It was recently brought to my attention that Amazon entered, or re-entered depending on your view of past events, the wine business last week. The new offering enables, oenophies, like myself, in 12 states (more coming soon!) the ability to access a selection of 1,000 wines ranging in price from $5 to $200. The direct delivery liquor business is one that is best characterized by red tape and unrealized potential. Few know this as well as Amazon who has been trying to break into the market for nearly 15 years. Amazon invested $30 million in Wineshopper.com in 1999, which subsequently went bust, and then sought a do-over through a partnership with New Vine Logistics, a concept that was felled by California regulators. This time around, Amazon has found a way to shift the regulatory burden onto its partners, the wineries, in order to enable the business model.

To the uninitiated, the above might simply be interpreted as another chapter in Amazon’s wine retail lore, a story about a company that is dogged in its pursuit of category leadership and not afraid to fail before it succeeds. However, to the trained eye there is more to the story. The reality is that Amazon’s ecommerce business is currently under intense pressure. Whether you believe that pressure is being driven by Amazon’s four wall retail competitors (such as Home Depot, Target or Wal Mart, among others) or the manufacturers themselves, Amazon’s dynamic pricing model has drawn the ire of the traditional retail supply chain to the point where they have started fighting back.  Notably, Target sent an open letter to manufacturers suggesting it was time to divide up the world and others have followed. So a logical response, while Amazon waits out (from its perspective) these merchandising reindeer games, would be for them to push into regulated markets where they can create real barriers to entry, and therefore garner favorable economics.

So how does this relate to pet ecommerce?  The answer is in pharmacy.  One of the most protected retail environments is, as you would expect, drug dispensary. Not only are there significant compliance hurdles at the state and national levels, the drug companies have the final say in who can operate in the market by controlling the supply. It would be logical to assume that if Amazon is going to make a play for regulated markets it would enter the pharmacy space, and as a corollary the pet pharmacy space.

However that strategy is not without its own issues. From an animal health perspective, the drug companies rely on the veterinarians to recommend and dispense their products, so any efforts to disintermediate them would be a non-starter. One might be tempted to assume that if Amazon could move a sufficient volume of human prescriptions, the drug companies would have to provide them access to their pet solutions. Given that Wal Mart moves hundreds of millions of dollars of human prescriptions on behalf of major pharmacy companies but does not have access to the animal health solutions from the same manufacturing base demonstrates the perils of that assumption.  Therefore Amazon needs a vet centric solution that is seamless to the customer, but as we have seen in their wine effort, “where there is a will there is a way”.

Setting aside the “how” and focusing on the “why” is also important. If Amazon can bring together the breadth of companion animal products currently available to them with pet prescriptions, they would have an unmatched merchandising mix in the industry.  Through its partnership with Banfield Pet Hospitals, PetSmart could conceivably replicate the strategy. However, PetSmart outsources its ecommerce infrastructure to GSI Commerce, and is contractually bound to them for some. Further, four wall retailers don’t pursue dynamic pricing strategies; this is akin to cutting off ones nose in spite of their face. Even if they could overcome the infrastructure hurdles and channel conflicts, they could not build a team that could compete with Amazon online (who can for that matter?). PetMed Express might seem like a competitive threat until one understands that they source their supply through diversion (authorized buyers re-selling product out their backdoor at a profit) and not directly from the manufacturers. Regulators and drug companies will eventually choke off this grey market supply chain. And that leaves Amazon as the last man standing.

I would not bet against them.

/bryan

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Despite its size, the pet industry, as a whole, is under analyzed.  That is not to say there is a lack of analysis, but rather a lack of diverse perspectives.  The reason for the homogenous set of  “points of view” is largely structural.   There are a handful of very big companies that drive the pet industry from the product side — Mars, Nestle SA, Procter & Gamble, Del Monte, etc.  However, we have limited transparency into the granular performance of their pet brands because they either have no reporting obligation (Mars) or their pet business is quite small relative to their overall income statement or balance sheet.  Notably Nestle, who controls some 30% of the pet food business, does not report  its pet food segment separately.  The same can be said about pet retail — Petco, Petsmart, Wal Mart.   The primary industry reporters — Packaged Facts, Mintel, IBIS — rely, largely, on the same survey methodology.

