The summer of 1967 was the summer of love. It was the summer of hippies, of flower power and of counter culture; when Scott McKenzie sang that in San Francisco there was a whole generation with a new explanation. Yet on the other side of the US something far more influential was happening that would soon send its vibration not just across the nation, but across the globe. In Pittsburgh that summer, a franchisee of McDonald’s (US:MCD) introduced the Big Mac to its fast-food restaurant.
Weighing in at 7.6oz, a Big Mac comprises two 1.6oz beef patties, cheese, iceberg lettuce, pickles and onions, topped with a ‘special sauce’, all sandwiched into a triple decker sesame-seed bun. It was the meal on the go that came to epitomise both mainstream American culture and junk food. True, a Big Mac hardly counts as healthy eating, but it’s not quite the nutritional nightmare that its critics suggest. The US version – Big Macs vary from country to country – carries 530 calories, which is about the same as 10 ‘fingers’ of Nestlé’s Kit Kat. Put another way, every day a man could eat a Big Mac for breakfast, lunch and supper and still have almost 1,000 calories of his recommended daily intake to spare, more than enough to wash down each meal with a can of regulation Coca-Cola. Of course, you wouldn’t want to contemplate the long-term effects on his colon and, besides, a single Big Mac contains 48 per cent of the recommended daily intake of saturated fat.
However, we’re interested in this object because a Big Mac is the emblem of McDonald’s Corporation and the history of McDonald’s is all about the ability of truly great entrepreneurs to innovate; in the words of the original management guru, Peter Drucker – in his 1985 book, Innovation and Entrepreneurship – in their ability to spot “the inadequacy in an underlying process that is taken for granted”.
It’s not that McDonald’s invented the hamburger restaurant or fast food. In the US, both had been around for decades when, in 1954, a salesman of milkshake machines, Ray Kroc, happened upon the Californian fast-food operation of two brothers, Dick and Mac McDonald. The brothers already had fast food down to a fine art, focusing on a very limited menu – hamburgers, french fries, soft drinks and milk shakes – that they served up at the lowest possible prices in the fastest possible time.
It was the combination of big sales volumes of limited lines of stock – enhanced by the superfast service and reliability that encouraged customers to return – that generated brilliant profit margins. In that sense Kroc, who bought out the McDonald brothers in 1961, did not so much see the inadequacy in the underlying process as spot that McDonald’s offered such a neat solution to mass-market restauranting that it could crush the competition. And Kroc added his own element of genius, which was chiefly an obsession with precision and quality – the precision that adapted a caulking gun for catering use so that exactly the same quantity of sauce was squirted onto each burger; the quality that insisted that, if a customer had to wait longer than five minutes for an order, then it came free.
Whatever the criticism that McDonald’s has run into for decades now – for contributing to obesity, offering its employees ‘McJobs’, targeting children in its advertising – the brilliance of the company is reflected by the brilliance of its share price performance. Its shares were floated on the New York Stock Exchange in 1965 at $22.50 each. Factoring in the 12 stock splits since then, 100 shares bought on flotation – therefore costing $2,250 – would now equal 74,358 shares and, at $94.98 each (a recent price), would be worth $7.06m. Put another way, since then the value of the shares has compounded by 17.5 per cent a year. In contrast, the value of shares in all US-quoted companies, as proxied by the S&P 500 index, has grown at the rate of 6.7 per cent a year. To make that difference more explicit, $1,000 invested in McDonald’s in 1965 would today be worth $3.14m while the same amount invested in the S&P 500 index would be worth less than $26,000. Whatever it might do to your cholesterol levels, a Big Mac is good for your bank balance.
What’s true for Big Macs and McDonald’s is also true for other business processes and companies that were shaped by entrepreneurs who took the inadequacy in the underlying process and spotted the solution. Thus Clarence Saunders figured out the solution to the high overheads that crippled many small grocers and in 1916 invented the supermarket when he opened a self-service store in Memphis, Tennessee – Piggly Wiggly – that drastically cut down on staff numbers. Or in 1935 Howard Johnson found a solution that Ray Kroc would later use to accelerate the expansion of McDonald’s. Small-time restaurant operators often struggled with the quality of the food they offered and the lack of variety on their menu. Johnson’s solution was to introduce the franchise system. In return for a fee and captive sales, his company offered centralised buying and a prepared menu to ensure consistency and quality across a growing chain of ‘HoJo’ restaurants.
These inadequacies are all around us. They are there, but most of the time they’re accepted; they’re part of the scenery. It takes a business genius to grasp the solution and then to make money out of it. For investors, the trick is to spot the quoted company – it will probably still be small and young – that is doing for its particular patch what Ray Kroc did for fast food.
