roller coasterLike other consumer industries, the pet sector is discovering that today change in constant.  While this seems obvious, in the five years following the recession, the prevailing status quo enabled the pet industry to enjoy substantial and consistent growth.  The period that follows stability is often best characterized as turmoil, regardless of the amplitude or velocity of change.  Even modest changes after a long period of calm can appear daunting.  Over time disorder then turns into a new paradigm; the pet industry appears to be moving into its new status quo.  However, there is little rest for the weary as new challenges, such as trade policy and house brands, that pose new treats to incumbents.  And when those threats dissipate, new ones will rise in their place.  Industry evolution is now characterized by persistent change.

As we keep our eye on industry change drivers, the four themes we are focused on this fall, include the following:

  • Independents’ Conundrum Multiplexes. In our Spring report, we commented on the potential impact of Blue Buffalo’s move into FDM and subsequent acquisition would have on independents, many of which have historically “divested” brands that jumped the channel or were acquired by large CPG firms. In our store visits since the acquisition closed, we have certainly seen a deemphasizing of the Blue brand in specialty, though it remains widely available in the channel. The brand that has historically benefited most from independents scaling back on Blue has been Champion, a process that began when several prominent chains reduced or excluded Blue in wake of the 2015 labeling scandal. If, in fact, Champion is acquired by Nestle Purina, this would further complicate the merchandising strategies for independents. Many of the brands poised to fill the potential shelf space void lack the name recognition to drive traffic, the ability to rapidly expand production, or the marketing dollars to drive trade spend. Independents have survived upheaval before, but this time things may be more challenging and it leaves them more vulnerable to ecommerce.
  • Trade Policy Could Impact Growth. In September, the US expanded the tariffs imposed on Chinese goods to $250 billion worth of products. Of greater significance, the tariffs applied will increase from 10% to 25% on January 1, 2019. While the pet consumables supply chain has meaningfully shifted to US-sourced products, a broad range of pet products will be impacted, with hard and softgoods having the greatest exposure. What is unknown is how these tariffs will impact retail traffic, purchase intent, and transactions. Given that real wage growth has been muted for some time, there is potential that pet population growth could be impacted, which will have a trickle down effect on all industry categories. While there was once a widely held belief that China trade tensions would blow over quickly, we find market participants are preparing for a longer game, which includes seeking alternative sourcing in Vietnam, South America, and Mexico given favorable labor rates. Only time will tell.
  • House Brands and Private Label Growing. Consumer industries, broadly speaking, are experiencing a dramatic proliferation of house brands and private label offerings, as retailers seek to cash in on growth trends and the ability to control real and virtual shelf space. In the last two years, Target has introduced 20 brands, Walmart 18 brands, and Amazon 72 brands across different categories. Amazon’s owned brands are on pace to generate $7.5 billion of revenue in 2018, and grow to $25 billion in 2022. With manufacturer margins of 2x – 3x retailer margins, house brands make strategic sense. With consumers increasingly looking for value, private label could redirect $64 billion of purchases. Within pet, Amazon has launched house brand premium (Wag) and value (Solimo) kibble and wet (Simply Perfection) for dogs, as well as a supplies line (Pet Craft Supply). While these brands, and others that follow (dehydrated, freeze dried, super premium, etc.), will create competitive tension among marketers, it provides a segment of the industry that service these brands with a meaningful growth driver.
  • Private Equity Becoming Buyer of Lower Middle Market Pet. 2018 is on pace to be a record year for pet industry consolidation. Shifting consumer demographics, channel dynamics, and, now, trade policy are the key drivers of acquisitions. What is most notable, is not the volume or velocity, but who is doing the buying. Historically, when strategic buyers wanted something, their “ability-to-pay” priced financial buyers out of the market.  Today, the large strategic consolidators are hyper-focused on specific assets that address business model deficiencies and portfolio challenges, leaving a larger population of acquisition targets for the likes of private equity and private equity-backed strategics. This includes the food category, where the pricing advantage of strategics is magnified. Expect more deal announcement from financial motivated players, and invariably the valuation compression that comes from selling to a profitability motivated buyer.

Transformation in the pet industry continues to progress at a rapid pace, with market participants homogenizing around a common set of growth strategies. Major competitive moves continue to unfold, changing the strategic and operational landscape, with more dominoes to fall.  For market participants we suggest you hold on. While this roller coaster we are now on may have lost amplitude, the ride is far from over.

/bryan

Note: This blog is for informational purposes only. The opinions expressed reflect my view as of the publishing date, which are subject to change. While this post utilizes data sources I consider reliable, I cannot guarantee the accuracy of any third party cited herein.