theskeptic's Journal: P&G's Gillette Edge:The Playbook It Honed at Wal-Mart

Consumer-Products Giant
Helps Huge Retailer Make
Specialty Items Mainstream
Coffee Beans for Beginners
By SARAH ELLISON, ANN ZIMMERMAN and CHARLES FORELLE
Staff Reporters of THE WALL STREET JOURNAL
January 31, 2005

Procter & Gamble Co. Chief Executive A.G. Lafley has a strategy in mind for Gillette Co., and he learned it from navigating one of the business world's most intertwined relationships -- P&G and Wal-Mart Stores Inc. His approach: Take mundane products and make them so glamorous and distinctive that the world's largest retailer won't be able to resist them.

Mr. Lafley realized soon after becoming CEO nearly five years ago that Wal-Mart's strategy is not only to supply products at the lowest cost but to get people to turn to Wal-Mart for things they normally find elsewhere, at specialty stores, restaurants or even the doctor's office.

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  Graphic: Key brands at Gillette and P&G

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So P&G is upgrading its Olay face creams and marketing them as better than department-store brands and just as good as a botox shot from a plastic surgeon. Tooth-whitening used to be an expensive process that was available only at the dentist's office. P&G's Crest Whitestrips gave it a $25 price tag and made it possible for the masses. P&G, maker of the Actonel osteoporosis drug, helps women get bone-density tests in stores instead of a doctor's office. All of this is available at Wal-Mart. And now that P&G is buying Gillette for $52.4 billion based on Friday's close, P&G is likely to push even more such programs using Gillette brands.

For P&G and Wal-Mart, "it's a lot like a marriage," says Lou Pritchett, who, as P&G vice president of sales, met with Wal-Mart founder Sam Walton to establish the companies' relationship in 1987. "Sometimes you want to slice each other's throats, and there are other times when it's a love-in."

Fully 17%, or $8.7 billion, of P&G's $51.4 billion in sales come from Wal-Mart's 5,100 stores world-wide. The companies link their computer systems and share sales data and marketing plans. One of P&G's largest offices outside its Cincinnati headquarters is in Fayetteville, Ark., down the road from Wal-Mart headquarters. The two companies cozy up to each other, only at times to pull back and compete fiercely.

Being the best-selling brand is always a goal for consumer-products companies. But it has become a matter of survival as Wal-Mart has become a bigger player in the world of retail. Wal-Mart is brutally focused on stocking only a few brands on its shelves. Moving products quickly through its stores is crucial to the company's profitability, so Wal-Mart swiftly abandons products that aren't selling well.

Before becoming CEO, Mr. Lafley ran P&G's beauty business, which trained him in the power of selling an upscale image. He aims to push brands that were once mid-tier into the premium echelons. "Here's our real strategy -- secret sauce. We want to make the ... middle to the top of the market as big as it can possibly be through innovation and new ideas," said Mr. Lafley, in an interview as he was laying out his strategy in the summer of 2003.

The drive by P&G, Gillette and Wal-Mart to offer increasingly elaborate products at reasonable prices is helping reshape consumer taste across America. Items like cappuccino makers and spa treatments that were once the domain of specialty stores in cities on the coasts are now common throughout the country. Wal-Mart argues that it forces suppliers to become more efficient and passes gains to consumers in the form of lower prices and a broader selection.

P&G's acquisition was not driven by a desire to have greater leverage with Wal-Mart, Mr. Lafley said in an interview Friday. Asked if the balance of power has shifted to suppliers, he likes to reply, "The power has shifted to the consumer." P&G says it offers the same programs to all its suppliers and doesn't give any special treatment to Wal-Mart.

Instead, Mr. Lafley spoke of the potential of expanding into products like women's shaving, a market Gillette leads with its Venus brand but one that isn't nearly as developed compared with its men's lines.

Mr. Lafley, who had already established himself as P&G's most acquisitive CEO, buying up beauty companies like Clairol and Wella, wasn't looking for a deal. After expanding a restructuring that had begun under his predecessor, Mr. Lafley was finally shaking the nagging concern on Wall Street that P&G relied on one kind of restructuring program or another to achieve earnings growth. In recent months, he has told investors P&G was focused on internal growth, not dealmaking.

