The U.S. vitamins, minerals and supplements (VMS) market continues to expand, driven by the rising interest among millennials and Generation Zers, continuous product innovation with more complex modalities, and the increase of digitally native brands. An aging population and a burgeoning emphasis on health and wellness are also key drivers of growth. As a result, the VMS contract development and manufacturing organization (CDMO) market has emerged as an attractive investment opportunity. In addition to strong market fundamentals, a unique set of customer dynamics and a fragmented competitive landscape also provide prospective investors with a myriad of opportunities to create value.
Strong market fundamentals
Nutritional supplement sales in the U.S. have historically experienced mid-single-digit annual growth, with 2020 and 2021 being notable outliers as consumers focused on their health and well-being. However, growth stagnated in 2022 and 2023 as market demand normalized post-pandemic alongside inflation and other economic concerns, which acted as a modest headwind. Going forward, the market is expected to retain the gains it made in 2020 and 2021 and approached its pre-COVID-19 growth trajectory by 2024, with faster growth in key VMS categories like women’s health, experiential well-being (e.g., sleep, mind and mood) and personalized nutrition.
Format continues to be a key driver of growth, as gummies, liquids and other innovative non-pill formats (e.g., candies) have historically been among the fastest growers in the VMS market. Additional growth tailwinds include the continued shift toward premium, clean-label products and a focus on innovation, largely driven by the proliferation of digital-native brands.
A growing reliance on outsourcing and a unique set of customer dynamics
VMS CDMOs are expected to continue to benefit from growth in the broader VMS market, in addition to an increased propensity for brands to outsource to CDMOs. There are several factors contributing to the higher level of outsourcing. Digitally native brands typically don’t have their own manufacturing capabilities and rely on CDMO partners for their production and packaging needs. Few brands have the internal capabilities to cost-effectively manufacture across multiple formats, and many are increasingly relying on CDMOs for their expertise and ability to manufacture complex formulas.
In addition, CDMOs can help alleviate the regulatory compliance burden and enable brands to focus on their core competencies (typically sales and marketing), providing them with manufacturing expertise, increasing the speed with which their products get to market and serving as a secondary source of supply.
VMS CDMOs serve multiple customer segments, each with different priorities and increasing propensities to outsource production. Vertically integrated companies that manufacture the majority of their own products typically utilize external CDMOs for select modality or capacity needs to supplement their in-house capabilities, at an estimated rate of around one-third of their output.
Multilevel marketing and specialty brands, which outsource the formulation, sourcing, manufacturing and packaging for most or all of their products, value CDMOs that offer order flexibility and short lead times and have robust/innovative R&D capabilities. They outsource at an estimated rate of 75%-85% industrywide.
Due to their lack of manufacturing expertise, the segment with the highest propensity to outsource (90% or more) is retailers that sell their own private label brands alongside branded competitors.
A fragmented but consolidating competitive landscape
The VMS CDMO competitive landscape is highly fragmented. Most CDMOs offer multiple services and modalities to customers, and several of the larger players offer a broad suite of solutions as turnkey manufacturers, from R&D formulation, sourcing, blending and filling to warehousing and dispatch services.
But as contract manufacturers work to gain scale and breadth in order to better meet customers’ needs, those customers’ preference for one-stop shops has been powering consolidation. While smaller brands want to reduce vendor management time, larger brands are more concerned with mitigating capacity risk.
Multiple value creation opportunities for prospective investors
Investor interest in the VMS CDMO space has been strong the past couple of years, which has been contributing to higher deal valuations. Many recent deals have focused on companies that have a diverse customer list, in-house R&D, exclusivity agreements with customers, value-add capabilities and a track record of growth and stability.
There are numerous reasons to invest in the VMS CDMO space. Not only is the underlying VMS market large and growing, but key segments that are more likely to be outsourced to a CDMO — such as non-pill formats (e.g., gummies, liquids) and experiential well-being product categories (e.g., sleep, mind and mood) — are experiencing above-average market growth. Brands are increasingly outsourcing to CDMOs due to various factors, including increased regulation, the manufacturing expertise that CDMOs bring to the table and the speed to market they can facilitate. Meanwhile, the highly fragmented competitive landscape creates opportunities for roll-up M&A.
There are also multiple ways that VMS CDMO investors can create value, such as establishing one-stop-shop solutions across a breadth of modalities and/or service offerings for their customers. They can also invest in the business development team and infrastructure to energize the outbound sales efforts. Additionally, they can drive efficiencies through supply chain rationalization and scaling the back-office operations.
From an operational standpoint, they can invest in a team that is focused on improving efficiencies and capacity utilization in order to maximize gross margins, providing support for customer management/prioritization to increase profitability, and consolidating back-office functions — and even introducing artificial intelligence-powered solutions to potentially inefficient and/or manual aspects of a CDMO’s business (e.g., quoting, sourcing, quality assurance).
To learn more about the investment opportunity in VMS CDMOs, please download our analysis.
For more information, please contact strategy@lek.com.
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