Given the above, you can understand why I was excited to get my hands on Todd Hale’s “State of the [Pet] Industry 2011”.   Todd is SVP, Consumer Shopper Insights for The Nielsen Company.  Simply put, I think Todd brings a different and unique perspective to the table.  Because his firm has access to unprecedented amounts of transaction data, he is best situated to look at the industry from a consumer standpoint, as opposed to from a product or individual retailer standpoint, and of equal significance, put pet consumer behavior in the context of consumer behavior in other retail environments.

With that as my long winded set up, here are some key takeaways from his presentation (all data credits to The Nielsen Company):

  • The Polarized Consumer.  We often talk about consumers in terms of median household income.   One can then analyze consumer behavior across stratified income bands.  This is really nothing new.  But what Nielsen scan data (actual product movement and basket purchases) provides is the opportunity to, on a rolling 52-week basis, analyze purchasing behavior within these income bands and compare the results to prior year periods.   This data does not need a +/- 4% confidence interval because it relies on actual transactions, as opposed to sentiment.  What Hale’s data shows is that the consumer population is very polarized.  While the wealthiest 20% of the consumer population have exited the recession, as evidenced by growth in shopping trips and shopping dollars, all other income bands have contracted.   This demonstrates the fragility of the retail industry and validates how important the premium demographic is to the health of all retail, not just pet.   Using the same methodology, Hale shows that that the affluent (those with household incomes in excess of $70,000) purchase 40% of the pet food and consume 42% of the pet services, despite making up less than a third of the consumer population.   As a result, it is easy to conclude that the pet industry remains as vulnerable as other retail categories.
  • Pet is En Fuego.  If you look across U.S. retail formats, as measured by store counts, value and convenience are winning.   The number of warehouse clubs, supercenters, dollar stores, supermarkets and convenience stores have all increased since 2005.  Only drug and mass merch have contracted.   However, when you dig into the specialty retail category, home improvement and pet have shown meaningful store count growth during this same period, with pet doors increasing 43% and home improvement moving 10.5% to the positive.  Further, pet is the only store category that has shown positive household penetration over the past 10 years, increasing from 30% to 32%.   In short, pet specialty industry has been star performer in the retail landscape over the past six years.
  • PetSmart is More En Fuego.  We have covered the performance of PetSmart on this blog in some depth.  Our historical analysis demonstrated that once PetSmart stopped focusing on topline growth and embraced a balanced scorecard (same store sales, product level gross margin, earnings per share) it quickly became the premier retailer in the pet industry.   Hale puts PetSmart’s performance in perspective across all retailers, noting that PetSmart has produce a 14 quarter “winning streak” of positive comp store sales.   Nordstrom came in second in the discretionary spending category at six quarters.  Among all other retailers (discretionary, value, club), only Sam’s Club and the “dollar” stores (Dollar Tree, Family Dollar, Dollar General) have comparable winning streaks, with only Family Dollar and Dollar General having higher average comp store sales since 2008 than PetSmart.  While the bar for domination of the pet specialty channel is in fact low, Hale’s data proves how impressive the company’s performance has been relative to all retailers.
  • Inflation is Hurting/Helping Pet.  Based on Nielsen scan data for the past two years, prices have risen across the board, with the exception of alcoholic beverages and pet food, though pet food prices increased over 4%  in 2011.  Pet care and pet treats also experienced inflation of 2% and 3% respectively in 2011.   While inflation is hitting consumers at times when incomes are down, price increases have helped the pet industry grow to new heights (sort of perverse).  Notably, Hale’s data shows more pet industry inflation than PetSmart has reported, meaning price increases at grocery and mass have been more substantial than in pet specialty.
  • Brands Hang Tough.   The recession kicked off a new chapter in the branded versus private label tug-of-war across consumer categories.   As Hale points out, private label brands hovered at 19% – 21.5% of unit volume from 2005 to the middle of 2008.  During the recession, store brand volume shot up and has remained at 21.5% – 23.5% post-recession.   Since 2007, store brands have grown 21% in dollar volume versus 3% for branded items.  Notably within pet, all major categories have a lower penetration of store brands than the product average, and private label penetration has fallen in pet care, food and treat over the past year.   This is logical given that store brand attachment falls as income rises, and the pet industry is driven (per above) by the higher income demographics.

