In the past year and a half, as consumers have done more of their shopping online, many consumer-packaged-goods (CPG) companies have responded by ramping up their e-commerce businesses—whether by partnering with retailers, investing in their own direct-to-consumer (DTC) websites, or both. But selling products online is complex, and shipping and advertising costs are higher than they are offline. E-commerce profitability has therefore been a challenge for CPG companies. In this episode of the McKinsey on Consumer and Retail podcast, McKinsey’s Lidiya Chapple and Tatiana Sivaeva explain how CPG companies can profitably meet online consumers’ needs. An edited transcript of their conversation with executive editor Monica Toriello follows. Subscribe to the podcast.
Monica Toriello: As we record this episode, the Delta variant is raging in many parts of the world, causing anxiety and uncertainty and even raising the possibility of renewed lockdowns in some areas. One business implication for consumer-goods companies is that people could again shift much of their spending online rather than going to stores.
Since early 2020, many consumer-goods companies have been actively building their e-commerce businesses in response to overwhelming demand. And this demand has been sustained so far: McKinsey’s most recent research shows that as of mid-2021, US online penetration remains approximately 35 percent above prepandemic levels. E-commerce is clearly a growth channel for CPG companies—but it’s not always a profitable one. Shipping and advertising costs are higher in e-commerce, so profitability online has been a challenge for CPG companies.
Today, we’ll be hearing from two people who have spent a lot of time studying this problem and helping CPG companies improve the profitability of their online businesses. Our guests are coauthors of a recent article titled “High growth, low profit: The e-commerce dilemma for CPG companies.” They lead McKinsey’s e-commerce work with consumer companies in North America. Lidiya Chapple is an associate partner based in McKinsey’s Atlanta office, and Tanya Sivaeva is a partner in the New Jersey office. Thanks for joining us today, Lidiya and Tanya.
I’ve just given a very high-level overview of the situation: people are buying more online, and companies are selling more online. I’d love for you to give a little more color and detail. What are the challenges of selling online for CPG companies? And what seem to be some of the solutions?
Tanya Sivaeva: I can start with sharing some insights from our recent research. Online margins are definitely more challenging than offline, but we found two things that are encouraging to us. One is that scale does seem to matter online. Categories and companies that sell higher volumes online benefit from scale, and it’s reflected in higher margins. We also see that companies’ ability to manage three specific P&L items makes a big difference. Those three items are advertising investment online, promotion and trade investment online, and supply-chain costs associated with the online business.
Lidiya Chapple: Even as CPG companies are starting to think more about how to improve their e-commerce profitability, it’s their channel partners—the retailers—who are really going to turn up the heat on this in the coming months. In recent years, the game for retailers has been growth online. It’s been all about driving online penetration. And many retailers haven’t really accounted for the costs of selling online: they haven’t thoroughly tracked the digital-marketing costs or the supply-chain costs or calculated the true profitability of online. And as retailers begin to focus on profitability, they will be in turn asking for concessions from their CPG partners, which will only increase the margin pressure on CPG companies. All this is to say it’s been challenging already, but we do expect that CPG companies are going to need to pay even closer attention to their margins because pressure is coming from their retail partners.
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E-commerce success factors
Monica Toriello: And yet, your article says that according to a survey you did among CPG executives, they’re fairly confident that they’ll figure this out, right? They believe that margins and profitability will improve. Why do you think they believe that?
Lidiya Chapple: I think it really comes down to the fact that they expect to sell higher volumes online, which is the point Tanya was making earlier about scale. And, as they wade more deeply into this new world of e-commerce, they expect to get better at managing their costs and become more efficient at selling online.
Monica Toriello: Have you seen evidence of that?
Lidiya Chapple: Sure. Companies that are succeeding at e-commerce are doing a few things. One, they are being very disciplined about quickly reallocating dollars from brand budgets—the pay-to-play, brick-and-mortar trade investments—to what we call pay-for-performance retail media. In the process of doing so, they’re taking an honest examination of their current budgeting and planning processes to make sure that e-commerce is not just a bolt-on, an additional drop in the bucket, so to speak. That might have been OK when e-commerce was only a small percentage of total company sales, but as the e-commerce cost bucket grows, your ability to manage it becomes more important.
