HeLL breaks loose –

But there is a reason to Smile!

Switch from HLL to Colgate

Analyst
Toral Munshi 5540 8651 March 2004
(toral@indiainfoline.com)

Dealing
(+91 22) 2685 0505
Sandeepa Arora 5540 9033
Biren Patel 5540 8601

IT’S ALL ABOUT MONEY, HONEY!

 HeLL breaks loose- But there is a reason to smile!

Investment Summary

SECTOR RESEARCH HeLL broke loose last week when Proctor & Gamble (P&G) initiated a price
(FMCG) war by cutting detergent prices steeply. There is a possibility of a similar war in
hair care segment. This will cause a significant dent in HLL’s cash flows. A
Recommendation
surprise beneficiary of this price war could be Colgate. Colgate is a leading
player in oral care segment with meaningful competition from HLL. In this
HLL - SELL (Rs 157) segment, HLL will have not only lesser cash to fight but also a lesser cause as its
parent has exited the oral care category in select markets.
Incidentally, Colgate itself was at the receiving end when HLL cut prices sharply
Share Holding Pattern %
Promoters 51.55
some time ago. With parent support, Colgate launched new products to
Institutional Investors 26.94 consolidate its position, and is set to improve its financial performance also.
Other Investors 1.20 Colgate, which runs an advertisement campaign with a “smiling face” will
General Public 20.31
have a reason to make its shareholders smile too. We recommend investors switch
from HLL (Rs157) to Colgate (Rs138).
Share Price Chart

Valuation
At Rs138, Colgate trades at 18x FY04 (Mar) earnings, whereas at Rs157, HLL
trades at 20x FY03 (Dec) earnings. We expect HLL to pass through an extended
phase of heightened competitive pressures which will restrict topline as well as
bottomline growth. Colgate on the other hand is likely to witness improved sales and
profit growth over the next few years aided by
a) Revival in volume growth
b) Further decline in adspend as competitive pressures ease
Colgate - BUY (Rs 138) c) Lower tax outgo due to excise and income tax benefits on new manufacturing unit
at Himachal Pradesh
Share Holding Pattern % Over the longer term, decision by parent to make India a sourcing hub as the global
Promoters 51.00
Institutional Investors 12.54
restructuring of manufacturing locations gathers pace, could act as a big trigger for
Other Investors 2.02 growth and a further re-rating of the stock. We expect HLL to under perform the
General Public 34.44 market and recommend a switch from HLL to Colgate for a long-term exposure to
the FMCG sector.
Share Price Chart
Hindustan Lever Ltd (Rs 157)
(Rs mn) Sales % yoy EBIDTA % yoy OPM % APAT % yoy EPS P/E
12/01 1,06,676 20,958 16.1 16,413 7.5 21
12/02 99,549 (6.7) 23,404 11.7 19.6 17,557 7.0 8.0 20
12/03 1,01,118 1.6 24,364 4.1 19.7 17,717 0.9 8.0 20
12/04E 1,00,107 (1.0) 22,920 (5.9) 18.6 16,462 (7.1) 7.5 21
12/05E 1,00,607 0.5 23,014 0.4 18.8 17,493 6.3 7.9 20

Colgate India Pvt Ltd (Rs 138)

(Rs mn) Sales % yoy EBIDTA % yoy OPM % APAT % yoy EPS P/E
03/01 11,991 1,229 8.5 625 4.6 30
03/02 11,609 (3.2) 1,374 11.8 9.6 698 11.7 5.1 27
03/03 10,569 (9.0) 1,662 20.9 12.9 887 27.0 6.5 21
03/04P 10,622 0.5 1,767 6.3 13.5 1,056 19.1 7.8 18
03/05P 11,047 4.0 1,991 12.7 15.6 1,316 24.7 9.7 14
03/06P 11,709 6.0 2,304 15.7 17.1 1,677 27.4 12.3 11
March 09, 2004 2
 HeLL breaks loose- But there is a reason to smile!

The Detergent Wars

HLL won the war, but shareholders lost

SECTOR RESEARCH Flash back to the 80’s

(FMCG)
The First Detergent War was fought in the 80’s when a small manufacturer in
Gujarat aggressively marketed a detergent powder called ‘Nirma’nationally at one-
fifth the price of existing detergent brands. The launch changed the profile of the
Indian detergent industry.

HLL won the war, but shareholders lost

HLL launched Project STING (see Annex) as a strategy to win back market share.
The battle between HLL and Nirma has been well documented in Darden School of
Business, University of Virginia case study : “Hindustan Lever Limited Contemplates
India’s poor”. No doubt HLL won the battle, but as is evident from the chart below,
under performance with respect to BSE Sensex meant that share holders lost out.
The period of under performance coincided with the period of heavy fighting for
market share.
Exhibit 1: Stock underperformance during 1987-1990
20

HLL Sensex rebased

16

12

0
Oct-87

Oct-88

Oct-89

Oct-90
Dec-87

Dec-88

Dec-89

Dec-90
Jun-87

Feb-88

Jun-88

Feb-89

Jun-89

Feb-90

Jun-90
Aug-87

Aug-88

Aug-89

Aug-90
Apr-87

Apr-88

Apr-89

Apr-90

The Second Detergent War begins

We are about to witness what could be The Second Detergent War in India. It
started with Procter & Gamble (P&G) slashing prices of its 20gm Ariel sachets by
30% to Rs2 and Tide sachets by 50% to Re1. Hindustan Lever Ltd (HLL) followed
suit by lowering price of its premium Surf Excel sachet from Rs3 to Rs1.50. The
move by P&G was aimed at inducing trial of its brands and a gradual shift to the
brand as consumers experienced the benefit of a using a premium product. However,
sachets account for just 15-20% of the detergent volumes sold in the country.

