Navigating US Packaging Trends: The Current Opportunities for Brand Owners

Host:
Welcome to Insight Exchange, presented by L.E.K. Consulting, a global strategy consultancy that helps business leaders seize competitive advantage and amplify growth. Insight Exchange is our forum dedicated to the free, open, and unbiased exchange of the insights and ideas that are driving business into the future. We exchange insights with the brightest minds of the day, the most daring innovators, and the doers who are, right now, rebuilding the world around us.

Thilo Henkes:
Well, welcome to another episode in the L.E.K series of podcasts, and today, we're going to be discussing the packaging study, the brand owner study that we have been doing in the packaging sector for six years now. I'm going to be discussing some of the insights with a couple of colleagues of mine plus one of our dear friends from the industry. I'll introduce them in a few moments, but let me first start by talking a little bit about the study. This is a sixth year of this proprietary study, and this study is sent out to 400-plus brand managers and other packaging decision makers within the brand owner community, really to help to understand the packaging decisions that they are making and what is influencing their packaging decisions.

This particular study was most recently conducted in the fourth quarter of 2023, and it was sent out, as I mentioned, to over 400 brand owners and decision makers across a wide variety of end markets, specifically food, beverage, beauty and personal care, household and healthcare, and consumer electronics. We have segmented a lot of the feedback in this study from those brand owners, and very specifically, we're interested in understanding how their responses differ by size of brand owner. Ultimately, we've identified four central themes that have come out of this study. We'll be discussing those four themes again with my distinguished colleagues.

So let me introduce the distinguished colleagues. I'll actually ask them to introduce themselves. I will start with our industry veteran friend, someone who we've done a lot of work with in the past, is Roger Zellner. Roger, let me hand it over to you to introduce yourself.

Roger Zellner:
Hello. I'm Roger Zellner, and in my past life I led various R&D packaging groups at Mondelez, Kraft, and Oscar Meyer, which included global responsibilities for leading packaging and sustainability. I've continued consulting in the packaging space and currently am an advisory board member with Garlock Flexibles for Astara Capital Partners. I recently worked with the dairy industry to develop the Recycle The Jug campaign. My company is Rogue Zebra Consulting.

Thilo Henkes:
Welcome, Roger. I'm looking forward to discussing these insights with you. Also joined by two of my esteemed colleagues, Jeff Cloetingh and Jon Moss. Jeff, over to you.

Jeff Cloetingh:
My name is Jeff Cloetingh. I'm a managing director and partner with L.E.K. Consulting. I've been in consulting for the past 17 years, the past 12 of which with L.E.K. I spend all of my time in the packaging ecosystem. The packaging ecosystem for us is inclusive of upstream materials and inputs into packaging, conversion, distribution, and downstream in the distribution and fulfillment centers with equipment along the entire way. Thank you.

Jon Moss:
My name's John Moss, a partner based in the Boston area with Jeff and Thilo, also solely focused on packaging at L.E.K. Spend all my time exactly where Jeff says we focus, but do spend significant mind share thinking about the trends that happen at the end market level, what that means for growth for our packaging clients, and also what brand owners are looking for, and how our packaging clients can best meet their needs.

Thilo Henkes:
Wonderful. Again, thanks very much Roger, Jeff, and Jon for joining me as we evaluate some of the key themes that have come out of the study. Let's dive right into it. I mentioned that there are four key themes that have come out of the study. The first one we're going to talk a bit about is related to how brand owners think about the value of packaging and about the pricing of packaging and their willingness, if you will, to switch the packaging. My first question, which I'll pose to you Roger, ask you to start with, is ... This is a question we've asked now over the past six years, and what we're seeing is that brand owners across those different brand owner segments continue to view packaging as critical to their brand's success.

We see that across these various segments, and brand owners actually indicate that the packaging has become even more critical to them over the past year in 2023, despite some of the softness in the market due to interest rates and consumer demand that we've actually seen. So it's quite interesting that brand owners are telling us that packaging is even more important to them despite turbulence in the macro environment. So the question, Roger, is, why do you suppose that brand owners place even more emphasis on their packaging even when we get into market cycles or softness in demand?

Roger Zellner:
Thilo, it's a great question. My analogy is packaging is like a 24/7 news or sports network. It's on all the time with the consumers, and this day and age of more fragmented communication channels, that consumers may engage less frequently, your package is always on. I think you get more bang for the buck from a marketing perspective, especially if you are a smaller or medium-sized company. But I think it's also important to remember that consumers are not asking for more packaging, but the benefits that packaging brings to the product experience, both emotionally and functionally.

If continue with my always-on, 24/7 analogy, the package is what you see when you go online or in the store or look in your kitchen fridge or in your bathroom cabinet, or if you're out and about and away from home, the package is always with you. It allows you to buy the product in more places, use it more conveniently in different locations. It's a great enabler for a product experience more often in more settings. So consequently, brand owners, and I think especially smaller and medium-sized, see packaging as an enabler.

But let's understand that it's important not to kid ourselves. If consumers can get the same emotional or functional product benefits with less packaging, they'll take it, because they implicitly understand the cost, et cetera. The dark side of packaging always being on 24/7 is that, what do you do with that package when the product is done? We'll talk about that more later on, but one last point I'd like to add. For packages that are used for a longer period of time and multiple occasions such as beauty and cosmetics, that package takes on even more relevance, because it's always there.

Thilo Henkes:
Excellent. Thank you, Roger. Now, we talk a little bit about the turbulent activity that we've seen since 2020 with COVID and then the supply chain issues, which was then followed by some of the inflationary environment that we've seen. Jeff, I'd like to ask you specifically here, with regards to this inflationary environment that we've been experiencing, which is going to hit all end markets, but perhaps most importantly in food and beverage, how have brand owners thought about their spend on packaging and their ability to pass through incremental packaging costs on to consumers?

