Three months into the coronavirus lockdown and results have been mixed for major CPG companies. Companies that have diversified product offerings and sell through a variety of channels are doing moderately well. P&G, the Ohio based conglomerate, saw consumers stock up on paper goods and cleaning products. Fear of stock-outs led to panic buying and fear of the virus meant people washed their clothes more—and P&G owns Tide and Charmin. The result was a rise in revenue of 10 percent. Companies whose products decline in value during quarantine–beauty, luxury, travel–were not as lucky. Unilever saw flat sales, but with $58 billion in annual revenue, they will be fine. But what about small CPG companies?
For the time being, consumers are buying more coffee to get their fix at home, aiding producers like Nestle. In the 13 weeks ended May 17, U.S. retail sales at supermarkets and other outlets rose 15% from a year earlier, according to data from Chicago-based market researcher IRI.
But “at-home increases for coffee will never compensate for food-service loss,” according to Judy Ganes, the president of J. Ganes Consulting, which follows the industry. “Recovery won’t be quick.”
Before the virus hit, Chris Nolte and Paul Massard sold about 2,000 pounds a week of their Per’La Specialty Roaster to Miami-area hotels, restaurants and in the single coffee ship they ran. They started the roaster operation in late 2015, mostly focusing on hotels, and added the coffee shop two years ago.
Once the closures began, bringing the city’s tourist season to a brutal halt, that number dropped by 85%, according to Nolte.
It is hard to comprehend how any business can survive a spontaneous collapse. General Mills, the $17 billion food giant, stemmed the impact by transitioning supply and distribution lines to focus only on retail. They were able to accomplish this because it had a generation of time to diversify its offerings. Today, food service accounts for about 12% of the company’s revenue, retail accounts for sixty. For Per’La Specialty Roaster it is 85%.
How is the small CPG brand able to compete?
“We are using mostly Instagram and Facebook,” Nolte said in a phone interview from their roasting plants just outside Coral Gables.
Initially, the company had nine employees, but Nolte and Massard are the only two left working.
Now the two men, who met during their first semester in business school back in 2001, have pivoted to social media and online sales to overcome at least some of the sales dearth.
Internet or direct-to-consumers is always trotted out as the silver bullet for struggling companies in the coronavirus era. It’s basically the business version of telling unemployed people to ‘learn to code.’ It’s an unserious idea for a structural issue.
Food service involves selling and delivering one fifty-pound bag of coffee to one customer, retail involves selling fifty one pound bags to fifty customers. They have entirely different cost structures and operations.
Let’s take customer acquisition. A quick test reveals that it cost about $4.00 to run a targeted Google add for ‘Coffee’. If a pound of specialty coffee cost $5 to produce and sells for $16, that’s already 36% of the margin on customer acquisition—and that’s assuming every single person who views the add purchases the product—which is an asininely optimistic assumption. It also fails to factor in that every small coffee manufacturer is faced with the same dilemma—driving the advertising cost as demand for eyeballs increases.
The end result here isn’t good for anyone but large coffee producers—who already have a large retail business to offset the food service. I am not sure what the solution is, but it is going to be painful.
Sales of the company’s hygiene and cleaning brands, including Cif surface cleaners and Domestos bleach surged by double digits as consumers stocked up to clean their homes to fend off coronavirus. In-home food product sales also rose as shoppers loaded their trolleys.
But ice cream sales and the company’s food service business, which sells ingredients to chefs and restaurants in 180 countries, were hit hard by the pandemic. The company, which also owns the Magnum brand, said it missed out on the start of the ice cream season in Europe, with outlets closed and distributors reluctant to buy stock with an “uncertain holiday and tourism season” ahead.
All of this is understandable. As the table below shows, 79% of Unilever’s revenue comes from two categories: Beauty & Personal Care and Foods & Refreshment. Under COVID-19 quarantine people are spending less time doing their hair and make-up. They’re also eating out less. Packaged foods are flying off shelves, but unfortunately for Unilever, the bulk of its Foods & Refreshment margin comes from Ice Cream and Food Service—two categories crushed by social distancing.
Its last category, Home Care, which includes cleaning solutions, is doing fairly well—but it’s also it’s smallest and least profitable. In 2019, it accounted for about 21% of Unilever’s overall business—but just 16% of operating profit. Meanwhile, Beauty and Personal Care accounted for 42% of sales and 52% of operating profit.
Category
Revenue
% of Revenue
% of Operating Profit
Beauty & Personal Care
21.9 billion Euros
42%
52%
Foods & Refreshment
19.3 billion Euros
37%
32%
Homecare
10.8 billion Euros
21%
16%
Unilever accelerates an agile supply chain to meet COVID-19 demands
In my opinion, the most interesting tidbit from the earnings call had nothing to do with coronavirus. It had to do with an agile supply chain. When asked about how the pandemic changed the company’s operations, CEO Alan Jope responded:
Earlier in the pandemic we changed our monthly operational forecasting cycle to a weekly basis so we can reflect the rapid changes in consumer demand. And we have been using people data centres to pick up the changing consumer sentiment early.
Forecasting is a huge component on any CPG company’s supply chain. A company needs to not only know how much it plans to sell, but how much it needs to produce and accrue. A large CPG company will produce multiple forecasts, here’s just a small sample:
Forecast
Description
Accrual
Every CPG manufacturer pays retailers trade dollars—essentially a percentage of sales to ensure prime locations and promotional activity. Companies need to forecast this to ensure the end of month financials are correct.
Demand
A combination of Production, Sales and Supply Forecasts.
Production
How much the company will need to manufacture to meet consumer demand.
Sales
How much product retailers are going to buy.
Supply
How much raw material they’ll need to buy to make production goals.
Most CPG products have relatively predictable demand. Forecasting is centralized at a corporate level and done at a monthly basis. Demand Planners and Forecasters will run through a handful of different business scenarios and develop a forecast. Given the mass uncertainty caused by covid-19, Unilever is increasing forecasting frequency. This gives them more information and enables quicker decisions—reducing stock-outs. This is interesting, but not particularly unique. Most CPG companies are doing so.