So when Gillette CEO James Kilts initially approached Mr. Lafley last fall, the talks didn't go far. Then earlier this month, Mr. Lafley, attracted by Gillette's brands, went back to Mr. Kilts and they quickly hammered out a deal. The acquisition of Gillette would be far larger than any previous acquisition in P&G's 168 years. Its next largest was Wella for $7 billion.

For both P&G and Gillette, Wal-Mart is the largest single seller of their products. It accounts for 13% of Gillette's $9.25 billion in annual sales. P&G's sales at Wal-Mart traditionally have grown faster than its total company growth rate, which was 19% in its last fiscal year, ended June 30. Wal-Mart has even lately worried about suppliers becoming too reliant on it, noting that any time companies rely too much on each other, they inherit all the risks of the other.

Close partnerships between stores and manufacturers are becoming more common now, with such retailers as Costco Wholesale Corp., Target Corp. and Carrefour SA of France moving to that model. P&G and Wal-Mart pioneered the idea and created the template for others. So many manufacturers have offices near Wal-Mart that they dub the town "Vendorville." P&G and Wal-Mart representatives declined to discuss their relationship, citing a policy not to discuss supplier-retailer relationships.

About 300 people work in P&G's Arkansas office, overseeing sales of its brands to Wal-Mart and devising cross-marketing and other tie-ins. After a few years on the account, P&G tends to send managers on to the next assignment because they can often start to identify as much with Wal-Mart's needs as with P&G's, says Tom Muccio, who headed P&G's Wal-Mart team until retiring last year.

"The people were paid by P&G and sat in P&G's office, but it was like they were working for Wal-Mart and P&G equally," Mr. Muccio says. "The payroll just happened to come from P&G."

When Wal-Mart discovered a downside to P&G's and Gillette's pricier products like Crest Whitestrips and Mach3 razors -- these products were the most popular to steal -- it turned to the suppliers for an answer. One Saturday in January 2001, Tom Coughlin, a Wal-Mart vice-chairman, summoned executives from both companies to Bentonville, asking them to fix the problem, Mr. Muccio recalls.

So, P&G altered its packaging to make its products harder to steal. It changed its Olay package from a box to a clear plastic container with a flat piece of cardboard, known as a "clamshell" because it is so difficult to open. It made the Crest Whitestrips package larger and added an extra layer of plastic. It assumed the extra cost. Gillette also adopted clamshell packaging for its razor packs. For the blade refills, it created a clear-front, plastic dispenser system fitted with drawers that let customers take just one package at a time.

Until Messrs. Walton and Pritchett canoed down Arkansas' Spring River for two days in the summer of 1987, there was barely a relationship between the two companies. "We shipped them products and they sent us a check back," says Mr. Pritchett. "It was we sell. You buy. Good-bye." Years before, Wal-Mart had named P&G its supplier of the year, and P&G hadn't bother to show up to pick up the award.

But advances in technology made Mr. Pritchett believe the two could work together to sell P&G products more efficiently. Mr. Pritchett proposed that P&G share some of its consumer research with Wal-Mart in exchange for a better picture of how P&G's products were selling. Mr. Walton agreed, as long as Mr. Pritchett could sell the idea to his "Yankee bosses." Mr. Pritchett realized then how little the two companies knew about each other. "Cincinnati is in the Midwest," he recalls thinking. (Mr. Walton died in 1992. Mr. Pritchett, who has retired from P&G in 1989, now advises companies on the importance of partnerships.)

Early on, P&G employees, who relocated to Fayetteville to be close to Wal-Mart, called their adopted home Fayette-nam, and often griped about Wal-Mart's demands. Still, P&G and Wal-Mart came up with specific goals. In their first collaboration, Wal-Mart complained that Pampers diapers sat for too long in its warehouses, costing it money. Wal-Mart buyers were shipping diapers from the factory every two weeks. After gaining access to Wal-Mart's sales data, P&G assigned one manager to monitor the data and order just enough Pampers to meet sales but not too much so that the diapers sat in the warehouse.

By the mid-nineties, as P&G was starting to struggle to maintain its sales and earnings momentum, Wal-Mart's business was taking off with the rapid expansion of its supercenters. Wal-Mart was quick to take advantage of a P&G miscalculation. P&G had let the trademark on its White Cloud toilet paper lapse in 1994, in order to concentrate on its pricier Charmin brand. A private entrepreneur snapped up the trademark and sold it to Wal-Mart. Wal-Mart started displaying White Cloud with open rolls so shoppers could touch and compare. White Cloud sales quickly increased, hurting P&G's Charmin.

