My mental model of “commodification” in FMCG industries
I believe that it is important to first understand the term “commodification”. Within a capitalist economic system, “commodification” is the transformation of any inputs, tangible or otherwise, into objects of trade or commodities. In this post, only tangibility of a product is considered because it comes with inventory management that influences mental models. The ultimate beneficiaries of “commodification” are end-users or consumers with higher purchasing power because of increasingly cheaper goods, relative to their intrinsic and extrinsic value in the market. This leads me to a general rule of thumb:
- Most FMCG products, and thus their constituents/ingredients are assumed to be subjected to the pressures of “commodification”.
- For each trade conducted between buyer and supplier in a FMCG supply and value chain, an average 5% net profit is to be expected.
- Increasing frequency of this interaction vertically would ultimately lead to more expensive product for end-users, which may or may not be more value competitive.
- The cost structure at equilibrium for a commodified product is idiosyncratic to an industry, rather than being idiosyncratic to a company.
For example, in B2B value-added transformation of goods (or manufacturing), the cost structure would be as follow (with cross-validation from literature and calculation of net profit against total revenue from public listed FMCG companies):
40–60% material-input cost (including any necessary pre-treatment cost);
20–30% labour cost;
10–15% energy cost;
5–10% logistic cost;
2–5% marketing cost.
Thus, one would be hard-pressed to have net profit significantly above the industrial average of 5%.
Any new sustainable/green product that seeks to replace a status-quo commodity will thus be subjected to the pressures of “commodification”, while one has to achieve one of the following attributes to find traction in the market:
In our globalised world of trade, supply and value chains, any reprieve from the pressures of “commodification” which is typically in the form of innovation, is temporary. The rate of “commodification” can be industry specific, but higher in FMCG industries. In non-STEM based innovation, to move forward with increasing profitability, the path seems to be either or both of these two:
- Vertical integration: Eliminating “middle-men” can lead to cost savings, but the “middle-men” responsibilities do not magically go away. The ownership of these responsibilities is merely shifted, towards the integrator if they desire their own self-agency on matters of brand value and integrity.
Juxtaposing mental models with that of SAAS or platform businesses
These usually B2C companies have low or no inventory for tangible value addition, thus mental model is rather different. The mental model is one of growth models which is user-acquisition centric in the earlier phase of the business’ life cycle, while user retention is its later phase. This explains why these businesses spend anywhere from 80% and 120% of their revenue on sales and marketing. It then plateaus around 50%. Their low exposure to inventory results in different kind of mental model.
Thus relatively, value-added manufacturing or transformation of goods, is more CapEx intensive, with lower ROI, and longer payback period. Thus, I am apprehensive about applying the mental models needed for SAAS or platform businesses not impeded by inventory, into businesses with high exposure to inventory no matter the degree of its product innovation. It is like bringing a hammer to a piano recital. Cost structure for businesses with inventory yet working on tangibility of product innovation has a non-SAAS specific concern, they do not have much leeway for huge expenditure in marketing and/or play by the conventional Silicon Valley’s definition of “growth”.
This post is merely my rumination and cataloguing my growth process, not with the intention of a satisfying closure for the journey ahead as product innovation meets realities of FMCG industries. It is also for my future reference to filter out abnormalities from norms, irrespective of whether these are good signs or bad signs, as abnormalities would be worth my time for further scrutiny and study.