From Pricing Power to Precision: An Evolution for Consumer Companies

Podcast from Deutsche Bank Research with interviews on current economic and financial topics. Listen as economists and analysts from Deutsche Bank present their views. Welcome to Podset.

I'm Jonathan J. Ranch and the head of European Equity Research Product. I'm delighted today to be joined by three very important guests, Steve Powers in the U.S., Tom Sykes and Mitch Collett in Europe, who are respectively running our Consumer Staples franchise globally.

And of course, we've just come back from our Consumer Conference in Paris, which is our biggest marquee conference, over a thousand participants and 120 companies. It really has a fantastic buzz. It's one of our landmark conferences and indeed one of the industry's landmark conferences.

So first of all, Steve, let me welcome you to the show as head of U.S. Consumer Staples. Thank you very much for joining us this morning.

Well, thanks for having me, Jonathan. It's a pleasure. So, Steve, obviously, there's always a lot to unpack from a conference like this, and everyone understands the economic pressures that we're under right now, especially given the political backdrop.

But resilience seems to be a surprisingly strong takeaway and a recurring theme of the conference. What were your key thoughts? Yeah, I would agree with that.

I think the central message from the conference was that while the consumer is pressured, the consumer is at the same time proving more resilient than was feared, at least coming into the conference. So I don't think the message from companies in Paris last week was downbeat, certainly not downbeat relative to investor expectations ahead of the event. But I would say that the resilience we are seeing and that we heard from companies is not uniform.

What we heard consistently is a description of a far more selective, a more hesitant, and certainly a more value-conscious consumer, particularly in the United States. Consumers are not pulling back broadly all at once, but they are assuredly picking their spots. And I think that nuance is pretty important.

Demand while resilient is definitely weaker and is more volatile. Whether we look at trends week to week or month to month, we're seeing a lot more volatility. Categories tied to clear functional value are holding up better, for example, energy drinks.

And the biggest source of stability, when you look across the landscape, is actually outside the U.S., where trends were generally described by companies across the board as more constructive. I'd also say that we're entering a period where outcomes across companies are more execution-driven and the market is more clearly rewarding winners while penalizing laggards. Category exposures matter, and I'm sure we'll talk about that, but increasingly, it struck me listening to companies across the conference that as pressures are felt more uniformly across staples, success is really about how well you execute within the category and how strong your capabilities are across disciplines such as innovation and pricing and productivity versus a broad-based kind of riding the wave of category momentum.

I think if there's a third key takeaway from the conference, it's around pricing, where I think it was clear to me that the playbook around pricing has evolved. We're facing a period of time when inflationary pressures have rebuilt, but companies are no longer in a position to rely on broad-based pricing to offset that inflation or to drive growth. They're going to be forced to lean much more heavily on precision and what they describe as revenue growth management, so mixed management, price-packed architecture optimization, more targeted, nuanced promotional calendars rather than just taking list price.

I think that combined with productivity is how companies are going to be forced to manage through this period. Ultimately, demand is there for companies that are executing well, but it's a narrower window and more selective, less forgiving, and that's pushing the sector towards greater dispersion across companies. When you talk about the message of resilience not being uniform, was that more idiosyncratic across different companies or was it very much category-driven where you said that the functional value was doing better, perhaps the more discretionary spend doing less well?

I think at a high level, there is a hierarchy across categories or subsectors, so it's not a completely uniform picture across staples broadly. At a high level, the hierarchy to me coming out of the conference is pretty clear and it's similar to our expectations going into the conference. At the top of the list is non-alcoholic beverages.

I think companies participating in non-alcoholic beverages categories are generally speaking better positioned. That's driven by a combination of relatively robust category growth, particularly in categories like energy, as I mentioned, or hydration, those categories with functional benefits. Non-alcoholic beverage as an industry also benefits from global scalability.

The companies that are in stronger positions within the sector tend to have distribution prowess. They have a bigger moat around their go-to-market model and they have relatively strong pricing power and heavily evolved revenue growth management capabilities. All of that is working in the favor of non-alcoholic beverages.

That's been true and I think it remains true as we look ahead. Next to me would be household and personal care and pockets of beauty, while acknowledging that the picture across that landscape is more mixed. There are still strong, I would argue structural tailwinds in categories like prestige beauty and pockets of personal care, but you are starting to see more variability by subsector and by price tier, especially as consumers become more value conscious.

I think that's especially true in areas of home care. But next on the list outside of non-alcoholic beverages would be household personal care slash beauty. On the other end of the spectrum where I think the challenges are more pervasive are in packaged food and alcohol.

