Innovation from the inside out

R&D in the Australian FMCG industry

Survey 2007

Innovation from the inside out R&D in the Australian FMCG industry Survey 2007

Forward
As the Partner-in-Charge of Deloittes Global R&D Tax Incentives service line, I am pleased to present the results of the survey we conducted in early 2007, Innovation from the inside out R&D in the Australian Fast Moving Consumer Goods industry. I want to thank the participants in the survey for providing their insights and observations concerning the rapid pace of innovation in the FMCG industry in Australia. The results of the survey confirm that consumer preference and competition continue to drive this industry. These factors require significant spend on R&D in order to meet constantly changing consumer needs, whilst driving down costs. These expenditures relate to product innovation, manufacturing process improvements and software development. While many global FMCG companies cite government regulations as an inhibitor to innovation, the Australian survey participants did not see this as having a significant impact on their R&D spend. Through limiting red tape and providing incentives, such as the R&D tax concession, the government can assist the Australian FMCGs competitive position in the global environment. I hope you find this report interesting, informative and thought provoking. Best regards,

Tom Hogan Partner-In-Charge Global R&D Tax Incentives

Innovation from the inside out R&D in the Australian FMCG industry Survey 2007

Executive summary
The key observations arising from a survey of the FMCG industry in Australia are as follows: t  he FMCG industry is a highly competitive industry which involves itself in research and development (R&D) activities i nnovation is a key strategy of the FMCG industry, and in many cases has been well developed and integrated into the strategic plans of related businesses t  here are a number of drivers of innovation and R&D within the FMCG industry including, but not limited to, industry competition, the impact of Australian retailers, consumer preferences, the ageing population, the changing face of manufacture and the industry rules and regulations. Each of these drivers will impact differently on an FMCG business and will, of course, depend on the product suite offered by the business.

Background
In February 2007, Deloitte R&D Tax Services Australia undertook a survey of a number of Australias leading FMCG manufacturers, which focussed on the subject of R&D in FMCG. The survey was conducted as part of a presentation delivered by Tom Hogan, Global Partner-In-Charge R&D Tax Incentives, and Karen Stein FMCG R&D Partner Australia which discussed the many issues which drive innovation and R&D in FMCG. The respondees to the survey, which was electronically generated during the above presentation, included 15 FMCG companies whose head office is located in NSW. The relative size of these companies is as follows: two companies with annual turnover of less than $150m t  hree companies with annual turnover more than $150m and less than $500m f  our companies with annual turnover more than $500m and less than $1 billion five companies with annual turnover of more than $1 billion one company with annual turnover of more than $4 billion. The collective turnover of the participant companies is more than $15 billion. This sample size represents more than 53% of the FMCG industry whose head office is located in NSW and who also have a turnover of more than $150m per annum. The results of the survey, together with an analysis of innovation and R&D in the Australian FMCG industry, are presented in this document.

Innovation from the inside out R&D in the Australian FMCG industry Survey 2007

Objectives
The FMCG industry has been growing at a rapid rate during the last 20 years. Companies have been focussed on acquisitions and expansion which has resulted in a highly competitive market fuelled by growth, product and market dominance, and an increasing level of R&D. Our objective was to conduct a survey which focussed on the issues driving innovation and R&D in the Australian FMCG industry. Given that 80% of the Australian FMCG industry is located on the east coast of Australia, we believe that our sample is representative of the greater number of participants in the industry. It is understood that within the Australian FMCG industry, those companies who have a turnover of more than $150m per annum accumulatively account for a turnover of over $60 billion. Of this, it is understood that 50% of these FMCG companies, with a cumulative turnover of more than $30 billion, have their head office located in NSW. The intention behind our survey was to involve a representative number of participants from the industry, by focussing on organisations with their head offices based in NSW. It is recognised that many of these companies have manufacturing facilities located nationally.

Limitations
Whilst we consider this to be a representative sample to establish some useful information, this remains a relatively small population and therefore care has been taken to protect the anonymity of those who participated. Therefore, some of the results are not as detailed as we would have preferred. The results need to be considered carefully in light of this limitation. Care should also be taken in reading the results as definitive. Our intention is to conduct a wider survey in the second half of 2007, with a view to obtaining more detailed responses from a larger group of people. We hope to then provide a more detailed analysis and identify further trends.