We’re actually moving away from scenario planning and trying to focus on building agility and responsiveness into the company. And I don’t know that we should all be spending too much time locking in particular views or scenarios for the future, but rather unleashing the trapped capacity that most big organizations have by letting go and letting people close to the markets, close to the front line, exercise their judgment and their decision-making. We’ve discovered a new responsiveness in Unilever that I wish we had unlocked years ago, but it’s taken this crisis to do that.
This is almost the definition of an agile, resilient supply chain. What does this mean in practice?
Unilever is moving away from mass centralized forecasting and into a decentralized model—putting decision making power in the hands of the front line. Centralized planners won’t spend their time modeling various scenarios—the front-line worker will drive opportunities. It’s potentially a revolutionary change that requires flawless execution of technology and business process.
During the coronavirus pandemic, where decades of mismanagement and grift at major retailers led to accelerated bankruptcies, Walmart trended the other direction. Absolute dominance.
Walmart, America’s largest retailer, saw overall revenue increase by 8.6% while maintaining higher operating margins. Online sales, arguably the most critical battleground in modern retail, grew 74%. “Our omnichannel investments have us in a unique position to serve customers in ways others can’t.” CFO Bret Biggs told investors. “Customers are gravitating towards store pickup and delivery, driving record demand for these services leading to triple-digit growth in U.S. eCommerce sales during peak periods.”
Barring any massive regulatory changes, Walmart is poised to continue to dominate a post-COVID-19 world. It raises two questions: How did Walmart get there, and what does it mean for others?
Omnichannel—the holy grail of traditional retail
There are a lot of different definitions of omnichannel. Truth be told, it has morphed into a buzzword over the last few years–partly due to the interest and the money companies are willing to invest to achieve it. Shopify, who offers a really competitive technology infrastructure for small firms, provides this definition:
Omnichannel retailing is a fully-integrated approach to commerce, providing shoppers a unified experience across all channels or touchpoints.
Omnichannel essentially means giving the customer the ability to buy whatever they want; however, they want it. Theoretically, it means that a customer can order ten items, pick up four at the store, get five delivered, and pick up the final item on their way to the destination. Branding and positioning should be the same throughout the entire transaction.
From a practical perspective, it means rethinking almost every aspect of a company’s supply chain to make life easier for consumers. This is both a technology and a business process problem.
There are likely technical challenges to achieving what the ultimate goal is – opening up inventory across the network to customers, regardless of where or how they are shopping. Real-time inventory is not widely accessible throughout these organizations and legacy systems are not equipped to handle the sophisticated routing necessary to make “ship from anywhere” an executable, cost-effective concept.
He then explains how it relates back to the underlying business process:
Opening up stores to operate as fulfillment centers is not simply a technology challenge. It can fundamentally challenge the way brands approach inventory management. If the ultimate goal is to have product available when, where, and how the customer wants it, then inventory needs to be staged in the network to make this a feasible goal. For brands that operate with lower inventory on the shelves and little back-room space, there won’t necessarily be the volume available to ship or for in-store pick up. The product mix at stores, along with the inventory levels available, could either drive the omnichannel strategy for a retailer, or need to be adjusted to allow for new functionality such as buy online, pick up in store. Simply plugging in the technology won’t boost the top line if the product isn’t there to be purchased to begin with.
Walmart mastered omnichannel
Based on Walmart’s results, and explanation, it’s pretty clear they solved both the process and technology hurdles associated with omnichannel.
CEO Doug McMillon explains:
In the U.S., we quickly rolled out ship from store and we’re now temporarily fulfilling orders placed on walmart.com through about 2,500 of our stores. We also launched Express Delivery to provide customers the convenience of having their orders delivered to their door in under two hours. The Express Delivery is available at nearly 1,000stores today, and our goal is to be in around 2,000 stores by the end of June.
This transition is a real-life case study on how retailers don’t need to directly compete with Amazon. Walmart isn’t trying to offer everything and ship it from centralized distribution centers. It is using its existing decentralized infrastructure to service customer needs.
As I’ve written before:
Through itself and third-parties, Amazon offers almost every single product on earth and has over 300 distribution centers that help turn a cost into a profit center. Walmart offers a fraction of the assortment in its 4,700 stores, and has just 20 distribution centers to fulfill them. It would years and billions of dollars to mimic Amazon’s network and business model. No traditional retailer has the time or the patient investors required. Basically, no traditional retailer can compete playing Amazon’s game.
The Coronavirus forced Walmart to transition.
What does it mean for others?
Coronavirus has meant doom for most retailers. Prior to the pandemic, most were faced with competing against Amazon, a hybrid retailer, while dealing with legacy infrastructure and higher fixed cost. Covid-19 introduced several new variables into the mix—including store closures and additional cleaning costs.
It’s not going to be easy for retailers. Transitioning to an omnichannel distribution scheme is costly, but those that unlock it might just survive.
Writing on the Andreessen Horowitz blog, influential tech entrepreneur Marc Andreessen published It’s time to build. The essay laments Western civilization’s response to the coronavirus. To Andreessen, who the New Yorker labeled a “farsighted theorist” and sits alongside Bill Gates and Peter Thiel in the pantheon of serious Silicon Valley thinkers, the issue is desire.
He writes:
The problem is desire. We need to want these things. The problem is inertia. We need to want these things more than we want to prevent these things. The problem is regulatory capture. We need to want new companies to build these things, even if incumbents don’t like it, even if only to force the incumbents to build these things. And the problem is will. We need to build these things.
With respect to Andreessen, the problem isn’t desire. The problem isn’t inertia. The problem isn’t will. Those are vague passive buzzwords that help distribute blame evenly across society rather than at the specific, powerful groups whose actions created the situation.