To me, those categories continue to appear more pressured. Those categories are dealing with weaker elasticity, more private label competition in areas, especially in food, and generally less pricing power. You also have category headwinds layered on top in the form of health and wellness concerns, GLP-1 implications, SNAP program reductions in the US, etc.

The sector does matter and non-alcoholic beverages are in better positions and food and alcohol are in the most challenged position. But within that, I do think that execution is increasing as a differentiator. Even within pressured categories, you're seeing companies perform quite differently depending on their portfolio construction and their capabilities.

Right now, it's often challenger brands that are outflanking larger incumbents and that's just another factor to layer into the mix. Which brings me on to the topic of innovation and organic growth, which is a key driver of organic growth. Given the consumer backdrop, is that just a lot tougher for companies to deliver?

The short answer is yes. It's definitely getting harder. I think what came across pretty clearly is that the consumer, as I mentioned, is more selective and competition is increasingly elevated, including from those challenger brands I mentioned.

That is all raising the bar for organic growth. I would also argue the bar for innovation has gone up. Historically, I think you could afford to be more incremental in your innovation and still have the desired impacts of line extensions, new flavors, and packaging tweaks.

In past periods of time, that was arguably sufficient. I don't think that's the case today. Successful innovation needs to deliver much more clear, tangible consumer benefits because the consumer is much more discerning.

It needs to be priced much more sharply in this value-sensitive environment and it needs to secure, importantly, retailer support, which is increasingly difficult to do as the retailer landscape becomes more consolidated. So, I think you have consumer challenges, you have competitive challenges, and you have a higher bar to clear in terms of the impact of innovation. Given the pressures that we're therefore seeing from all sides, clearly deal-making has been a feature of the sector of recent times.

Did you expect that trend to continue to accelerate? What are your thoughts? I think that the dynamic continues.

I don't know if it accelerates. We've seen quite a bit of deal-making over the past six to nine months across the space. But as you say, as the challenges on existing portfolios continue to rise, then it's a natural inclination for management teams to think about changing the portfolio construction, whether through addition or subtraction.

So, I do think it will continue. But I also think that public companies need to tread lightly because I think what's become clear over the past six to nine months is how the market is reacting to deal-making, especially large-scale deal-making, which is to say with a lot of scrutiny. Even where there's arguably pretty sound logic for larger strategic deals, whether it's filling portfolio gaps or increasing one's exposure to growth categories or building scale or enhancing capabilities, investors are not rewarding the industrial logic alone.

Investors are really—I think it's a show-me situation, so they need to see execution because they're very concerned about value destruction. They're concerned about distraction risk. They're concerned about increased financial risk, especially if balance sheet leverage goes up.

So, I think companies need to be thoughtful about how they approach deal-making going forward, and that probably results in a greater emphasis on smaller, bolt-on-sized transactions, targeting M&A activity at more discrete, more clearly strategic assets. And there's probably going to be more scrutiny on returns and timing because I think the market's patience for waiting for larger, arguably higher-risk deals is low right now. So, I think M&A remains part of the toolkit, but the bar to create value is higher and the burden of proof has clearly shifted to execution rather than just the base logic of certain transactions.

And Steve, when you stand back and look at all the different meetings that you've attended, the firesides that you've hosted, what did you find as the most surprising takeaways for you from the conference? Yeah, I would say there are probably three. I think first, going back to where we started, just the degree of resilience that we heard, especially internationally.

I think going in, many investors expected to hear a story of more clear demand weakening globally and more on a synchronized basis across geographies. And I think what we heard was that international markets are currently acting almost as a stabilizing force set against pressures in the U.S. So, that divergence, U.S. softening versus the international markets holding up, I think is probably more pronounced than people expected.

And to me, that's definitely something to watch, especially for global companies that are reliant on those overseas markets. I think the second thing was just how quickly capabilities, especially in the area of AI, have evolved. I think a year or two at gatherings such as our conference, discussions around those capabilities were far more conceptual.

And today, they're clearly being integrated and embedded across operational processes, whether that's pricing discipline or marketing enhancements, supply chain optimization, sharper consumer insights. AI is definitely being leveraged. Digital capabilities are definitely ingrained in company operations.

But I think what was also striking to me is that a lot of companies are doing very similar things in that regard. So, the benefits of those capabilities as true differentiators is not 100% clear to me. To not embrace the change, to not embrace the technology is assuredly to fall behind, but it's also not yet clear who is clearly gaining advantage from these technologies.