In summary, Hale’s data provides us a different lens through which to view the pet industry.   The dominant perspective, to date, has been that of the product provider, and we are led to believe that the manufacturer dictates to the customer what he/she wants and consumes.  Hale helps us understand that the tail may in fact be wagging the dog — consumer behavior, and the ability of pet retailers to incent that behavior, may have been the more powerful force in driving the growth of the industry over the past five years.

/bryan

I’m not a big fan of Las Vegas.  Generally speaking it’s too hot during the day and too cold at night for my enjoyment.  Further, as I have aged I’ve become less of a fan of noise and crowds and rooms without windows.  While you won’t find me hitting the strip on a personal vacation, I make an exception for SuperZoo, the “National Show for Pet Retailers”.

Of the major pet shows, SuperZoo is, in my opinion, the most valuable to attend for someone who surveys the industry.  Part of that charm is due to the shortcomings of the other major retail shows.  As an example, Global Pet, the largest pet show in the nation, is, well, as you might expect, big and dominated by the presence of the large industry players.  Sprinkled in between are a host of import companies and the mid-market is pushed into the corners of the room.  The booths of the innovators are usually quite crowded and getting an audience is pretty tough; product providers are there to do business after all.   In its defense, Global Pet has the best press room.  Further, the benefit of Global Pet is that is sets the tone for the year, even if you have to travel to Orlando.

In contrast, SuperZoo helps you see take a pulse on the state of the year.  The show provides a great sense of what retailers have done year-to-date and what they will be emphasizing for the holiday season.  Of significance, the show, because it is perceived as regional, is not dominated by the large multinational CPG players; the mid-market is well represented.  Further, it is much easier to get access to business owners and learn about the state of the industry company-by-company.   SuperZoo also has the best food (Lotus of Siam is my favorite), which is important in picking your tradeshow.  It also means that our bi-annual report publication date is just around the corner.

As I prepare for my fourth SuperZoo, I’m very interested in what I will see for a variety of reasons.   First, I’m interested to get a read on how the industry is doing in light of the broader economic climate.   Prior to the 2009 recession, the pet industry was viewed as “recession proof”.   While the industry thrived relative to other consumer facing franchises during financial downturn, the contraction did take some wind out of its sails and the message was recast as “recession resistent”.   In contrast to 2009, where the impact of reduced liquidity was so broad, we should be able to get a real read on how decoupled (or coupled) the pet industry is to the general economy.  Currently, we have stagnant GDP growth and high unemployment but also rising consumer incomes and improving individual balance sheets.  Notably, Petsmart (our pet industry public company proxy) posted strong 2Q2011 results with same-store-sales increasing 5%, comp transactions growing 2%, total sales increasing 7% and earnings growing 32%.   So is this a case where Petsmart is executing impeccably, or is the industry thriving against a relatively sanguine economic backdrop?  Conversations at SuperZoo should yield some insight.

Second, I’m interested in getting a better sense on the state of pet food, dog food in particular.   While any pet pundit would pursue this line of inquiry at anindustry show, I am now more interested than ever as I believe the market dynamics are changing.   Notably, the super premium category is seeing hyper-competition driven by big budget CPG acqusitions, large independents increasing sales and marketing spend (Blue Buffalo television commercials anyone?), and in-house brand launches for the largest independent pet retailers.   I see this environment as very challenging for a mid-market kibble manufacturer who does not have a meaningful angle of differentiation.  However, I also see this as a great time for food companies pushing alternative form factors (dehydrated, raw, freeze-dried) as all the kibble marketing messages now seem to blend together.   I’ll be looking to see if the recent equity raised by the upstarts in this niche translates into an increase presence at their booths.