Let’s take this specific passage of It’s time to build:
We see this today with the things we urgently need but don’t have. We don’t have enough coronavirus tests, or test materials — including, amazingly, cotton swabs and common reagents. We don’t have enough ventilators, negative pressure rooms, and ICU beds. And we don’t have enough surgical masks, eye shields, and medical gowns — as I write this, New York City has put out a desperate call for rain ponchos to be used as medical gowns.
1. We don’t have enough coronavirus tests, or test materials — including, amazingly, cotton swabs and common reagents.
We do not have enough coronavirus test because of mismanagement from the Trump administration—full stop. According to reporting by ProPublica, one of the finest news organizations in the world, the CDC “shunned the World Health Organization test guidelines used by other countries and set out to create a more complicated test of its own that could identify a range of similar viruses.” When that test was sent out to labs—it failed to work. Basically, we needed a car, a friend offered to give us his, but we insisted on building our own—and it didn’t work. America wasted valuable weeks because the decision was made to use a proprietary test.
2. We don’t have enough ventilators, negative pressure rooms, and ICU beds.
We do not have enough ventilators because of a combination of greed and lack of antitrust enforcement. In 2006, after the SARS crisis, civil servants realized that the nation was woefully under prepared for a pandemic. They identified ventilators as a hazard point and set out to stockpile 40,000 of them. This again is contrary to Andreessen’s assertions that Western governments were asleep at the wheel.
They weren’t, they were just outfoxed by private interests.
The ventilators were to cost less than $3,000 each. The lower the price, the more machines the government would be able to buy.
Companies submitted bids for the Project Aura job. The research agency opted not to go with a large, established device maker. Instead, it chose Newport Medical Instruments, a small outfit in Costa Mesa, Calif.
Newport, which was owned by a Japanese medical device company, only made ventilators. Being a small, nimble company, Newport executives said, would help it efficiently fulfill the government’s needs.
Ventilators at the time typically went for about $10,000 each, and getting the price down to $3,000 would be tough. But Newport’s executives bet they would be able to make up for any losses by selling the ventilators around the world.
“It would be very prestigious to be recognized as a supplier to the federal government,” said Richard Crawford, who was Newport’s head of research and development at the time. “We thought the international market would be strong, and there is where Newport would have a good profit on the product.”
By 2011, Newport had three low-cost ventilator prototypes ready. The plan was to have one approved and ready for the use by 2013. Then, like essentially every industry in modern times, the medical device industry consolidated. The business school reason is that bigger medical device companies can offer more products and better services to hospitals. The real reason is that consolidation is pure monopoly strategy. The bigger you are, the more leverage you have in negotiations.
In 2012, Covidien, a large medical device company, bought Newport and five other smaller device manufacturers. Within a year, despite the guaranteed contract and profit, Executives at Covidien shut Project Aura down.
Back to the New York Times:
Government officials and executives at rival ventilator companies said they suspected that Covidien had acquired Newport to prevent it from building a cheaper product that would undermine Covidien’s profits from its existing ventilator business.
In 2014, Covidien was purchased by Medtronic for $42.9 billion and shifted its headquarters from Minnesota to Ireland—to avoid taxes. Today, Medtronic is worth $126 billion. America still doesn’t have enough ventilators.
3. And we don’t have enough surgical masks, eye shields, and medical gowns.
The reason for this is somewhat straightforward. In the early 2000s, private equity started to invest in health care providers. As I’ve written about before, private equity isn’t actually that good at running a traditional business. It is good however, at transferring value from a business into management’s pockets. That’s exactly what happened in healthcare. Costs were cut, services were reduced. It happened in obvious places, like less nurses and doctors, and less obvious places like medical supplies.
Additional supplies come with additional storage costs—so private equity backed hospitals adopted just-in-time supply chain principles. “Keeping goods (PPE) on hand costs money,” NBC news reported, “and to private equity, that’s like putting dollar bills on a shelf.” It also accelerated an existing outsourcing trend. On a per unit basis, the difference between made-in-America and made-in-China PPE is tiny. “But when you’re talking about millions of units, it does add up,” Robin Robinson, the former head of the federal agency in charge of stockpiling protective gear told the Dallas Morning News. Today, only five percent of surgical masks are made in America. The rest are made abroad, who are understandably prioritizing their own citizens over exports.
Marc Andreessen fills the rest of It‘s time to build with similar out of touch truisms about education, housing, and life in America. In his mind, there’s nothing that can’t be solved by software.
We know one-to-one tutoring can reliably increase education outcomes by two standard deviations (the Bloom two-sigma effect); we have the internet; why haven’t we built systems to match every young learner with an older tutor to dramatically improve student success?
First, I absolutely love how he needlessly drops the “Bloom two-sigma effect.” There is nothing more Silicon Valley than using isolated research as a panacea explanation for a structural problem. Second, 15 percent of American students lack access to the internet at home. How are they supposed to connect to tutors? Through magic? My wife works for a low-income school district. They have mailed out tens of thousands of assignments to students—like they’re running a correspondence class in 1974. Peel back the onion a bit more and ask yourself, “Why don’t student’s have home internet?” The answer is simple. They are poor. The families can barely pay rent, let alone spend $75 a month on home internet. The solution here isn’t tutors, it’s low-cost high-speed internet, provided by the government.
This gets to the real issue, the real cause of America’s poor coronavirus response—inequality. You can find it in every aspect of the coronavirus, from who gets sick to who gets laid off. It seems like he forgets this.
Andreessen established himself as a serious Silicon Valley-type with his essay “Software Is Eating The World.” The essay’s general thesis is correct. Software is automating vast swaths of the American economy—making things much more efficient. Andreessen failed to realize that a lot of the past world’s inefficient parts were there by design—and they supported this thing we call society.