They’re also working on bolstering their attribution capabilities. There have been lots of recent advances in media platforms, data, and advanced analytics that allow CPG companies to have a better view of e-commerce marketing ROI, which is important if you care about profitability, of course. In line with all of that, they’re turning up the visibility on omnichannel performance management and governance. All of these things that I described are different ways to be more thoughtful about your performance management online.
There have been lots of recent advances in media platforms, data, and advanced analytics that allow CPG companies to have a better view of e-commerce marketing ROI.Lidiya Chapple
We’ve also just done some new research as part of our 2021 Commercial Excellence Benchmarking Survey. While I can’t get into that yet, because we’re still processing the data, one thing I can say is that we’re also seeing that companies succeeding online have a stronger revenue-growth-management [RGM] muscle, meaning that they’re much better at figuring out the right assortment, pricing, and promotions to support omnichannel sales. And when we asked winners what they’re focusing on now, those who have figured out RGM are turning their eye on supply chain and marketing investment. That’s probably not surprising, since these three pieces—RGM, supply chain, and marketing investment—are the biggest cost drivers.
‘eRGM’: Pricing, assortment, promotions
Monica Toriello: As you said, Lidiya, RGM encompasses pricing, assortment, and promotions. What are successful CPG companies doing right when it comes to online RGM, or eRGM?
Tanya Sivaeva: Let me highlight a few. I don’t think there is a proven playbook, but there are tactics and strategies that definitely work. When it comes to eRGM, or what I would rather call omnichannel revenue management, it starts with data and making sure that the data can be translated into analytics. Understanding and getting real transparency into pricing online is step one.
Second, they need to understand the online shopper: where she shops, why she shops there, what her price sensitivity is. I think oftentimes there are too many assumptions, rather than facts, that inform the decisions.
Third, be very clear about assortment, which is key for unlocking successful eRGM strategies: understanding what assortment sells online and can be profitable online. Be very mindful and purposeful about using exclusives online—that’s the third element.
Monica Toriello: Tanya, I just want to ask a quick question about those three elements, because they sound a bit basic, right? Knowing your competitors’ prices, understanding how shoppers shop, paying close attention to your assortment—those sound like things that consumer companies have been doing forever. But you’re saying that bringing in data and analytics is the new thing and it’s a hard thing, a challenging thing. Is that right?
Lidiya Chapple: Monica, I just want to address your comment about “aren’t these the basics.” While it’s absolutely true that RGM has been a staple lever of commercial excellence in brick-and-mortar retail—and understanding consumer needs, behavior, segments, and whatnot has been a staple, again, in offline—I don’t think CPG companies have historically put so much focus on understanding the holistic omnichannel journey of that consumer. And—surprise!—it looks different. The elasticity of your products offline is not necessarily the same as it is online, nor is the competitive set, nor is the occasion that the shopper is shopping for.
Tanya Sivaeva: Another big unlock in revenue management and in some of the other topics we’ll talk about is the ability to connect the data. Online is a data-rich channel that at the same time is typically analytics-poor. It’s hard to connect because the data sources are so fragmented. It’s even harder to connect online data with offline data. And it is even harder to connect online data, offline data, and your P&L data. But only if you make the connection across the three of those can you make informed decisions, and that’s quite a manual and complex exercise. But the winners, unlike everybody else, are going through that exercise right now.
Online is a data-rich channel that at the same time is typically analytics-poor.Tanya Sivaeva
Monica Toriello: Right, so eRGM yields different insights from offline RGM. Tanya, you were talking about best practices in eRGM and you mentioned pricing, insights into the online consumer, and assortment. What else do CPG companies need to get right?
Tanya Sivaeva: A couple more things. Expanding the range of eRGM tactics is important. We can do some things online that we cannot do offline—for example, subscriptions. Being clear about when to apply these tactics really helps alleviate some of the eRGM challenges.
