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To win back consumers, big brands should invest in R&D and innovation

Ryan Caldbeck
Contributor

Ryan Caldbeck is the founder and chief executive of the consumer and retail investment marketplace CircleUp.

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The world of consumer goods is changing. Consumer tastes are becoming more and more fragmented and big incumbents continue to lose market share to upstart brands. It’s often difficult for these incumbents to figure out how to respond. CPG is full of smart people but many of the biggest brands have seen their sales stagnate or decline over the past several years.

Consumer companies can increase profit and deliver shareholder value by either growing in revenue or cutting costs, but the strategies these companies have taken to try to turn the tide just aren’t working. When they innovate, they only make incremental changes to products (like reducing the fat of a potato chip), instead of offering consumers new products that they actually want.

Or they spend billions on advertising to convince consumers that they should buy already existing products. If they can’t increase revenue, they’ll cut spending by stripping out valuable business teams or merging with other consumer companies to slash costs (à la Kraft-Heinz). These strategies do not position Big CPG for long term success, I’d like to suggest a few that might.

Before I dig in here, I want to say upfront that I don’t have all the answers (or even most of them). I’m the CEO of a startup with 65 employees — not a massive corporation with 30,000 employees. The insights I hope to share are gathered from over a decade working in consumer investing and helping consumer companies grow, but they’re ultimately insights from the outside looking in.

Replace “Kellogg’s” with the name of PepsiCo, Estee Lauder, Nestlé, Kraft -Heinz or countless other big brands and the observations should still resonate. This isn’t about just one company, it’s about the dynamics that exist for virtually all CPG incumbents.

What I would do differently

On day one as CEO of Kellogg’s, I would take a hard look in the mirror and I would ask myself which Kellogg’s brands are still relevant and can grow. I recently had a conversation with a former VP of a major CPG company and he said that Big CPG is guilty of thinking that everything can be relevant if they bring the right news to it. I agree. As CEO, I would acknowledge up front that we have certain brands and products that are cash cows now-but are slowly dying.

An uncomfortable but proactive step would be to sell the legacy cash cows that are dying and invest the cash windfall into innovation. This week I was in another discussion with a 20 year veteran from a Fortune 100 consumer company who said “I think in 10 years our company will no longer exist. It will be broken up.” Conversations about selling legacy brands will make a lot of consumer executives squirm, but they are conversations that need to happen. Cutting the dying cash cows is the hardest but probably most important step in righting the ship.

After deciding which of our legacy brands to divest, my next step would be to publicly announce that we will shift focus away from cutting costs and towards investing in a culture of innovation to actually grow the business. This will likely cause our stock price to go down in the short term, but in the medium to long term this will help our company tremendously.

Simply put, we can’t survive by cutting costs forever. We need to grow. Our culture of innovation will be built and promoted in a variety of ways. What follows isn’t a sequential list but rather initiatives that should be pursued in parallel:

1) Research and Development. We will signal to Wall Street that we are going to focus on growth and innovation, not cost-cutting. We’re going to go through a rehaul of the R&D process and pipeline and we will dare to dream bigger. In 2017, Kellogg’s spent $148 million (1.1% of net revenue) on R&D. This may at first sound like a lot, but for comparison, Google spent $16.6 billion (15% of net revenue) on R&D during the same time period. The dichotomy between tech and consumer spending on this front is highlighted in the chart below.

R&D Spending as a Percentage of Annual Net Revenue

Source: Company 10-Ks for 2017

It’s no wonder that one of these companies has been making Frosted Flakes the same way for over 60 years (with goofy TV commercials for most of that time) while the other started as a search engine and now builds phones, maps, and self-driving cars. Imagine how comical it would be for a tech company to sell the same product for 5 years, let alone 50. R&D is not just about coming up with a new flavor or lowering the fat content of an existing product.

As one big CPG veteran told me recently – “consumers don’t care about ‘whiter whites’” anymore”. It involves building an adaptive infrastructure that truly listens to what consumers want and then relays that information to development teams in a way that allows them to be agile and effective. We need to have an R&D team that is focused on the category and consumer, not the product. Instead of Pepsi thinking about a lower fat potato chip, they need to be rethinking the snack category as a whole.

Why is it insane to imagine AB InBev developing a beer that doesn’t cause hangovers, but it isn’t crazy to imagine Elon Musk sending people to Mars? Why is it laughable for Clorox to invest a billion dollars into developing a non-toxic, safe substitute for bleach, but it’s normal to imagine investing $15 billion into Uber – a company that is trying to replace all taxis in the world and rethink transportation? Those comments are meant to push public CPG CEOs, not to degrade SpaceX or Uber.

Good R&D also involves keeping your ear to the ground for great ideas that may already be out there. There could be a toothpaste in India that would revolutionize the way we think about toothpaste in America, but we’ll never know if we aren’t listening. For an example of what can happen without this R&D infrastructure, look no further than the pharmaceutical industry where Big Pharma companies are now having to pay to outsource innovation because they can’t foster it in house. CPG is becoming Big Pharma.

