Analysed: How Can Consumer Packaged Goods be Disrupted?
Using Aggregation Theory to observe whether a Kodak-style downfall is possible
I’ve recently been spending time thinking about how a CPG company could face a Kodak-style overnight business model disruption, such as when Kodak’s main business of selling film collapsed as cameras went digital. I’m not talking about smaller erosion (such as market-share loss to mushroom brands that I wrote on previously). But something big!
Let’s take Ben Thompson’s Aggregation Theory as a starting point. He suggests that the value chain for any given consumer market is divided into three parts: suppliers, distributors, and consumers/users. In the “pre-Internet” era, success depended on controlling distribution (eg. Blockbuster controlling distribution to on-demand video through a network of stores).
The Internet made distribution of digital goods and cost-to-serve close to zero. With distributors no longer able to compete based upon exclusive supplier relationships or physical infrastructure, the supply side (eg. the product) can be commoditised, leaving consumers/users as a first order priority. Think how superior the consumer-experience is for Netflix vs. how it would have been for an old video rental store.
However, if we try and translate this Aggregation Theory model to CPG, it doesn’t really work. That is because there is almost no way of bringing distribution cost-to-serve close to zero. Why is that? Because CPG products cannot be digitised. There is not a realistic digital substitute for a coffee product or a shampoo product. There is a physical product which needs to eventually reach the consumer.
From a product perspective, CPG companies are somewhat stuck in a “pre-Internet” era, where success depends a lot on controlling distribution. And the sophistication of that distribution cannot be overstated, with multiple levels of distributors giving impressive reach and penetration. To illustrate just how sophisticated: Unilever claims that 3.4 billion people use its product every day. That is almost the same reach as the Internet itself (at c. 4.3 billion users)
In his noted book Good to Great, Jim Collins describes how companies transition from being good companies to great companies. Much of the focus in on management principles. Collins discusses that technology was insignificant as far as starting a transition from good-to-great, and that the industry itself is not significant.
However, looking at performance of companies since publication of the book; it is clear that industry and technology are very important. Those companies distributing physical products or services which cannot be replaced with digital substitutes have indeed performed well (and yes, the other management principles Collins focuses on probably don’t hurt). For those companies whose products can can be replaced with digital substitutes, not so much!
Although this only focuses on 11 companies, I suggest a broader dataset of companies which existed on stock exchanges in 1990 (pre-internet) would show that those with resilient distribution not easily at threat from zero cost digital substitutes have been most successful in the 33 years since.
Digitally Native Vertically Integrated brands have attempted to disrupt the paths to the consumer by bypassing existing distribution channels. However, the reality is that the value density of most consumer goods products is low, with only premium categories in developed markets looking like they might be a realistic target. Even then, those companies are now also leveraging existing distribution routes to market to improve their unit economics.
Don’t get me wrong, I do believe that CPG companies have left value on the table on the supply and demand-side:
Capacity in network: most factories are not running at full utilisation and companies are so focused on service level that they often prefer dedicated supplier agreements on physical infrastructure like warehousing or logistics (which is also often not fully utilised)
Product residuals: because of the economics of mass production, long production runs are a necessity. Products are sometimes produced which cannot be sold due to shelf-life requirements, lower-than-expected market demand etc. (I have written about some liquidation strategies here)
Under-served white spaces: due to the focus on mass and typical cost-to-serve paradigms, there may be segments, whether geographical (eg. small markets, rural areas) or niches (eg. ethnic segments) where participation does not make sense
Product revolution: focus will be on innovation and incrementality, and not truly disruptive offerings due to a reluctance to cannibalise the core and spend money on education of customers by growing a category which low-cost competitors may then undercut
Based on what I have shared so far, we have established that distribution cost to serve can never be brought to zero due to the inability to digitise the supply, and the circumvention of the existing distribution is not profitable in to-consumer models.
However, there is one way that I can see the CPG industry could be completely disrupted. It would be a superior brand-agnostic distribution offering for businesses (which would be focused on developing markets where distributive trade share is significant).
The service would offer something like the following:
Digital platform (so that shops can order independently without having to go through salesman)
Low minimum order value (so that shops have to tie up less cash in inventory. Offering credit lines would be even better)
Next day delivery commitment (the end-to-end service should be vastly superior to drive distributor switching)
Offer multi-brand product range at good prices
With such as service you could increase wallet share to the point that the small shops and businesses only need to use this distributor service and no longer need to go through the branded manufacturers. By this point, if you could control the distribution, you could then commoditise the supply side, negotiating aggressively with branded manufacturers if their products were too expensive.
I was thinking that in a hypothetical scenario I would try to set up this model in an island nation (eg. Sri Lanka) which is less import/export driven than a market in a geographical trading bloc. However, when I mentioned my thoughts to a friend in Egypt, he drew my attention to MaxAB which is already doing something similar there.
It fulfils many of the criteria mentioned above: a digital platform used by 150,000 unique traditional retailers, low minimum order values with digital cash collection, and multiple supply-side relationships. It has also acquired some of its competitors to allow enhanced physical infrastructure coverage.
It seems like it is getting its tentacles around the industry in Egypt (and Morocco). My friend mentioned it is now going to start producing its own private-label products to compete with the branded suppliers. Now that is starting to sound threatening!