Consumer products companies continue playing safe as M&A appetite wanes

Consumer products companies want to protect what they have and shore up lost margins rather than make bold M&A moves.

Significant shifts in consumer behavior over the last few years have been accelerated by the COVID-19 pandemic. While consumer products companies were facing headwinds even before the pandemic, the disruption companies experienced in 2020 has magnified the impact on both top and bottom lines.

According to the latest edition of the EY Global Capital Confidence Barometer (pdf), 85% of consumer products company respondents saw a decline in revenue, while 89% say their profits dropped due to the pandemic. However, many are optimistic that the pain will be short-lived. Nearly half (48%) expect revenues to return to pre-pandemic levels this year. A similar percentage (47%) think it may take until 2022 for profits to return.

This recovery is expected to remain uneven, something the sector witnessed in the second half of 2020. For example, staples saw better growth as home-bound consumers bought more and explored new varieties while growth in many discretionary categories slowed down. Within staples, the channel landscape has changed dramatically — food and beverage consumption in on-trade channels slumped but thrived in off-trade. Lack of outdoor movement, entertainment and socializing negatively impacted beauty categories, but consumers indulged in personal care products. Changes in consumer behavior likely will persist in the near term as the risk of new virus outbreaks remains and continue to drive a difference in the growth trajectories of consumer product subsectors.

As consumer products companies look to regain margins and market share, they will want to focus on three key imperatives:

1. Act fast to capture opportunities
2. Get off the M&A sidelines
3. Leverage technology to increase customer engagement

1. Make the bold moves — seize opportunities as they arise

Consumer company executives appear torn about the actions to take to transform their organizations. Respondents name divesting underperforming assets, increasing customer interactions through digital touchpoints and using technology to replace higher-cost labor as their top strategic considerations for improving profit margins. Unsurprisingly, consumer executives admit that their biggest challenge to implementing their strategy is the tension between the need to transform vs. the unpredictability of current operations.

For respondents undertaking a business transformation, executives cite their top two priorities as delivering cost reduction (28%) and creating a more flexible operating model (23%). Despite 89% of consumer products respondents highlighting a decline in revenue during the pandemic, it is interesting to note that “driving revenue growth” and “acquiring a business” are not among the top transformation levers.

Consumer products companies also have been conservative in committing capital to drive growth. The pandemic, as well as ongoing geopolitical uncertainty, seems to have increased this conservativeness, with 84% of respondents saying they have delayed or stopped a planned investment. The good news is that for 71%, the delay is a pause rather than a full-blown retreat.

That said, now is the time for consumer products companies to set aside their conservatism. This is particularly true for companies in consumer products subsectors such as staples, which are enjoying better quarters compared to the last few years. One of the lessons companies learned from the Great Financial Crisis was that those that acquired in a time of crisis outperformed those that retreated and retrenched.

It’s time for consumer products companies to make the bold moves, including making M&A a strategic priority to position themselves for the opportunities ahead.

2. Don’t sit on the M&A sidelines — active acquirers can outperform

Although consumer products companies would benefit from seizing the opportunities around them, based on M&A intentions, consumer products companies still seem content to sit on the sidelines. Only 39% of consumer products executives say they will be actively pursuing M&A in the next 12 months — 10 percentage points lower than the intentions of respondents across sectors.

Stiff competition and high valuations may be putting off some consumer products companies. More than three-quarters of consumer executives expect increasing competition for assets, particularly from private equity. One-third say their company failed to complete or canceled a deal in the past 12 months because of a disagreement on valuation.

Of those considering an acquisition, slightly more than half (51%) say they will be looking at bolt-ons to increase market share. Only 14% are considering a transformative deal — another reflection of the uncertainty gripping consumer executives.

One more sign of the cautious approach by consumer products companies is the trend toward divestment rather than acquisition. Identifying underperforming assets for divestiture currently is among the top three strategic activities for consumer respondents, highlighting the preference to chase lost margins through retrenchment rather than growth.

Now is the time for consumer products companies to leverage M&A. Transformative deals offer consumer products companies the potential to become disruptors as opposed to being disrupted, pushing beyond their traditional boundaries and engaging new customers in ways they never before had considered.

3. Understand your future consumer and what’s important to them

Consumer behavior and preferences globally have changed in ways that were unimaginable last year. In the wake of these shifts, only one in five (21%) consumer executives believes their company has overperformed during the pandemic relative to their competitors.

As companies prepare for the future consumer, the short-term shifts they are seeing may be here to stay. In response, more than half (52%) of consumer products respondents say that they have increased their strategic focus and investment on customer engagement.

This investment in technology to improve customer engagement has consumer products executives weighing the value of buy vs. build. Of those with M&A intentions in the coming year, 25% say their main strategic driver for doing so is to acquire technology, talent, production capabilities or innovative startups.

Ultimately, consumer companies need to understand what type of engagement they want with their consumers. Do they want direct access to their customer? Or do they simply want to improve communication channels to strengthen their relationships with customers? The answer to these questions will drive their capital allocation decisions.

In both instances, consumer products companies will need better data and analytics tools and communications capabilities than they currently have. They may also need to shift their culture to create more of an online, direct-to-consumer (D2C) and start-up mindset. And while organizations may need to be able to build the foundation for this, they’ll want to consider M&A to bring in the right talent with fresh ideas that enable consumer products companies to rethink their business models to match their ambitions for reimagined customer journeys.

While few of the COVID-19-led changes in consumer preferences will persist, the long-term shift toward increased adoption of technology will mean that consumers will be in the driver’s seat more than any other point in memory. Consumer products companies will need to both build and buy to meet their expectations on their terms. If they can anticipate what future customers want and make the bold moves to deliver when and how they get it, better financial performance can follow.

Kristen O'Leary, Chinmay Ojha and Anuj Bhatia of Ernst & Young LLP contributed to this article.