March 09, 2004 3

 HeLL breaks loose- But there is a reason to smile!

SECTOR RESEARCH P&G made its second move by announcing a huge 46% cut in the price of Tide and a
(FMCG) 27% cut in the price of Ariel large packs. Two days later, HLL reacted by announcing
29% and 26% cut in large pack prices of its premium brand Surf Excel and midpriced
Surf Excel Blue (earlier known as Surf) respectively.

How much does HLL get affected?

The Indian detergent market largely comprises of three segments – Popular, Mid-
priced and Premium. What the price cuts have done is effectively brought down the
huge price differential between the popular and the premium brands from 7x to 5x.
This move is likely to bring about a dramatic change in the consumer profile of each
segment. The impact would be felt by brands in all segments as mid-priced users may
upgrade to premium brands, while popular brands may face volume pressure as
customer upgrade to more affordable mid-priced brands. All leading national players
in the industry – HLL, Nirma, P&G and Henkel as also the smaller regional brands
are likely to witness a huge realignment in their customer base.

HLL with its dominating presence in all the categories is likely to be the worst
affected, as
¾ Detergents is the largest and the second most profitable business of HLL. The
stakes are therefore much higher for HLL than for P&G.
¾ HLL also faces the additional risk of its premium brands eating into share of
its own mid-priced and its mid-priced brands eating into share of own popular brands.
¾ On the other hand, P&G’s detergents are marketed by the 100% subsidiary
of P&G, USA. The parent would therefore easily be willing to absorb losses for a
few years for market share gains. The listed entity only manufactures for the 100%
subsidiary and infact would be a key beneficiary of any volume share gains that P&G
gets.

Caught between the devil and the deep blue sea

HLL, therefore finds itself on the point of a double-edged sword wherein
¾If it did not cut prices, there would be a big threat of losing market share in its
largest business
¾If it cut prices, that would not only put huge pressure on already shrinking margins
– it also raises a question on the future strategy for its leading power brands – Surf
and Rin.

March 09, 2004 4

 HeLL breaks loose- But there is a reason to smile!

SECTOR RESEARCH
(FMCG)
The challenge of managing brand equities
The price cut have led to three major realignments
a) Premium brands Surf Excel and Ariel now cost 25-30% less than before
b) P&G’s Tide has moved from the mid priced segment to the popular segment
c) Rin Supreme is now more expensive than Surf Excel Blue

Exhibit 2: Revised pricing structure of P&G and HLL brands

Original Price Revised Price Change Category realignment
Per Kg Per Kg % From To
P&G Brands
Ariel 135 99 -27 Premium Premium
Tide 85 46 -46 Mid priced Popular
HLL Brands
Surf Excel 140 100 -29 Premium Premium
Surf Excel Blue 90 67 -26 Mid Prices Mid Priced
Rin Supreme 80 80 0 Mid Prices Mid Priced
Rin Shakti 40 40 0 Popular Popular
Wheel Active 26 26 0 Sub Popular Sub Popular
Wheel Green 20 20 0 Sub Popular Sub Popular

The key challenge for HLL would be maintaining the premium brand equity of its
Surf brand, a variant of which is now available at a price discount to a Rin variant.
Will consumers accept a ‘Rin’, which is more expensive than’Surf’? Does this pricing
not go against decades of brand equity established in consumer minds? Won’t the
Rin Supreme user upgrade to Tide – which is certainly perceived as a more premium
brand than Rin? Managing the equities and positioning of long established brands,
therefore would be a big challenge for HLL.

The challenge of managing profitability

HLL has had a long history of facing several such marketing wars - be it in the oral
care, fairness creams, shampoos or ice-creams. And it has been able to fight these
wars without taking a big hit on its profitability in the past. But this time around, it
could be different due to a variety of internal and external reasons

¾The company faces low or negative category growth in almost all product
segments that it operates in.

¾ Strong regional brands have strengthened their stronghold over local markets in
the past few years and have already been eating into existing market shares.

March 09, 2004 5

 HeLL breaks loose- But there is a reason to smile!

SECTOR RESEARCH ¾ Competition gnawing from all directions in all segments- There is increased
(FMCG) Competition not only from existing national players, and stronger regional players,
but also from a larger number of multinational companies eyeing the Indian market as
imports become more competitive in an era of lower protection.

