CPG Business Model
Coca Cola, L’Oreal, Kellogg’s, Unilever - what do these seemingly very different companies all have in common? They make everyday goods used by consumers all around the world. These brands make products that people want, generate repeat customers and have successfully made their products habitual purchases. But what is a consumer packaged good (CPG) and the CPG business model?
What are Consumer Packaged Goods (CPG)?
Consumer packaged goods are foods, beverages, household goods, and personal products that are bought for short-term usage and replaced frequently. According to the Consumer Brands Association, CPG sales totaled $1.53 trillion in 2020, nearly 9 percent of which went to small CPG companies (with revenues less than $100 million).
Characteristics of CPG products
CPG products are affordable everyday goods that are purchased frequently and consumed quickly. Consumers put in little to no effort in choosing these products and they are sensitive to prices. Think of the last time you went into the supermarket, how long did it take you to decide which tomato sauce to buy? The average consumer spends 13 seconds purchasing a brand in retail stores.
Consumers have a lot of options with similar (low) price points when making a purchasing decision. Their short window of attention makes generating and sustaining repeat purchases the basis of the CPG business model. CPG companies compete with each other on brand recognition, customer loyalty, price, quality, product variety, and packaging.
While types of products may vary, below are the main characteristics of the CPG business model:
- Low-cost products: CPGs are typically low cost items. For example, a box of cereal will run $3 compared to a beach vacation that can run in the thousands. This means consumers from different income levels can afford and buy packaged goods.
- High volume production: CPGs are produced, packaged, and shipped in bulk. Think large volumes - a single Kraft Heinz factory can make up to 600,000 boxes of Mac and Cheese every day to keep up with 1 million boxes sold each day!
- Low margins: Margin is the percentage difference between the sale price and the cost of making the product, or the percentage of how much the product sells for above the actual cost of the product itself. It is used as a measure of profitability and improving your margin requires either increasing your price or reducing variable costs. High ingredient costs and price-sensitive consumers result in low-profit margins in the industry. This means that CPG brands need to sell at higher volumes to make money.
- High inventory turnover: Higher inventory turnover means goods on the shelf in stores are sold and re-ordered quickly. Space is a finite resource in stores and distribution warehouses. This means that retailers and distributors rely on product selling quickly to make money themselves.
- Widespread distribution: The ceiling on gross sales is a lot higher in packaged products than in a restaurant. A retail location has a natural limit on how much it can bring in. Comparatively, in packaged products, you can increase your revenue by adding more accounts and there are well over 35,000 supermarkets in the US alone, not to mention the opportunities online.
- Prominent shelf space: You might have heard the phrase “Eye level is buy level.” Prominent shelf space is valuable real estate in retail - it can boost brand recognition and increase sales. CPG brands pay for product placement, promotions and displays to encourage consumers to buy their product over their competitors’.
- Buyers with high bargaining power: Retailers such as Walmart, Target and Whole Foods are able to negotiate pricing with CPG companies because they sell high volumes of their products and decide on shelf placement.
- High spending in marketing and sales: Consumer engagement with CPG products is low and they tend to default to previous purchases. This is where brand awareness and repeat purchases come in. CPG industry ad spending totaled $26.7 billion in 2020.
How the Cookie Crumbles: CPG Business Model Edition
All this terminology might sound complicated so let’s bring it all together in the example of a growing CPG business we call Cookie Co.
Cookie Co. launched in 2018 and has since grown into a regional brand sold across the Mid-atlantic and Northeast. They sell their chocolate chip cookies in retail stores at $4 for a package of 10. As mentioned earlier, because of the low price point of their products, CPG brands have to sell high volumes to be profitable. Cookie Co.’s low price and wide distribution to supermarkets in these two regions allows it to sell 75,000 packages per week across 20 supermarkets and make $30,000 in revenues every week.
Now that we know how much it costs them to make their cookies and the revenue they earn by selling them, we can look at how much of the revenue Cookie Co. gets to keep by calculating their margin. Remember, margin is the percentage difference between the sale price and the cost of making the product. Cookie Co spends $22,000 on their raw ingredients, labor, packaging, and other variable costs to make 75,000 packages per week. They subtract their cost of $22,000 from their revenue of $30,000 and divide that figure by the revenue to get the margin of 26 percent. That means that Cookie Co. keeps 26 percent of its revenue and spends 64 percent on purchasing more ingredients and packaging for their cookies and growing their business!
