Two years ago things were looking up for Procter & Gamble (P&G). Jonathan Birchall reported, “Bob McDonald, who took over as chief executive of P&G in the summer of 2009, … pledged to regain market share by winning millions of new customers in both new and existing markets, while continuing to expand the range of its existing brands.” [“Emerging markets lift P&G fortunes,” Financial Times, 27 October 2010] At that time, P&G reported that it had “gained market share across its global markets, as new products and demand from emerging markets offset sluggish consumer spending in the US and Europe.” The future appeared bright and P&G’s stock was on the rise. By September 2011, the business landscape had shifted and it was obvious that company’s strategy had to be adjusted. The middle class was in a financial morass and “the world’s largest maker of consumer products [was] betting that the squeeze on middle America will be long lasting.” [“As Middle Class Shrinks, P&G Aims High and Low,” by Ellen Byron, Wall Street Journal, 12 September 2011] Melanie Healey, group president of P&G’s North America, told Byron that the change in the business landscape had required P&G to “think differently” about its product portfolio.” For years, Byron notes, P&G had targeted an affluent middle class to sell its products. She writes:

“P&G’s profits boomed with the increasing affluence of middle-class households in the post-World War II economy. As masses of housewives set up their new suburban homes, P&G marketers pledged that Tide detergent delivered cleaner clothes, Mr. Clean made floors shinier and Crest toothpaste fought off more cavities. In the decades since, new features like fragrances or ingredient and packaging enhancements kept P&G’s growth robust.”

The problem is that offering “new features” is not the same thing as offering innovative products. That is where many pundits believe that P&G has gone astray in its strategy. John Bussey compares offering new features to a bunt in baseball whereas striving to create innovative products is more like swinging for the fences. He admits, “In the great game of product innovation, sometimes a bunt is better than no swing at all.” [“The Innovator’s Enigma,” Wall Street Journal, 4 October 2012] To make his point that P&G has started to bunt rather than swing away, he discusses one of P&G’s latest offerings a “new over-the-counter sleep aid ZzzQuil.” He writes:

“ZzzQuil is hardly a breakthrough, or even a small discovery. P&G’s NyQuil cold and flu medicine contains three active ingredients, one of which is an antihistamine that makes you drowsy. Consumers have misused NyQuil for years as a sleep aid even when they didn’t have a cold. So P&G took a familiar antihistamine, diphenhydramine, left out the other ingredients for a cold, and gave it its own package and name: ZzzQuil. No unification theory of the universe, this. What’s more, P&G was late: Competitors, such as Johnson & Johnson’s Tylenol PM Simply Sleep, got to market long ago with similar products. … ‘It’s a sign of what passes for innovation at P&G,’ says an unhappy portfolio manager. ‘It’s not enough. It’s incremental, derivative.'”

Bussey admits that there is nothing inherently wrong with incremental improvement; but, he asserts, profitability can’t be sustained over the long run using that strategy. He explains:

“Bill Fischer, who teaches innovation and management at IMD in Switzerland, says big innovations—upheavals in an industry—are generally followed by periods of consolidation, and then by valuable incremental innovation involving the same product. Continuous improvement, or kaizen, has been Toyota’s claim to fame, for example. The trick is that the cycle tends to repeat itself. ‘Big guys get wiped out because they’re so busy making incremental improvements, they fail to see the big challenges coming from a completely different realm,’ he says.”

In other words, the only sustainable strategy for profitability is for a company to create its own cycle of upheaval and improvement. In meantime, Bussey argues that critics shouldn’t dismiss the short-term profits that products like ZzzQuil will likely bring in. “Small innovations have their virtues,” he concludes, “and the return on that distraction may be better than critics think.”

Since emerging markets (and their rising middle classes) represent the most promising growth potential, I suspect that products for those markets is where companies should expect to see the greatest innovation. Procter & Gamble, however, believes that products that do well in developing markets will also do well with lower income consumers in America. The big question is whether or not P&G will be the company that comes up with those innovative products. Lauren Coleman-Lochner and Carol Hymowitz report that P&G’s research and development (R&D) budget as a share of total sales has been falling for a decade and is now closer to its competitor’s R&D budgets. [“Losing Its Innovative Lead,” Bloomberg BusinessWeek, 6 September 2012] They continue:

“For much of its history, Procter & Gamble didn’t just launch new products, it created new product categories, from the first mass-produced disposable diapers to Crest teeth-whitening kits. That’s one reason P&G has more than 1,000 Ph.D.’s among the 8,000 employees at its 26 innovation facilities around the world. ‘P&G is largely a branded science company,’ says Larry Huston, former innovation officer at P&G who’s now managing director of 4inno, a consulting firm. Lately, though, there’s been a dearth of pioneering brands emerging from the world’s largest consumer-products company.”

