For almost 40 years, the US consumer goods sector was among the safest of havens for investors. It rewarded them with annual returns well above the market average—second only to those of the energy sector—and in a bumper period from 1985 to 2002 outperformed the S&P 500 index by almost 20 percent annually. Since then, the sector has barely outpaced the index, despite persistent attempts by companies to find winning strategies. While inadequate cost controls and a failure to deliver significant value from a wave of mergers and acquisitions haven’t helped, one factor is the dominant culprit for the current malaise: the industry’s response to changing commodity prices.

Losing control

From 1985 to 2002, consumer-packaged-goods companies regularly passed on to consumers increases in the price of inputs (including aluminum, cereals, oil, and paper) while holding the line on prices when raw-material costs declined. In this way, these companies maintained profit margins when input costs rose and enjoyed expanding margins when they fell. In fact, we estimate that between 1996 and 2002, the strategy of passing on commodity price increases was responsible for two-thirds of net margin expansion in the sector, or roughly $10 billion in value.