Why CPG goliaths have only begun their fall.
As grocery buying digitizes, CPG giants are seeing the advantages they’ve possessed for more than a century erode.
The following article was originally published in “What I Learned This Week” on May 4, 2017. To learn more about 13D’s investment research, please visit our website.
In explaining the company’s weak first-quarter performance — 1% organic growth — Procter & Gamble CFO Jon Moeller told earnings-call listeners last week: “[There are] probably more sources of volatility today than at any other time in history.” It’s a stark statement for a company founded in 1837. Yet, the motivations for Moeller’s comments are clear. In 2016, the top 20 consumer packaged goods companies saw flat sales, while smaller firms averaged 2.9% growth. This follows four years, 2011 to 2015, in which large CPG companies lost an estimated $18 billion in market share to craft manufacturers.
Now, the decline of top CPG companies appears set to accelerate. Large grocery retailers are altering store footprints to better serve consumer demand for fresh, healthy, and local foods. Meanwhile, margins are being relentlessly squeezed by the pricing war between Walmart and Amazon (WILTW April 6, 2017). And, finally, there is reason to doubt the industry’s two primary ways of offsetting losses — consolidation and emerging market growth — can still be effectively leveraged.
Once again, we come back to an enduring theme of ours, Scale Factor (WILTW January 7, 2016). In industries where production scale and product quality are inherently intertwined, big brands are struggling. The CPG industry clearly illustrates how powerful and relentless this force has become in the Digital Age. As grocery buying digitizes, CPG giants are seeing the interlocking advantages they’ve possessed for more than a century progressively erode. In turn, small manufacturers — better equipped to meet niche and ever-changing consumer tastes — are seizing market share and forcing systemic shifts in the global food industry. The process has only begun and for the giants of the CPG industry, there appears no clear path to salvation.
Since the rise of industrialized production and national distribution networks, CPG behemoths have been able to maintain a stranglehold on consumer tastes by dominating advertising, shelf placement, and pricing power. The proliferation of the internet and smartphones has weakened these scale-driven advantages.
As we wrote in WILTW November 5, 2015: “Products have and always will be judged based on two core criteria: value and quality. Due to the ubiquitousness of legacy brands — in advertising, on grocery store shelves, and in households — consumers long assumed they were getting the best balance of both by purchasing legacy products. Online research, however, has empowered consumers to see past assumption and judge value and quality on a case- by-case basis according to their personal case-by-case criteria.”
A survey released last week by consulting firm Clear M&C Saatchi captures how fast and far brand loyalty has fallen. Clear interviewed more than 2,500 consumers in the U.S. and U.K. about 19 food and beverage categories and 200 brands. They found that 86% of U.S. consumers and 83% in the U.K. “seek out brands based on their attributes rather than their status — regardless of category.” In the U.K., this is roughly an 11% increase from six years ago. In the U.S., the increase is even greater: 15%.
Yet, while CPG giants have suffered sustained sales declines due to this shift, the damage has been mitigated by the resilience of the grocery business to disruption. In the U.S., e-commerce accounted for only about 1% of grocery sales in 2016. The average American still makes 1.6 trips to the grocery store per week. And given the dominant market share possessed by CPG giants, they have maintained legacy influence in their relationship with their primary industry partner — brick-and-mortar retailers. This has protected shelf-placement and pricing power. However, 2017 appears a tipping point.
As The Wall Street Journal reported this week, many of the country’s biggest retailers — from Kroger and Shoprite to CVS — are renovating store footprints to prioritize fresh and healthy food, prepared meals, and items from local manufacturers. It is clear why: according to Nielsen, sales of packaged food and beverages declined 0.4% in the year ended February 25, which compares to growth of 1.7% for fresh meat, 1.9% for produce, and 4% for deli-prepared foods.
Moreover, the price war between Walmart and Amazon has demonstrated the waning control big CPG brands have over their pricing. As reported by Recode, Walmart gathered top CPG brands in February, demanding they either shave 15% or more off their wholesale prices or the brick-and-mortar giant would limit their distribution and create their own store-brand products to replace the inventory.
The bottled beverage industry illustrates how costly this loss of pricing power could prove. Soda consumption in the U.S. has fallen for 12 consecutive years, including 1.2% in 2016. The average American now drinks roughly 640 8-ounce servings of soda annually, a 31-year low. Yet last year, total soda sales dollars actually increased 2% to $80.6 billion as the beverage industry’s giants, PepsiCo and Coca-Cola, shrunk package sizes and charged higher per-ounce prices.
With Amazon’s grocery ambitions escalating, it is likely the margin pressures on CPG giants will escalate too. As we explored in WILTW December 15, 2016, Amazon’s strategy to disrupt the grocery industry appears clear: bifurcating buying between brick-and-mortar sales of perishables and e-commerce sales of pre-packaged goods.
In Seattle this month, Amazon will host CPG companies for a three-day summit in which the company will sell the merits of shifting focus from brick-and- mortar to e-commerce. Given the strained relationship between CPG giants and traditional retailers, it could prove an appealing pitch. However, digitizing CPG sales is a slippery slope. As we’ve seen from iTunes to Uber and Facebook, digital platforms suppress supplier pricing power. Moreover, e-commerce’s functionally-infinite aisles means near-endless choice for consumers and more native access to product research, meaning digitization will likely exacerbate the underlying problem driving CPG giant struggles.
Which brings us to what many point to as the likely salvation for CPG giants: M&A. To date, industry leaders have taken a two-pronged approach. First, they have escalated acquisition of craft brands and formed venture capital firms to fund others. It is unlikely to prove a panacea. CPG giants have struggled to head off emerging trends and take over start-ups without compromising the authenticity and flexibility that instigated the acquisition in the first place. In addition, the decline of CPG giants is death by a thousand cuts, meaning craft investment will not occur in numbers great enough to stop the bleeding.
Second, as Kraft Heinz’s failed bid for Unilever suggested, CPG giants are poised to escalate megadeal activity in order to create supply-chain efficiencies and reclaim pricing power. However, given the escalation of megadeals over the past few years and the intensifying populist pressure to crack down on corporate power, it appears possible, if not likely, global regulators will block further consolidation of the CPG industry:
If megadeals are indeed blocked, CPG giants are left with one great hope: emerging market growth. Yet, more and more, it appears emerging markets are less opportunities than case studies for Amazon’s bifurcation strategy. As The Financial Times wrote in March: “Many traditional retailers are not profitable in these markets any more as emerging consumers go directly from wet markets (for fresh produce) to e-commerce for dry goods.”
Because corporations possess less power over food systems in emerging and developing markets, there are fewer systemic barriers to digitization. As a result, sales are digitizing faster, making emerging and developing markets bellwethers for the future of global grocery buying. And given the headwinds faced by CPG giants, it appears increasingly likely they will be a smaller and smaller part of that future.
This article was originally published in “What I Learned This Week” on May 4, 2017. To subscribe to our weekly newsletter, visit 13D.com or find us on Twitter @WhatILearnedTW.
