£7 trillion, protected by these three moats

£7 trillion, protected by these three moats

Yesterday I wrote about startups getting a taste of the consumer packaged goods (CPG) market. I’ve been writing about it a lot in The Penny Share Letter.

CPG is a huge industry. It’s worth an eye-watering £7bn per year. The basic story is that giant conglomerates have owned the CPG business for 100 years. They’ve make billions in profit, year-in year-out. And they’ve squashed anyone who tried to muscle in on their turf.

It doesn’t sound like fertile territory for small caps, does it?

But I’ve been digging around the CPG area for a few months now and I’ve found something. The ground is shifting beneath the giant CPG companies. And it’s creating opportunities for small, focused competitors.

Stuff on ads, stuff in supermarkets

I’ll back up for a second. What is CPG? Yesterday I wrote,

Unilever is part of the consumer packaged goods (CPG) industry. CPG companies basically make all the things you find in a supermarket. You might not realise it, but a small number of big companies like Unilever, Nestlé and Proctor & Gamble own most of the supermarket brands. The same company makes your soap, margarine, deodorant and frozen pizza. Small competitors find it hard to get a look in – giants like Unilever either squash them or buys them up.

The CPG giants make huge money, year after year. Last year, CPG was worth more than eight trillion dollars. That’s trillion, with a t. The giants have dominated that business for over a century. That’s how they were able to afford a giant stone headquarters in 1929. And it’s how they’re still occupying it.

So CPG is stuff you get at the supermarket. Another explanation might be the stuff you see on TV ads.

You might ask yourself what frozen pizza, deodorant, washing powder, and instant coffee have in common. Why are they all made by one company?

The three moats

There are three reasons why CPG companies are so big, and why they make such a diverse range of products.

So what do frozen pizza, deodorant, washing powder, and instant coffee have in common? They’re all branded. You hear about them on TV ads and billboards.

CPG companies are experts at branding. They spend huge money promoting their wares on TV and the likes because they know that if they connect with a customer, that customer is likely to stick with them for a very long time. And a customer who buys the same washing powder every week for 35 years is very valuable indeed.

That’s why brand advertising is aimed at young people. The CPG companies are trying to get their hooks into customers’ brains early, before their competitors do.

And that’s why one CPG company might own a stable of different brands which compete directly with one another. Unilever sells Dove deodorant to women by appealing to ‘real women’ and ‘natural beauty’; then it turns around and sells Lynx deodorant to men by promising it attracts sexy underwear models. CPG companies are crafty like that.

Brands keep out competitors. After Unilever spends a fortune brainwashing you into buying their detergent, you’re not likely to take a chance on a no-name startup.

Another thing frozen pizza, deodorant, washing powder, and instant coffee have in common: they’re sold in supermarkets. Supermarkets buy in bulk and they negotiate hard. That favours a big competitor who can negotiate right back at them. And supermarkets have limited shelf space. Big CPG companies can fight to get their products the best spots on the shelves.

For example, Unilever makes Hellman’s mayo and Amora salad dressing. Hellman’s is a big seller and Amora is not. So Unilever can go to Tesco and demand that it stock Amora if it wants Hellmans.

The third big advantage the CPG giants have over new entrants is in R&D. You might not think of soap and margerine as particularly high tech. But these companies spend billions on R&D every year.

Remember the Gillette Mach 3? It was a razor with three blades instead of two, and it came with a huge marketing campaign. It’s easy to take the mick out of the Mach 3 (and The Onion did ). But it cost three quarters of a billion dollars to develop the thing. And that turned out to be money well spent, increasing sales by nearly 50%. Startups can’t hope to match that level of investment.

So those are the three moats which protect CPG companies: their brands, their relationships with supermarkets, and their R&D. The three moats have protected CPG giants for over 100 years.

I’ve been saying for the last two days that CPG companies are starting to have problems. The three moats aren’t quite as intimidating as they once were.

Tomorrow I’ll explain what’s going on. And I’ll explain how tiny startups are starting to eat the CPG giants’ lunch.

Today and yesterday I’ve been writing about what I’ve been up to in The Penny Share Letter. I’ve invested in two tiny companies which are breaking open the CPG business, and “gorging themselves like a mosquito on an elephant”. To read about the companies and the opportunity, try The Penny Share Letter here.