Why money is pouring into CPG startups
This week I’ve been talking about the consumer packaged goods (CPG) business. CPG is a monster. It’s worth £7 trillion a year. And it’s dominated by a couple of giant conglomerates like Unilever, Proctor & Gamble and Nestlé.
I’m into this story because I’ve found a couple of smart little companies which have found a way to break into the business. And now they’re gorging themselves, like mosquitos on an elephant.
On Tuesday I wrote about the CPG giant Unilever, one of Britain’s biggest companies for over 100 years. Yesterday I wrote about CPG giants’ big advantage over the rest, and the three reasons they’ve stayed on top for so long.
Today I want to talk about what’s changed. I want to talk about the cracks in CPG’s business model, and the opportunity for startups.
A weird deal
A recent deal tells the story. Last summer, Unilever bought a startup called Dollar Shave Club for $1bn.
Dollar Shave Club isn’t a typical $1bn CPG company. It’s only four years old. It’s not yet profitable. It doesn’t have a big ad budget. It doesn’t have a fancy high-tech product. And it doesn’t have any relationship with supermarkets.
That’s really weird! Recall from yesterday that I said big CPG companies have three big advantages: they have strong brands which are expensively developed, mostly on TV; they spend big on R&D to come up with innovative products; and they have strong relationships with supermarkets.
Dollar Shave Club didn’t need any of that stuff because it figured out how to sell directly to consumers online. The company launched with a famous viral video explaining its business model (which has since been viewed 24m times).
The video goes like this: Dollar Shave Club’s blades are basic, but they’re good enough. They only cost $1. Gillette charge you $20, and $19 of that goes to Roger Federer.
Dollar Shave Club was able to build a great brand with smart viral videos, social media campaigns, and direct advertising (more on that last part later). And it shipped directly to consumers. All of those things are cheap enough for a startup to afford, and can be scaled up to serve lots of customers if needed.
Back in the day it wasn’t so easy for CPG companies to get their brand out there. CPG companies had to literally invent soap operas in order to flog soap and detergent. Building a brand took a lot of money. But not any more.
Venture capitalists smell money
Dollar Shave Club isn’t a once off. As the following chart shows, money is pouring into CPG startups. The size of deals has tripled and the number of deals is up around 80%. There’s something moving here.
(Click image to enlarge)
So specifically, what’s changed for CPG startups? How are they doing it?
Three things have changed. The first and most important is the growth of digital advertising. A small brand can now target a specific customer with a specific message. That’s great news for the brand because digital marketing is cheap. You only pay for what you use. No need to blow millions on a big TV or radio campaign which may or may not work.
In fact, digital advertising does more than just level the playing field. It actually gives the little guy an advantage. That’s because there’s diminishing returns to scale in digital marketing: it’s harder to spend £100m well on Facebook than it is to spend £1m. Unilever doesn’t rely on Facebook to spread the word about Dove soap because Facebook isn’t the best way to reach huge numbers of people. But a startup soap company can run a Facebook campaign with a small budget, and a targeted audience, and have a lot of success.
The second thing to change is the retail environment. As I’ve been saying, CPG’s relationships with big retailers like supermarkets is one of their greatest advantages. It’s hard for a small startup to get a look-in with the likes of Tesco.
But supermarkets aren’t as powerful as they once were. People are spending a bigger and bigger chunk of their money online. And in a world where people are buying online, the scarce shelf-space at supermarkets doesn’t matter any more. Instead Amazon can stock 1,000 different soap brands in their warehouse and customers can choose the one they like (or the one Facebook ads have convinced them to like). It’s like supermarkets and CPG companies are symbiotic. They need each other to survive.
And the last thing that’s going against big CPG companies, and towards small startups, is customers’ tastes. Basically customers are dividing into smaller and smaller niches. That’s bad news for big CPG companies because there are only so many different brands they can manage.
They are able simultaneously to sell the Dove brand for young women and the Lynx brand for young men. But selling four brands for each gender gets unmanageable. That’s an opportunity for small focused startups, like Dollar Shave Club.
This fragmentation of the market is showing up in retail, too. In the past the big national chains sold a bit of everything, like supermarkets or big chemists. Now there are many more national chains serving specific audiences. Again, good news for startups. Again, bad news for big CPG.
I’m taking a couple of days over this story because it demands a bit of time. I’ve been working on it for months now for Penny Share Letter subscribers, and it’s already yielded two excellent investment opportunities. To see how these companies are starting to disrupt the CPG business, click here.