A Radical New Marketing Model
The systematic under performance of smaller consumer brands results in $6bn of lost revenue. Today, there is no efficient method of growing these brands. This is the a story of a venture designed to create a new risk and reward model to unlock the growth in these unloved brands.
Just over five years ago, along with three world-class partners, I started a new venture.
The business was designed to create a new risk and reward mechanism for creating growth in the consumer brand industry. We worked with the senior leadership teams of many of the blue chip consumer goods businesses on mandates to grow several well know brands. Our work kick-started carve out and disposal strategies and we raised capital to invest directly. Eventually we concluded that our model was too radical to implement as we had envisioned. Each time we were to execute, our partners moved closer to a traditional solution — a carve out. Our work became advisory rather than principal, the opposite of our intention.
Human creativity and ingenuinity have the power to fundamentally alter the fortunes of brands, sadly, to often the incentives are not properly aligned between partners.
Here in this note, I thought it would be useful to capture some of what we learned. Hopefully the experience will be beneficial to an industry in signifcant flux.
During my 20 year career in advertising, I became increasingly fascinated with the incentive structure that governed the relationships within the marketing service business. I believed that it was a hugely important and unexplored area. It may not sound all that interesting, but to be clear, what I mean by “incentive structure” is the model, the way that marketing and advertising business is conducted and how it and the people in it are motivated, those who are selling the promise of growth and those who are buying it. Was it a good deal for both sides? Was everyone heading in the same direction really believing that they were better together?
I wasn’t so sure. In our increasingly complex and competitive world there was an ever-growing demand for marketing and the growth it promised. However, the means of creating, producing and delivering this work was underpinned with a business model built on the foundations of timesheets and markups. Incentives were clearly not aligned. Getting the model right could be a real game changer. WhiteCap was born, and our new venture would put all our skills and experience to the test.
The Perfect Storm and an industry in flux
A lot of change is impacting the consumer brand world. There are obvious shifts occurring — the internet, mobile technology, the enormous investment of venture capital (in 2014 $47.3 billion was invested in 3,617 deals in the US alone, 62% up on 2013) and talent into those sectors, creating new opportunities and media, all relentlessly competing for the best people.
The resulting decreasing life span of dominant incumbents in all industries (the average lifespan of an S&P500 company is predicted to be 20 years today versus over 60 in 1960)
The increased interest in corporate venturing (participating in 18% of US 2014 deals) and then there are the less obvious, but no less enormous shifts, like the massive growth of private equity (available resources in 2014 $1.2 trillion), it’s appetite for consumer brands (50% funds focus on buyout or growth — often brands).
Closer to the industry, we see the high cost of re-engineering towards a digital business model (in terms of restructuring due to revenue and cost reduction), the reducing longevity of tenure for senior roles across agencies and brand owners, a resistance to risk, crowdsourcing of creative work, production automation, programmatic media buying, a significant andpronounced trend towards native advertising, the residual effects of a shift from commission to fee structure and the continued failure of payment by results to gain any real traction. These factors combined to create the ‘Perfect Storm’.
An unexploited opportunity?
We believed this ‘Perfect Storm’ was a huge opportunity. The hypothesis we developed was simple. Blue chip brand owners were concentrating their resources on high growth markets and strategic brands. They wanted focus and simplicity. Many brand owners were brand and cash rich but talent starved. A marketing or product manager spending 10% of his or her attention on a smaller brand could not compete effectively against 100% of a hugely hungry and leveraged entrepreneur. Sure, there was an institutional constant, such as cash flow and distribution that provided significant competitive advantage but it was unlikely that these smaller brands and their part-time teams were taking full advantage of it. In many cases we went on to discover that many of these smaller brands were a headache for the sales teams of the big consumer businesses.
The current agency model of time and materials is not aligned with these goals.
We set out to identify these under-resourced brands and in partnership with the brand owner, develop and deploy a growth plan. A plan that we would fund with our own capital, raised from family offices, alternative investment and growth orientated funds. Our investment in terms of intellectual property, time and capital bought us a ‘carried interest’ in the growth we created. All partners share in the gain. We estimated the market opportunity to be over $6billon in lost annual revenue.
Simple. Clear. Innovative. The brand owner gets to participate in new growth; our investors in a brand that is off market and consumers can once again buy a previously loved brand brought back to life.
We reviewed 4,000 consumer brands over a six year period, refining our sample to a database of around 1,300 brands in the US and Western Europe. The results were not surprising, big strategic brands were growing; over the analysis period compound growth was 3.5% for brands with annual revenues over $350million.