¾In the past, a speedily growing and highly profitable businesses (such as
personal product and toilet soaps) subsidized higher marketing investments in
other segments. Today, the core soap and detergent categories are de-growing and
margins are under pressure. In personal products the company has just managed to
push up growth to double digits levels aided by the power branding strategy. There
too margins remain flat. The beverages business continues to be impacted by an
adverse commodity cycle. The foods business is not mature enough - and would
need further investments for a few more years.

Likely impact on profitability

HLL’s soap and detergent turnover in 2003 was Rs43.8bn, of which an estimated
Rs20bn is contributed by detergents. It is HLL’s most profitable business after personal
products. The business contributes 42.6% to HLL’s revenues and 48.5% to its EBIT.
However Revenues remained flat while EBIT margins in the business have been
shrinking and stood at 24.8% in 2003 as against 25.9% in 2002.
Exhibit 3: HLL’s Soaps & Detergents business
Revenues (Rs mn) 43,794
% of revenues 42.6

EBIT (Rs mn) 10,883

% of EBIT 48.5

EBIT Margins (%) 24.8

We estimate that EBIT decline to range between Rs700mn - Rs1200mn, depending

on whether company is able to grow or maintain volumes or loses volume share to
P&G. The adverse impact on EPS could range from Re0.6-Re1.00. The company
would require a 15-20% surge in overall detergent volumes to maintain revenues and
profitability at current levels.

March 09, 2004 6

 HeLL breaks loose- But there is a reason to smile!

SECTOR RESEARCH
Shampoo war looming ahead - could add insult to injury
(FMCG)
A much bigger threat could emerge if P&G decides to follow a similar strategy in
shampoos. It is very evident from the moves made in the last 2 years that P&G has
strategically decided to play the volume game in India. Its success in feminine hygiene
has encouraged it to imitate the strategy in detergents. Like detergents, shampoo too
is marketed in India through the 100% subsidiary Procter & Gamble Home Products,
which gives it significant leeway to take losses without being answerable to
shareholders. Currently P&G’s shampoo brands are sold at a 20-30% premium to
HLL’s top end shampoo brand. But P&G has recently launched a mass market
shampoo brand Rejoice at a significantly lower price point (pitched against HLL’s
Sunsilk and Clinic Plus)

Exhibit 4: Price of 100ml shampoo packs

P&G Brands Rs
Head & Shoulder 64.0
Pantene 61.0
Rejoice 39.0
HLL Brands
Clinic All Clear 50.0
Sunsilk 41.0
Clinic Plus 37.5

If P&G does decide to go ahead and cut prices of established shampoo brands like
Head & Shoulders and Pantene also, that would mean really really big trouble for
HLL. In a scenario like that, other competition like Colgate, Nirma and Cavincare
would also make moves to launch their own attacks. And that would mean a big dent
on HLL’s Personal Products business – the only business that is witnessing double
digit growth and expanding margins at present.

March 09, 2004 7

 HeLL breaks loose- But there is a reason to smile!

The Return of the Tooth Fairy

SECTOR RESEARCH The Toothpaste War of the 90’s

(FMCG)
Colgate Palmolive India Ltd dominated the Indian oral care scenario until the late
70’s.Competition came in the form of Balsara’s Promise in the early 80’s and HLL’s
Close up in the late 80’s. Things really heated up when HLL aiming at increasing its
share in the oral care market launched an oral care marketing war in the mid 90’s.
The success of Pepsodent, which was pitted Colgate’s largest brand CDC, hit hard
with Colgate losing significant market share during the period. 1999 to 2000 was the
most exiting period in the oral care history of India as a complacent market leader
was taken over by an aggressive competitor’s moves HLL emerged victorious and
strengthened its position as a strong No 2 with 35% market share. Colgate during the
period lost market share from over 60% to 47%.

The leader fight backs

An awakened giant retaliated by a slew of new launches such as Colgate Fresh
Stripe, Colgate Double Protection, Colgate Total, Colgate Whitening and
Colgate Herbal, Cibaca Top, gaining back a part of the market share loss. Colgate’s
sales grew by 8% yoy in FY01 and market share inched up to 49% aided by success
of Colgate Herbal and repositioning of Cibaca Top in the economy priced segment.
But by then new competition had arrived in the form of SmithKline’s Aquafresh and
homegrown brands like Anchor. While Acquafresh could not garner significant market
share, domestic brands like Anchor and more recently Ajanta have positioned their
products on ‘natural’ and ‘vegetarian’ platforms and restricted market share gains for
both HLL and Colgate. The prolonged war between Colgate and HLL and their high
decibel advertising led to spiraling advertising costs, hitting margins hard. While HLL
subsidized its high decibel advertising by funding it through other more profitable
businesses, Colgate’s profitability took a big hit. Colgate’s adspend rose from a mere
9% of sales in FY96 to a peak of 20% of sales in FY02!