Innovation from the inside out R&D in the Australian FMCG industry Survey 2007

R2 = 0.3624

Innovation from the inside out R&D in FMCG

The Australian FMCG industry is a highly competitive sector in which R&D plays a major part. The industry is defined to include a range of goods including food and beverage, personal and household products, and generally refers to those goods which are sold through supermarkets and smaller retail stores.
40%

R&D is considered as a fundamental strategic element of most R&D businesses. is considered a fundamental strategic element of most FMCG Defined plans mapping out the road to product FMCG businesses. Defined mapping out road to and process development are plans seen by many as anthe essential part of a product R&D and process development are seen by many as an successful and innovation framework. 80% of those surveyed essential part plan of a successful R&D and R&D, innovation framework. have a strategic which incorporates and of those, half have a plan which is well developed and integrated within the business. These strategies arealikely to consider the many issues 40 80% of those surveyed have strategic plan which incorporates discussed below, which are driving innovation within the industry. R&D, and of those, half have a plan which is well developed and 39% 35 integrated within the business. These strategies are likely to consider the 30 many issues discussed in this survey, which are driving innovation within the industry. 25
20 15 10 5 0 15% 10% 7%

Research expenditure in the food, beverages and tobacco sector totals close to $260m, and of this 75% is spent by the largest 2% $260 million, and of this 75% is spent by the largest 1 Government 1 Government of manufacturers. assistance is aiding suchsuch R&DR&D 2% of manufacturers. assistance is aiding with over 93% of those surveyed utilising the R&D Tax Concession, tax concession, through either the adoption of the tax deduction at 125%, or a combination of the 125% and incremental 175% rate. It is also recognised that other forms of assistance assistance,including includingGovernment Government grants such as the Food Industry Grant program, have accelerated some of the funding of R&D within FMCG.

50%

60%

70%

80%

Revenue growth Hewitt Best Employers Other Organisations

Profit growth

Does your business utilise the R&D tax concession?

60 50 53% 40 30 20 10 7% 0 Yes, both 125% and 175% Yes, 125% only No 40%

Does Doesyour yourbusiness businesshave haveaastrategy strategywhich whichincorporates incorporatesR&D? R&D?

40 35 30 25 20 15 10 5 0 Yes, well developed and integrated Yes, but not necessarily actioned strategy No, not considered part of our strate Don't know/not sure 0% 20% 40% 40%

100 80
1 Australian Food Statistics 2005, Department of Agriculture, Fisheries and Forestry,60 p21 4 3

87%

40

15
40 35 Innovation from the inside out R&D in the Australian FMCG industry 10% Survey 30 2007

33% 15%
39%

10 5 0

7%

60 20 50 60%

10
40

25 20 15 10 5

Revenue growth
15%

Profit growth

0
30 33% 20 10 0

7%

0%

Hewitt Best Employers Other Organisations

10% 7%

Yes, we utilise our in-house resources

Yes, however we couple this with third party experti No, we always bring in external expertise Don't know/not sure
7% 0%

Competition

Revenue growth

Profit growth

Hewitt Best Employers Through our experience, we have recognised that R&D activities Other are certainly driven byOrganisations the high levels of competition within the industry.

The FMCG sector is highly competitive, with the 20 largest manufacturers making up 50% of the industry, and only a couple 40 of the largest food and beverage manufacturers owning over 50% 2 With of the 40% 40% limitations in retailer shelf space, 35 product categories. manufacturers are focussed on developing products which will 30 them with differentiated, desirable, visibly branded products. provide US studies have shown that the average supermarket carries only 25 40% 40% 35 30,000 of around the 100,000 branded grocery products available. 20 In addition, some 15,000 to 20,000 new products debut in the 30 US each year.3 From a global point of view, some 182,000 new 20% 15 were introduced to the market 25 products during 2006, and of these 105,000 were defined as food and drink products.4 This creates a 20 10 highly competitive market in which R&D is critical to the success 20% of a15 new product. However, such competition carries high risk, as 5 in the products fail, 10 US, it is understood that four out of five new 0% no matter how well they are manufactured or how useful they are. 0 5 Quite simply, it comes back to the limitations of available, Why? 0% accessible shelf space. Yes, well developed and integrated 0
40

