Nestlé’s returns have underperformed the MSCI World Index by 44% over the past two years, leading to CEO Mark Schneider’s recent exit. Did Nestlé’s board overlook key expertise gaps? As the company regroups, it’s not too late to apply these lessons and build a more resilient strategy.

Over the past two years Nestlé’s return to shareholders has underperformed the MSCI World index by 44%. Nestlé have stumbled badly and the CEO, Mark Schneider has been asked to step down. In 2019, we published an article, “Why Giants Stumble,” in the California Management Review. It examined 45 cases of giant U.S. and European companies where, as at Nestlé, the CEO had been forced to leave or left under a cloud after the company had substantially underperformed relative to the stock-market over the past one to two years. Based on our analysis we proposed an Emperor’s Clothes Test for avoiding stumbles and, in the article, took Nestlé as an example to illustrate how the test might be used.

Could our Emperor’s Clothes Test have helped to prevent Nestlé’s stumble?

Nestlé’s stumble is a surprise. Branded consumer goods producers are generally stable businesses and, though P&G had stumbled at the end of the 1990s, there were no similar giants that stumbled over the more recent 10 year period that we examined. What’s more, Nestlé’s stock market performance was strong under Mark Schneider’s leadership from 2017 to 2022.

Nestlé’s stumble reflects the sobering realization that, although the company has supported the share price through high payments to shareholders in dividends and share buybacks in excess of net profit, operating performance has been unimpressive and hopes of a strategic transformation of the business mix towards healthcare and nutrition have been dashed. Under Schneider’s leadership, despite a roughly CHF 9 billion inflow from a partial sale of the L’Oreal stake, Nestlé financial debt increased, from end 2016 to end 2023, by CHF 32 billion, from CHF 23 to 55 billion, while equity fell from CHF 66 to 36 billion.

After a time, maintaining share price momentum by disposals, increasing debt leverage and returning cash to shareholders becomes unsustainable, particularly in a world of higher interest rates. The focus must shift to improving business fundamentals. From 2017 to 2023, under Schneider’s leadership, Nestlé sales grew from CHF 90 to 93 billion and trading operating profit increased from CHF 13 to 15 billion—rather modest improvements. With a background at Fresenius, a healthcare and clinical nutrition company, Schneider was expected to help realize Nestlé’s strategy of substantially growing the healthcare business. But that did not happen. Sales in Nestlé’s nutrition and health science segment are unchanged since 2017.

Could taking our “Emperor’s Clothes Test” have helped Nestlé do better? What a company must do to pass this test is, as the name suggests, obvious but frequently overlooked. In a nutshell: to pass the test, top decision makers should be chosen for their capabilities to meet the specific strategy and operational challenges the company faces and not merely have good general management and financial skills. If managers don’t have the specific background and capabilities needed, either they should be changed or the strategy should be changed. Not long after Mark Schneider was appointed CEO, we wrote, “If the board had applied the Emperor’s Clothes test before his (Schneider’s) appointment, his advocates would have had some explaining to do.” ….“Schneider clearly has general management and financial skills but lacks expertise in consumer brands. While he has a health care background, he lacks a technical education or experience in nutrition science or in a technical discipline relevant to actually designing and developing a health care offer. His success at Fresenius came not from operations but largely from acquisitions.”

Our study also showed that strategies based on big acquisitions or diversification into new business areas, both of which, in combination, would be needed to capitalize on Schneider’s areas of particular strength, were highly risky and a major cause of stumbles. An alternative, less ambitious, strategy with less emphasis on growth in healthcare and nutrition would have been possible but difficult to justify after Schneider’s appointment.

Of course, no individual manager can combine all the specific skills needed to ensure the success of a major global company. So the Emperor’s Clothes Test examines if others in the board and top executive team bring complementary skills that the CEO may be lacking and if these top decision-making bodies are of a size and composition to ensure good debate and discussion. Here too Nestlé had some explaining to do.

We wrote, “The Nestlé top team was strong on branded goods, but apparently weak in the technical skills for developing the health care and nutrition offer. Greg Behar, as of early 2018 the executive board member for nutrition science, was trained as a mechanical engineer and worked for many years at Boehringer Ingelheim, a pharmaceutical company. He had no obvious background in nutrition.” We also noted: “Only one of 12 Nestlé non-executive directors had a consumer brands or food retailing background… Yet there were five non-executive directors with a financial services background. Health care representation is equally thin.” Shortly after we wrote the article (but before it was published), Nestlé made new appointments to the board strengthening Fast-Moving Consumer Goods (FMCG) competence, Kaspar Rorstedt and Kimberly Ross. But Rorstedt stepped down in 2022 and the board of directors and the executive board have remained apparently weak in members with a relevant technical education and practical business experience in developing nutritional healthcare products.

The Emperor’s Clothes Test also considers if the board of directors is sufficiently independent from executive management to challenge their decisions, and if the size and composition of top decision-making bodies is likely to foster good productive debate. Nestlé has only one non-independent board member in addition to the CEO, but this is someone with a particularly important position, the chairman. Paul Bulcke has now been on the board, first as CEO then as chairman, for 16 years. To have a good discussion, a management body should not be too large. The Emperor’s Clothes Test suggests 12 people as a top limit. The Nestlé board has, in most recent years, had 14 members and now has 15. The executive team, at the time we wrote our article had 14 members, this fell to 12 but had risen again to 16 members by the end of 2023.

The questions in the Emperor’s Clothes Test are positioned as “comply or explain.” There may be good reasons for not complying. But it was no coincidence that we, at the time, picked Nestlé to illustrate how to apply the test. And it appears there were some simple measures the company might have taken to avoid stumbling. Nestlé is down from where it was in 2022, but certainly not out. It is not too late for Nestlé, and other companies, to apply the Emperor’s Clothes Test on the next stage of their journey.