Consumer Products Update Lots of Change Coming

<p>Cradle
to grave, lots of change is occurring in the consumer-products sector. These
changes will produce new challenges and cause significant restructuring of
operating business models as to how products are made, distributed and sold.
The size and impact of these changes will have a noted effect on the
consumer-products marketplace for years to come. They will also affect our
lives both as consumers and restructuring professionals. Here are some of the
key strategic drivers behind these changes:

</p><p> <i>The gap between the good and not so good continues to widen in the retail
channel.</i> Good retailers continue to
operate and perform in ways that make it very difficult for more marginal
retailers to compete. Good retailers are able to maximize the leverage created
by their financial, technological, logistical and marketing resources. The
effective retailer is focused on increasing market share, improving margin and
growing profits. Those retailers who have made missteps in the development of
their financial, technological, logistical and marketing platforms have transitioned
into survival mode. Expect the downturn in the economy to result in cash-flow
challenges for retailers in this survival mode, which will compel them to
continue to consolidate, downsize and close stores.

</p><ul>
<li>Many
consumer-products manufacturers and distributors depend on the existence of
department store concepts and specialty stores as outlets for their products.
However, there are those who believe it is reasonable to consider that the
department-store concept and mall-based specialty store concepts are outdated
and challenged to find their place in the retail marketplace. Recent reports by
leading specialty chains such as The Gap, Eddie Bauer and J. Crew, among
others, have reflected significant declines in comparative store performance.
Well-established department store chains such as Federated Department Stores
and Dillards have recently closed stores.

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Earnings performance, return on invested capital, return on equity and the performance of consumer-products companies in the public equity markets has all made equity investment in the consumer-products sector unattractive.
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</li><li>Department store operators are increasingly engaged in a searching evaluation
as to the highest and best use of department store properties. In many cases,
the value of department store real estate has been depreciated on a
retailer's books to the point where significant gains in ROI (return on
investment) can be realized from the redevelopment or redeployment of those
assets. These gains may in some cases outweigh the expected ROI from continued
operations. These operators must re-invent their operating models in order to
justify continued investment.

</li><li>Specialty store
concepts have become duplicative to the point that their sales are driven
primarily by discounting. In the last decade, we saw the success of
private-label brand development in mall-based specialty stores. Success bred
imitation, and now it is difficult to differentiate one popular private label
from another. Moreover, with standardization in overseas production, the
differences in quality between brands is difficult to discern, forcing the
specialty retailers to spend more on advertising while taking earlier and
larger markdowns.
</li></ul>

<p><i>China leads the Far East in reestablishing its competitive advantage in the
manufacturing sector.</i> Standardization in
manufacturing technology, supply-chain software and logistics software coupled
with inexpensive labor has allowed manufacturers in China to start producing
high-quality consumer products at low prices. The difference in quality between
products manufactured in the Far East and Europe and the United States is
fractional at best. This phenomenon has resulted in the commoditization of many
consumer products, thereby deflating the price and margins for such products.
The Internet has provided the necessary communication link for dramatic sales
growth and marketplace expansion for many of these Far East suppliers. Their
fanatical zeal to drive inefficiency out of the manufacturing and delivery
process has resulted in spectacular growth and created further competitive
pressure for consumer products manufacturers in the rest of the world. Entire
sectors in the American manufacturing base are headed the way of the domestic
consumer electronics and apparel manufacturers. They will become small or not
exist at all.

</p><p><i>Driven by
efficiency and focused on eliminating cost within the supply chain wherever
possible, retailer demands on suppliers are daunting.</i> It's not just about the product. A supplier
had better have and understand the information, and manage inventory, price and
logistical support to meet an ever-increasing list of demands from the best of
its retail customers.

</p><p><i>American business has made progress.</i> Managing obsolescence profitably still continues to challenge even the best of
the group. Concept, product, inventory, location and consumer taste change
quickly. Product innovation remains the driver of growth in sales, margin and
profits. However, for every 10 new products, only two will be successful.
Liquidity is an absolute requirement to leveraging opportunity in this
competitive environment. The lack of acceptable ROA (return on assets) from
underperforming assets coupled by an economic slowdown has resulted in an
oversupply of product, price deflation, duplicative concepts, an oversupply of
underutilized real estate, tightened credit markets and, for some, a liquidity
crisis. The supply channel is overburdened with obsolete assets. The market
will continue to lower values and depress growth in its own natural correction.
Many companies will be directly affected by this challenging set of
circumstances.

</p><p><i>Finally, we look at the capital side of things.</i> Earnings performance, return on invested capital, return on equity and
the performance of consumer-products companies in the public equity markets has
all made equity investment in the consumer-products sector unattractive. The
balance sheets of consumer-products companies are becoming increasingly
leveraged. In the current environment, vendor debt really takes on the
character of traditional equity. Operating capital, now generally
collateralized debt, continues to become more expensive for marginal players.
These costs shorten the timeframes for correction, and leverages up operating
risk.

</p><p>We have spoken about many of the current challenges faced by consumer products
companies today. Yet with all the challenges, some companies continue to
prosper. Capital, cash flow, growth and innovation are the ingredients that
typically fuel successful efforts. Given current rates of return and the
competitive environment discussed above, it is at best difficult to expect
significant new financial investment in consumer products companies.

</p><p>If they are to survive, consumer products companies must continue to challenge
themselves to find ways to differentiate on terms other than price alone.
Companies must be willing to look at unproductive assets and manage
obsolescence in a way that increases ROA. Concept, location, inventory,
customer focus and market share all should be evaluated in the consideration of
changing and redefined strategies. An honest look at a company's
capabilities and competitive position is a good starting place.
Asset-reconfiguration strategies require the conversion of obsolete assets as
part of the liquidity strategies to fund change. There must be reasonable
timelines for correction and re-growth given the competitive and changing
marketplace. Eventually the marketplace will self-correct. Between now and then
there will be lots of activity, lots of challenge and lots of opportunity.

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