The beer industry, which is dominated by a few big players, might seem like a tough environment for small companies. But craft beer is the fastest-growing segment. Photograph: www.alamy.com
A number of Fortune 500 companies like Merck have been in the news lately for restructuring and downsizing their research and development efforts. Merck is not unique among the largest companies: many appear uncommitted to investing in and developing new products, instead relying on smaller enterprises for innovation that they can buy or license.
At the same time, smaller companies are innovating successfully – and not just in new industries like social media, but also in well-established consumer industries, where the largest competitors have the advantage of billions of dollars in resources and decades of experience. This is particularly true in growing areas of health and sustainability, where many young growth companies are creating better-for-you (BFY) brands. These brands often feature products made with natural ingredients or more sustainable materials, thereby minimizing the use of chemicals and/or waste.
Two areas where young companies have used innovation to compete successfully against well-established giants include craft beer and naturally sweetened soda.
The beer industry has been highly concentrated – or dominated by a few players – for several decades, a scenario that typically limits competition. In 1992, the top three companies accounted for 79% of the US industry. Today the top two companies, Anheuser-Busch InBev and SABMiller, which have each merged with a big competitor, account for roughly the same market share.
However, the fastest growing beer segment is craft beer. While sales in the rest of the industry are flat or declining, craft beer sales grew 17% last year.
Craft beer companies have accomplished this by tapping into regional loyalties and consumers’ desires to try new flavors with ingredient profiles that are different from the established players. And while the largest companies are making acquisitions and introducing their own versions of craft beers, they have mostly struggled to develop new products that resonate with consumers.
Similarly, the soda industry is also highly concentrated. Marketing budgets, as well as large-scale manufacturing and distribution, make up the backbone of the largest companies’ success. This may not seem like the best category for a young company. And yet, as with beer, the largest soda companies are beholden to the success and the support of their largest brands.
These brands are the cash-flow engines of their enterprises, so reinventing them to keep up with changes in consumer taste isn’t easy. This provides a window of opportunity for innovative young companies that can quickly develop, market and distribute products to meet consumers’ preferences for new tastes and better-quality ingredients.
Numerous companies have rushed to meet this need. The battle between large and small competitors has intensified recently, as overall soft drink sales have declined. Sales of regular sodas fell roughly 3% last year, according to Nielsen data through 21 December, while diet sodas which declined more than twice as fast at 7%.
Surveys indicate that consumers are reducing their caloric intake and searching for healthier alternatives. This plays into the hands of many new beverage companies, which are creating new brands that use low- or no-calorie sweeteners; natural sweeteners, such as stevia; or other natural ingredients.
If the Mercks of the world rely increasingly on acquisitions for growth, in the short term, they will likely underperform their competitors in the short term and see lower share prices. In the long term, if the industry giants don’t innovate – if they continue to lose their entrepreneurial cultures – they will lose market share and be pushed aside by new entrants.
According to a recent study by BCG and IRI, the largest companies have lost 1.4 market share points – worth more than $10bn – to small and mid-sized companies since 2009. Very few of the largest companies are growing sales, volume and market share, the study concludes.
As a venture capitalist who previously worked in a Fortune 10 company, I believe that without an internal commitment to innovation, even the strongest brands in the slowest-moving industries will eventually wither and die.
Among the companies we finance, we look for management teams that embrace a lean, non-hierarchical style, that are quick to jump on emerging trends such as BFY products and sustainability, and that permit an environment of controlled risk-taking and failure. Belief that valuable insights may be sourced outside the company is also important, both for smaller companies and larger ones.
Large companies might consider strategic alliances and investments with venture capital and private equity firms in order to incubate and assimilate a more risk-oriented approach towards growth. Corporate leaders in large companies that are committed to organic growth and want to continue to lead their industries can find great examples in small companies.
Rosemary L. Ripley is a managing director of NGEN
