Scale or sale: D2C brands feel the FMCG pull as consolidation in the sector grows

Earlier in January, fast-moving consumer goods giant Hindustan Unilever struck up sale talks with skincare startup Minimalist—a deal that would value the brand at a colossal Rs 3,000 crore.

Apart from being one of the biggest deals in the direct-to-consumer (D2C) sector in recent times, this deal also belies a larger trend: of consolidation and alliances between the D2C and FMCG sectors.

India's direct-to-consumer brands are increasingly seeking a marriage of convenience with FMCG brands, offering relevancy and appeal among younger consumers for resources to scale up their operations.

A growing list of D2C consumer startups are seeking to merge with offline legacy brands as they wake up to the challenges of scaling beyond digital channels. The move aligns with a growing trend of private market investors seeking exit opportunities amid subdued consumer demand and intense competition.

Several brands in the D2C beauty and personal care segment are exploring strategic options, including Wow Skin Science, which is reportedly seeking buyers at $250 million, down from its previous $400 million valuation.

Legacy brands have a Gen Z issue

Traditional FMCG giants are grappling with shifting consumer preferences and the rise of quick commerce platforms, which enable D2C startups to offer a level of convenience and immediacy that typical trade channels struggle to match.

During a recent call with analysts, Hindustan Unilever executives emphasised that the FMCG behemoth was focusing on developing channel-specific offerings, as ecommerce—which includes quick commerce—is growing at three times the rate of modern trade.

"New-age brands and their products appeal more to the younger generation today than traditional players, whose consumption is on the rise. Naturally, incumbents are facing challenges," said Swati Murarka, Principal at Bertlesmann India Investments. "Particularly with the advent of quick commerce, the distribution and visibility of new-age brands have significantly increased. This resurgence brings back the ‘build versus buy’ debate for larger conglomerates, with many likely to opt for the latter."

The FMCG brands, particularly those relying on general trade channels and mass-produced products, are feeling the heat. "Gen Z, or the younger generation today, wants products that are more personalized and customized for their needs," Murarka added. "The positioning and targeting strategies of new-age brands cater to these preferences more effectively, addressing the right pain points. Traditional brands will need to catch up."

With growing penetration across metros, and an increasingly younger cohort making purchase decisions, traditional FMCG majors have had to re-think brand positioning strategies from a one-size-fits-all approach to adding more problem-specific solutions for a more digitally literate audience.

The trend has already resulted in several deals. Emami took full ownership of The Man Company last August, while Marico completed acquisitions of Just Herbs and plant-nutrition brand Plix. The Parachute palm-oil maker had previously also acquired Beardo in 2020 at an undisclosed valuation.

In the food sector, ITC acquired Yoga Bar for Rs 175 crore.

Digital dreams meet offline reality

For D2C brands, the push toward mergers comes amidst a growing recognition of digital-only companies and their limitations. While the quick commerce market share is projected to grow by more than 70% by the end of this decade, it will still be less than 5% of the total grocery market, according to Bernstein Research.

"Most D2C brands today have a great online presence, but in India, an online brand can make you a Rs 500 crore business but it won't make you a Rs 2,000-3,000 crore business," said Anurag Ramdasan, Partner at 3one4 Capital. "For building a Rs 2,000-3,000 crore business, you have to go offline."

"Online first founders will have a struggle moving offline," Ramdasan added. "Offline also gives you better margins. Today, Amazon charges 30%, Zepto charges 35% commissions. Offline distribution typically would charge 5-10% plus retailer margins but it requires huge discipline in inventory management and demand predictions."

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Explained: How distribution woes, inventory correction hit Mamaearth stocks

Mamaearth parent Honasa Consumer's recent woes highlight the challenges of offline expansion. The company's shares tumbled after its second-quarter results and traded below IPO price, after it showed unexpected losses from inventory corrections.

The company's attempt to transition to general trade distribution to improve margins and consumer reach led to significant operational disruptions and inventory problems.

Such transition challenges underscore the complexity of India's retail landscape. Traditional retail channels still dominate, with neighbourhood stores accounting for 87% of grocery sales, data from the Bernstein report shows. While quick commerce platforms offer new distribution possibilities, their high commission rates of 30-35% squeeze margins compared to offline retail's 5-10%.

"For founders, the decision often depends on where they are in their personal journey, the company's ability to raise additional capital, the terms of the deal on the table, and whether it's more favourable than a primary equity raise from a VC or private equity firm," said Rajit Uboweja, Partner at Stride Ventures.

The surge in strategic discussions also comes amid broader market challenges, including subdued consumer demand and inflationary pressures affecting disposable incomes, particularly in urban areas where many D2C brands have concentrated their growth.

"Amidst the urban consumption slowdown, we should expect significantly increased M&A activity across the board in the startup ecosystem. Companies will need to quickly start combining to increase scale and improve efficiency," shared Kunal Bahl in a post on X in November last year.

With traditional FMCG giants seeking to tap channel-specific offerings and minimise overlaps, the consolidation trend in India's D2C space appears set to continue.