“Today’s largest direct marketing platform is a software company — Google,” he wrote, “Now it’s been joined by Groupon, Living Social, Foursquare and others, which are using software to eat the retail marketing industry.” This was correct. Prior to the rise of Google, retail marketing was a diverse industry—run by media companies. As software ate the advertising industry, the news industry lost 68 percent of its advertising revenue—a large portion of it transferred to Google’s pockets. The impact wasn’t spread out equally. Large established brands like the New York Times thrived, while 20% of local newspapers disappeared.
I’m sure proponents could argue that the advertising market was now more efficient. But at what cost? No local news creates news deserts, which leads to more public corruption, which leads to a worse society. From a financial perspective, new research suggests that less local news results in higher bowering costs for municipalities. From a human perspective, the middle-class of journalism was gutted.
In 2019, Google controlled around 38% of the online advertising market. Today, just five firms control 75% of the nearly $130 billion digital ad market. That’s billions of dollars that used to be distributed across the media landscape, from national to local publications, concentrated into just five firms.
Again—inequality. We’ve created a system that doesn’t build wealth. It transfers it from one group to another.
The Master Switchby Tim Wu is a masterful book on the rise and fall of information empires. He traces the evolution and industrial organization of the telegram, telephone, radio, television, and the ultimately the internet. His general thesis is that information technologies start with hobbyists, and gradually transition into gated monopolies as they gain widespread adoption. An information monopoly comes with massive responsibility. At one time, AT&T effectively controlled all of America’s telecommunications. From the wire on a telephone poll, to the phone connected to the jack, Ma Bell designed and maintained every aspect of the system. In exchange for the monopoly, and the profits it generated, Bell invested billions of dollars in basic technological research. Bell Labs, the company’s research arm, earned seven Nobel prizes. Over time, the responsibility mindset evaporated.
Tim Wu explains:
The old empires were suppressive and controlling in their own ways, yet each had some sense of public duty, informal or regulated, that they bore with their power. At their best, they were enlightened despots. But the new industries’ ethos held that profit and shareholder value were the principal duty of an information company. What reemerged was similar in body but different in its soul.
When Andreessen wrote It’s time to build he probably meant it as a call to arms. But he missed the point. The coronavirus is a reckoning of the new soul.
The general consensus is that seemingly overnight Zoom went from an unknown company to essential infrastructure. That’s not true.
Prior to the coronavirus, it was a major player in enterprise communications. The reason most people didn’t know about it, is that it was designed as a B2B company (business-to-business sales) rather than a B2C (business-to-consumer). The company had a $16 billion IPO in April of last year. Hard to argue that it’s a “surprise” success after that. For several reasons, B2B companies typically don’t generate the amount of hype consumer-facing firms do.
To understand why Zoom is everywhere now, you need to understand that Zoom is really two businesses: software as a service and hardware.
Software as a service
This is the Zoom everyone knows about–video conferencing. Zoom offers this service through a freemium model. Basic service is free, and customers upgrade to paid tiers for additional features. This is a commodified industry. For the typical non-commercial user, there’s a limited difference between Zoom/Skype/Facetime/Google/Teams. The only major benefit for regular folks is that Zoom allows more than four people on a video screen at once. Zoom does offer benefits over the others for enterprise meetings (larger number of participants).
Hardware
Zoom became a viable business by concentrating on business communications. The following is a typical business situation that displays Zoom’s value.
Imagine that you own a factory in Minnesota. All of the operations people work out of the Minnesota HQ (finance, supply chain, etc.). Meanwhile, you have ten salespeople selling your product throughout America. Every month you have a meeting to talk about the impacts of each function on sales. 15 HQ employees attend the meeting in person and the 10 salespeople call in. Prior to Zoom, the company was required to maintain a bunch of different systems to run this meeting.
Room scheduling system to ensure the conference room is reserved
AV system to display the presentation to the people in the room
Screenshare system that ensures remote workers can see the presentation in real-time
Conference call technology to ensure that everyone can hear everyone
Audio system that captures all the conversation in the room
Cameras in the room so that remote people can see speakers
Zoom was the first one to provide all six in an integrated, easy-to-use offering.
Zoom Rooms is our software-based conference room system that transforms every room–from executive offices, huddle rooms, training rooms, to broadcast studios–into a collaboration space that is easy to use, simple to deploy, and effortless to manage.
Designed to increase workforce collaboration across in-room and virtual participants, Zoom Rooms bring one-click to join meetings, wireless multi-sharing, interactive whiteboarding, and intuitive room controls for a frictionless Zoom Meeting experience.
Zoom Rooms can leverage purpose-built hardware, such as Zoom Rooms Appliances, for a turnkey deployment, or customize room builds with Zoom’s open hardware ecosystem and professional audio/visual equipment, enabling organizations to build video conference rooms for any use case.
Zoom took something that was fragmented and boring, and made it easy for IT people to manage. When the Coronavirus happened, Zoom was well positioned, because many tech-savy business were early adopters. This isn’t to say it has been painless. Here’s Zoom’s CEO talking in BusinessWeek about the growing pains of moving from a B2B company to B2C.
Yuan argues that Zoom’s issues stem not just from its explosive growth but also from the new types of users flocking to it. “We built this as a platform for knowledge workers, for businesses with IT departments,” he says, sitting against a digital backdrop of the San Francisco hills that he obscures as he leans into his webcam. For Zoom users in nonpandemic times, he goes on, there would be a tech support person helping them set up their screen-sharing settings and reminding them to have a password.
The whole article is worth a read.
TL/DR – Zoom didn’t come from nowhere. It was a massively successful enterprise communication platform that is now used by regular consumers.
On March 23, a day when the United States registered 135 coronavirus deaths, Sanderson Farms, America’s third-largest poultry processor, announced one of their workers tested positive for the virus. It was the first reported case from a major meat processor. Three days later, Smithfield Foods joined the fray by announcing an additional case at its massive South Dakota pork plant. Within days, industry giants JBS and Tyson made similar announcements.