So, that will also be something to watch. And then maybe going back to what I was discussing earlier as a third takeaway is just that importance of execution and the differences we're seeing in company outcomes from across between those companies that appear more front-footed and executing well versus those who are struggling. Everyone's facing the same or similar macro headwinds, but the companies that are in a better position to execute through those headwinds are being disproportionately rewarded by the market.

And I think that also came across through the conference. That's very clear, Steve. Let's take this opportunity then to switch across to Europe.

So, let's move across to Tom Sykes, the head of consumer stables in Europe. Tom, how did the feedback from European companies differ from those in the US? Well, hi JJ.

Thank you. The full impact of higher raw material prices and how that might affect pricing and demand is similarly to US companies yet to flow through the business models of the majority of European companies that attend it. Most European stables had some degree of stocks availability or hedging up until H1.

So, pricing is only now being put into the market depending on the cadence of price negotiations across different regions. We did hear from several companies that trade negotiations with European buying alliances were taking longer than they had done previously, which given the relative weighting may affect European companies more. We also note that in the US, Amazon now appear to be the marginal price setter along with Walmart in the US, particularly in HPC.

There's no one wants to be more expensive than Amazon for the same product and Amazon don't run annual contracts. Many companies had also given cost guidance based on $100 oil previously. So, there wasn't a need to raise the cost impact and it's too early for many second order effects.

So, the inputs are known, but similarly to Steve's companies, the outcomes in terms of demand and elasticity are not, but the likelihood is that H2 will see progressively higher pricing and progressively higher impacts on demand. Companies similarly are looking to address this upcoming COGS increase by maximizing productivity so they can lower the need for pricing. They're looking to innovate so they can sell premium products to less impacted, more affluent consumers and also we heard about more value engineering of products to more value seeking consumers.

This is, of course, a natural reaction to the ongoing bifurcation of the consumer that we're seeing, particularly in the US, but also across other economies. European companies like those in the US are also accelerating portfolio change and looking to allocate capital to higher growth categories and geographies. Predominantly, this is through Bolton M&A with companies highly focused on digitally native high growth assets versus lower growth cost synergistic acquisitions, which as Steve mentioned, have had increased scrutiny by the market.

I would say as well, channel shift remains front and center with the high growth in HPC being seen across channels such as Amazon and TikTok. Over the last few years, these channels have helped drive overall demand, but have also provided a platform for smaller peers, which certainly have been taking market share. Listed staples companies have had an advantage, scale advantage in R&D production, A&P and distribution in the long run, and some of these advantages in A&P and particularly in distribution have been eroded.

You can deliver and get national coverage if you like by delivering to an Amazon warehouse versus needing to be in every store and national grocery chains. And so, yeah, those were the main impacts that we saw across our companies. Yeah, very thorough run through.

You've seen some considerable differences between geographies and income tiers. Yeah, there are, of course, many differences by geography. There were certainly heightened concerns coming into the conference that consumers in Southeast Asia and India in particularly would be impacted by affordability, headwinds and COGS increases driven by the Gulf conflict.

Overall, the commentary was less negative than we believe investors expected, although the direction of travel hasn't changed. Notable, though, was the commentary around share gains by large companies that had access to different sources of supply versus smaller peers in those particular regions. There seemed to be a little bit more optimism on China driven by wealth effects from the rising stock market, although that was still relatively low growth.

I'd say overall, Europe was seen as low growth remaining quite promotional, and LATAM overall was seen as a little weaker, although with large differences across the businesses. Overall, company commentary seemed a little more cautious, as Steve was saying, on the US, although perhaps some of the European peers were a little bit less explicit about that than some of Steve's companies. I would say it's not clear as well if some of this is caused by perhaps pre-spending of tax rebates ahead of checks, ahead of actually receiving them, or whether this is due to weaker actual demand.

But certainly the commentary around middle to lower income consumers was consistently more challenged than that for higher income, asset heavy consumers, if you like. Staples companies on the whole obviously don't have much of a wealth effect. They're not wealth effect beneficiaries, so if the stock market goes up, we don't sell more or even more expensive laundry powder.

They're a function of median real wage growth, and so therefore with increasing inflation expectations, it feels likely that real wage gains will be more challenged in the US and globally, and affordability issues will be higher for middle to lower income consumers than those who are, at least for now, sitting on significant wealth gains. Very clear, Tom. Maybe I can move across to Mitch, who's the head of beverages in Europe, but maybe before we tackle beverages, I must ask you about AI.

