in his
consulting work, he puts the advantages of scale this way: "It's the
ability to invest in building capabilities which are distinguishable
from competitors, like: assessing and integrating acquisitions,
managing investor relations and specific areas of technical expertise."
Big firms can make investments, adds Klein, "while smaller firms go
broke with one idea."
When Gillette decided to look for a big merger, Klein's role once
again was to advise the board of directors and work with management and
investment bankers. This was not the first time the company had
considered a merger. Two years earlier, Kilts approached his
counterpart at Colgate-Palmolive Co., Reuben Mark, to discuss a
possible "merger of equals," but the sides couldn't agree on a
valuation and who would run the combined company. In 2004, Gillette
approached Colgate again and the results were pretty much the same. But
four months later, Gillette began talks with Procter & Gamble,
which bought the company in February 2006 for $54 billion.
For Gillette, selling to P&G would reward shareholders and solve
the size problem. For P&G, committed by chairman A.G. Lafley to
look outside the company for growth, the deal was an attempt to build
out its portfolio. One area that P&G was particularly interested in
was Gillette's toothbrush business. P&G's toothpaste brand, Crest,
has been trying to gain market share from the industry leader, Colgate,
for years, and P&G hoped the deal would help it gain a competitive
edge in the dental isle. The idea is to pair Gillette's number one
toothbrush, Oral-B, with Crest toothpaste, similar to the way shampoo
and conditioner are packaged as an extension of a single product.
According to a recent Wall Street Journal article, the idea has yet to
pay off. One hurdle: getting Oral-B staff to move from Boston to
P&G headquarters in Cincinnati, where a Gillette manager decided
the operation needed to be.
Another big driver for the deal was that the two companies could
help each other expand internationally. Over the years, P&G has
developed top-notch distribution systems in such fast-growing markets
as China, Russia, Poland and the Philippines, and the chance to move
Gillette's products through them was an important reason for the deal.
Gillette has its own strengths in such countries as India and Brazil
and could help P&G in those markets.
On the international fronts, things seem to be going well. P&G
cited strong growth in developing markets when it announced earlier
this month that net income was up 14% (to $2.51 billion) in its fiscal
third quarter. Overall, P&G's businesses and stock have performed
well since the deal, though in a bond prospectus filed in May, it noted
that the integration of Gillette continues.
While Klein believes that P&G's scale will help it compete in
the years ahead, he sees three key challenges for all the
consumer-products companies. The first is intensifying competition.
Retailers are growing steadily more powerful, and their growing lineups
of private-label products pose a serious threat to manufacturers.
The next challenge for consumer-products companies will be figuring
out how to become more efficient. "A lot of the low-hanging fruit has
already been picked off," he says, adding that companies would be well
advised to rethink what their core businesses are and what functions,
beyond the back office, can be outsourced.
The last challenge may be the toughest of all: It's the shortage of
good people going into product development and marketing in this
now-mature industry. Yes, Kilts has earned spectacular rewards for his
work in the field: a total payout of $77 million after the sale of
Nabisco and as much as $165 million from the sale of Gillette. Klein,
too, has presumably done well in these deals, though he declines to say
how well.
But those prizes were years in the making, and they won't be easily
duplicated. These days, the young Peter Kleins of the world are much
less likely to go into consumer products. As they make their way,
though, they'll still do well to consider the lessons Klein and his
colleagues have learned over the years. CD
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