The future of CPG is niche
There’s no doubt that the world of CPG is changing. The industry is being disrupted by new entrants and new distribution channels which is leading to loss of market share for the largest CPG companies and consolidation. Having been an operator and investor in this space, I have strongly held views on where the industry is going. I’m convinced that the future of CPG is niche and that competitive advantage in the future will come from owning strategic distribution and marketing assets.
How we got here
CPG brands and the retailers that are the distribution vehicle for these brands have a long intertwined relationship that could be called symbiotic or parasitic depending on your point of view. Regardless, the majority of CPG products are sold in physical retail stores. In most categories, pre-COVID e-commerce penetration represented far less than 10% of total volume. COVID has changed this but it’s safe to assume that the majority of CPG sales will come from physical retail for the near future.
While the largest CPG companies are losing market share, the largest retailers are actually growing in share. These retailers have consolidated their power over time which gives them a significant influence over the industry, and in particular, innovation in the industry.
Retail buyers are most focused on the sales or margin per foot / item that a brand drives (including the ancillary effect that brand might have on the category). This way of looking at distribution has had an immense impact on consumer goods. Driven by retail economics, a successful product had to have mainstream appeal. By appealing to the masses, a product had a better chance to get and keep shelf space. Think about this: what are the odds you could find gluten free bread on a Walmart shelf 10 years ago? In the past, a product that spoke to a niche simply couldn’t hold up to the same metrics as a mass market brand. Many product categories sorely lack innovation because the incentives between brands and distribution were misaligned.
To make products successful at retail, brands have always leveraged marketing spend to drive awareness and trial. In CPG’s pursuit of funding marketing, brands became exceptionally good at squeezing cost and thus profit out of their supply chain. As companies scaled, they were able to benefit from economies of scale making larger CPG companies more profitable than smaller ones.
Today many consumers are more focused on product quality than price. This change in the willingness of consumers to pay for premium products is also changing how scale benefits players in the industry. Margins alone may create a profitable brand but without a true consumer value proposition, high margins may not equate to growth. Many CPG companies have squeezed much of the profit they can out of existing supply chains and are no longer able to grow profits without revenue growth.
In some industries, having success enables companies to take more risk. However, in CPG, success presents a paradoxical challenge between short and long term health. Successful brands earn more shelf space but to find growth, often have to cannibalize their own SKUs to make room for new products. This just raises the bar for large CPG companies to find bigger ideas - making niche products even harder to justify internally. Put another way, there’s no reward for small ideas that can be big over time.
Aside from distribution challenges, CPG marketing is also a story of scale and volume more so than relevance. Even today, most CPG brands use traditional media to advertise their brands. However, these mediums, until recently, have been tuned towards volume versus targeting. With the shift towards digital, much of this is now changing. The internet is leveling the playing field between large and small brands in terms of both distribution and marketing. The CPG world of the future will favor the most relevant brands and the best products.
Today’s CPG reality
Internet shoppers don’t need to browse shelves. They operate under a whole different set of rules. With product filters, attributes, reviews, and search boxes, consumers can find exactly what they’re looking for. A limitless catalog means that ‘stores’ are no longer constrained by shelf space and can house millions of SKUs. If no product exists to serve a customer need, marketplace sellers will analyze this unfulfilled demand and create products to fill these voids.
Enabled by the internet, advertising channels have changed to allow greater abilities to target consumers and leverage intent. Brands know what consumers are looking for because of the search box. Given prior purchasing history and demographic data, finding consumers within a specific demographic has never been easier. Moreover, the internet rewards relevance. Products with greater click-thru / conversion rise to the top of search results pages on Google and Amazon. Super fans and influencers can spread the word faster than ever before and convince new consumers to form preferences even in categories they’ve never purchased before. Once a purchase is made, brands can reward loyalty and repeat buying in ways they never could before. In fact for most online stores, buying again is easier than buying something new.
What this means for the future
Winning on relevancy and reviews is much harder than winning on shelf presence and package design. In CPG language, the ‘first moment of truth’ is disappearing while the second is growing in importance. The impact of packaging is changing from a ‘conversion’ to a ‘margin’ lever and companies need to think of their web presence (whether DTC or through Amazon) as just as important as packaging.
We are on our way to a world with unlimited SKUs where the best product for the individual consumer will win. With this endless array of choice, brands are still incredibly important but how brands will win is changing. Besides winning on product, CPG brands of the future will need to have an unfair advantage in terms of distribution.
It’s never been more important for a brand to own their audience or be able to influence distribution. The benefits of scale are moving from COGS (cheaper ingredients, better cost structure) to sales and marketing (free/cheap ways to reach consumers, ability to cross sell). This is the shift facing large CPG companies: the ability to manufacture a product at scale will not be as valuable in the future as owning the customer relationship.
I expect to see a blurring line between distribution and brand with CPG brands owning their own distribution as well as retailers putting more resources into their private label efforts (which has been the case for many years). CPG brands of the future may also own content and other assets that keep them top-of-mind with the consumer. Dollar Shave Club produced great commercials but why stop there? Perhaps history will repeat itself: soap operas were once produced by large CPG companies who funded their production in order to have a captive advertising channel.
There are many implications for entrepreneurs and venture capitalists. For entrepreneurs, the shifts occurring today will be very positive. Founders naturally prioritize product and relevancy to produce highly differentiated products that resonate with a specific audience. For investors, the shift towards niche brands has already changed how many view this category. Many investors are shifting focus from brands to the infrastructure to support this new wave of companies. I believe +$1b outcomes in CPG will be few and far between. However, a category leader with global reach may still create a large outcome. As a result, in some verticals I expect brands to go global much sooner. There are likely to be more small acquisitions; capitalizing those businesses appropriately will be key. We will also continue to see roll up’s and family of brands strategies that seek to benefit from cross promotion between products. Across all CPG brands, product development will adapt as well with brands improving products over time (stronger relevancy / reviews), the same way software is continuously developed. There is a significant untapped opportunity for companies who are developing ways to sense demand online (search trends, etc.) and then create products to fill voids in the marketplace.
The future of CPG is niche and a new wave of consolidation may be beginning. Large CPG brands will own a larger, more diverse portfolio of smaller brands. All brands will evaluate how the partner with or acquire assets that give them an unfair distribution advantage. The industry will change with certain segments becoming less profitable and more competitive but ultimately, the consumer will win.