In this week's edition:
- The Frame Up
- The Challenge
- Navigate to Where the Puck Goes Next
- CPG’s Roots of Disintegration
- Quantify: Where Will the Puck Go in CPG?
- Implications for Different Players
- Strategic Options
- The Fastest Path to Profitability
- Balancing the Risk and Uncertainties
- Winners and Losers
- Closing Thoughts
The Frame Up
Hockey great Wayne Gretzky once said, “the key to winning is getting first to where the puck is going next”. Imagine if there was a model to help you do the same thing in your business.
Could Procter & Gamble or Unilever be reshaped into future Wall Street stars like Nvidia? Perhaps anything is possible when we live in a time of massive change. Traditional Consumer Package Goods (CPG) companies are feeling the pain as they are challenged by an ever expanding universe of disrupters including nimble competition/specialized upstarts, the rise of D2C and digital retail transformation. Couple all of this with the weight of CPG companies’ historical structure in being vertically integrated CPG giants and you have a formula for massive future disruption and disintegration.
In Clayton Christensen, Michael E and Raynor, Matt Verlinden’s Spring 2023 Harvard Business Review Article “Skate to Where the Money Will Be” the three authors offered a model to predict “where the puck” would go in key industries based on a simple principle: “those who control the interdependent links in a value chain capture the most profit”.
The Challenge
In the past two decades vertically integrated CPG giants like Procter & Gamble (P&G), Unilever and Nestle have famously disrupted their own models in steadily outsourcing their manufacturing and distribution links. In the 1980s, P&G produced around 80% of its products in-house. By the 2000s, that had dropped to around 50% as P&G shifted to an "asset-light" model. For example, P&G sold off its paper pulp mills, citing the commodity nature of that business. It now relies on the whims of the free market and specialty pulp suppliers for raw materials.
Many large CPG companies have also outsourced their retail sales coverage and distribution. These companies previously had large in-house sales forces calling directly on retailers, but over the last thirty years have been shifting to using third-party brokers and distributors. Industry estimates suggest outsourcing has allowed many of these CPGs to reduce capital expenditures by 20-30% and operating costs by 10-15% compared to a fully vertically integrated model. However, this has also reduced these CPGs direct control over the supply chain and interactions with retailers. They have had to invest more in managing their network of outsourced partners and ultimately lost some of the interdependent links in their value chain. This has shifted profits and power towards the specialized players they now rely on, such as contract manufacturers, retail brokers, logistics providers, and distributors.
The HBR article “Skate to Where the Money Will Be” identified the key catalyst for disruption as technologies become "good enough" for mainstream customers, the value chain tends to dis-integrate, with specialized players emerging to capture profits in the areas they can differentiate. P&G's move towards an "asset-light" model reflects this dynamic unfolding in the CPG industry.
So while outsourcing has delivered cost savings for P&G, it may have also reduced P&G’s ability to capture the full profit potential of those links in the value chain. Maintaining brand equity and retailer relationships has become more challenging in this more distributed model.
Navigate to Where the Puck Goes Next
If the CPG industry is to progress and innovate further it is best to look to other industries where disruption and disintegration have happened at an accelerated pace. The personal computer industry is the modern day poster child of disintegration. IBM led the charge in the late 1970s and early eighties as they literally owned the computing industry from mainframes to personal computers. But Big Blue’s dominance eventually gave way to specialized players who were disrupting its value chain in companies like Microsoft (software), Dell (customized hardware) and Intel (chips). As the HBR article noted, “the pace of technological progress generated by established players inevitably outstrips customer ability to absorb it, creating opportunity for upstarts to displace incumbents”.
We have also seen and are experiencing this with mobile phones. Mobile phone technology has become so good that it is outstripping our ability as consumers to absorb it all. This has created opportunity for companies focused on mobile processors, operating systems, app platforms, etc., who can capture profits by controlling key interdependent links, similar to what happened in the PC industry. For example mobile tech’s ability to outstrip our ability to absorb it has opened the door for upstarts creating low tech less technically intrusive phone challengers like Punkt 4G Mobile Phone, The Light Phone and Easy Phone. Note: this is happening in the AI industry now as new specialized players are popping up to take on new roles in offering more niche and specialized services versus what OpenAI, Google and Anthropic have to offer in their LLMs; e.g., chatbot curators like Botpress and Zapier and AI search specialist Perplexity .
The shift towards commodity hardware and the growing importance of software, services and user experiences has reshaped the mobile value chain. Just as Microsoft and Intel consolidated power in the PC industry, we've seen companies like Apple, Google and Qualcomm become central players in mobile by controlling critical elements.
