Modern retail will choke the life out of (young) consumer brands
A speaker at a recent closed-door conference that I attended, made a presentation on the different kinds of business models and what makes them successful. One very important observation that he pointed out, and that stuck with me was:
“If the key to the success of a restaurant start-up is location, location, location,
Then the key to the success of a consumer goods start-up is distribution, distribution, distribution.”
Expressing my investment focus on consumer brands in a blog post earlier this year and in the interview with Sudhir Chowdhary of Financial Express, propelled some excellent deals into our pipeline, many of which are in the advanced stages of evaluation. Most of the start-ups that came to us however, were utilising modern retail as a part of their distribution strategy, an expensive approach, that I have some serious doubts about.
Most modern retailers take 30-35% of the sales price of product as their “cut”. For 90% of start-ups, this massive pay-out is equivalent to the cost price of the product. Over and above this cut, start-ups must shell out money for ATL/BTL marketing, PR, etc which makes the total marketing cost well over 50% of the sales price.
Although such a large pay-out of the sales price is required at early stages, marketing costs are meant to reduce over time and become a smaller percentage of revenues with scale. Retailers however, continue to ask for a standard 30-35%, causing a massive drag on financials.
Furthermore, most modern retail stores have terrible payment terms (barring a few) and withhold payments for 45-60 days causing expensive start-up capital to be stuck in working capital. Most retailers also have clauses that force their vendors to take back items that have not been sold and are approaching their expiry date, which could be a function of the store not performing well due to certain issues that the vendor has no control over.
For the expensive money paid out to modern retailers, they provide very little data on the consumers that are buying a start-ups’ wares, making it difficult for start-ups to get accurate customer insights and improve their offerings or develop new lines of products.
I have been heavily influenced by a case study that I did in college on how Walmart destroyed Vlasic pickles in the early 2000s by becoming its biggest customer and the reason for the drop in its margins. Vlasic eventually filed for bankruptcy protection.
In my opinion, selling directly via an online e-commerce platform or through their own website is the way to go. Although this may lead to copious amounts of money spent on marketing and logistics, it pales in comparison to the amount start-ups shell out to modern retail chains. Additionally, direct selling gives the start-up access to direct customer feedback (which is invaluable) which will significantly improve the product & research team’s understanding of the target audience and allow customer service to quickly respond to consumer grievances, suggestions and behavioural changes. Another upside is that the products can be shipped nationwide beyond the geographical boundaries of modern retail stores. This is something that has the necessary “escape velocity” to quickly scale revenues – I cannot impress enough upon the importance of this feature for the investment attractiveness of a venture.
The point that drives the proverbial final nail in my argument to avoid a massive reliance on modern retail is the emergence of several private label brands. Many retailers (Amazon included) use the sales data of top performing categories and brands and start looking for options to private label them. This means that not only is a new brand paying these modern retail stores 30-35% of their revenues, but they are also acting as the guinea pig to augment the retailer’s private label portfolio and increase its profitability.
Therefore, I strongly advocate that founders should avoid the modern retail route until they have reached a commanding size or just avoid them (if they can) altogether.