Recipes for challenger success in challenging times
How to keep partying like it’s 2019
Ah, the halcyon days of the twilight twenty-tens, when consumers cared about cause, iOS allowed tracking without opt-in, money was cheap, and CPG incumbents were clueless. These were exhilarating times for challenger brands in CPG, where founders could pick a category, identify the wrong to people or planet they wanted to right, launch a better/fairer/cleaner product online, scale with dizzying speed, and exit before P&G or Unilever even realised what had just smacked them in the face. Challenger brands were the talk of the town, and they offered consumers the hope of a better way in a world of ugly compromises.
Alas, the common mistake of many a prospering founder is to believe that the circumstances that enabled them to succeed will continue, unchanged, into the future: that market dynamics will stay the same, that incumbents won’t react, and competitors won’t innovate. Every business plan always assumes the world stands still. That’s not actually how the cookie crumbles, regrettably, and the past 5 years have seen virtually every market force turn from challenger brand enablers, to threatening their very existence.
First Apple switched off user tracking, spoiling the economics of selling consumer brands online. Then the world went to hell in a handbasket, tightening consumer’s wallets and with it their willingness to pay a premium for ethical products. Subscriptions turned toxic. Interest rates rose. And incumbents reacted big time: virtue-washing their legacy products in wild claims of sustainability and social responsibility, confusing consumers and turning them (rightly) sceptical of cause claims made by any brand, new or old. And then incumbent CPG giants stopped buying up insurgent challenger brands, imposing strict expectations around scale and profitability that seemed out of reach for nearly all. Faced with all these headwinds, investors shrugged, packed their bags, and stopped backing challenger brands, evaporating, in a puff, the ready supply of growth capital everyone had relied upon. In one fell swoop, 2022 turned the challenger brand dream into an existential nightmare for most.
The Sage of Omaha is fondly quoted as saying: “when the tide goes out, you see who’s been swimming naked”. That certainly holds true for many challenger brands, plenty of which are a sorry sight at present, burdened with unsustainable unit economics, ring-of-fire churn in customers, me-too product formulations, and only wafer-thin balance sheets to cover their modesty. Scores of them are going out of business every week. But a tough market also brings positives: it weeds out the weak, roots out irrational competition, and gives space to breathe to those who have a genuine blade with which to fight the incumbents’ status quo. Truly great companies are great, no matter the market.
So here’s the recipe book for those brands we’re observing as blossoming despite the storm:
They have a clear reason to be
Far too many challenger brands came to market between 2015-2022 with only flimsy stakes to claim. Many offered little more than a channel alternative to consumers – ie to buy the brand direct, online, rather than via bricks and mortar retail, for ultimately questionable convenience benefit. Others had very weak differentiation, eg nothing more than sustainable packaging, which was very easily copied by incumbents. Almost all relied on co-packers and third-party formulators for capital efficiency and speed to market, but this came at the cost of the products being, at their core, generic and undifferentiated. None of this is good enough anymore. Those brands winning in the challenger space today offer a genuinely novel alternative to the incumbents, with products that (a) have cause at their core, baked into the proposition, and not just as a founder origin story, (b) they raise the bar on performance, value and experience in their category, rather than just being a more expensive and inferior quality alternative to the incumbents, and (c) they challenge the status quo fundamentally (ie the essence of how a category is served, using breakthrough science, process or positioning), as opposed to challenging it superficially (eg merely by using clean ingredients, which can be copied in a heartbeat). Asked in the street about why any given challenger brand matters, and what sets it apart, consumers ought to be able to give a clear answer in a single sentence. If they can’t, it means the brand has no reason to be, and will struggle to be taken seriously.Their brand has power
Successful challengers cut through the din of competition thanks to iconic brand execution - with design, language, equities & ownables all orchestrated into a clearly differentiated, stand-out, and relevant whole. At a time when consumers’ attention span, online or in store, is measured in fractions of seconds, true brand power makes all the difference in the journey from awareness to consideration and trial. Gone are the days when good products with weak brands were given the benefit of the doubt. Brands now need to be exceptional.They obsess about gross margins
Gross margin is the oxygen that allows challenger brands to breathe. It funds growth, it covers opex, it finances new product development. Far too many challengers focused purely on top line revenue as the measure of their success, then ran out of cash because revenue without gross margin is meaningless. The most successful brands today build task forces dedicated to gross margin expansion, eking every fraction of a percent out of their supply chain, formulations, packaging and logistics. It provides them with the fuel to continue growing, profitably, where others have to throw in the towel.They prove they’ve cracked omnichannel
Direct-to-consumer (DTC) seemed like a godsend when it broke through in the mid-2010s. Tools like Shopify allowed founders to be up and in business, selling their wares to consumers within days, not the months (or years) it takes to secure listing in a major retailer. And DTC allowed for swift iterations on the back of direct consumer feedback, powerful storytelling, and a wholly novel packaging design language, all of which helped set challengers apart from the physical-shelf-dominating incumbents. But DTC has its limits, notably in ever-increasing CACs, and ever-decreasing consumer willingness to sign up to yet another subscription, or the hassle of buying their products from multiple sources. So challengers today need to break beyond pure DTC, and show their brands can live and prosper on third party platforms (Amazon) and physical retail shelves too. The CPG giants no longer “value” DTC skills as sufficient reason to acquire a fledgeling challenger. On the contrary, acquirers now apply a deep discount to any brand that hasn’t proven it can scale across channels, beyond DTC. Showing omnichannel success has become a must.They focus on unique capabilities
All great companies do something uniquely better than anyone else in their competitor set. They might have better consumer insight, superior technology, more effective marketing, better industrial design, cheaper unit economics. Whatever it is, no brand scales to greatness on the back of mediocrity. Challengers that are single-minded in (a) understanding what the core capabilities are they must perfect in order to stand above their category competitors, and (b) make it their laser-focused mission to build exceptional teams and extraordinary ways of working to sharpen those capabilities to be best-in-class, are consistently the ones to beat expectations on growth, and garner outsized attention from investors and acquirers. When asked what their organisation does leagues better than anyone else fighting in the space, and why this is relevant, founders should be able to answer without a second’s hesitation. Few can.Their P/L is optimally shaped to suspend disbelief
In the happy days pre ‘22, many CPG incumbents were willing to forgive negative EBITDA in their challenger brand acquisitions, because they were buying (a) relevance with consumer segments who didn’t trust them, (b) growth they were excluded from, and (c) capabilities (esp DTC) they lacked. The M&A focus of incumbents now has shifted resolutely to profitable growth. For challenger brands ultimately looking to exit, this means prioritising honing their P/Ls to high EBITDA profitability at minimum to the contribution margin level before opex, and ideally right to the bottom of the P/L itself. Acquirers will still suspend disbelief around economies of scale in opex flowing to a high-teens EBITDA bottom line. Acquirers won’t suspend disbelief any longer that larger scale will somehow bring cheaper acquisition costs, greater marketing efficiency, or higher consumer repeat. If a challenger brand’s 5-year plan envisages delivering its profitability hockey stick thanks to efficiency gains pre opex, few will be the investors or acquirers willing to listen.
Life was certainly easier back in 2019. However, greatness is forged with the hammer of adversity, and the challenging environment for CPG insurgents today is yielding a crop of exceptional brands whose blades combine excellence in the levers that count, with the importance of the cause they stand for. While this is undoubtedly a more challenging set of criteria for founders to deliver against, it’s exhilarating witnessing the very best achieve just that.
Ernesto Schmitt is co-founder at The Craftory, the progressive investment fund on a $550M mission to back the world's boldest consumer brands.