Lastly, I remain interested in other opinions about pet e-commerce.   We’ve heard the party line from Petsmart in their 2Q earnings call, but I want to get it from the product providers perspective.   Of greatest interest is how their wholesale pricing is being impacted by what is clearly price competition in the industry.  Further, with the increase in proprietary product at the major pet retailers, I want to know if the mid-market pet players see the direct channel as their future, and if so how they are going to change their operating model.

If you are going to be in Vegas for the show.  Give me a shout, and hopefully we can meet up and chat.

/bryan

Fresh off our visit to Global Pet Expo in Orlando, Florida, I am pleased to offer you my updated views on the pet industry.   The timing of this reports reflects my intended go forward publishing calendar — post Global Pet Expo for spring, and post SuperZoo for fall.   As always your comments and feedback are welcome.  Full access of the report is always available via email.

/bryan

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The factory of the future will have only two employees, a man and a dog.  The man will be there to feed the dog.  The dog will be there to keep the man from touching the equipment. — Warren Bennis

Global Pet Expo was by all measures a solid show — more exhibitors, more attendees,  and more hype.   And while the convention did a great job of displaying how far the industry has come in the past 5-years, it also did little to create dialog regarding the challenges the industry will face in the near to medium term.

While I remain bullish on the pet industry, I try to take a balanced perspective allowing myself to be guided by the facts; I’m a realist mixed with a pinch of idealism.  To me, there is plenty to indicate that the pace of innovation  within the industry has slowed over the past 12-months.   Everything I saw at Global Pet Expo was incremental in nature — new companies offering “me too” product, product companies offering solutions that address very narrow niches, and a fair amount of “packaging updates” (albeit nice ones).   As an example, I don’t believe a company should exist just because its products are made from recycled material — there as to be more.  Further, my dialogs with pet food manufacturers and distributors suggest the segment did not have a cohesive plan for the pending inflationary cycle that will begin to manifest itself in the second half of 2011.

To the positive, industry fundamentals remain solid.  According to the American Pet Products Association the industry grew 6.1% in 2010 and is expected to grow another 5.1% in 2011.  The pet population is growing driven by an increase in the number of multi-pet households.   Spend on pets as a percentage of personal consumption reached an all time high in November 2010 according to the Bureau of Economic Analysis.   Further, most of the major pet companies produced solid growth in 2010 (Central Garden & Pet, the notable exception).

As always, PetSmart provides a great window into the state of consumer pet spend.   The company’s equity valuation handily outperformed the S&P500 during the second half of 2010, increasing 33.1% versus 14.2% for the S&P500.  Further, same store sales averaged 5.9% over the second half of 2010 versus 0.9% for the prior year period.   The company continues to out comp Walmart and Target with respect to same store sales.   Sales were up, earnings were up, comp transactions were  up.   Further, PetSmart management expressed strong satisfaction with the early results of its proprietary product launched, stated that private label and exclusive product sales had increased in from 16% to 18% in the fourth quarter of 2010 versus a five year target of 25%.

Periods of lower innovation tend to drive more active consolidation as established companies seek to buy strong product development companies and expand market share.   What is notable is that these efforts continue to be driven by the private equity community.    Most of the notable acquisitions of the past six months, save for Nestle’s acquisition of Waggin Train and The Hillman Company’s acquisition of TagWorks, LLC, have involved private equity.  However, as these two deals indicate a consolidator market is emerging for properties with a threshold level of revenues +/- $50 million.

Where we go from here is going to be a function of whether expectations converge.   Market multiples of public traded pet companies continue to expand.   This pattern is relatively consistent with other stock categories that have significant exposure to discretionary consumer spending; in short the market is pricing in a recovery.    These multiples along with the deals of 2007 – 2009 continue to set valuation expectations for sellers.   However, buyers seem increasingly less willing to pay a significant premium for pet properties, in part because there are other segments of the market that appear more attractively priced.   Further, one has to believe the market will separate into the leaders and the laggards, with the leaders demonstrating true innovation and enjoying the valuation premium that goes with that disposition.