New pricing strategy yielding results

The two large players in the industry called truce last year, realizing that while they
slugged it out fighting with each other, the smaller players were strengthening their
positions. The fight over market share and resultant high advertising and promotional
activity resulted in increase in product prices for consumers and lack of focus on
consumer need. Both the major players lost market share, while local competition
took advantage and gained market share by affordable pricing. A slowdown in FMCG
growth rates also restricted their ability to spend any further. Mutually consenting to
figh local players on the pricing platform, both Colgate and HLL cut product prices
last April. The lower realizations were expected to be compensated partly by cutting
down on promotions and freebies and partly by the higher volume growth driven by
improved product affordability.
March 09, 2004 8
 HeLL breaks loose- But there is a reason to smile!

SECTOR RESEARCH Improving topline and lower adspend driving profit improvement
(FMCG)
The strategy has worked well as is evident from Colgate’s topline growth improvement
seen in the last two quarters. September quarter sales were higher than June quarter
by 1.4%, while December quarter sales have jumped 9% over sales in September
quarter.

Exhibit 5: Sequential sales growth

10.0 9.3

8.0
6.0
4.0
2.0 1.4
(3.4) (3.3)
0.0
(2.0) Mar-03 Jun-03 Sep-03 Dec-03
(4.0)
(6.0)

Meanwhile adspend has been brought down from a high 20% of sales in FY02 to
17.5% of sales in FY03 and 15% of sales in FY04. Operating margins saw a
corresponding improvement in FY03, and a marginal improvement in FY04 margins.
Colgate’s net profit has witnessed a 27% yoy growth in FY03 and a 21% yoy growth
in the first nine months of FY04.
Exhibit 6: Will Adspend go back to pre 1998 days?

25 Adspend % OPM%

19.9
20 18.0 18.5 18.2 18.2
17.3 17.5
15.7 15.7 15.2
15
13.4 12.3 12.7
11.6
9.4 9.2
10 8.9 8.4 8.3 8.2

x1
5
03/95

03/96

03/97

03/98

03/99

03/00

03/01

03/02

03/03

03/04

March 09, 2004 9

 HeLL breaks loose- But there is a reason to smile!

SECTOR RESEARCH HLL’s worries could make Colgate smile

(FMCG) The detergent price war started by P&G will erode HLL’s margins and put pressure
on its cash flows. The detergent stakes are too high for HLL and at this point in time
it can ill-afford to divert any resources into the oral care biz. Also unlike P&G, HLL
may not find funding support from Unilever, who has exited from the oral care category
in certain countries such as US and Canada in line with its Path to Growth strategy of
focus on fewer brands. As HLL and P&G slug it out for the detergent market, benefits
will possibly accrue to Colgate. Colgate, by making a few right moves in the current
scenario, could effectively utilize this phase to strengthen its position in the category.
The timing could not have been better as a booming economy and strong agricultural
growth could trigger a long awaited rural demand revival and spur category growth.

On a strong footing globally

The parent - Colgate Palmolive – has reported a record earnings growth during
2003. Worldwide dollar sales rose 6.5% to $9.9bn, an all-time record, global unit
volume grew 3.5% and operating profit increased 8%. Net income rose 10% to a
record $1,421mn and diluted earnings per share increased 12% to $2.46, also a
record. This is Colgate’s 31st consecutive quarter of increased gross profit, net income
and earnings per share. The parent continues to grow volumes and improve market
share in key markets of US, UK, Latin America and Asia. The parent expects the
strong volume growth and profit improvement to continue in 2004 driven by new
product innovations, improved productivity measures and aggressive global cost
savings activity.

Outsourcing could be icing on the cake

There is a rising parent interest in Indian operations and India is likely to emerge as an
outsourcing hub for the parent. In a recent international presentation made to consumer
analysts Colgate-Palmolive Executive Vice President, Mr Ian Cook talked about
rationalization of manufacturing facilities as one of the key cost savings initiatives to
expand margins. The parent company has drawn up a 5-year plan of cutting down
toothpaste and bar soap manufacturing locations to 15 each and toothbrush
manufacturing locations to 8 globally. He also spoke of new manufacturing facilities
currently being set up in India for toothpaste and China for toothbrush. The Chinese
facility would be supplying toothbrush to 55 countries around the globe by end of the
current year. Such large-scale production would mean huge economies of scale in
procurement and manufacturing. Mr Cook also discussed Colgate’s global approach
to manufacturing, supply chain and procurement enabled by investments made in
SAP. Sourcing organizations have been established in China and also in India on an
experimental basis for procurement of raw materials, product materials and indirect

March 09, 2004 10

 HeLL breaks loose- But there is a reason to smile!

SECTOR RESEARCH materials too. Colgate Palmolive globally procures US$1bn of indirect materials every
(FMCG) year and expects 10-15% savings from this initiative.
Colgate India’s new toothpaste manufacturing facility in Himachal Pradesh would
entail investment of Rs500mn and would provide income-tax and excise benefit to
the company. The facilities are being set up for domestic consumption only at the
moment. However given that the new plant in India is being set up at a time when the
parent is actually looking at cutting down the number of manufacturing locations
worldwide, does give an indication that India could likely emerge as one of the 15
sourcing destinations post restructuring And when that happens, it would mean a
huge growth opportunity for a company that has been languishing under the weight of
low category growth.