Perhaps it’s because there is no evidence that coronavirus transmits through food, but you would have thought that news like that would have led the national news that night. After all, it’s our collective food supply. Instead, it was mostly relegated to the industry press. The New York Times/Reuters article on the closure of three plants clocked in at 257 words. That’s because America views its retail food industry, a $6 trillion market, in boring terms. There are no big Apple-style keynotes for the year’s newest products. The entire industry just kind of happens—and we buy the finished product at a grocery store. Given the concentrated nature of the industry—most companies probably like it that way.
The uncomfortable reality is that from an operational standpoint, the last forty years created a meat production system almost uniquely positioned to spread the coronavirus and exaggerate its impact.
There’s a good chance we’re about to pay the price.
The rise of industrial meat packing
For the bulk of the century, meatpacking, like dairy and other agriculture products, was a regional affair. Independent operators sold farmers animals and feed. Farmers raised the animals and meat processors butchered them. Processors then sold the meat to Wholesalers, who distributed the finished meat to grocery stores. This ecosystem supported rural economies for a generation. It was also inefficient. Each link in the food chain meant an additional salary. Starting with chicken, and led by Tyson Foods, the meat industry vertically integrated.
Business reporter Christopher Leonard explained in his book Meat Racket:
Under Tyson, all these businesses have been drawn onto one property. The company controls every step of meat production, with each aspect being centrally directed from the company’s headquarters in Springdale. The company’s control spans the lifetime of the animals it raises. Before there is a chicken or an egg, there is Tyson. The company’s geneticists select which kinds of birds will be grown.
Today, a handful of massive plants process America’s meat supply. Around 20% of America’s overall meat supply comes from Tyson, who has about 100 plants. Like most production plants, these facilities are optimized by maximizing output per square foot.
At many meat-processing plants, workers are “essentially elbow to elbow,” said Thomas Hesse, president of United Food and Commercial Workers Union Local 401, the largest private sector union in Western Canada that represents 32,000 members, mostly in food processing and retailing. Though employees are usually wearing protective gear, the risk of contagion is difficult to completely eliminate.
Basically, our food supply is dependent on getting thousands of people in a closed space and having them work closely together. It’s a recipe for disaster.
Last week, the Smithfield pork plant that had its first case in late March, was forced to close.
By April 15, when Smithfield finally closed under pressure from the South Dakota governor’s office, the plant had become the number one hotspot in the U.S., with a cluster of 644 confirmed cases among Smithfield employees and people who contracted it from them. In total, Smithfield-related infections account for 55% of the caseload in the state, which is far outpacing its far more populous Midwestern neighbour states in cases per capita.
We have a situation where thousands of low-paid workers, concentrated in a confined space, are choosing between paying rent and potentially getting sick. The concentrated structure of industrial meatpacking means that America’s meat supply is caught between their collective Sophie’s Choice.
Antifragile Theory
Nassim Taleb burst into the American consciousness with his 2007 book The Black Swan. In it, he argued that society is primarily shaped by unpredictable events with massive impacts—which are then rationalized after the fact. The book received almost universal acclaim; the London Times argued it “altered modern thinking.” In 2009 he followed the landmark release with Antifragile, an attempt to describe a framework to thrive in a black swan world. “In spite of the chronology…” Taleb wrote in the book’s introduction, “Antifragile would be the main volume and The Black Swan its backup of sorts.”
The book lays out a framework for developing systems that thrive in the disorder caused by black swan events. Fragile systems collapse under pressure, antifragile thrive. One of the central tenants of Antifragile is that large institutions pose a threat to a system’s overall stability.
In spite of what is studied in business schools concerning “economies of scale,” size hurts you at times of stress; it is not a good idea to be large during difficult times. Some economists have been wondering why mergers of corporations do not appear to play out. The combined unit is now much larger, hence more powerful, and according to the theories of economies of scale, it should be more “efficient.” But the numbers show, at best, no gain from such increase in size—that was already rue in 1978, when Richard Roll voiced the “hubris hypothesis,” finding it irrational for companies to engage in mergers given their poor historical record…As with the idea of having elephants as pets, squeezes are much, much more expensive (relative to size) for large corporations. The gains from size are visible but the risks are hidden, and some concealed risks seem to bring frailties into the companies.
Later:
But these systems learn because they are antifragile and set up to exploit small errors; the same cannot be said of economic crashes, since the economic system is not antifragile the way it is presently built. Why? There are hundreds of thousands of plane flights every year, and a crash in one plane does not involve others, so errors remain confined and highly epistemic—whereas globalized economic systems operate as one: errors spread and compound.
Summarized:
The benefits of economies of scale, the rationale the mergers that created the massive meat processing companies, overshadow massive risks—which reveal during a crisis.
A few closures wouldn’t matter to a system with thousands of operators, because the production impact of closures would be negligible to the overall system.
Unfortunately, we don’t live in an anti-fragile system. In fact, everything from dairy to condiments is now concentrated higher than any time in American history. Today, four firms control about 60% of the chicken industry, 63% of pork, and a staggering 80% of beef production.
Remember the pork facility that Smithfield shutdown? Well, it’s huge. “The facility,” Reuters reported, “is one of the nation’s largest pork processing facilities, representing 4% to 5% of U.S. pork production, according to the company.”
In the age of coronavirus, American consumer product companies, like General Mills, are working overtime to ensure that people stay fed in an era of self-containment. It has been almost two weeks since President Trump declared a national emergency, and numerous states followed with “safer-at-home” orders. In a matter of days, Americans went from eating out and grocery shopping a few times a week, to all at once bulk purchases.
The coronavirus transition has massive impacts from an operational point of view. Overnight, restaurant and coffee shop sales went to zero and empty shelves became the norm in grocery stores. However, large CPG companies like General Mills are well-positioned to handle it. To understand why, you need to understand that General Mills is three separate business—spread across five segments–wrapped under one corporate entity.