Look for the balance of 2011 to be instrumental in setting the tone for the balance of the cycle.  A strong year for the industry could set of us off again, just like 2007.

/bryan

happy-puppehAgainst a backdrop of macroeconomic uncertainty, the pet industry continues to thrive.   While the prevailing theory that the industry is “recession proof” is being sternly tested, market fundamentals of pet ownership remain strong and consumers are skimping on themselves as opposed to their pets and/or children.  Further, the premium demographic continues to have a voracious appetite for efficacious products that are good for their pets as well as the environment.

That being said, the recession has set in motion a number of trends that will, in my view, forever change the pet industry landscape.  While several of these trends are in the “early innings” so to speak, the momentum behind them is significant.  The companies that stand to win during the next phase are those that recognize the seachange and position themselves to take advantage of the wave.  This period will separate the leaders from the pack, to steal a phrase.

Recession Not Found Here?

Pure play equities of pet related companies fell precipitously with the market during the second half of 2008.  However, unlike the general market, these equity began to experience their recovery in November 2008.   The primary driver of equity price contraction was based on fundamentals — earnings for these core names fell 30% from the prior quarter, which spooked the market (in truth some of this could be chalked up to seasonality).

In reality 3Q2008 was up year-over-year from an earning perspective, albeit only slightly.  In a world where flat is the new “up”, this should have been investors first signal that the market was overreacting in this category and  pet related equities were becoming oversold.  Notably, earnings rebounded strongly in 4Q2008 posting year-over-year growth of ~ 4% (weighted by market capitalization), driving a correction with respect to public company valuations.   Thus, the prospects for a technical recession in the pet industry are in fact quite low.

pet-industry-3-30-09

Notably, the macro economic environment did not constrain equity deals in the pet space.  Key deals including Hammond Kennedy Whitney/FURminator, TSG Consumer Partners/Dogswell and Tyson/Freshpet were all announced against a declining or, even abysmal backdrop.   Appetite for pet related concepts has never been higher among growth equity funds due to the prevailing dynamics and long term fundamentals.

pet-industry-3-30-091

Key Trends for 2009

So what are the seismic shifts of which I speak?

First, I believe we are in the early innings of a major shift in the pet retail landscape. PetSmart and Petco are facing significant competition from Wal Mart as they battle to be the one-stop-shop for the mid-tier pet buyer. Wal Mart’s merchandising acumen coupled with their reach and financial strength make them daunting opponents. Large pet specialty will take share among the most attractive demographic and thrive amidst the chaos among big box players. Their ability to educate buyers and offer patrons a favorable service experience situates them to be long term partners of both customers and the most compelling pet related brands. They will also take share from contracting boutiques hit be financial hardship.

Second, in bad times value trumps luxury.  The downturn in the U.S. economy has eroded the balance sheets of mainstream consumers. While companion animals will continue to a growing part of our society, consumers will become more fickle as it relates to spending on their pets. Product (excluding consumables) and service providers must give pet owners a compelling value proposition if they expect to experience continued growth. This change is expected to be lasting.

Third, consumers want to know what they are paying for.  In the food arena, efficacy is going to become important, a concept which many have taken at face value.  The market has become saturated with better-for-you pet food brands whose differentiation has become hard to appreciate. Supply chain control and organic are no longer differentiators. As distribution opportunities contract, due to contraction in the boutique market, and funding dries up, solutions that can demonstrate high degrees of efficacy will prevail. Customers will begin to demand results for their incremental dollar.

Finally, pet health will come in to focus as owners make difficult choices with their limited free cash flow.  Pet related health care is even more inefficient than its human corollary. Relations between veterinarians and their customers is strained by the high cost of service and medications and the limited proliferation of pet insurance. Further, compliance rates on even basic pet medications are sub-standard. Solutions will arrive that deliver compelling value throughout the pet health care supply chain, driving operating and cost savings at the clinic level, compliance rates among drug applications and ultimately satisfaction for pets and their owners.