Coleman-Lochner and Hymowitz note that P&G’s most recent game-changing blockbuster products “were all launched at least a decade ago.” Returning to Bussey’s baseball metaphor, ten years is a long time to go without a hit. Peter Golder, a professor at the Tuck School of Business at Dartmouth College, told Coleman-Lochner and Hymowitz, “P&G is built on creating new categories, and innovation is in its DNA, but they need to rediscover it.” Regaining P&G’s “mojo” hasn’t been easy. Coleman-Lochner and Hymowitz note that P&G has had to lower profit forecasts three times since the first of the year. That has made investors very uneasy. Coleman-Lochner and Hymowitz continue:

“Chief Executive Officer Bob McDonald … is under pressure from activist investor William Ackman, who in July took a $1.8 billion stake in P&G and may seek management changes. Blockbusters have ‘dried up a bit,’ acknowledges Bruce Brown, P&G’s chief technology officer. ‘We want to get back to more of that.’ McDonald earlier this year assembled a team of researchers, marketing managers, and senior executives from across the company to chart a bolder innovation course. The group spent 10 weeks analyzing P&G’s new-product pipeline and selecting the most promising ideas for development. But most won’t be ready for at least another year.”

It was reported that Ackman recently greeted McDonald by presenting “him with a 75-page litany of complaints about his three years at the helm of the consumer-products giant—poor results, eroding investor confidence and sagging employee morale.” [“P&G’s Stumbles Put CEO On Hot Seat for Turnaround,” by Emily Glazer, Ellen Byron, Dennis K. Berman, and Joann S. Lublin, Wall Street Journal, 27 September 2012] More recently, it was revealed that several P&G executives had sent a letter to P&G board member Jim McNerney, Boeing’s CEO, detailing their concerns with McDonald’s leadership. [“Letter Takes On P&G Chief,” by Emily Glazer and Joann S. Lublin, Wall Street Journal, 22 October 2012] With all the criticisms being raised, it comes as no surprise that that there are reports that “Mr. McDonald’s job could be at risk if the cost-cutting and product-refocus plans he has announced don’t deliver results.”

Coleman-Lochner and Hymowitz assert that McDonald is being judged against P&G’s proud history which “is filled with such consumer-product innovations as the first synthetic detergent (Dreft, in 1933), the first fluoride toothpaste (Crest, in 1955), and the first stackable potato chip (Pringle’s, which later dropped the apostrophe, in 1968). Researchers typically have leveraged technologies already used in P&G products to come up with entirely new ideas. For Crest Whitestrips, launched in 2002, they adapted bleaching methods from P&G’s laundry business, film technology from the food wrap business, and glue techniques from the paper business.” They continue:

“In recent years, however, the company’s product pipeline has been mainly focused on ‘reformulating, not inventing, products,’ says Victoria Collin, an analyst at Atlantic Equities in London. Among these are new scents of Tide for Eastern European markets and Secret deodorant’s Natural Mineral line. As a result, analysts say P&G has lost customers in the U.S. and other developed countries, who’ve switched to cheaper products made by such rivals as Unilever, as well as store brands.”

Coleman-Lochner and Hymowitz lay some of blame for P&G’s innovation stagnation at the feet of McDonald’s predecessor A.G. Lafley. Although Lafley was smart enough “to increase the rate of product development by collaborating with outside partners who could help with everything from packaging to product design,” he “also decentralized R&D, making business-unit heads responsible for developing new items. R&D chief Brown says that inadvertently slowed innovation by more closely tying research spending to immediate profit concerns.” In other words, Lafley’s moves sacrificed long-term innovation for short-term gains. The result has been a lost decade for P&G.

At P&G’s annual shareholder meeting, McDonald stated, “We are renewing our commitment to discontinuous innovation—that is, to innovation that obsoletes current products and creates new categories and new brands. In the meantime, many superior product innovations are in the market now, including Tide PODS, Downy UnStopables, ZzzQuil, Pampers Baby Dry, Charmin DuraClean, Bounty Trap & Lock, Crest Pro-Health for Life, Olay Regenerist, and a full portfolio of superior new products on Pantene and Head & Shoulders.” [“P&G Committed to Innovation That Creates New Categories, New Brands,” SupplyChainBrain, 10 October 2012] With so much attention and being given to the company and so much pressure being applied to McDonald, I won’t be surprised to see a flurry of new products being introduced over the next few years. Still, Glazer and Lublin predict that McDonald will face “a tough audience when the consumer-products giant reports first-quarter earnings” today.