How General Mills is
organized
Since its founding in 1856, General Mills has worn a wide variety of hats. In the 1960s, it manufactured toys. In the 1980s, it founded Olive Garden. Today it focuses primarily on food manufacturing through five separate segments.
Segment
Description
North American Retail
Packaged foods that you purchase at grocery stores. General Mills creates products, sells them to retailers, who then sell to consumers. This is the General Mills that you’re most likely familiar with.
Convenience Stores & Foodservice
Packaged foods that institutions in North America “assemble” and sell to consumers. For example, General Mills sells cake mix to an operator (hospital), who then bakes the cake and serves it to patients. Other operators could include schools, restaurants, and work cafeterias.
Europe and Australia
A combined version of the first two segments, with a separate retail arm to sell ice-cream directly to consumers.
Asia and Latin America
Similar to Europe and Australia
Pet
Like North American retail–except General Mills creates food for pets
If you look closely at each segment, you’ll see three different businesses—each with separate corresponding processes:
Manufacturing finished food goods.
Manufacturing food goods that an operator finishes.
Retailing finished food goods.
How coronavirus impacts a large food company like General Mills
The management of
General Mills talked about the impact of coronavirus on the firm’s Q3 investor
call.
But, look, as we look at March so far, we haven’t seen a big fall-off in our Convenience & Foodservice business through today. But clearly, the situation continues to evolve, and you like us saw stores closing, and that’s a big piece of our business. We also see the restaurant traffic is down and what we’re seeing is those two things, there is some offset by what we see in Convenience Stores where the traffic is strong. And so, unfortunately, certainly with healthcare. And so, we would expect in the fourth quarter that our C&F business would be down for all of those factors. But look, the situation continues to evolve and ways that you would probably anticipate.
Essentially, since almost all restaurants and group food facilities have closed to help slow the spread of COVID-19, General Mills expects foodservice to drop tremendously. This situation could be devastating to a firm that concentrates primarily on foodservice, like Sysco or US Foods. But remember, General Mills is diversified across three separate businesses: finished food goods, operator finished goods, and retail. Demand for goods that an operator finishes and retail have cratered, but the volume may transfer directly to finished food goods. That segment, North American retail, generates almost 60% of the company’s total sales.
In the last ten years, food manufacturers like General Mills have spent hundreds of millions of dollars, reworking their retail offerings to fit changing consumer tastes. New flavors and fresh options flooded grocery shelves. Often, the investment falls flat. It’s hard, even for a large firm, to break through. Consumers have so many options—from restaurants to meal kits. Now, most of that competition is gone, and the volume is pushed back into traditional grocery. In China, who has been fighting the coronavirus for months, General Mills saw its direct-to-consumer retail arm crater, and frozen dumplings rise by double digits.
Jon Nudi, the
President of North America, explained the potential impact within America:
We’ve worked hard over the last few years to renovate the majority of our product lines. If you think about refrigerated baked goods, we’ve touched the bulk of that business which is big, important and profitable for us. Cereal has been renovated as well. So we do believe it’s an opportunity, perhaps as consumers come back and try our products again after several years to see the products and the improvements that we’ve made and ultimately, hopefully, drive penetration for the long-term.
I can’t imagine that ten years ago, when General Mills decided to revamp their product lines, it imagined that a global pandemic could help it re-solidify its hold in grocery stores.
Just one week after March 15, 2020, when President Donald Trump claimed the US had ‘tremendous control’ of the coronavirus pandemic, California Governor Gavin Newsome ordered all state residents to stay home. “The order,” the New York Times reported, “represents the most drastic measure any governor has taken to control the virus.” Similar orders may become the norm, as ‘worse case” expert predictions place the COVID-19 death toll at potentially millions of people.
Given the public health scope of the coronavirus, it
seems somewhat trivial, but the effective shutdown of the American economy will
have massive impacts on the CPG world. On one hand, there’s probably never been
more demand for a lot of the CPG world’s products (packaged foods, paper goods,
and hand sanitizer in particular). On the other hand, it’s going to be harder
and harder to source many of the products that Americans use every day.
The result will be a nation of 350 million people, who are used to living in relative abundance, adjusting to a life of relative scarcity. Many in the industry expect that long lines and empty shelves are going to become the short-term new normal. A recent survey by DigitalCommerce 360 revealed that 44 percent of surveyed retailers expect production delays. 40% percent expect ongoing inventory shortages throughout the year. What’s frustrating is that the coronavirus isn’t the cause of the scarcity—it’s a symptom of a more significant issue: the outsourcing of the American supply chain.
CPG Supply Chain System Shocks
It’s a 12-hour flight from San Francisco to Taiwan. Once
there, you’ll find Hsinchu, a city of about half a million people. Hsinchu is
relatively obscure unless you manufacture computers. If you work in the industry,
you know that in the late 1990s, the two largest semiconductor manufacturers
were located in the same Hsinchu industrial park. An earthquake struck the
island in September 1999. The damage forced the country to press pause on a
week’s worth of production.
Barry Lynn describes what happened next in his book End of the Line:
The first Americans to feel the effect of the quake were, therefore, workers at factories that depend on components made in Taiwan; within days, thousands of manufacturing employees were sent home from assembly lines from California to Texas. The next Americans to feel the quake were investors. As Wall Street began to make sense of the disaster, traders quickly off-loaded stocks of some of the biggest electronics firms with Dell, Hewlett-Packard, and Apple among those that fell furthest. Last of all, Americans felt the quake as consumers. By Christmas, shoppers faced shortages of everything from laptop computers to Furby dolls to Barbie Cash Registers, all of which had been hit hard by parts shortages.
Barry Lynn – End of the Line
All of this over a one-week delay caused by an earthquake. Now, the entire economy, including the CPG industry, is facing a shutdown that may last months.
The slowdown is a reminder of how heavily many US companies rely on Chinese suppliers, whether for finished goods or component materials: Procter & Gamble, whose brands include Charmin, Pampers, and Tide, warned investors in late February that about 17,600 of its products would be impacted by the disruption in China, where it has 387 suppliers shipping more than 9,000 materials.