The last point I want to highlight is the importance of paying attention to details and tactics. One example is marketplaces. Often, disruption from marketplaces is the main reason why companies cannot realize profitable omnichannel revenue-management strategies. So understanding the pricing in marketplaces, thinking about what the sources of disruption could be and what you can do about them, all the way to potentially establishing your own marketplace—this is a critical part of translating strategy into reality.
Monica Toriello: By marketplaces you mean e-marketplaces, right? Like Amazon? Do you think a CPG company can survive without selling on Amazon?
Lidiya Chapple: You have to be where your shopper is, and how you get to your shopper largely determines the channel strategy you build. Amazon is a huge player in the space and will only increase its investment in grocery and other CPG categories.
Amazon, frankly, has become table stakes for most CPG companies. Our latest research suggests that winners in e-commerce typically play across a broader range of channels, beyond just Amazon. Now the winners are looking at places like Amazon Business. They are thinking about cross-border e-commerce, in some instances. They are starting to dabble in social-media selling. Some of them are dipping a toe into their own sales-enabled DTC sites. So, yeah, you have to be on Amazon, but I don’t think that’s actually enough.
Lessons from the toy and pet-food categories
Monica Toriello: There are some product categories in which the shift to online happened years ago, like toys and pet food. People have been buying those online for years. But other categories are still mostly purchased in physical stores: food, drinks, household products. Talk about whether that’s changed during the pandemic and what you expect to see postpandemic.
Lidiya Chapple: The short answer is that it certainly has changed, and we do expect the new behaviors to stick, for the most part. Our retail colleagues looked at this question a lot more closely in their recent report, The state of grocery in North America. One of the compelling things they found is that in 2019, e-commerce penetration hovered around 4 percent of grocery sales in North America—so it was an important channel for consumers but still very niche. By late spring 2020, e-commerce penetration had reached about 10 to 15 percent of grocery sales. In some regions, like high-density urban areas, it was over 20 percent.
The recent consumer-sentiment surveys show that the shift in behavior toward e-commerce appears to be quite sticky. Consumers like it; they’ve been pleased with the experiences provided by grocers, both for click and collect and for delivery. Across categories, consumers indicate a continued preference for shopping online, and that’s starting to happen even in some of the historically harder-to-crack categories, like fresh meat and produce—both of which, by the way, saw a five-percentage-point increase, versus prepandemic levels, in net intent to continue to purchase online.
Monica Toriello: What lessons do you think CPG companies can learn from those categories or from companies that are further ahead on the e-commerce growth curve, like pet food and toys?
Tanya Sivaeva: First of all, there has to be a willingness to set a very bold aspiration and go public with it. Some of those companies stated a desire to shift 30 percent of their sales online even when their categories were at 10 percent or below. Second, a willingness to put investment behind this commitment. Commitment without investment is not worth much. Third, obsess over understanding the consumer and shopper, the role of the online channel in the consumer and shopper journey, and how the online and offline channels interact. And, finally, translate all of that into measurable KPIs, find a way to constantly track those KPIs, and align the entire organization behind them.
Retailers as media agencies?
Monica Toriello: Another thing you mentioned earlier that winners are doing is reallocating more of their marketing dollars toward retail media networks, or RMNs. Say more about that. First of all, what are we talking about? Is that, like, commercials playing on the TV screens in Walmart stores? What are CPG companies actually buying when they spend their marketing dollars on an RMN?
Lidiya Chapple: The specific marketing tactics employed by various retail media networks vary and, by the way, they are constantly getting more and more sophisticated. It can be paid and preferential placements, paid search, events on the retailer’s homepage where your brand is featured as a partner of that event. It can be more sophisticated promotional arrangements.
Tanya Sivaeva: At the macro level, it’s retailers trying to become media agencies.
Lidiya Chapple: Yeah. They’re monetizing the eyeballs on their websites.