Concerns
High reliance on single category
Colgate’s excessive reliance on a single category in India has been the biggest concern.
Colgate India’s oral care business accounts for 94% of its turnover and more than
98% of profits , as against a diversified product range of oral, personal, household
surface, fabric care and pet nutrition businesses globally

Exhibit 7:Segment turnover and profitability

Turnover Contribution Profit Contribution
Personal
Personal Others
Others Care
Care 0.2%
0.5% 1.6%
5.3%

Oral
Care
Oral
94.2%
Care
98 2%
Personal care biz – turned around last year, but reported losses again in H1 FY04
Colgate has expanded non-oral care product portfolio in the current year and launched
a wide range of liquid hand washes, shower gels, bar soaps and talcum power under
the Palmolive aromatherapy range. While the new launches would enable the company
to expand the earnings base, initial brand building efforts could impact margins. The
personal care business, which had turned around and made a nominal profit of Rs31mn
in FY03, reported a loss of Rs64mn in H1 FY04.

March 09, 2004 11

 HeLL breaks loose- But there is a reason to smile!

Annexure

SECTOR RESEARCH
Case A: Hindustan Lever Limited Contemplates India’s poor[1]
(FMCG)
Project STING At 9:30 a.m. on a Monday morning in June 1987 the top managers of Hindustan
Lever Limited (HLL), the Indian subsidiary of the giant multinational Unilever PLC were having
an important meeting. Having gathered from all regional offices to the HLL headquarters in
Bombay these managers were discussing the launch of Project STING -- the Strategy to Inhibit
Nirma Growth. For a company like HLL that had a reputation and performance history that was
unbeatable, it was fairly strange that top management would waste their precious time
discussing strategies to inhibit the growth of a small time entrepreneur like Nirma. However,
over the past decade Nirma had risen from nowhere and had overtaken HLL in the detergent
sector. So far HLL had ignored rural India, but Nirma’s recent success in this disorganized
sector had brought HLL back to the drawing board. Reconsidering their approach and deciding
how to regain dominance in India’s detergent market HLL’s executives were going to d iscuss
three questions that morning.
1.Strategy - Should HLL enter the rural Indian market?
2.Marketing and Distribution - Considering the logistical hurdles of this market how should
HLL plan it’s entry?
3. Design - What kind of product should HLL introduce to combat Nirma?

Hindustan Lever Limited

Hindustan Lever Limited or HLL was the Indian subsidiary of Unilever PLC, one of the world’s
largest multinational corporations. Founded in 1930 and based jointly in the Netherlands and
the United Kingdom Unilever sold its products in approximately 150 countries. Predating the
creation of Unilever, Levers products first came to India as early as the late 19th century when
India was a part of the British Empire. The first Lever product to be introduced in India was
Sunlight soap. This ‘foreign’ product was affordable and available to the British citizens in
India and only a small section of the Indian well-off urban population. Thus setting a trend for
the profile of clients that HLL would develop.

In a truly multinational spirit Unilever was aware that success in India involved having local
managers who understood both the Indian way and the Unilever way. After a series of exclusively
foreign managers, Mr. Prakash Tandon became the first Indian Director in 1951.
By 1955 Unilever had a well-trained local taskforce with about 65% of all managers being
Indian. HLL was among the first foreign subsidiaries to offer Indian equity at that point and had
10% of Indian participation. Unilever gradually divested its stake in HLL and by 1982 it held
only 52% equity in the company. By the late 1970’s HLL had gained the reputation of being “a
role model for companies that want to succeed in India”[2] and was one of the most sought
after places to work at in the country. With products ranging from food and beverages to home
and personal care products HLL was considered India’s largest household Packaged Mass
Consumption Goods (PMCG) Company.

Looking specifically at the Indian detergent industry, HLL was the undisputed leader.
Traditionally, Indians had used bars or tablets of soap to wash their clothes. Clothes washing
had involved scrubbing a wet garment with soap and then beating it with a club (similar to a
baseball bat) or against a stone. HLL changed everything by introducing the revolutionary Surf
washing powder in 1959. By introducing a washing powder they encouraged people to move
from the club to the bucket. Part of their marketing strategy involved demonstrations of how
clothes are washed in buckets with a washing powder. Surf was an immediate success and
occupied the top spot in the national detergent market. While the concept of a detergent was
every Indian housewife’s solution to grueling hours of clothes washing, only a fraction of them
could afford Surf. Bright blue in color and packaged in a large colorful carton (like the breakfast
cereals in the United States) Surf was too expensive for rural India.
The rural poor could not afford Surf and so continued to use bars and clubs. Surf was expensive
to begin with, and with the early 70’s came a rise in the price of crude oil and a massive
increase in the cost of raw materials. Surf doubled in price from 1974-75 and so became even
more unreachable for the rural people. At this time a host of new medium sized competitors
came into being but HLL maintained dominance.[3]

March 09, 2004 12

 HeLL breaks loose- But there is a reason to smile!