“Each of these suppliers faces their own challenges in resuming operations,” Jon Moeller, P&G’s CFO, told analysts. “The challenges change with the hour.”
Hilary George-Parkin – Vox.com
The past two decades saw an incredible increase in the
internationalization of the US manufacturing supply chain. Most large companies
have supply chains that cross multiple boarders. There’s massive benefits from
this–most notably cost. But there are also risks–big ones–often ignored by
most until they happen. Today, we’re seeing the risks play out in real-time.
The result will be an interesting dynamic. CPG companies
that resisted the allure of the creation of cheap, but complicated supply
chains, may actually prosper–simply because they can source raw materials
effectively. Luckily, most food processors fit into this camp. There
shouldn’t be any major issues sourcing and processing food for market.
The idea that any of this is an unpredictable shock is simply nonsense. It’s merely an information lag. The circumstantial evidence dates back to Taiwan and the late 1990s–anyone who argues otherwise is incompetent or ignorant.
Their (Li and Fung) international network of sourcing and logistics relies on three things: cheap energy, cheap materials and political stability. Climate change has the potential to upend all three.
Consumer packaged goods (CPG) companies are everywhere. However, most consumers know the brands not the companies. Sprite, Tide, and Moleskine notebooks are all packaged goods brands purchased and used by millions every day. Coca-Cola, P&G, and Moleskine are the CPG companies that produce them. From an operational perspective, a CPG company manufactures products, sells them to retailers, who then sell them to consumers.
The table below gives a few more examples:
CPG Company
Brands
Coca-Cola
Coca-Cola, Diet Coke, Honest Tea
Conagra
Slim Jim, Duncan Hines, Hunts
FritoLay
Lay’s, Doritos, Cheetos
Nestle
Cheerios, Gerber’s, Pellegrino
Proctor and Gamble
Crest, Gillette, Tide
Uniever
Axe, Dove, Lipton
CPG Brands have been around for hundreds of years, although in modern times, CPG categories are mostly considered to be fast moving goods like food, drinks, and cleaning products. Put it this way, if you buy it regularly, it’s probably a CPG. Today, CPG brands are marketed around a variety of traits. Some like Clif Bar and Gatorade are performance-based. Others, like Dove soap, are centered around equality and self-love. Originally, CPG brands were built around one thing: safety.
Why is this? In the early 1900s, most goods were effectively brandless, sold out of general stores from bulk supplies. This led to manufacturers and retailers taking advantage of an unwitting public.
Lemon extract often contained no lemon. Bottled soft drinks used coal tar, a carcinogen, as a colorant. Some ketchups used saccharine, even then suspected as a hazardous adulterant, as a preservative. The “tin” in tin cans contained as much as 12 percent lead, which leached into the fruits and vegetables. Zinc chloride, used to prepare the tops for soldering, often ran into the cans during the soldering process, poisoning the food inside.
As a result, CPG companies began to brand themselves in terms of quality and safety. If a consumer saw Dove soap on the shelf, they knew it was a quality bar that floated, and they’d purchase it with confidence. Manufacturers were now incentivized to differentiate their products. If you’re looking to learn about the business processes and operations that enabled this differentiation, check out this article, which details the rise of Kraft-Heinz. If you’re looking to learn about private label business strategies read this article on TreeHouse Foods. The rest of this post focuses on the high level business strategy of a CPG company. The goal of each is to try and sell as many products as they can, to as many customers as they can reach.
Today, most CPG companies adopt a business model that pushes towards horizontal or vertical integration to accomplish the goal.
CPG, P&G, and Horizontal Integration
Up until about twenty years ago, the definition of a CPG company was straight forward. P&G was a CPG company that manufactured a variety of household products that customers purchased at retail stores.
Research and development: Creating a product that consumers want.
Production: Figuring out how to manufacture the improved product at scale.
Supply Chain: Ensuring that you have enough raw commodities to manufacture the product.
Transportation: Getting the product to the customer (retailer).
Sales: Ensuring the product gets prime placement for a customer through negotiations and pricing.
Marketing: Generating consumer awareness and demand through advertising.
These processes are incredibly scalable and repeatable across multiple categories of goods. Once a company builds up a production system or a sales department, it can sometimes seamlessly plug new items and offerings into the established business process.
Horizontal integration is simply when a company in one category, expands into another category. In the case of P&G, it started in bath soap, moved to laundry soap, then paper products, coffee, potato chips, and even dog food. Each category may seem different, but the core business processes are the same. The general process of producing, selling, and distributing aspirin and cough medicine to retailers is identical. The more products that a CPG company can sell into a retailer, the more leverage it generates. Fifty years ago, a lot of vertical integration was done organically, through research and development. Today, it’s primarily done through acquisitions. The logic is simple. Lax anti-trust enforcement means that retailers are becoming more and more powerful, which means that a CPG company needs more brands to bargain with.
CPG Companies and Retailer Segmentation
Just because the goal of a CPG company is “to sell as as many products as they can, to as many customers as they can reach,” it doesn’t, however, mean that a CPG company will sell its products to all retailers. The retailers it chooses to sell to should fit within the brand’s perceived segment.
Initially, a branded CPG company like P&G was hesitant to sell products through discount stores—as it believed the stores tarnished their middle-class identity. But money talks. Many opted to sell smaller pack sizes and value options when dollar stores became a consistent revenue driver for manufacturers.
On the other hand, Nike is a premium brand. It’s mostly an apparel company, but they certainty produce some CPG-like products. You will probably never see Nike products at Dollar General. Instead, it opted to target high-end retailers and athletic stores, but even that is changing.