Further competition is arising from the global marketplace of the Yes, we utilise our in-house resources FMCG sector. Large, strategically placed production facilities, such Yes, however we couple this with third party experti as those located in Asia, are increasing the level of competition due No, we always bring in external expertise to low labour and raw material costs and the increasing number of Don't know/not sure SKUs introduced into the market. This competition cycle, extending from the competitive global market through to the supermarket 35 to undertake R&D activities to ensure that shelf, reinforces the need products are differentiated from those entering the market, in terms 30 life. of quality, variety and shelf 33% 33% In order to remain competitive, industry participants are often 25 35 reviewing the cost of manufacture. Efforts are made to reduce production inefficiencies, reduce waste and increase outputs. 20 30 33% 33% This focus has driven R&D with 87% of those surveyed regularly undertaking process related R&D to reduce their cost of 20% 25 15 manufacture. Of this, a total of 93% utilise their in-house resources, whilst 60% also utilise20 third party assistance. 10
15 10 20%

13%
13%

5 0 5
0

Very much To some degree Very much

To some Not at alldegree Not atknow/not all Don't sure Don't know/not sure

Yes, necessarily Yes, but wellnot developed andactioned integrated

Yes, not but considered not necessarily No, part actioned of our strategy No, not considered part of our strategy Don't know/not sure Don't know/not sure

Does your business undertake process related R&D to reduce its cost of manufacture?

Do you utilise in-house engineering resources in undertaking process related R&D?

60

100 100
39% 80 80 60 40 15% 87%

35 35 30 60%
25 33% 33% 27% 20%

50 40 30 33% 7% 20 10 13% 0% 0% 0

87%

25
20

60 40

27%
20%

20
15

15
10

20%

20%

20

10%

10 5
0 5 7% 0%

0 Revenue growth

20

Profit growth

13%

0%

0%

Hewitt Best 0 Employers Regularly Other Organisations Irregularly Never Regularly Don't know/not sure

Irregularly Never

Yes, we 0 utilise our in-house resources Yes, we've had to undertake R&D to reduce the imp Yes, however we couple this with third party expertise To some degree No, we always bring in external expertise No, R&D has been impacted Yes, our we've had tonot undertake R&D to reduce the imp Don't know/not sure Don't know/not sure

To some degree

No, our R&D has not been impacted Don't know/not sure
35 30
5

Don't know/not sure

2 Ibid 3 Slotting Allowances in the Supermarket Industry, Food Market Institute, p2 40% 40% 4 Mintel Global New Products Database 2006

33%

33%

25 20

60 39% 39% 60 50 40 40 30 30 20 20 10 10 0 0 7% 7% Yes, we utilise our in-house resources 0% 0% 33% 33% 60%

60% in the Australian FMCG industry Innovation from the inside out R&D 50 Survey 2007

15% 15% 10% 10% Revenue growth

7% 7%

Revenue growth Hewitt Best Employers

Australian retailers

Profit growth Profit growth

Australia has two dominant retailers, Coles Myer and Woolworths. Hewitt Best Employers Other Organisations Their role in the market place has changed in recent years from pure retailers to product conscious marketers. Both have announced Other Organisations plans to increase their share of in-house branded products from 13% to 30% by late 2007.5

This can impact on R&D in the FMCG sector in a number of ways. On the one hand, opportunities are created for manufacturers who 60 develop and manufacture in-house branded products for the retailer. In some cases, large contracts can eventuate which provide 60% much 50 opportunity for the manufacturer, and R&D is required to develop 40% the product specification, or the associated manufacturing 40% processes. In addition, these manufacturers may undertake their 40 40% 40% own R&D to improve their range of private branded product. The competition resulting from the increasing share of in-house 33% branded product requires a focus on the development of private 20 branded product.
20% 30