Obviously a major topic at the conference last year. You also published on it last year. How has that debate around AI moved on in 12 months?

Yeah, if anything, and thank you for having me, AI was an even bigger topic this year. It was pretty much in every conversation with every company, and I think the key debate remains whether the potential cost and efficiency benefits will be offset by greater competition lower entry barriers, and also price deflation driven by AI shopping assistants. I think most corporates that appeared at the conference see this as a net benefit, and I think it's generally true that larger companies tend to be more digitally enabled, but our own survey work suggests that there is some category divergence, and specifically consumers are unlikely to accept a brand substitution from an AI assistant in beer, spirits, and soft drinks, whereas they're much more open to AI-driven substitution in home care, personal care, and packaged food.

So the AI debate is going to continue. I think it's going to have a bigger impact going forward. It's still too early to know the exact impact, but it's clearly going to disrupt all of these industries to some extent.

And what were the beverage-specific takeaways from the conference? We also talked about non-alcoholic beverages from Steve's perspective, but please add your thoughts. The key debate remains whether beverage alcohol weakness primarily in the US is structural or cyclical, and clearly a big part of that debate is health and whether growing health concerns are a continuing drag to beverage alcohol growth.

As with other categories, affordability is a large and growing focus, and there is some evidence of price deflation, specifically in spirits, as well as companies targeting more affordable price points, either with value-focused brands or with smaller format innovation, which clearly come in at a much lower price point. Convergence remains a big topic, so ready-to-drink is seen as a big growth opportunity for distillers, but it is also being targeted by brewers and soft drink players, so that's ready-to-drink spirits products. At the same time, brewers are also moving into adjacencies such as soft drinks, and that's an increasing focus for several companies, as well as straight-up spirits.

So there's clearly convergence across the three main strands of beverages. I would echo Steve's point about non-alcoholic beverages being the most resilient sub-sector within beverages. I think beer has some puts and takes.

Demand is generally pretty resilient, and there is some tangible excitement ahead of the FIFA World Cup. Spirits is perhaps more challenged, and to some extent that reflects a reliance on the US, where the market has been soft for some time now, but there are some company-specific opportunities emerging, as well as some real evidence of self-help happening. Very clear, Mitch.

If I can ask you both one last question, maybe starting with you, Tom, what do you find the most surprising piece of feedback from the conference? Yeah, I think probably the near-term demand in India, Southeast Asia being a little bit more resilient, and certainly some companies talking about the degree of share gain that some companies have been talking about. It'll be interesting how that plays out in the second half of the year because certainly some of the smaller peers may be improving their supply situation.

We don't know what's going to happen with the conflict, but certainly I think some of that near-term resilience was certainly more than expected. I'd also say amongst the AI conversation was the extent to which the owners of large brands believe that search via LLMs will support larger brands versus smaller peers. LLM-based, they will create curated lists of branded products, and most of our companies believe that that will be an advantage because you will have more larger brands in those curated lists versus smaller brands.

I'm not sure I totally believe that that is a sustainable advantage, but certainly the companies are off the view that that is a near-term and longer-term advantage for them. As a consumer buyer, I can say I do use Claude Pro to make my selections these days and go through the reviews for me, so I'm certainly using that process. I haven't noticed the brand outcome yet, but we'll see.

Mitch, what's your thought? Similarly, I think the confidence with which the companies we cover are viewing the next six to 18 months, because clearly it's quite an uncertain geopolitical environment, but having been through COVID and then the cost inflationary period post the Russia-Ukraine war, I think consumer staples are more certain about their ability to manage those challenges going forward and look forward to the next six to 18 months with a greater level of certainty that they can manage any supply issues, they can deal with any cost challenges, and while it may be more challenging to take up pricing to offset those cost challenges, I think, as Steve said, there's lots of solutions to that problem. So I think the companies are a lot more confident about how they can manage that uncertainty going forward because they're just a lot more used to it now than they were.

Tom, Mitch, Steve, thank you very much for joining us and running us through the Consumer Conference, and thanks to all of you that have been listening so far as part of DB Podcept. Podcept, the podcast from Deutsche Bank Research. This podcast has been produced by Deutsche Bank and may contain research as defined in method 2.

The information discussed is believed to be reliable and has been obtained from public sources believed to be reliable, although Deutsche Bank makes no representation as to its accuracy or completeness. Opinions, estimates and projections discussed constitute the current judgment of the speaker at the time of recording. They do not necessarily reflect the opinions of Deutsche Bank and are subject to change without notice.

For further important information, please visit research.db.com.