Nike plans to continue working closely with 40 partners, ranging from brick-and-mortar standbys like Foot Locker Inc. and Nordstrom Inc. to newer partners like Amazon and online luxury boutique Farfetch, on new apps and in-store experiences. It said it wouldn’t eliminate the thousands of other retail accounts that it currently manages, but Nike Brand president Trevor Edwards said “undifferentiated, mediocre retail won’t survive.”
Nike’s decision to abandon Amazon had many drivers. The first is probably Amazon’s refusal to combat counterfeiting. The second is perhaps Nike’s desire to integrate vertically. Vertical integration is when a company internalizes every business process—from 1-6. Instead of buying another brand to create more leverage against retailers, it buys a commodity supplier or builds its own storefront to create efficiencies within production and distribution.
This strategy obviously can’t be executed by all CPG companies—especially fast-moving consumer goods (FMCG). It would be completely unrealistic for Coca-Cola or Campbell Soup Company to open stores that only sold their products. It’s also entirely impractical for a FMCG to develop a profitable direct-to-consumer business. Customer acquisition costs are too high for the products given that Facebook and Google own an effective duopoly on online advertisement. Most CPG vertical integration comes from retail stores themselves–who do so through private label.
Private Label CPG and Retailer Vertical Integration
So far we’ve focused primarily on branded CPG. That is, the name brand products that every knows and loves. But brands do not operate in a vacuum. Coke is not just competing against Pepsi, but against Walmart’s Sam’s Cola. For as long as chain retailers have existed they’ve sold some level of unbranded or private label products.
For the bulk of the 20th-century private label, brands were considered inferior to branded products. That changed, however, when many products became standardized through better production and supply chain practices. Today, private labels aren’t just low-priced offerings, but brand builders for the retail chains themselves.
The three best-selling private label categories in food and nonfood may still be predictable—milk, eggs, and bread in food; food-storage and trash bags, cups and plates, and toilet tissue in nonfood. However, today’s large and sophisticated retailers are able to develop credible private label offerings for categories where traditionally customers were more wary of straying from their favorite manufacturer brand names. Nowadays, store brands are present in over 95 percent of consumer packaged goods categories. Among the fastest-growing categories for private label sales are lipstick, facial moisturizers, and baby food.
Once you see a Retailer’s operating model, you’ll understand why there is such a push from retailers.
Retailer’s Operating Model
The image below is a typical retail operating model.
The shelf price is the price consumers pay a retailer. The margin is the difference between what the retailer paid the CPG company, minus the retailer’s labor and fixed costs. As you can see, there isn’t much in the retailer’s margin. This graph doesn’t include all retailer considerations (consumer preferences, product demand via mass advertising, differences in revenue per square foot of shelf-space, etc.). Still, you can certainly see why retailers want to get to vertically integrate through private label.
If a retailer owns the production of private label good, they mostly capture all the margin between the production cost and the shelf price. The high fixed cost associated with production gave manufacturers power in a negotiation, but as retailers have become larger and larger, the cost became a non-issue.
The end result of this is that established CPG brands aren’t just facing competition from other manufacturers, but they’re facing intense competition from retailers–who used to be their partners.
In Conclusion, What is a CPG Company?
It’s tough to give a complete and exhaustive definition of a CPG company. That’s because they are so varied in what they produce and how they sell. But definitions help, and hopefully, this helps better understand what a consumer packaged goods company is and the business model it uses to makes money.
At a high level, a CPG company is a firm that manufacturers products that consumers regularly buy. It then sells those products to retailers, who sell them to the end consumer. The goal is to sell as many products, to as many consumers as possible. Today, CPG companies succeed by generating leverage over retailers by offering a variety of goods through horizontal integration. Conversely, retailers are vertically integrating, and offering their own private label goods to compete with CPG companies.
Last week the Campbell Soup Company announced that its recent investment in soup marketing paid off. This news is somewhat surprising. Nearly all research shows that consumers want fresh food. According to IRI, in 2017, fresh sales accounted for approximately 30.5 percent of all food sales, with produce, bakery, and deli meats accounting for most of the growth. This created a situation where companies like Campbells scrambled to pivot towards the perimeter of the grocery store — where fresh produce reigns supreme.
Not only are we attracting new households, we are attracting younger households which bodes well for the future. In particular, on tomato soup, a good percentage of the gains came from millennial households. Frankly, this is a trend that many believed was not possible. Of course, there were puts and takes across the portfolio and not everything worked perfectly. So let’s break it down.
Starting with condensed, you can see our enthusiasm for our return on investment, especially with our Icon SKUs, tomato, chicken noodle, cream of mushroom and cream of chicken, where we continued the turnaround. Consumers responded favorably to our messaging and quality improvements.
What was Campbell’s messaging? Glad you asked.
Later, in the transcript.
If you see how the ads are constructed, we’re actually embracing the can and really connecting it to the quality of the food inside, whether that’s no added preservatives on chicken noodle or whether that’s 6 tomatoes or romancing it in the occasion of the — of grilled cheese sandwich and tomato soup, which we haven’t advertised in a long time, and I think those are all very,very strong.
Consumers seem to have agreed. According to analyst reports, Campbell’s condensed soup is up about 3%, while the overall category is down 3.5%. That means that Campbell’s growth is a direct result of consumers switching from other brands and private labels.
The Campbell Soup Company’s fresh food problem remains unsolved.
In 2019, after seven years, the Campbell Soup Company sold off its Campbell’s Fresh lines — marking an end to the packaged goods company’s foray into fresh food. The unit was never able to stay consistently profitable — despite accounting for over $2 billion in sales. Campbell’s has a supply chain built for packaged food. It could not control for the unforeseen cost associated with selling fresh produce to consumers.
The increase in soup sales is good news for a company facing an uncertain future. Despite the positive short-term results, the problem remains: almost all consumers say they want fresher food, and Campbell doesn’t offer it. The recent growth is artificial, a result of increased marketing and promotional spending. It won’t be sustainable unless the company increased efficiency — through things like revenue growth management. But at least the company is investing in its brands, unlike someone we know.