However, the increase in in-house branded product can, in some Yes, we utilisewe our in-house couple thisresources with third party expertise cases, inhibit R&D. Ahowever mid-sized FMCG company, who manufactured Yes, however we couple this with third party expertise No, we always bring in external expertise the bulk of its product for Australias major retailers, was impacted when advised that they no longer to purchase its own No, we always bring in external expertise Don't know/not surewanted private branded product. The sales Don't know/not sure were to be limited to the retailers in-house branded products. This significantly impacted the FMCG companys R&D strategies. 7 Whatever the outcome, the increasing dominance of in-house 50 branded products is certainly impacting R&D in one form or another. 35 Our survey demonstrates that 53% of those companies surveyed 47% 40 had their R&D impacted by the dominance of in-house branded 35 30 33% products, with 20% highly 33% impacted and 33% impacted to some 30 degree. 30 33% 33% 25
25 Further, more than 53% of those surveyed believe that the cost 20 20 of doing business with the major retailers has had an impact on 20 R&D. 33% 20% their responded that they have had to undertake R&D 15 20% activities and incur 20% 10 associated expenditure to reduce the controllable 15 10 of manufacture, in contrast to the less controllable costs costs 13% associated with market entry, shelf space and marketing costs 0% 10 13% 5 including returns, 0 promotions, retailer determined discounts etc. 5 however suggested that they have not had to undertake R&D 27% 0 Yes, dramatically to reduce such costs. 0 Very much Yes, to some degree Very much To some degree No To some Not at alldegree Don't know/not sure Not atknow/not all Don't sure 33%

By 10 way of example, 20% Inghams Chicken stated publicly that they are 0% competing with their contribution to the in-house branded product 7% 0 by continually innovating with their own branded product to 0% maintain shelf space.6
Yes, we utilise our0% in-house resources Yes, however we couple this with third party expertise Yes, well developed and integrated No, we always bring in external expertise Yes, well developed and integrated but not necessarily actioned Don't know/not sure Yes, but considered not necessarily actioned No, not part of our strategy No, not considered part of our strategy Don't know/not sure Don't know/not sure

Has your R&D been impacted by the dominance of in-house branded products?
35

Has doing business with the major retailers had an impact on your R&D?
35 35 30 50 33% 33% 40 30 20 10 47% 27% 27% 20% 20% 40% 20% 20%

Don't know/not sure

87% 30 87% 25 20 15 10 5 0 Regularly Regularly Irregularly Irregularly Never Never Don't know/not sure Don't know/not sure Very much 13% 13% 0% 0% 20%

33%

33%

30 25 25 20 20 15 15 10

0% 0%

13%

10 5 5 0 0

13%

0%

To some degree Not at all Don't know/not sure

0 Yes, we've had to undertake R&D to reduce the impact Yes, dramatically Yes, we've had to undertake R&D to reduce the impact To some degree Yes, to some degree To some degree No, our R&D has not been impacted No No, our R&D hassure not been impacted Don't know/not Don't know/not sure Don't know/not sure

35 30 33% Off the Shelf, A. Ferguson, Business Review Weekly 5 October 2006. 25 Innovation driving Chicken Tussle, L. White Foodweek 8 September 2006 27% Ibid 1 above 20 15 20% 20%
6

60 50 53% 40 30 20 27%

5 6 7

Innovation from the inside out R&D in the Australian FMCG industry Survey 2007

Consumer preferences Changing consumer preferences are having a major impact on R&D in the FMCG industry. With the movement towards a healthier lifestyle, manufacturers are focussing their R&D on fat-free, low-carb, reduced-salt, nutritious foods. The trend away from highly processed, salted and sugared products has led the way for the R&D budgets of the FMCG industry. Such R&D involves more than changing a 3% fat product to one which is 97% fat free! Many R&D teams are focussing on the benefits of low or no trans fat products, as well as gluten and other allergen free products.
60% In addition, the fast growing organic market (a $450m market growing at 14% per annum in Australia 8) is creating a new market segment to which industry players are responding. This market is not only focussed on food and beverage products, but also affects personal and household product development.

Ageing population Australias ageing population is another driver of innovation and R&D. The many changes of the ageing population influence the path of innovation within the FMCG sector. 60% of those surveyed have responded to the changing needs of the ageing population and focussed their innovation and R&D on these needs. Biological changes in vision and mobility can create the need and demand for modified products, such as easy-open packaging. This 50 requires both product and process innovation. Similarly, the ageing population wants to be stronger and fitter and is seeking additional functional 47% foods which provide them with health benefits. 40 The introduction of the % daily intake labelling launched by the Department of Agriculture, Fisheries and Forestry has responded 30 needs of the ageing population and will, coupled with their to the 33% unique demands, drive innovation.
20changes arising from changes to empty-nesters or caregivers Social can result in a greater ability to explore changes in lifestyle, resulting 20% in altered shopping patterns. This creates an opportunity for the 10 development of product strategies to tap into this new market 0% segment. 0