Tanya Sivaeva: What I see a lot of companies doing today is finding pockets of money to invest in RMNs. What winners are doing is starting a holistic conversation on how to rethink commercial investment. It’s no longer about the historically established marketing budget, trade budget, and shopper budget. All this money has to come together and be rethought, given the new consumer journey and where the consumer shops and what really makes an impact on this consumer.
Lidiya Chapple: I think Tanya’s absolutely right; it’s a more holistic conversation. The smartest guys in the room, so to speak, are setting very explicit expectations with their retail media partners on both data sharing and measurement. They’re not just takers in the conversation. They’re making sure that they get the right value equation from investing in retail media.
The online supply chain
Monica Toriello: One area that seems to be presenting a huge challenge to all CPG companies recently is supply chain. There are tons of articles about shortages everywhere, not just in e-commerce but in physical stores as well. Can you point to best practices of CPG companies that are excelling in e-commerce supply chain?
Tanya Sivaeva: Sure. There are two horizons that I’ll talk about. First, with all the supply-chain issues that CPG companies have faced recently, the e-commerce channel has probably been the most challenging, given its volatility and difficulties in forecasting. So putting disproportionate focus on understanding how to serve the channel and how to improve the quality of forecasting there is priority number one.
However, it’s also important to keep in mind longer-term unlocks for supply chain. Unfortunately, there are not as many best practices as I wish. But three areas are interesting to explore. One is rethinking product and packaging for e-commerce. The example I find most inspiring is one of the iconic manufacturers of laundry products. They went beyond just rethinking packaging; they rethought their product and removed the most expensive part to ship. They took out water from the laundry detergent, making it much more friendly for the e-commerce environment. That’s question number one: What is the right package that will delight the online consumer but at the same time will be cost-effective given the online supply chain?
Question number two: How can CPG companies rethink their networks to provide more cost-effective solutions for either their own online plays or to support their e-tailers? There’s been some interesting developments in microfulfillment solutions, for example. And the last question is about retail partnerships. It’s a joint problem: E-commerce is driving up supply-chain costs for both retailers and CPG companies, so what are the partnerships and solutions that are possible to reduce cost? That’s another area to explore.
Lidiya Chapple: In just the last month, one of the nation’s largest big-box retailers announced that it created a last-mile fulfillment service from its network. The groundbreaking news is not that it created this service—the service already existed for well over a year—but that the retailer has now opened it up to others, whether it be small businesses or big companies. The brilliant thing there is that it actually creates a more efficient network for the retailer, so they’re able to deliver their own volume in a much more cost-efficient way. They’re getting more out of their own network while also monetizing it.
‘Stop planning for perfection’
Monica Toriello: What do you think the future e-commerce consumer is going to care about most? Is it convenience, assortment, speed, price, or something else?
Lidiya Chapple: Well, they want it all. They want a frictionless omnichannel consumer experience. That’s really becoming table stakes because that’s the kind of experience that the tech companies have set as the standard. Think of the big search engines of the world, the big telephone-hardware providers, the gig-economy transportation providers. Those are what consumer companies are being measured against.
Monica Toriello: Final question: If you could deliver one main message about e-commerce to a room full of CPG executives, what would your message be?
Lidiya Chapple: I would say don’t obsess too much with calculating the incrementality of selling online. Sometimes we see CPG executives get really focused on getting a granular understanding of the incrementality potential of e-commerce for their specific categories. What we do know is that for most CPG categories, there’s at least some incrementality from online purchases. This is particularly true in categories like snacks and soda—if it’s in your pantry, it’s gonna get consumed quickly.
But our advice would be to not overly focus on that. In the end, it’s all about following the consumer to where they want to shop, in order to continue getting their share of wallet. And e-commerce is the way to ensure that your products stay relevant for the next generation of shoppers. Incrementality is just a bonus.
Monica Toriello: So what you’re saying is that CPG companies just need to move—and move fast?
Tanya Sivaeva: Yes, that’s exactly my thought. From our survey, we know that the laggards are still debating where e-commerce should sit in their organization, while the winners are reimagining supply chain, marketing, and customer experience. So my advice would be stop planning for perfection. Move in an agile fashion and learn as you go. That is the only way to victory.