Growth vs Profitability – The trade-off is getting brutal for CPG
The obsession with growth has long been driving CPG’s resource allocation decisions. Even though, over time, different firms have articulated different trade strategies, at their core, most of them essentially meant “wooing the retailers to capture the primacy on the shelf”. From front-loading the investment structure to signing up to unrealistic servicing norms (95% service level even for SKUs with high variability), CPGs succumbed to almost every demand of retailers. As the competitive intensity grew, CPGs progressively made the investment architecture more lenient – making the proportion of “front margin” alarmingly high.
- Trade spend is now the second largest line item in the CPG P&L (next only to COGS)
- The rate of growth of trade spend (10-12 % CAGR over the last 5 years) has far surpassed revenue and COGS growth over the corresponding time period
Consequently, the strains are already visible in the P&L. While, the lack of sustainability of the current investment architecture is widely acknowledged, a majority of the firms are still grappling with how to respond to this burgeoning trend.
Dancing to the tune of retailers – but how long?
The available profit pool has been steadily shifting to favor retailers, much to the dismay of CPG firms. On an average, 70% of the trade investment is in the form of “front margin”. The modern retailers are especially averse to accepting any conditionality in their incentive architecture and it augurs well with their objective of giving primacy to their own private level brands. CPGs have tried various routes to market models including DTC to circumvent the intermediaries and offset the higher fulfilment cost with the proportionate savings in the channel incentives. But, DTC still remains less than significant for most firms and “scale economies” in DTC are still much below the threshold.
Conditional investment is the answer – but it is easier said than done
Changing the underlying trade investment architecture with minimum friction with the retailers is perhaps one of the biggest hurdles CPGs would have to overcome, especially when retailers are used to the “easy money”. Most of them have endeavored to expand the proportion of “back margin” in their investment mix by way of introducing a range of “Pay for performance” and “Pay for compliance” programs – but the subscription percentage of those programs is not too inspiring. Plus, more often than not, those programs have failed to achieve the objective of balancing the investment structure. Our experience shows that the extent of gains businesses can achieve by balancing the investment structure can be quite compelling
Crafting the investment – both art and science
The underlying basis of the trade investment architecture should be mutual “win-win”. CPGs need to recognize that not all retailers are created equal and the opportunities that they represent are also significantly inequitable. Hence, having a “broad brush” investment approach towards trade only defeats the purpose of trade investment.
Firms should profile their retailer universe based on their current performance and future potential. That’s where they need to leverage sophisticated analytics to build various scenarios and make sense of a range of economic consequences that might potentially arise, before they zero in on the right structure.
However, once the right structure is designed, convincing the retailers on how proposed “back margin” can potentially influence sell-out—which in turn would improve the retailer’s GMROI—is nontrivial! Retailers tend to take a very narrow view of their return – equating it with just the front-margin and fully ignoring the back-margin. The retailer’s perception gets further bolstered by the inability of most firms to convince them that the real ROI is driven by both “margin” and “velocity” and back-margins are fully aligned to drive up velocity at the shelf. Higher velocity, even with a moderate margin, produces a much superior return for the retailer. But it is tough convincing retailers. It requires a unique mix of contextual intelligence at the point of action and interpersonal soft-skills – without which it would just remain a paper plan!
Recognizing the gravity of this trade marketing problem, we at ITC Infotech have evolved a robust “intelligent planning and execution” framework along with our platform partners with an aim to deliver significant competitive advantage to our CPG clients.
We have worked with a range of CPG leaders around the world and have helped them tailor make fit-for-purpose investment structures for their channel partners. The result is a significant profitable growth of their portfolio. If you want to benefit from our approach and methodologies and get a deeper insight into our work, please reach out to us at email@example.com.