SECTOR RESEARCH The Rise of Nirma In 1969 Karsanbhai Patelts life typified that of millions of other Indians. He
(FMCG) worked as a chemist in a factory in Ahmedabad in the western state of Gujrat. Earning a
meager salary on which he was desperately struggling to make ends meet. At the same time
Karsanbhai recognized that there was a vacuum in the rural Indian market for an affordable
detergent. There were low quality soap bars that did not wash very well and were very time-
intensive or there were up-market detergent brands that washed very well but were too
expensive. Karsanbhai recognized the need for an affordable detergent and concluded that a
good product would create its own market. On the basis of this rather simplistic but accurate
belief, Karsanbhai started conducting experiments in his kitchen. His efforts finally yielded a
pale whitish yellow powder that he named “Nirma”, after his then one-year-old daughter Niranjana.
In no time he began producing small quantities of washing powder and selling them to his
neighbors. He packaged his product in small pouches with neither colorful decorations nor
designs. Every morning Patel got onto his bicycle and went from door-to-door selling his
washing powder. Soon wholesalers and distributors from different neighborhoods, towns,
cities and states of India started arriving at Karsanbhai’s doorstep to buy and redistr ibute
Nirma. Karsanbhai took on no responsibility for delivery or distribution; but his product was
soon available at every corner of India. Once Nirma arrived on the rural market things changed
for India’s poor -- they had an option.

By 1977 Nirma was the second largest volume seller in the country. Despite this, no other
company took Nirma seriously. The marketing gurus of the world believed that Nirma was a
regional product that was seeing temporary success and that its bubble would soon burst.
They predicted that at such a low sale price, the margins Karsanbhai was making per unit
would not sustain his business for long. Moreover, HLL completely ignored Nirma and believed
that it was no threat at all. HLL considered themselves a superior company with a superior
brand, and there was a strong belief that the only clients worthwhile pursuing were the Indian
middle class and elite. Since Nirma was not in their market segment, HLL did not consider
them a threat. The general belief was that rural Indians were poor and the rural sector was too
disorganized to bother with.

Understanding the Rural Market In India, HLL had disregarded a huge market segment that
due to its sheer volume held great promise and potential. By ignoring the lowest rungs of
society HLL was in danger of being toppled from the leading position. The question is why had
HLL ignored the rural markets? In order to understand the dilemma facing HLL at this time it is
important to know how traditional business is conducted, especially as far as multinational
corporations are concerned. C.K. Prahalad and Stuart Hart help us to understand this by
looking at the market as a pyramid.[4] The Top tier of the market consists of about 75-100
million people who earn more than $20,000 a year (See Exhibit 1). This group consists of the
elite/ middle and upper-income people in our societies. Most of these people live in the developed
world and a few in the developing world. The second and third tiers consist of the rising middle
classes, living mostly in developing countries and earning between $1,500 and $20,000 a year.
Prahalad and Hart estimate that between 1,500-1,750 million people live in Tier 2 & 3. Finally,
we come to the bottom of the pyramid, Tier 4, which consists of around 4 billion, people who
earn less than $1,500 a year. Most of the people in Tier 4 live in the developing world, however
there are some who live in urban inner city areas in both the developed and the developing
countries. [5]

Typically, MNC’s have focused on the first tier as it allows for the highest margin of returns. In
many cases the second and third tiers of the pyramid have also been focused on, however, the
people at the bottom of the pyramid have usually been ignored. While those in Tier 4 have been
ignored for a host of reasons it is interesting to notice that by concentrating on the top three tiers
MNCs have marketed to only 30% of the world’s population. MNCs have ignored Tier 4 because
it has always been assumed that those living in Tier 4 do not have any disposable income and
so cannot afford the products produced by the MNC’s. Nirma’s success in rural India dispelled
the myth that rural consumers are poor and do not have the disposable income to buy consumer
goods. However, the additional reason that MNC’s were wary of Tier 4 markets was because
these markets constituted what is called the ‘disorganized sector’ where a lack of infrastructure
and development hinder effective mar keting and distribution of products. Finally, due to high
overhead costs most MNC’s are not able to price their goods in the manner that local companies
March 09, 2004 13
 HeLL breaks loose- But there is a reason to smile!

SECTOR RESEARCH can thus, refraining from entering the rural market due to their inability to be price competitive.
(FMCG) The Case of Rural India Looking specifically at India it is easier to understand what working in
rural markets entails. In the early 1980’s the total population of India was around 750 million of
which 70% lived in rural areas.[6] Thus India’s rural population, which was comprised of 525
million people, was equal to almost twice the population of the United States of America.
India’s rural market comprised 12% of the world’s population. With an estimated annual
growth rate of 1.7%, India was the second most populous country in the world. By the year 2010
its population was expected to reach 1.15 billion.[7] The sheer size of the rural Indian market
was the greatest attraction for entering it.

Despite the sheer size and potential volume of business in rural areas, HLL stayed away from
the rural Indian market for the simple reason that it was physically very difficult to penetrate. The
nature of rural markets has always been very complex and rural India presented a number of
unusual challenges for HLL. In India the rural client group lived in approximately 570,000
villages spread across the Indian countryside. Approximately 90% of India’s rural population
lived in small way-out villages with populations of less than 2000. Most villages neither had
electricity nor running water. Access to telephones and the Internet was unheard of. Due to a
lack of infrastructure, only 45% of the villages could be reached by road, and few of these were
all weather roads.