26: A bar of Imperial Leather soap – the power of fast-moving consumer necessities
Imperial Leather – it’s an odd name for a bar of soap. Why call soap ‘leather’? That’s partly why we’ve chosen Imperial Leather as an investment object, because there is a little story, and a lot of history, behind it. Besides, Imperial Leather nicely illustrates the point we want to get across, which is about the power – and the importance – of so-called ‘fast-moving consumer goods’, which are so familiar nowadays as a product category that they are shortened into their own very inelegant acronym – FMCG.
Back to Imperial Leather. The product has its origins in late 18th century London when George III was on the throne, Britain was fast becoming the richest nation on Earth and – thanks to that – there was an early form of a consumer boom. In the demand for new and interesting products, a Russian nobleman commissioned a cologne from perfumers Bayleys of Bond Street that would remind him of the imperial Russian court, then at its most splendid. Bayleys duly came up ‘Eau de cologne ImperialeRusse’ – somehow its scent would be better if its name was in French – and used birch oil to give the cologne its distinctive aroma. Since birch oil was used in the tanning process for leather and since Russian leather was fine quality – although, quite likely, its bear skins were better – it seemed quite natural to bring ‘leather’ into the title. At least that’s what the firm of Cussons did when they took over Bayleys in the early 20th century and used the cologne as the scent for Imperial Leather soap, which was launched in 1938.
There is no connection, therefore, between ‘imperial’ and the former British empire, which is a bit odd because – apart from the UK – it is in the former empire that Imperial Leather’s sales are strongest, especially in Nigeria and Ghana. In large part that’s due to the 1975 takeover of Cussons by a Scottish/Greek trading house, Paterson Zochonis, whose imperial links were strong and which is now called PZ Cussons (PZC).
However, wherever they are from, the shoppers who buy Imperial Leather do so for much the same reasons that all consumers target their own chosen fast-moving consumer goods. They are buying stuff they need and therefore the purchase is important, but it’s not a big one. It’s a small but necessary purchase that they’ll make time and again; one which they won’t want to dither over. As such, they need a product they like, but – more important – one they trust.
That’s what fast-moving consumer goods are all about – trust. The bar of soap you buy should do the job. It should smell nice, makes lots of lather, last an acceptable amount of time and stay firm even when it’s left in the water. Similar criteria apply to shampoo, detergent, toothpaste, and toiletries of all sorts. From there they extend to processed food and drinks – although soft drinks much more than alcoholic ones – and, dare we mention it, to tobacco.
If fast-moving consumer goods are so important to shoppers then inevitably they become important for the companies that make them and for the investors who own the companies. Their merit is in the certainty that they will be purchased – week after week, month after month; without thought, without contemplation, without effort.
That makes them a valuable product. For the manufacturer it means an assured stream of income that flows continuously. So companies that specialise in FMCGs have wonderfully reliable cash flows. They are not like those companies that depend on comparatively few large contracts, where the work is often done long before the cash comes in. Sure, such companies can ‘book’ a profit in their accounts when they bill their clients. But an invoice isn’t cash; it won’t pay the companies’ own bills.
FMCG makers don’t have this problem. The gap between making the goods and bringing in the cash is much shorter. True, they are often supplying the big supermarket chains that have made a fine art of ensuring that they have sold the goods before they pay for them. Even so, because the turnover of goods is so rapid, both retailer and manufacturer get good cash flows – even if the retailer’s are a little better.
And, of course, we are talking about giant-sized products. Among the range of products whose annual sales are over $1bn, the Anglo-Dutch consumer goods maker Unilever lists the Dove brand of ‘personal care’ products (ie, soap, shampoo and antiperspirant), Flora margarine and the Magnum range of ice creams. Similarly, Unilever’s giant US rival, Procter & Gamble, lists Crest toothpaste, Gillette razors and Head & Shoulders shampoo.
Marketing people will immediately say that consumers’ loyalty is to the brand not to the producer. So consumers will happily mix, say, Dove products with Head & Shoulders. It does not even occur to them that they are made by different – and rival – companies.
From the perspective of investors, it does not much matter, either. What’s important for investors is the strength of a brand, the loyalty it commands from consumers and whether the multinational consumer-goods company they invest in has enough such brands to ensure good cash flows and profits.
And the very fact of their high share ratings indicates both that the leading FMCG companies do have sufficient numbers of powerful brands and that investors are willing to pay handsomely to get a slice of their cash flows. For example, recent multiples of earnings per share to share price – the so-called PE ratio – commanded by the global leaders in the field were 22 times earnings for Procter & Gamble and almost 21 times for Unilever and for Nestlé, the Swiss giant that focuses on processed foods and bottled water via brands such as Nescafé and Perrier. As for PZ Cussons, the maker of Imperial Leather? In comparative terms, it’s a little company without the scale of, say, the mighty Unilever. So its share rating lags a bit, coming in at 15 times earnings.