Net net, I expect the balance of 2009 to be challenging but good for pet related industries.   Notably, I believe we will see additional pet related equity deals as investors seek to put capital to work in sectors that continue to grow.  As the debt market improves, leveraged buyouts of some of growing bell weathers of the industry (a la FURminator) begin to come in to play, assuming valuation expectations have come down due to market realities.   One would also expect public pet companies to seek to buy growth in a effort to fuel their lagging equity prices.  This could kick of a consolidation phase in the middle market, but I’m not overly optimistic.

As always, you can contact me for a complete version of our market presentation.

/bryan

goggie1It’s been a while since I wrote about pets (no that is not a picture of a bat to the left), primarily because there has not been too much to talk about.  That said, there are many people who read my blog for my insights on that market and nothing else.  As such, I need to do a refresh for my fan base (yuk, yuk, yuk).  Over the past 45 days I’ve cobbled together some bits and pieces, that when laid out on a canvas makes a mural, a mural which doesn’t quite look like the one I painted 6 months ago.  Here is a substantive update on the current industry as I see it.  Alternative perspectives welcome.

Pet Businesses Get the Flu Too

Many pundits, myself included, put forth a view that the pet market was recession proof.  The view was that pet spending would be one of the last areas to go.   While we have not seen a collapse in the sector, we have certainly seen significant compression from a valuation perspective.  PetSmart, our public proxy for the retail channel, has seen its market cap erode by 40% based on a diminished retail outlook.  However, the company today reported that it met third quarter estimates but took down EPS projections for 2009 and used a very cautious tone with respect to forward prospects.  Overall a basket of pure play pet companies is down +/- 30%, and 50% from their highs in September, still slightly better than the S&P 500.

pet-industry-index-vs-sp-5001

The reality is consumers are trading down on food (except for me since now my dogs are eating “the ancestral diet”, I need to talk to my wife about that one), mass merchants are on the market share hunt, and price increases in the services sector are not going to be sufficient enough to offset falling demand.

With respect to food, prices have increased 15% – 25% across the board vs. a 4.9% increase in the Consumer Price Index.  This is putting the pinch on consumers pocket books.  Forty percent of pet owners claim to be economically sensitive with respect to pet food.  Therefore, it is no surprise that major producers are reporting declining sequential sales at retail and a mix shift from specialty brands to grocery and private label (gaining 2% points of share in 2008; however sales of Rx dog food, the top top end are accelerating, though from low comps).   Both PetSmart and PETCO have noted softening sales in their discussions., but have seen less trading down than diversified distributors.  Pet services passed on price increases of between 3% – 10% earlier this year.  However, Packaged Facts sited professional pet care and pet grooming as 2 of the top 3 areas for consumer cut backs in a recessionary environment. PetSmart reported slowing growth in pet services from 21.5% in 1Q2009 to 15% in 3Q2009.

Net net, pet businesses may not be feeling the same heat and other consumer discretionary, but they are still feeling a pretty big pinch.

Changing Face of Pet Retail

The current retail paradigm is set to see an overhaul in the pet market.  We expect the economic downturn to result in significant rationalization of the pet boutique market, especially in the more economically sensitive Midwest and South.   A contraction of 20% – 40% would not be unprecedented given the capitalization of these businesses and their exposure to discretionary items, include pet fashion, the top area for cutback in tight economic times.

Additionally, higher energy prices and a desire for bargains will push people to one-stop-shop alternatives at the expense of boutiques.  Purchase occasions for pet owners is expected to drop ~ 3% in 2008.  PETCO is attempting to skim off boutique customers by expanding their product lines to include natural and high end product alternatives, while at the same time compressing the lower end of the market by offering store labeled products.  My dogs don’t seem to mind PETCO branded rawhide.  PETCO is also expanding their service offerings to include third party insurance.  Services are an additional point of differentiation vis-a-vie boutiques.

That being said, PETCO and PetSmart will face stiff competition for core staples from WalMart.  In October, WalMart CEO, Eduardo Castro-Wright upgrade WalMart’s focus on the pet industry to a WIN category (categories that are growing, have scale and where WalMart can be the market share leader).  If in fact consumers continue to trade down, WalMart will be the beneficiary.  WalMart’s Ol’ Roy line (technically made by Nestle Purina) is the nations top selling dog food, and WalMart has aggressively moved into the premium market with its Natural Life brand.   PetSmart said they were not worried about WalMart back in May 2008.  I wonder if that sentiment has changed.

