The CPG Dilemma (and Opportunity)
At Equal, we love to “follow the money” within retail. Today, we’re excited to showcase a massive segment that is severely underserved by technology solutions and services - Consumer Packaged Goods (CPG), which includes food & beverage (F&B), household supplies, personal care, health & wellness, pet, and baby - totalling almost $2T in spend in 2022.
Our initial hypothesis on the CPG segment was that COVID would catalyze a mass movement to digital grocery; interestingly, we’ve yet to see this trend fully materialize. While digital grocery’s growth off a small base has been impressive, digital penetration for CPG still vastly underperforms broader retail. Per eMarketer data from 2022 and 2023 (synthesized in the graph above), only ~7% of F&B transactions happened online, compared to the overall rate of 15% across all retail. Health & beauty enjoyed a higher digital penetration of 18%, but still doesn’t touch the top ecommerce categories. When we strip out the these two huge retail categories (as well as auto and other), the overall ecommerce penetration rate vaults to 41%, ~6x the rate of digital F&B adoption and ~2x that of health & beauty. What is so special about CPG, especially F&B, that’s made it so challenging for ecommerce?
The Ecommerce Shoe Doesn’t Fit
On the surface, CPG appears to be an ideal match with ecommerce - spend is non-discretionary and occurs at a high frequency. However, when we peel back the onion, it becomes clear CPG economics simply do not work for ecommerce, particularly for DTC:
Low average order value (AOV) - CPG products generally have much lower price points than other ecommerce mainstays like apparel or consumer electronics. COGS for the biggest F&B conglomerates hover at ~65% of revenue, so for a $5 bag of popcorn, there’s only $1.75 left after accounting just for product costs…
High logistics costs - Shipping high-weight / volume CPG products is expensive, particularly relative to AOVs. Coupled with the prevalent free shipping / discounting expected with ecommerce, already thin margins are even more pressured. We’ve witnessed the economics of several brands where the cost of shipping the item (especially in small batches) exceeds the actual revenue of the item
Expensive cold chain infrastructure - F&B is even more challenged as many in the category require cold chain infrastructure, which is meaningfully more expensive. There is exploding demand for cold chain capacity but new assets are expensive to build and take time. Smaller brands are extremely disadvantaged here as they have to fight for capacity with giants like Amazon, Walmart, Pepsico and more. Learn more about Lineage Logistics, the largest cold chain REIT provider and one of the largest IPOs of the summer, in our breakdown here!
Limited upsell / cross-sell opportunities - It is incredibly difficult to organically expand and extend brands within CPG - that’s why big CPG conglomerates generally grow through M&A, particularly through the last decade. McKinsey profiled ~400 notable deals from 2013-18 alone and Bain reported that frequent acquirers outperform their peers, with 2x sales growth rate, 1.8x profit growth, and 1.2x total shareholder return growth than the industry average. Without the ability to upsell or cross-sell, it’s much harder for CPG brands to increase AOVs (and improve profitability)
Coupled with rising CACs endemic to all categories, DTC leaves little room for profitability and zero room for execution error for CPG products. Unsurprisingly, of all Shopify stores, only 4% and 2% are health & beauty and F&B respectively. Even Amazon, with all its scale advantages and best-in-class operations, has yet to crack truly F&B, which was the 7th largest category for Amazon and held less than 5% of GMV in 2022 (compared to top categories of electronics at 26%, apparel & accessories at 17% and books/media at 12%). Instacart has recently ascended into profitability but not driven by its core grocery business, but rather its advertising business ($871M of high-margin revenue against a total net income loss of $1.6B in 2023, and $217M of advertising revenue vs. $130M of total net income in Q1 2024).
Win the Buyer, Win the World
Retailers remain crucial gatekeepers for the CPG industry and are the ultimate arbiters of which products reach the mass consumer. In other categories, brands can build direct relationships with customers through their Shopify stores but as we’ve established above, DTC is a much harder channel for CPG. These brands have to turn to wholesale much earlier in their career to not only meet consumers where they are, but also to reach the economies of scale required to optimize manufacturing and supply chain costs, lower the per unit raw ingredient, production, and shipping cost. One single SKU in Costco can represent millions of dollars!
Retailers like Walmart, Costco, Kroger, and Target control valuable shelf space and dictate the terms of distribution, product assortment, pricing, and promotion. Retailers own the interaction with the consumer and they even own the point-of-sales data critical to understanding industry trends and competitive dynamics. For emerging CPG brands, the retail buyer is the ultimate customer. Flipping one single buyer unlocks thousands of retail doors, which can represent exposure to millions of consumers. Winning the buyer, not the consumer, is what unlocks the next (and necessary) phase of growth.
Ironically, once in stores, consumers love emerging brands! That’s why big CPG companies have to resort to buying emerging brands to grow. Per Bain, “insurgent” brands (<$25M of annual revenues) have grown 10x+ than their category average over the last 5 years. IRI and BCG’s annual “Growth Leaders” reports also illustrate that Small and Extra Small CPGs have steadily taken share from Large and Medium CPGs since 2016. Once brands break through and get national distribution, they can grow extremely quickly. Justin’s went from $11M in 2011 to $100M in 2017, selling to Hormel along the way for $286M in 2016. Kodiak Cakes saw just $3.6M of sales in 2014, but has 50x+ since then and was bought by L. Catterton in 2021. The value creation story in CPG is very real, but it's not dominated by the digital commerce channels that VCs are accustomed to underwriting in other aspects of the economy.
The Retail Enablement Opportunity
Much of the retail enablement solutions (and VC dollars) over the past decade have focused on supporting retail and ecommerce companies that are foremost focused on digital distribution but we believe it’s critical to “follow the money” in retail. In CPG, the money is in wholesale and it’s with the retailers. Equal portfolio company Starday, a next-gen food conglomerate, initially focused on digital channels but quickly saw the superior scale and efficiency of wholesale channels. They’ve since launched in thousands of doors with national retailers like Target, Krogers, Walmart, Whole Foods, Sprouts, The Fresh Market, and more. Existing solutions focus on the DTC and ecommerce ecosystem and there’s a dearth of adequate, wholesale specific enablement platforms for companies like Starday.
Two of our major themes this year are “The CPG Commerce Ecosystem” and “The Transactability of Wholesale” (see 2024 Equal POV on Investing in Retail) because the pain points that CPGs, especially emerging brands, encounter are distinctly unique from other retail categories, given how heavily reliant they are on traditional offline channels. Getting into, and succeeding, in retail is a whole other ballgame, particularly given how offline and antiquated wholesale processes remain. CPGs also have to manage a more challenging supply chain that’s regulated and / or perishable, all the while managing cash flow constraints when working with procurement and payment cycles of large retailers. We view CPG as one of the most exciting and underserved segments in the retail segment today and will be sharing more of our thoughts on the category over the next few months.
The size of the prize is enormous for emerging solutions to better enable this ~$2T segment. We’ve already made a bet within the space, but there are multitudes of problems to be solved! If you are, or know anyone, building CPG-specific enablement solutions, we would love to chat (chelsea@equal.vc)!