60 50 40 30 20 10 0

Of those surveyed, 47% stated that their R&D has been dramatically impacted by the move to organic and natural products, whilst 33% had been impacted to some degree. In other words, 80% have had their R&D impacted by this change in consumer preferences. Another growing market sector is the Halal market which has strict requirements relating to food and beverage products. Each yearYes, Australia exports products to more than 70 countries, many we utilise our in-house resources of which have a growing Islamic population. The worlds Muslim Yes, however we couple this with third party expertise population is expected to double in size to 3.4 billion in 24 years.9 No, we always bring in external expertise Many manufacturers have adopted processes which allow for Halal Don't know/not sureentry into a growing market. This requires certification, creating innovative practices, and can drive innovation and development. Has your R&D been impacted by the move to organic and natural products?
7% 0%

33%

Yes, dramatically Yes, to some degree No Don't know/not sure

Has your companys R&D responded to the needs of the ageing population?
50

35 30 25 20 15 10 5 0

50 40 30 20% 20 10 0 Very much Yes, dramatically 20% 13% 0% 33% 47% 33%

40 30 20 10 0

47% 40%

33%

13%

0%

Yes, dramatically Yes, to some degree No Don't know/not sure

To some degree Yes, to some degree Not at all No Don't know/not sure Don't know/not sure

35 30 25 20

60
8 The Big O, Jane Adams, The Australian Way, February 2007 50 33% 9 Diversity is an asset, Australias Halal Food Industry, Department of Immigration and Multicultural and Indigenous Affairs, 53% 2004 50

27% 40 47%

40 30

60 60 50 50 40 40 30 33% 30 20 20 10 10 0 0 33% 60% 60%

50 the inside out R&D in the Australian FMCG industry Innovation from Survey 2007 50 40 40 30 30 20 20 10 47% 47% 33% 33% 20%

The changing face of manufacture 0% Traditionally, Australia has adopted a model of closed innovation 0% 7% from idea generation to the market release, where the basic Yes, we utilise our in-house resources principles of innovation require all R&D to be undertaken in-house.
Yes, however we couple this with third party expertise Yes, we years, utilise our in-house In recent the FMCG resources industry has been moving to a model No, we always bring in external expertise however we couple thiscollaboration with third partywith expertise of Yes, open innovation where third parties is Don't know/not sure key towe the success ofin innovation and R&D. This is taking many No, always bring external expertise 7%

20% 0% 10 0 experts assert that rules and regulations have been Industry 0% 11. Of those strangling innovation in the food and beverage sector 0 Yes, dramatically

Rules and regulations

surveyed, 27% have changed their R&D plans due to the current regulatory restrictions. Yes, to some degree
Yes, dramatically

forms, including manufacturing under licence agreements, tolling Don't know/not sure arrangements, and direct collaboration. Graham Stuart, Director of Strategy with Fonterra highlighted this approach. Today, innovation is becoming more about collaborationnot all great ideas come from inside our business. By moving to an open innovation model, we are able to join up with suppliers, biotech companies, universities, 33% 33% governments and sometimes even our competitors, to work together to create33% new products. By having access to 33% knowledge and technologies that may otherwise have taken the company considerable time and resources to develop 20% internally, it was able to shorten development cycles and ensure it was fast to commercialise new products.10
13% Partnering with others within the industry is providing speedier access to expertise, resources and markets, and allows for greater 13% cost containment and profitability. R&D and innovation is certainly being driven by such an approach. Very much To some degree Very much Not at all To some degree Don't know/not sure Not at all Don't know/not sure 35 30 35 25 30 20 25 15 20 10 15 5 10 0 5 0 Yes, we've had to undertake R&D to reduce the impact To some degree Yes, we've had to undertake R&D to reduce the impact No, our R&D has not been impacted To some degree Don't know/not sure No, our R&D has not been impacted Don't know/not sure 20% 20% 33% 33% 27% 27% 20% 20% 20%