HLL’s decision to stay away from the rural markets was not limited to the physical challenges
of the land, but also by the so-called ‘social and cultural’ challenges of the people. In trying to
sell their product in rural areas HLL would be dealing with a client group that had never before
been focused on by multinationals. Banners and leaflets alone would not be effective since
only 43% of rural Indians could read. Moreover, India was a country where 15 recognized
languages were spoken along with over a few hundred dialects so any media campaign would
have to be effectively translated. HLL would have to tackle the challenge of marketing a product
in the absence of conventional marketing and advertising tools. Since only 57% of the rural
population was reachable by mass media HLL could not depend only on television or radio to
get their message across; they would have to be innovative.

Nirma Overtakes Surf: The War of the Bubbles While it may seem that Nirma was of inferior
quality, housewives of rural India were not objecting. Karsanbhai’s product was in high demand.
At one-third the price, as long as Nirma washed almost as well as Surf, the consumers did not
mind. Going from 0% of the market share in 1976 to 61.6% of market share in 1987 Nirma had
pushed HLLfrom the top. At the same time, until 1989, Surf remained between 2.5 to 3.6 times
as expensive as Nirma.

HLL was astounded by the growth of Nirma. HLL had a very clearly defined idea of what the
specific ingredients of a detergent should be and what ratio they should be mixed in. According
to HLL, Nirma was a low quality product. HLL commented that Nirma did not contain any
whitening ingredient, had insufficient active detergent, had no perfume and was rough on the
skin. The rumor was that Nirma contained lower levels of active detergents and more fillers and
soda ash. Despite all these factors Nirma had outperformed Surf in the market. Looking at the
following figures in Exhibit II the rate of growth of Nirma is astounding. [Now here let’s talk
about the design of each product: their chemical makeup, etc.

By 1984, Nirma occupied the position of No. 1 brand in Asia leaving Surf far behind.[9] Everybody
was shocked, most of all HLL. The key question is: how was Karsanbhai able to achieve such
tremendous success in an arena that had been dominated by HLL for so many years?
Karsanbhai’s response to this was that he saw an opportunity where others had not bothered
to look.

He said, “I found a massive market segment that was hungry for a good-quality product at an
affordable price…so I decided to keep my margins very low, and was happy if I could net
between three and five percent… profits really came from the huge volumes we generated”.[10]
Karsanbhai was a genius to have recognized the opportunity provided by this rural market and
he was able to successfully give them the product that they wanted at the price that they wanted.
A New Business Model - The Nirma Way[11]
March 09, 2004 14
 HeLL breaks loose- But there is a reason to smile!

SECTOR RESEARCH One of the starkest differences between Surf and Nirma was the price. While the contents of
(FMCG) the product may differ Karsanhbhai was able to produce such a low cost detergent. There are
many areas where he controlled expenditure. Aware that soda ash, the main raw material for
his product, was abundant in Gujerat, Karsanbhai set up shop in the vicinity. To keep a lean
organization Karsanbahi outsourced all the administrative functions. He contracted tasks like
selling, accounting, technical production capabilities and distribution. All this gave him the
flexibility to negotiate price during slow periods.

Till 1985 the Nirma ingredients were simply mixed by hand thus requiring neither machinery
nor capital investment. Due to the scale of his product and the simple non-mechanized
production process, Nirma gained a number of tax and excise benefits for not using electricity.
Since Nirma was a small-scale local venture, they did not have to pay excise duties that were
levied on multinationals.

Another area where Nirma saved millions was in labor costs. Being a cottage industry Nirma
was not compelled to abide by minimum wage rules. To maintain low costs Karsanbhai used
contract workers who were paid Rs. 85 per ton (In 1985 $1 U.S = Indian Rupee 12.368)[12] for
mixing raw materials and then bagging them into 1000 bags of 1 kg each. Payment was made
according to work done and since labor was not permanent no additional overhead for benefits
etc. needed to be paid. It was not until the mid 80’s that Nirma started to mechanize their
production process, however by then they were an already well-established name. In 1989
Nirma’s labor costs for 8000 workers was estimated to be between Rs 15-20 per person day
in comparison to HLL who paid their semi-skilled workers approximately Rs 30-40 per person
day. (In 1989 $1 U.S = Indian Rupee 16.225)[13]

When setting up a distribution system Karsanbhai was extremely aware of the importance of
keeping costs down. Once demand for Nirma had outgrown his ability to deliver on bicycle he
moved on to vans and then later to trucks. Nirma had neither a field sales force nor owned a
distribution network. Karsanbhai negotiated prices with truck and van suppliers on a daily
basis. As sales grew Karsanbhai eventually hired stockists (those who stocked additional
quantities of the goods) as commission agents. On the one hand it helped him avoid central
sales tax and the stockists were responsible for all transportation, octroi,[14] handling and
delivery costs. There was also a strict system of protocol and distribution depended on
prepayment for stocks so as to minimize risk for Nirma.