The key driving forces that led to the disintegration of the PC and mobile industries included technology maturity. For example as PCs and mobile devices became "good enough" for mainstream users, specialized players could emerge to focus on specific components and capabilities rather than fully integrated systems. Also the pace of innovation or rapid technological progress outpaced most consumers' ability to fully absorb new features and capabilities, opening opportunities for specialized solutions.
The commoditization of hardware is another force as the core hardware (processors, memory, etc.) became more commoditized, it reduced the ability of integrated players to maintain dominance. Further the importance of software and user experience was a key driving force as software, user interfaces, and ecosystem platforms became critical differentiators, and specialized players in these areas were able to consolidate power.
Finally the shift from scale to agility led to rapid innovation and responses to changing consumer preferences as these specialized nodes became more valuable than economies of scale in manufacturing. Also the improved access to components helped to standardized components and manufacturing capabilities enabling new entrants to more easily compete. These forces, observed first in the PC industry and then replicated in mobile, created windows of opportunity for specialized players to capture value by controlling key interdependent links in the technology value chain.
So the trends of technology maturity, value chain disintegration and the rise of specialized players that were observed in the PC industry are now happening in parallel to the mobile space. This suggests that CPG companies may be following a similar trajectory as they adapt to new digital and technological capabilities that are disrupting their traditional business models. Thus the key driving forces currently impacting the dis-integration of the CPG industry include several disrupters. First, the commoditization of manufacturing has led to contract manufacturers and specialized suppliers reducing the need for vertically integrated production. Second, the rise of digital direct-to-consumer (D2C) channels and marketplaces has led E-commerce platforms and D2C brands to disrupt traditional retail relationships. Third, the importance of data and analytics is opening up options for AI-powered consumer insights and predictive capabilities to create new sources of value. Fourth, the demand for sustainability has created a bevy of influential specialized providers of sustainable materials, packaging, and circular solutions. Finally, the acceleration of innovation cycles is changing the pace of change in consumer preferences and technology. As a result, we are seeing the initial warning signs in CPG as consumer preferences and technology are outpacing traditional CPG companies' ability to stay agile.
These forces are enabling the emergence of specialized players that can capture value by controlling key interdependent links, similar to the patterns observed in the PC and mobile industries.
CPG’s Roots of Disintegration
Zooming in from PCs and Mobile tech, one needs to understand CPG’s roots to better understand where to skate next, and specifically in its largest most dominant customer base, retailers. A&P was founded in 1859 as a coffee and tea store in New York City. A&P would eventually become a behemoth of retail in the first half of the 20th century. A&P was built on Industrial Age technology that helped it scale faster than any of its competition. A&P itself was a disrupter as it initially specialized in coffee and tea and eventually groceries against the traditional general store. During the second half of the 20th century, A&P’s dominance declined thanks to the transition from the Industrial Age to the Information Age and their slow pace of adoption of the new technology that came with it. On June 26, 1974, A&P’s and many early 20th century disrupters' death knell came in the form of the first UPC barcode that was used in a Marsh Supermarket in Troy, OH. Thus ushering in a new and more disruptive era of technology enabled retailing.
An example of another mid-century retail behemoth that gambled and lost on its most profitable interdependencies is Kmart. Kmart began its decline in the late 70s and early ‘80s as it was slow to adopt the new Information Age technologies. Those of us who were able to shop at Kmart in the 1980s can probably recall the persistent price checks that occurred whenever someone was checking out at the register. It was to the point that it felt like Kmart would dare you to buy anything in their stores. My family lived five minutes away from a large Kmart store and I recall my father complaining about going to Kmart because of the long check out lines and price checks. I still have “nightmares” from hearing the Kmart cashier calling over the intercom for a “price check” leaving you in the lurch of time famine waiting for the cashier to call a clerk to go back to the aisle where your item was located to lay eyes on the price tag. It was a gap in their POS system. Ultimately, A&P and Kmart also made missteps on acquisitions and divestments in the wrong interdependent links leading them further down the proverbial vacuum of decline.
Kmart’s folly became Walmart’s opportunity. Walmart built itself on being a low price leader on a foundation of having the most efficient and up-to-date Information Age fueled logistics system. Prices were low and aligned without gaps in their POS systems. In contrast, Amazon is an Information Age “baby” specialized challenger, with almost all of its competency and profitable interdependent links built on twenty-first century technology.
In the last thirty years, innovation has helped new upstarts challenge and disintegrate Walmart’s scale in the form of more specialized retailers like Sprouts, Aldi and Trader Joes. These retailers amongst others have been able to identify the key profitable interdependent links in the value chain and have owned them and begun chipping away at Walmart’s dominance. As a result CPG’s fate is inextricably linked to its customer’s fortunes and understanding the future profit centers requires an in-depth understanding of the transformations of its customer base.