35 30 35 25 30 20 25 15 20 10 15 5 10 0 5 0

Rigid red tape and No time processes have negatively impacted Yes, tolagging some degree Don'tin know/not the flow of innovation FMCG. sure Recent reports have highlighted No the limitations on product development within Australia. By way know/not sure that it took four years for the of example, it was Don't recently reported Australian Beverages Council to steer an application through the regulatory process for fortified beverages (a $350m lost opportunity) to level the playing field with New Zealand, a country not impacted 12 by such 50 restrictive food regulations. Interestingly, 53% of those surveyed had not had their R&D 50 47% impacted by existing rules and regulations. This may reflect some 40 of the less stringent regulations surrounding the manufacture of 40% 47% 40 household and personal products.
30 30 20 20 10 10 0 0 40%

13% 13% Yes, dramatically Yes, to some degree Yes, dramatically No Yes, to some degree Don't know/not sure No

0% 0%

Don't know/not sure Has your R&D been impacted by the existing regulatory rules and regulations? 60 60 50 53% 50 40 40 30 30 20 20 10 10 0 0 Yes No Yes Don't know/not sure No Don't know/not sure 27% 27% 20% 20% 53%

10 Australian Food and Grocery Council Annual Conference, Canberra, September 2006 11 Dick Wells, Chief Executive, Australian Food and Grocery Council, 20 January 2007. 12 Ibid 8

Innovation from the inside out R&D in the Australian FMCG industry Survey 2007

Conclusion There are a myriad of factors which can influence and drive innovation and R&D within the FMCG industry. Companies are required to balance theses influences such that they maximise their investment in R&D and resulting profitability. Our survey has confirmed that consumer preferences in particular play a major role in the development of R&D strategies within the FMCG industry. With a growing consumer voice, we are likely to see more and more innovation programs responding to the demands of the FMCG consumer. With a large percentage of FMCG manufacturers adopting a strategic plan which incorporates innovation and R&D, we can expect the further development of a highly competitive and responsive market.

8 9

Innovation from the inside out R&D in the Australian FMCG industry Survey 2007

Contacts
Sydney Karen Stein, R&D Partner and FMCG R&D Industry Leader Tel e-mail +61 (0) 2 9322 7387 kstein@deloitte.com.au About this survey The Deloitte FMCG Survey aims to provide insight into R&D within FMCG through a sample of Australian FMCG industry participants. The survey was conducted on 15 February 2007. Participants could choose to submit their feedback via remote keypad technology during the presentation delivered by Deloitte. The survey was completed by 15 FMCG industry participants from NSW. We make no representation or warranty about the accuracy of the information or how closely the information gathered in the survey will resemble innovation or R&D in the FMCG industry. Circumstances might have changed since the time this information was gathered, this survey does not take such matters into account. All responses and weighting methods are confidential and only aggregate responses have been reported. Some questions may not total 100% due to rounding. We have compiled the information into a series of graphs and have drawn certain conclusions about innovation and R&D based on a weighting that we have allocated to these responses. The graphs and our conclusions are based on the answers we received in the survey and the weightings given to those responses.

Karen Stein is the leader of the Australian FMCG R&D Industry Group. She services many of Australias largest FMCG manufacturers, and has a wealth of experience in this industry, having consulted in the area of R&D tax concession and grants for 17 years. Jason Crawford, R&D Partner Tel e-mail +61 (0) 2 9322 3805 jacrawford@deloitte.com.au

Jason Dunnachie, R&D Partner Tel e-mail +61 (0) 2 9322 3678 jdunnachie@deloitte.com.au

Melbourne Serg Duchini R&D Partner Tel e-mail Brisbane Aaron Thorn R&D Partner Tel e-mail Perth John Oesterheld, R&D Partner Tel e-mail Adelaide Mark Reuter R&D Principal Tel e-mail + 61 (0) 8 8407 7221 mreuter@deloitte.com.au 61 (0) 8 9365 7288 joesterheld@deloitte.com.au + 61 (0) 7 3308 7023 aathron@deloitte.com.au + 61 (0) 3 9208 7376 sduchini@deloitte.com.au

Disclaimer This Survey is provided as general information only and does not consider your specific objectives, situation or needs. You should not rely on the information in this Survey. We accept no duty of care or liability to you or anyone else regarding this Survey and we are not responsible to you or anyone else for any loss suffered in connection with the use of this Survey or any of its content.

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