Consumer packaged goods (CPG) companies are everywhere. However, most consumers know them by the brands they produce. Sprite, Tide, and Moleskine notebooks are all packaged goods purchased and used by millions every day. Coca-Cola, P&G, and Moleskine are the CPG companies that produce them. At a high level, a CPG company manufactures products, sells them to retailers, who then sell them to consumers.
CPG Brands have been around for hundreds of years. Today they’re positioned around a variety of traits. Some like Nike 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.
In the early 1900s, most goods were effectively brandless, sold out of general stores from bulk supplies. Unbranded sales led to manufacturers and retailers taking advantage of an unwitting public.
In his book on the rise of the Atlantic and Pacific tea company, Marc Levinson, explains:
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 of consumer uncertainty, a CPG company could complete on quality and safety—which is exactly what they did. If a consumer saw Dove soap on the shelf, they knew it was a quality bar. This general value proposition created the following business model for a CPG company: to try and sell as many products as they could, to as many customers as they can reach.
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. As I wrote earlier, six major business processes drive consumer product companies.
- 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. 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 against its customers. It’s the rationale for a wide variety of acquisitions. The more valuable brands a manufacturer has, the more a retailer needs to bargain.
This 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. 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.
In presentations to investors on Wednesday, Nike executives emphasized the company’s ongoing plans to sell more goods digitally and directly to consumers, a shift from its longstanding model of selling through sporting-goods stores and other traditional retailers.
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.”
After a few years, NIKE announced it would no longer sell through Amazon, instead, looking to build up its own direct-to-consumer capabilities.
A CPG Company and Vertical Integration
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—except it tweaks number 5.
A vertically integrated CPG company would sell products to retailers and own individual store locations or feature a robust direct-to-consumer/catalog model. In the case of Nike, it now has over 1,150 retail locations—each with an average revenue of $34 million.
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.
Private Label CPG and Vertical Integration
For as long as chain retailers have existed they’ve sold some level of unbranded or private label products. If you think back, this is nothing more than vertical integration. A retailer owns the real estate and the production line.
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 retail brand builders.
According to the book, Private Label Strategy:
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.
It’s easy to see why retailers are attracted to the proposition. 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.
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.