We need to scrutinise the ‘cost of business’ for challengers

Is now the time to start talking about the enormous hidden cost of innovation in the fmcg operating model?

The retail market has changed. Range differentiation holds immense value, consumer trends are evolving more rapidly than large fmcg companies can keep up with, and remarkable innovation is emerging from small, often unknown new businesses. Retailers have clearly noticed this. Almost all of them now have an ‘incubator’ scheme to help them compete with new, different, or interesting innovations.

However, with profit maximisation on the agenda in every board meeting, I am surprised we are still accepting such enormous inefficiencies in both retailers and brands when it comes to innovation.

We have accepted a narrative that it is almost impossible for brands to be profitable until they reach a certain scale. It is absolutely true that in the vast majority of cases, investment is required. But should we be questioning this more? From where I sit, it is clear brands largely lose money because they are whittling away hundreds of thousands of pounds on ‘costs of doing business’ in a system not designed for them.

For example, the financial investment required just to get a conversation with a buyer is staggering. At YF, we are fortunate enough to work with many of the UK’s most promising new brands, and over 75% of our clients’ founders are career newcomers to the fmcg sector. To reach the stage where they get noticed, they often need to invest in sales teams, trade shows, data, trade PR, advertising, and more. Some clients have even resorted to renting billboard space outside retailer headquarters.

They are spending tens, if not hundreds, of thousands of pounds just to elicit a response to perhaps eight emails from key buyers. But by the same token, brands that don’t spend these levels are seldom being picked up in a sea of thousands. It’s the ‘cost of doing business’, we say.

On the other side of the coin, while most retailers don’t measure the true P&Ls associated with their branded innovation programmes, it is widely accepted that the accretive percentage margins are rarely enough to offset their cash investment in onboarding and managing small suppliers. One retailer confessed its programme will be “losing us a lot of money, but it’s the price we pay for differentiation”.

Known areas of leakage for retailer P&Ls include goods in and supply chain inefficiencies, and store hours usage. It also includes buyer time dealing with questions day to day – from issues in onboarding and supply, to data, compliance and more. GSCOP often, rightly, adds further financial burden on the relationship.

This situation isn’t surprising, as working with challenger brands differs significantly from dealing with established fmcg giants. The current retail system was designed for fewer, bigger suppliers, not thousands of smaller ones.

To address this, we have two options: accept that the operating model needs to change for new and small brands, or continue under the current model and bear both the hidden and opportunity costs. If we opt for change, we might benefit from looking at operating models in the foodservice sector, which involve working closely with intermediaries. This approach, successful in countries like the US, allows retailers to focus on their core competencies.

In what is a fundamentally unprofitable system for both sides, the goal should be to create a more efficient system that enables the same outcomes profitably. It will supercharge the innovation agenda.