2) Incubation. In addition to investing in and partnering with great consumer companies, we will provide space and expertise in house to help them grow. Kellogg’s recently partnered with Conagra Brands and the City of Chicago to invest in a $34 million food incubator that is expected to support around 75 companies, 80% of which will be in the snack category. This is definitely a step in the right direction, but I’d want us to go bigger and take the operation in house. I’d like to incubate 100+ companies per year from a wide variety of categories and become the Y Combinator for consumer. This will be a win-win. We get to help great consumer companies grow and these companies get to leverage our expertise and infrastructure.

3) Venture capital. Too many CPG companies only invest in brands once those brands are 5+ years old and end up paying a huge sum as a result. I would change our mandate to invest in companies that will be interesting 10 years out – not just companies that we think are going to contribute immediately to our revenue or existing product strategy. We need to take the long view here and data plays a big role. Kellogg’s will not identify innovation just by sending a dozen people to Expo West. We need a non-commoditized data and technology solution that can help us identify breakout brands early by looking at their growth potential- not their Expo sales booth. Kellogg’s is actually ahead of most CPGs when it comes to venture in that they have a venture arm of $100 million. But this is still too small.

I would start by having our venture arm manage assets of $500 million (less than 4% of net revenue but still 50x the AuM of many CPG corporate venture arms) and tell them that they are going to invest in 200-300 companies, focusing on early stage companies with less than $10 million in revenue over the next 2-4 years. If that sounds insane, look at Google’s GV for some inspiration. They build a diverse portfolio to foster innovation from many and sometimes unexpected angles. If tech VCs can have a portfolio of hundreds of companies, so can we. A venture arm in consumer is nothing new. Many large CPG companies have launched venture arms, but most of these consumer VCs only plan to invest around $5-$10 million across 3 to 4 companies. Then the CEO loses his or her nerve, succumbs to the pressure of short-term cost cutting, and bails on the strategy. We will dare to take the long view.

Beyond just capital, I would create a structure that provides these companies resources and support to help them be successful. We will create a program to allow for externships between Kellogg’s (and possibly our partners) and the portfolio companies we invest into. Hardly a week goes by that I don’t receive an email from a brand manager, marketer, supply chain expert, or others at one of these public CPGs who are looking to move to a smaller company. This externship program will be an asset for the smaller brands while also acting as a retention tool and bringing innovation back to Kellogg’s.

4) M&A. I’m not against M&A, but I am against M&A for the sole purpose of stripping cost as a strategy to deliver long-term shareholder value. My belief is that in 10 years the revenue from the core existing products of many consumer companies will be much smaller than it is today. These products won’t be replaced by 1 or 2 new products, they’ll be replaced by hundreds – or thousands. That is the fragmentation of the consumer or what we have called in the past the Personalization of the Consumer. Big CPG can either buy these products (at an earlier stage) or lose to them. I would want our company to ingest a lot of smaller brands rather than forking out hundreds of millions (or billions) of dollars once these brands are already big. We will need to also invest in the infrastructure necessary to work with many more brands and benefit from their growth. The brands will join the Kellogg’s family rather than threatening it.

5) Partnerships and joint ventures. Every now and then you will hear about a joint venture or partnership in consumer but they are few and far between. Why? I think a lot of times big consumer companies fear that partnering with another company will mean splitting profits which can negatively impact bottom line. This is not a productive attitude. You see examples of successful partnerships in almost every other industry- whether it’s Google teaming up with Walmart to offer Walmart products on Google Express, or Chrysler teaming up with Waymo to work on driverless cars, partnering with a variety of stakeholders can often help foster the best innovation. I also think there is a big opportunity to partner with other consumer companies to foster education in the sector itself. We could host conferences that bring together the best consumer entrepreneurs and the brightest ideas and we would all benefit as a result.

Why this matters

If my plan as CEO were effectively implemented, I think we would see three powerful effects. Firstly, by making more small bets on more emerging brands and building a culture of innovation, Kellogg’s would become a dominant player in consumer goods. They will no longer fear being displaced. They will be the ones creating and harnessing the disruption. Secondly, this roadmap would ensure that the best products make it into the hands of consumers and that everyone has access to a wider variety of foods and healthier options. Finally, by building this infrastructure, Kellogg’s would be able to assist entrepreneurs with their distribution, brand, supply chain, and team. As these companies grow and succeed, this will also result in increased value for shareholders. Consumer is an extremely inefficient market, but Kellogg’s can be the public company that helps change that.

Again, it’s easy for me to suggest strategies like this. It’s much harder to implement them when you’re on the inside looking out. I think a lot of Big CPG CEOs probably do have bold ideas that would help their companies in the long run, they are just unable to pursue them in an environment that obsesses on the short term – a board that demands immediate cost cuts and a market that demands immediate stock value.

So these CEOs are hamstrung and left to rearrange chairs on the deck of the Titanic while the whole ship is sinking. They fear that if they do too much to try to save the ship they won’t last long. Gates, Musk, and Bezos are free to be visionary and push their companies to the cutting edge of innovation while Cahillane (CEO of Kellogg’s), Hees (Kraft-Heinz), and Quincey (Coke) have to work within the box they are put in. I truly hope that big consumer companies will begin to innovate, be creative, and listen to what consumers want- and that corporate boards and Wall Street will realize the long-term value of these things. If the industry doesn’t evolve, you never know, Google might just step in with the next big breakfast cereal.

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