We see this played out at a larger scale in companies such as PepsiCo. PepsiCo is the second-largest manufacturer of branded food and beverages with $70.4 billion in revenue in 2020, followed by rivals such as Nestle, Kraft, Unilever and Coca Cola. Its market share in the soft beverage category in the US was 22 percent in 2020, meaning the company generated nearly a quarter of the industry sales.
PepsiCo has been so successful because they sell low cost products at very high volumes. Their extensive production capabilities allows them to produce enough product to keep up with the high sales volumes. Another unique advantage they have is their large market share. They get lower prices on their ingredients and packaging, which in turn increases their margins. In 2020, Pepsi sold $22.5 billion worth of products that cost $10.5 billion to make and earned a gross profit margin of 53 percent!
Despite having slightly higher margins, they still need to sell at high volumes as often as possible to maintain profitability. The speed with which they sell their products to customers determine their inventory turnover in a given period as a higher ratio indicates inventory is being sold and distributed faster. Companies want this ratio to be between 6-12 and Pepsi averaged an inventory turnover of 8.11 meaning they managed to turn over their inventory 8 times within a year.
Keys to Success in the CPG Business Model
CPG is a game of extensive distribution, low margins, and high inventory turnover. Successful CPG businesses make affordable products at scale and sell them to a large consumer base in retail locations across the country. Let’s break down what each of these components mean:
Extensive distribution: Companies like Nestle, Pepsi and Mondelez all have operational capabilities to produce high volumes of their products at a low per unit cost and distribute it to supermarkets, convenience stores, online retailers and pretty much anywhere customers shop for food items. If you’re looking for a Kit Kat, Oreos or a can of Pepsi, chances are that you’ll be able to find them anywhere food items are sold because CPG companies distribute their products widely.
Low margins: CPG industry is competitive with many options for customers to choose from. This makes differentiation between products difficult and many customers across different income levels rely on price to make their purchasing decisions. With the exception of the premium category, CPG companies offer their products at low prices to reach as many consumers as possible. CPG businesses accommodate for the low margins by selling a high volume of their products. They accomplish this by selling more per store and selling into more stores.
High inventory turnover: Inventory turnover reflects how fast products sell in a given period of time. As we discussed above, CPG companies sell affordable products at a low margin to a large number of customers so higher inventory turnover means higher revenues. CPG companies are constantly trying to increase their sales and repeat purchases by growing their consumer base and developing strong brands.
In a competitive industry like CPG, successful companies grow their brands and maintain margins through mass-market brand building, product innovation and expansion into fast-growing categories. This requires anticipating and responding to evolving needs of consumers and innovating products through packaging, formulation, and variety to better satisfy consumer needs. In other words, CPG brands are constantly working towards creating a product people want.
For example, Pepsi attributes its success in the CPG industry to the strength of its brands and innovation and marketing efforts, coupled with the quality of its products and flexibility of its distribution network among other factors:
“Success in this competitive environment is dependent on effective promotion of existing products, effective introduction of new products and reformulations of existing products, increased efficiency in production techniques, effective incorporation of technology and digital tools across all areas of our business, the effectiveness of our advertising campaigns, marketing programs, product packaging and pricing, new vending and dispensing equipment and brand and trademark development and protection.
Pepsi’s large marketing and sales budget and extensive procurement, manufacturing and distribution capabilities allows it to maintain sales and market share despite fierce competition in the industry.
Takeaways for smaller CPG brands
In this guide, we talked about the characteristics of CPG products, the CPG business model and the recipe for success using the example of one of the largest CPG companies, Pepsi. Their scale advantages, category know-how, partnerships with retailers and strong advertising capabilities make them competitive in this industry.
What does it take to succeed in the CPG industry? Making high volumes of affordable products that consumers need on a regular basis. Sell your products in various channels (physical stores as well as online commerce), listen to what your consumers want and keep up with what your competitors are offering by constantly innovating to build your CPG business to last!