How the Capital Crunch Affects Contract Manufacturing

The bar for raising equity is now several times harder for CPG startups, and the supply of venture debt is at its lowest level in at least a decade.

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For startups and growth-stage companies in the food and beverage consumer packaged goods (CPG) space, the past 12 months have seen an escalating set of challenges. In particular, the obstacle of obtaining working capital for growth has become an acute problem and threatens the growth trajectories of even the brands that have well-established products.

For the $200 billion food and beverage contract manufacturing industry that has been the production engine for this growth, formidable perils lie ahead.

Contract manufacturers (CMs) have both benefited from and enabled the meteoric rise of thousands of successful new brands in the past decade, and the industry has grown at a 11-12% CAGR in the past decade. Their modular infrastructure has empowered food entrepreneurs to launch, iterate and scale products with unprecedented speed, and with an order of magnitude less capital required for production.

New brands that have capitalized on the desires of modern consumers would not have been possible without the proliferation of CM capabilities. Spurred by growth rates rivaling tech startups, a cadre of venture and private equity investors sprung up virtually overnight, supplying the capital for brands to fulfill ambitious growth plans.

But the party is over -- at least for now. Inflation was the harbinger, interest rates hitting 5% the storm, and Silicon Valley Bank’s collapse the storm surge. It’s brutal out there: the bar for raising equity is now several times harder for CPG startups, and the supply of venture debt is at its lowest level in at least a decade.

How contract manufacturers can thrive

Forward-looking CMs would do well to figure out how to ensure they are able to keep their production lines busy. One key strategy is ensuring that current customers and prospects with verified growth lined up have the working capital necessary to grow smoothly. CMs can play a substantial role in this by offering net payment terms.

Many brands are looking at hockey-stick growth in the next 12 months, having just signed national distribution deals with some of the nation’s largest big-box retailers. But the greater a brand’s success is, the greater too is their need for working capital to cover those expansion costs. Brands have 90-plus-day cash conversion cycles that start with paying upfront for materials and CM production, in addition to placement fees and other costs essential to any successful rollout. CMs that can afford to offer net payment terms can gain a significant advantage over competitors that require full upfront payment.

Of course, there’s no such thing as free capital, and CMs may be eyeing their cash flow with as much trepidation as their customers. If offering payment terms is not a viable tactic, CMs can also look to form partnerships with lenders and refer customers during the production planning process. Platforms can help CMs expedite capital access to help growing customers increase production-per-run quantities, directly impacting top-line revenue and margin.

Another bright spot for CMs is in private label production. Retailers are well capitalized and relatively unaffected by the credit crunch, and inflation has driven cost-conscious consumers increasingly to private label. Store brands grew 10.3% in dollar sales in the first quarter of 2023, after record growth of 11.3% in 2022. Getting into private label requires a bit more preparation and readiness, as many have a higher bar on certifications than with smaller brands.

The future looks bright

At the end of the day, the food and beverage CM industry in the United States still benefits from substantial tailwinds. The generational shift driven by Millennials’ and Gen-Z’s insatiable demand for diversity of flavors and health trends is yet to peak; in a decade they will vastly outnumber older consumers in their retail food purchases.

Enterprise food CPG has been one of the last manufacturing verticals to broadly shift to outsourcing, in the way that durable goods have decades ago. But the shift is accelerating, and nearly every modern brand acknowledges that nimble and flexible production is necessary in the age of the Gen-Z consumer. There are many up and coming brands that will thrive if they can obtain the capital to do so. CMs that can adapt their businesses to help address the pain points of growth customers will be well positioned to reap the benefits from this for years to come.