In the tech space, it is cheaper than ever to start a company because open source code frameworks, on-demand cloud compute infrastructure, and other factors have drastically lowered the costs of building software startups. Can the same be said for starting a CPG company? The short answer is: maybe. That’s because of the industry’s supply chain model, the network between a company and its partners to produce and distribute a specific product or service to a customer.

The traditional supply chain model is Big CPG’s largest moat against startups. Big CPG has long established supplier partnerships and the scale to negotiate lower upstream activity cost while leveraging its marketing machines to increase velocity at retailers. Startups often don’t have the scale or relevance needed to drive down costs associated with supplier partnerships. Simply put, with the exception of the final customer, every time an external party interacts with your product or service, there is an associated cost and each partner has a desired margin.

The diagram below illustrates how many supply chain partners are typically needed to get a product to a customer.

Supply chain costs every CPG startup should know

Using the diagram as reference, let’s imagine Meal-Rep, a fictitious CPG startup, wants to enter the market with a healthy meal-replacement bar at a price point of $4.99. Under the traditional supply chain model, would this even be a feasible business? Let’s find out.

For most CPG categories, the ideal gross margin is 40%+, so for Meal-Rep to hit their desired MSRP of $4.99, it needs an upstream activities (ingredients, packaging, manufacturing) cost of about $1.20 per meal bar. This is because the margins demanded by downstream activities partners eat up a majority of the would-be profit; wholesalers/distributors take between 10–20% and retailers require 40–50%. The chart below lays out the economics of getting to a $4.99 price point.

It will be difficult for Meal-Rep to sustainably reach a $4.99 price point because of these factors:

Margin demands of downstream supply partners
Lack of scale to negotiate lower unit prices from upstream supply partners
Minimal initial product velocity at retailers to warrant deals from retailers

How a CPG Startup can compete

Based on the supply chain’s economic structure, upstarts like Meal-Rep have a few options.

OPTION 1: Leverage the traditional supply chain model knowing that they will operate at an initial loss until they reach product-market fit which will manifest into scale and velocity.

Pros: larger footprint & quicker path to scale.
Cons: Lower margins (>40%) & lack of customer data.

OPTION 2: Bypass downstream supply chain partners and enter the market via a direct-to-consumer path.

Pros: High margins (50–70%) & direct customer data.
Cons: Small footprint & Fulfillment cost.

OPTION 3: A hybrid of the first two options. Each of these initial launch strategies has their advantages and disadvantages. Pros & Cons are a mix of the other two options.

Specifically launching via direct-to-consumer only exposes a product to a fraction of its potential customer base so although margins will be high, the scale variable may not be optimized for under this launch vehicle. Although the percentage of e-commerce sales has been increasing over the last 10 years, close to 90% of sales in the U.S still happen at brick & mortar locations. For startups to truly be successful, they need to leverage the traditional supply chain model and partner with retailers who can get them more eyeballs and sales for their products. So maybe startups can overcome Big CPG’s supply chain moat if they are willing and can afford to lose margin while gaining scale and velocity.

Cross-posted on Medium

SKU’d Thoughts 3: Can CPG startups overcome Big CPG’s supply chain moat?