Starved of oxygen, smaller non- strategic brands under $100 million declined at 0.5% CAGR.
We estimated that the annual revenue of these smaller brands was $30.8billion in 2011,9.4% of the total revenue but 47% of the total number of brands. If those brands had grown at the same rate as their bigger siblings they should have annual sales of $37billion. The difference represented $6 billion in lost revenue.
It would be impossible to grow all these brands in the same way as the fewer far larger brands. We needed to refine our targets and develop a new more efficient way of stimulating growth. We identified those candidates that were non-strategic in scale, flat or in moderate decline in terms of growth and investing below the category in terms of marketing. We narrowed our list, focussing on markets where there was growth opportunity, positive consumer trends, a brand with interesting story and where the candidate brands might benefit from digital innovation and a lower cost marketing model.
The model in action
We quickly learned that our model was unique and attractive; the risk carried for brand owners was limited. For investors while we were providing opportunities to participate in off-market deals, our proposal was similar to a venture capital bet, if there was no growth there would be no return, the investment would be sunk.
Our gain-share model the returns were closer to PE returns, of around 1.5 -3x over the term, or an IRR of between 20–30%.
As we closed in on a number of deals and our focus turned to the specifics. How do we value and control the broader benefits of the corporate owner? Did our deal include sales, R&D, supply chain, corporate services such as IT and admin? We began to work through which resources should be in our remit and which were out while we focussed on ways to protect our investment by securing it against the equity of the brand.
Suddenly we begin to see that our model was beginning to look more like a joint venture and less like a gain-share vehicle. Each party would contribute assets, some tangible (cash, revenue, inventory, a sales team), some intangible (a brand, a growth plan, corporate services and support) into a new special purpose vehicle. Contributions would be valued and the brand would be run separately by an independent, entrepreneurial management team. We benchmarked our brand versus other M&A activity, calculated the valuation, the forecast return and assessed the risk.
But as we worked towards each deal (there were permutations of seven) the potential for the brand owner to turn the initiative into an auction and a more traditional carve out became very tempting. The removal of a non-core asset from the portfolio and realising some incremental captial was a powerful draw. Simplification and return. Our goal of focussing on under- resourced brands was actually requiring senior leadership teams to focus on the very brands that were considered non strategic. Increasingly aspects of our business model were difficult to implement and monetise. While many of the consumer businesses we’ve been working with liked the idea of a partner bringing capital and talent, as we got towards execution, it began to resemble the more traditional carve out — not our sweet spot nor an area where we have competitive advantage. We were attempting to create an entirely new market and business model for brand growth — while the approach was innovative it was not sustainable.
A time to pivot
We had moved full circle, journeying from a new growth model for consumer brands, thru an innovative joint venture to a traditional carve out. Our original mission to reinvent the risk and reward model, while valid was difficult to implement and execute. We had created a business competing directly with buyout and growth funds. We concluded that it was time to develop towards an advisory business.
Over the last four years, I’ve come to a number of realisations.
Good marketing is hugely under priced and bad marketing is extremely over priced. How much would an investor price the risk of marketing investment? Advertising people are reluctant to price brand growth. It is complex. However ourearly assessments suggest that a WhiteCap investment should be delivering an IRR in the mid to late 20% over a term or a return on money of between 2–3x. Such returns could be generated from compound revenue growth of about 10–15%.
Applying lean startup methodologies to existing buisnesess can build a new entrepreneurial culture and focus. But it requires startup-like commitment (risk) and startup like success (ownership, compensation). Many organisations are not setup to facilitate this agile approach.
It is very unusual to build a bottom up budget and therefore price the cost (and risk) of growth.The structure and allocations of A&P budget are set within clear ranges, usually by category.
Sales and distribution strategy and implementation should not be separated from A&P strategy development and deployment. Strategy and creative assets are rarely shared or integrated across both disciplines. Joining them up can only create a stronger and more effective plan.
The growth answer often lies within the brand owning organisation with an individual or small group who really cared passionately about the product. Rarely did we see such informal interactions encouraged.
For most of the blue chip consumer goods businesses, smaller brands do not offer the level of upside potential to warrant real investment in terms of time, people or capital for the brand owner.
The time for change in the industry is now. WhiteCap attempted to create an entirely new market; originally we saw this as a positive but in hindsight it meant that the model was unproven which just added risk. An incremental approach building on a strong preformence related model way well be the path to follow today.