So it is no surprise that some of these specialized retailer upstarts have spawned a new generation of smaller more specialized CPGs. For example specialized natural foods operators like Sprouts, Lazy Acres and Fresh Thyme Market have been an onramp for a deluge of specialized naturals CPGs like Chosen Foods, Method and Stonyfield Organic.
Quantify: Where Will the Puck Go in CPG?
So where to skate in CPG? Where will the money go? How can CPG companies prepare and predict where the proverbial “puck” will go?
Four key areas to look closely in the future are: AI/data analytics, digital brand management, sustainable tech, and smart manufacturing. The reasons why these areas are key is they will capture significant value in the evolving CPG industry because these specialized capabilities allow players in these segments to capture an outsized portion of the value being generated, similar to how Intel, Microsoft, and others consolidated power in the PC industry value chain. Specialized players and startups control over critical links creates high switching costs and barriers to entry for CPG incumbents.
For example AI/Data Analytics are providing predictive consumer insights to optimize product development, marketing, and operations. These analytics also are enabling real-time personalization and targeting at scale and unlocking new revenue streams through data monetization.
Digital Brand Management and Digital Platforms are enabling CPGs to control the critical consumer interface and touchpoints in a digital-first world. CPGs can now leverage data and AI to enhance brand positioning and customer engagement, orchestrate omnichannel experiences and direct-to-consumer channels.
Sustainable Technology is helping to meet growing consumer demand for environmentally-friendly products and packaging. It is also enabling circular economy models and new cost savings through materials innovation and providing certifications and transparency that build brand trust.
Finally, Smart Manufacturing is helping CPGs to optimize production, quality, and supply chain efficiency through automation and analytics. It is also helping to facilitate mass customization and personalization of products and reduce costs and inventory through predictive maintenance and demand forecasting. For example Coca-Cola has added robotics and automated many of its bottling and distribution centers enabling greater efficiency, customization and personalization.
Implications for Different Players
Ultimately there will be different implications for different players in the CPG industry based on how they have managed the core of the interdependent links in their value chains. For example, traditional CPG companies, emerging specialists, retailers, technology providers and start-ups/innovators will all be impacted by some degree of uncertainty. The steps they take to ensure they are preserving and curating the right and most profitable interdependent links will determine their fates and long-term value to their consumers as a whole.
Strategic Options
CPGs have options including for incumbents to focus on investing in the right key capabilities, partnering with specialists and restructuring themselves for agility. New entrants will need to identify the key value capture opportunities, build specialized capabilities, and target specific value chain segments.
The Fastest Path to Profitability
Over the next three years, CPGs will need to focus on accelerating the adoption of AI/analytics, digital platforms, and sustainable tech. Beyond three years, there will be a need to invest in smart manufacturing, further embrace D2C channel shifts and curate and champion integrated sustainability models. Finally, five to ten years out CPGs will need to embrace a fully transformed industry structure with specialized value chain players. All of the above will require a critical focus on building specialized capabilities quickly, rapid response to consumer preferences and the effective management of complex partner ecosystems, data governance and responsible AI strategy execution.
Balancing the Risk and Uncertainties
The path forward for CPGs will not be without its risk and uncertainty. CPGs will need to pay close attention to regulatory changes impacting AI and data usage and sustainability mandates. There will also be evolving consumer preferences outpacing CPG's ability to adapt and consequently opening the door for specialized upstarts and innovators. There will be some difficulty with legacy for some CPG companies to transform legacy assets and culture (part of IBM’s issue in losing the PC revolution to Apple). Finally and no less important is a laser focus on going on pro-fence in managing potential cybersecurity and supply chain disruptions.
Winners and Losers
Ultimately there will be a CPG landscape riddled with winners and losers. The winners will be AI/data platform providers, digital brand leaders, sustainability innovators, smart factory specialists. The losers will simply be the rigid, slow-moving CPG incumbents unable to transform and contract manufacturers unable to differentiate.
Closing Thoughts
Change is inevitable and so too is disruption and disintegration. Questions we as CPG leaders should be asking ourselves and our direct reports: to what degree the disruptions in the value chain are impacting the key driving forces outlined above and whether we are leaving money on the table in terms of outsourcing and identifying the key interdependent links in the value chain that have the potential to capture those links most RELEVANT to future profit (skating where the puck is going). The great CPG disintegration need not be a matter of factual or fictional circumstance. Instead it should be a matter of a desire to win over the customer and out-innovate the competition through an iterative and predictable process of identifying the key shifts away from profits before they happen and relative to when the product is more than good enough for the customer and shift resources proportionately as needed to grow future profit centers. This is a wake up call for CPG’s leadership to shift focus from putting out fires to building a long-term profitability engine. Stay classy and disruptive CPG people!
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