While advertising did not appear as a cost in his initial budgets, by the late 70’s as televisions
slowly started to spread into rural India, so did the Nirma ad campaign, with its simple message
and catchy jingle. By the early 80’s Nirma became synonymous with good quality and low-
price. The stockists were also responsible for promotions and they funded 50% of promotional
expenditure for their goods. Nirma’s sales reached a rate of growth that was two to three times
that of the industry in general. As a result of all the above measures Nirma survived and
flourished on what looked like a miniscule margin per unit.

The HLL time-line In 1977, with a 12% market share, Nirma was the second largest volume
seller of detergent in India. Surf was the leader with 33%. Still, for a long time HLL did not think
that Nirma could ever present a potential threat. The general belief between marketing gurus
and within HLL was that Nirma’s bubble would soon burst. They did not believe that Nirma
could survive on the miniscule per unit margins they were making. In addition, being a
multinational, HLL had tremendous overhead costs and therefore had never considered itself
capable of providing a low cost detergent to compete with Nirma’s low priced product. For this
reason HLL had traditionally stayed away from the rural and low-income market. Finally, at the
time HLL had two detergent producing factories, both of which were having productivity and
industrial relations problems. So HLL decided to wait and watch.

However, by 1985 Nirma was outselling Surf by 3 to1. While Nirma had a market share of 58%
Surf’s had dropped to 8.4%. From nowhere, Nirma had risen to become one of the largest
selling detergent brands in the world.[15] Nirma had not only increased its share of the pie, but
had increased the size of the pie itself. Moving into a so far untapped market, Karsanbhai was
responsible for expanding the detergent market 10 times. To HLL’s surprise, consumers were
March 09, 2004 15
 HeLL breaks loose- But there is a reason to smile!

SECTOR RESEARCH
starting to compare HLL’s high quality Surf powder with Nirma. HLL researchers reported that
(FMCG) persistent use of Nirma caused blisters on skin and damaged clothes by weakening fabric in
the long run. According to HLL’s Research and Development team these side effects were due
to the high soda ash content in Nirma. Despite these criticisms, Nirma was being perceived as
a much cheaper and fairly comparable alternative to Surf. This jolt in consumer confidence and
the massive decrease in sales forced HLL to recognize that Nirma was here to stay. Nirma
was successfully toppling the giant from the bottom of the pyramid. Finally, in 1986 Nirma
started testing a new detergent bar that would be directly marketed as a challenge to Rin, HLL
’s leading and most profitable detergent bar at the time. At this point HLL recognized that it was
not just a question of Surf, Nirma was systematically undermining HLL’s dominance in the
industry and for the first time HLL got a glimpse of what could be the ‘beginning of the end’ of
their detergent business. It was time for HLL to react.

[1] This case was written in July 2002 by Research Associate Pia Sabharwal Ahmad under the
supervision of Professor Michael E. Gorman, Professor of Technology, Culture &
Communications and Systems Engineering at the School of Engineering and Applied Science,
University of Virginia, and Patricia H. Werhane, Ruffin Professor of Business Ethics, Darden
School of Business, University of Virginia. This case was written as a basis for class discussion
rather than to illustrate effective or ineffective handling of an administrative situation. Copyright
ã 2002 by the University of Virginia Darden School Foundation, Charlottesville, VA. All rights
reserved. To order copies, send an e-mail to dardencases@virginia.edu. No part of this
publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted
in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—
without the permission of the Darden School Foundation

[2] Hindustan Lever: Role model for Multinationals, Financial Times, August 1, 1997

[3] Charlotte Butler, Hindustan Lever Limited: levers For Change, Case registered at London
Business School in 2000. Page 40-41.

[4] C.K. Prahalad & Stuart Hart, Strategies for the Bottom of the Pyramid, 1999. Seen at http://
www.wri.org/meb/wrisummit/pdfs/hart.pdf

[5] C.K. Prahalad and Stuart L. Hart, The Fortune at the Bottom of the Pyramid. Seen at http://
www.changemakers.net/library/temp/fortunepyramid.cfm

[6] See Appendix 1 for Map of India.

[7]Population statistics taken from the following sites http://www.undp.org.in/report/IDF97/

idftab.htm, http://mohfw.nic.in/popindi.htm, http://www.library.uu.nl/wesp/populstat/Asia/
indiac.htm, http://www.eia.doe.gov/emeu/cabs/india/indiach1.htm, http://www.cs.colostate.edu/
~malaiya/india.html#Populations%20in%20the%20Sub continent

[8] Charlotte Butler, Hindustan Lever Limited: levers For Change, Case registered at London
Business School in 2000. Page 47.

[9] One Man Show Rivals Multi Nationals, 2000, Responsive Database Services, Inc., Business
and Industry, Rodman Publishing Corp., Happi-Household & Personal Products Industry, Vol.
37, No. 2; Page 26.

[10] Karsanbhai Patel – A Clean Sweep, June 27, 2002. Seen at. http://www.indiaprofile.com/
people/karsanbhaipatel.htm

March 09, 2004 16

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