While WalMart and PETCO/PetSmart fight for the commodity and mid-tier, I expect to see considerable growth within and the evolution of regional specialty pet food and products chains.  Mud Bay, Muttropolis and emerging brands like Embark are, in my opinion, the wave of the future.  These chains offer a wide selection of better for you foods and staples and back it up with the acumen to sell it.  Their focus on service and building community will keep them well situated.   The demographic they are targeting comprise 33% of pet owners who purchase 43% of pet food and 51% of pet supplies and 62% of pet services (Packaged Facts).  This demographic seeks out natural and organic products and is willing to pay more for them.

The Businessman Trumps the Enthusiast

During the early stages of the pet growth cycle, the business landscape was cultivated by pet enthusiasts, people who had a strong affinity for the pet market and who wanted to find a way to blend their love of animals with a career.  In a market where a rising tide floats all boats, this was a salient strategy and produced nice outcomes for many business owners.  However, that landscape is changing.  Company formation around the pet space now centers on people who view the pet market as a business first and as an affinity play second.  That’s not to say that these folks are not pet owners and advocates, but rather they are not in the business because of their pets.

Some salient examples of this include, webvet, a new media play aimed at being the WebMD for the pet space.  Founder William Zacchero was an Executive Vice President with American Interactive Media, a developer of an marketer of entertainment content and programs.  VetSource provides outsourced services that enable veterinary clinics and animal hospitals to better meet the needs of their clients by extending their pharmacy services to include home delivery and continuous replenishment.  David Laurance, CEO of VetSource and his team have been together through two prior pharmacy companies.  Laurance was a seasoned Omnicare executive before he target the veterinary market as a big opportunity for outsourced services.  The team behind Embark, a next generation pet retail concept, includes serial entrepreneur Landon Pollock. Embrace Pet Insurance, which was recently closed its Series A, was founded by Laura Bennett, a 16 year veteran of the human side of the insurance industry.

If you think about venture capital and the prototype companies they back, investors tend to focus on experienced management teams.  As outside capital has become more focused on the industry it has attracted seasoned professionals to the business of pets.

Pet Products Get the Green Sheen

The organic movement within the pet space is morphing outside of food and deeper into products.  Nearly every corner of the U.S. product economy is spawning companies trying to benefit from the “greening of America”, and the pet space is no different.  Environmentally and health conscious consumers are driving this proliferation, sparked, in part, by the 2007 pet food recall.  The food scare provided everyone a wake up call and the desire to understand the underlying ingredients within and composition of a product has never been higher.

The potential lift in the pet organic space is substantial, as only 7.3% of consumers purchase organic dog products, flat from a year ago, versus the consumer population which, according to a market survey from BIGresearch, 52% of the time purchases organic products occasionally and 10% purchase organic products always.  Nearly half (48%) of pet households seek out natural and environmentally friendly products (Packaged Facts), in their personal lives.  Natural supermarkets are providing an additional access point for consumers to buy organic pet products.

Long term I expect organic and environmentally friendly products to play a fundamental role in the pet industry, but a much more subtle level.  Ingredient origins and product composition will standardize around inputs that are safe and natural.  The market, at its center, will demand it.  It will become the de facto standard.

Let’s Make a Deal

The key unknown is how the transaction environment will impact the pet space over the near term.  While I continue to believe there is venture funding for pet start-ups and private equity capital for lower middle market pet food and product companies, the question is what is going to happen to  companies like Dogswell, Ruff Wear, Zukes, Simplyshe and other leading companies in the industry.  In all likelihood they will simply keep on keeping on, creating generous annual profits for their shareholders.  However, at some point a strategic buyer population must emerge for this cycle to become self propelling.   Attractive exits must be realized for funding events to accelerate at the venture level.  The Furminator and Castor & Pollux transactions were a good start, but more data points are necessary to derive a solid regression.

/bryan