P&G executives felt betrayed, executives involved in the business at the time say. All the consumer market research P&G had shared with Wal-Mart on how to sell toilet paper was being used against it. "The beauty about White Cloud for Wal-Mart was that we had built that Mercedes image and they brought it in at Chevy prices," Mr. Muccio says.

When Mr. Lafley hastily became CEO in June 2000, P&G was reeling from months of turmoil under his predecessor, Durk Jager. Mr. Jager realized P&G needed to innovate more quickly to keep its products relevant, but he went about it by trying to invent new ones like at-home dry cleaning kits and fruit-and-vegetable washes and neglected some P&G's core brands like Tide and Pampers. Mr. Lafley reversed that. He said he wanted innovation in the company's top 10 brands.

Mr. Lafley, who has a B.A. in history from Hamilton College and briefly pursued a master's degree in medieval and Renaissance history at the University of Virginia, latched onto Wal-Mart's effort to fill an ever-greater role in its shoppers' lives. P&G's consumer research helped develop specific programs for Wal-Mart that bundle P&G's products into a theme, like "Speaking of Women's Health," a nonprofit program that hosts several thousand women each year at a meeting in Cincinnati and hosts dozens of smaller events, to discuss topics like breast cancer and osteoporosis in Wal-Marts across the country. Another, "Babies First," is an initiative that supports children's immunizations, safety seats and a healthy diet. It is sponsored by Pampers, Wal-Mart and the American Academy of Pediatrics.

While P&G doesn't necessarily promote its products at such events, company marketers calculate that such events lend both P&G and Wal-Mart a halo, presenting P&G as an authority on parenting and health and Wal-Mart as a place to get an education on such topics. P&G thinks its sales of diapers increase as a result, giving its brand the clout to expand into new products like foaming wash mittens and disposable bibs.

In 2001, Mr. Muccio says P&G developed a brand of coffee, called Veneto, just for Wal-Mart. Seattle's Best Coffee, a mid-size brand then owned by AFC Enterprises, had approached Wal-Mart about selling its coffee beans for about $2 more than P&G's canned Folgers and about $2 less than P&G's higher-end Millstone brand. P&G's Mr. Muccio quickly suggested another option to Wal-Mart: P&G would develop a new mid-tier coffee specifically for Wal-Mart.

P&G came up with Veneto, a whole-bean coffee not as strong as Millstone or the similarly priced Starbucks. P&G and Wal-Mart employees on the project joked that Veneto was the Fisher-Price version of whole bean coffee, as in "my first whole bean." The product was specifically designed to appeal to consumers who had a taste for Folgers or its main competitor, Kraft Foods Inc.'s Maxwell House, but who wanted to participate in the Starbucks phenomenon. P&G's team helped Wal-Mart run consumer taste tests comparing Veneto with Seattle's Best, which is now owned by Starbucks Corp. Today, Wal-Mart stocks Seattle's Best at some stores and Veneto at others, but the P&G brand helped keep the competition from dominating that middle tier, according to Wal-Mart.

Coffee isn't even a priority product for P&G, and, with Veneto, P&G designed a product to get consumers to trade up from its own Folger's. The product, though, showed what has become one of P&G's greatest strengths under Mr. Lafley -- making consumers pay a premium for products that are only marginally different from the staples they've purchased for years.

Similarly, Gillette introduces major new product shifts in its razors every five to 10 years, and with them substantial price increases. Its trade-up strategy has a second part: As it introduces new razors, Gillette slowly pulls up the price of its "tail" brands, the older generations. Eventually, the company figures, a Mach3 user will notice that the new Mach3Turbo isn't that much more and will jump to the costlier product.

P&G is planning to leave Gillette's razor and battery businesses and its Braun line of small appliances intact, but meld the rest of the company's deodorant and other products into P&G's structure, according to a person familiar with the negotiations between the two firms. Mr. Kilts sees male skincare as an area where the companies could possibly team up to develop new products. P&G's knowledge of skincare, with its Olay anti-aging creams for women, combined with Gillette's reach with male consumers, makes it a natural, Mr. Kilts said in an interview. "That's something that exists as a sort of East Coast West Coast phenomenon now," says Mr. Kilts, "but we see it moving into the middle of the country and really taking off."