Given that we typically see the packaging being a pretty small percentage of the retail value of the product on the shelf, one might think that it would be reasonably easy for brand owners to pass on increases in their packaging costs, but we've seen a little bit of reticence to that. Are brand owners just gun shy about passing on these costs? What is the study telling you about this, Jeff?

Jeff Cloetingh:
Well, there's no doubt that the inflationary environment here is at an all-time high. Food and beverage, as a percentage of the consumer wallet, has reached the highest level it's been in the past three decades, and throughout the past two and a half years with which there's been this inflationary environment, it's also impacted the spend and the cost of packaging to brand owners. We've seen the cost be about 19% in aggregate over the course of the last 18 months from packaging converters to brand owners, and brand owners have not passed through all of that cost increase to the consumer.

We think there are a couple of reasons for that. One is that the pace and the magnitude of those inflationary pressures, which are not just on packaging, but also on ingredients, on freight, on transport, on getting the product to the channel, and there's been a hesitation to pass through at the same magnitude with which those materials have increased. But it's not the same across all end markets. Beauty and personal care, in particular, is the area where there's been the least amount of packaging cost increases passed along to the consumer, and a big part of that has to do with the price point already being at a premium price point on the shelf. In an inflationary environment where beauty, as a discretionary category, can potentially be rationalized out by a consumer, the brand owner does not want to give the retailer and the consumer a reason to trade out of a category such as beauty.

Thilo Henkes:
The packaging is certainly a critical component of how a brand conveys its value to the consumer. So my next question here regards sustainable packaging. We're going to be talking about this as a major theme here in a moment. Study has also shown how decision makers are thinking about their sustainability goals and how they think about a shift towards different materials and substrates for their packaging. Specifically here, Jon, what are we seeing here in the study? What are brand owners telling us regarding how they think about that shift towards sustainable packaging?

Jon Moss:
Yes. I think there are two data points that were really critical and interesting that popped up within the study, particularly when you think about the relative importance of these data points versus others. First, we took, what's driving change in packaging materials for brand owners, looking back historically? Responses included things like materials to extend shelf life, aesthetic appearance, cost savings, et cetera. None of these really reached half of the level of interest as the desire to move to sustainable packaging, which was cited by 70% of respondents as either their top, second most important, or third most important in terms of driving change.

So you ... really, really strong data as we think about what's driving changes in packaging overall, and then, also, we're thinking about, how has this evolved in terms of where brand owners are spending historically versus on a go-forward basis? Some of the key investments were around graphics and packaging, shapes, labels, primary packaging materials. But in terms of the single biggest driver of change, it was the share of sustainable packaging, and not only was this the biggest on a magnitude basis. It was also the factor that was driving the greatest acceleration in spending when you look forward versus backwards. So overall, very strong tailwinds when we think about brand owner preferences with respect to sustainable packaging and how they expect their spending to evolve longitudinally, i.e. over the next four years. We could talk a bit in to some of the minor headwinds we've seen over the last 12 months, but tremendous velocity as we think longer term.

Thilo Henkes:
That's great, and sustainability continues to be a major theme in the packaging sector. Although interestingly, over the past year, year and a half, it seems to have taken a bit of a back burner, but we're going to come back to the sustainability issue when we think about one of the next upcoming themes. Let's go to theme number two. Theme number two is regarding a major driver of demand for packaging that we've seen, I don't want to say reverse course, but has changed since 2018. That is SKU count.

So the question here is one that we've seen in and around with brand owners looking to manage their costs. In the inflationary environment over the past year in 2023 that we've seen, we've actually seen a trend, a continued trend of SKU rationalization that actually began, we believe, back in 2018 timeframe. So Jeff, the question for you is, based on what we've seen here with the study, what is driving this rationalization? What impact is the rationalization having on brand owners? Ultimately, I'm going to ask us questions somewhat facetiously, is product innovation dead?

Jeff Cloetingh:
Well, I think it's important to put this into some historical context. Between 1998 to 2017, the number of new SKU introductions increased in North America and Europe by a magnitude of five and a half times, so a significant proliferation and investment in new product introductions. This is new flavors. This is new sizes. This is new configurations, new graphics. Over the course of that timeframe, it introduced a tremendous amount of complexity in the brand owner supply chain, from printing, to filling, to sourcing. If you were to look over the course of the past 18 months, there have been some very high-profile announcements of SKU rationalization campaigns, Tyson, Nestlé, J.M. Smucker, P&G, Unilever. All have publicly come out with SKU rationalization programs oriented around reduction of underperforming SKUs.

Now, in many of these statements, they also are affirming their commitment to innovation. What we observe is the number of new SKU introductions is slightly coming down relative to that 2017 peak. Why would a brand owner be doing this? For starters, in the study, the biggest reason was simplification around supply chain, but very specifically, having a direct impact on profitability. We asked them the magnitude of uplift expected from a gross margin basis for some of these actions, and their range, the weighted average was about 75 to 80 basis points of gross margin improvement following a campaign such as this. So no. Innovation is not dead, but brand owners are being thoughtful about placing fewer bigger bets in selected areas as opposed to a very wide variety of bets and allowing them to linger without failing fast.

Thilo Henkes:
So if innovation is, in fact, not dead, where do you see brand owners focusing some of their innovation efforts? What are the types of packaging? What are the areas within their stable of SKUs where you do see brand owners putting some emphasis on packaging innovation?

Roger Zellner:
Okay, well, Thilo, and if I may be so bold as to comment on Jeff's comments, in my past experience, I certainly was leading global simplification efforts. We were looking at saving tens of millions of dollars. Now, when you start looking at some of these tail SKUs, think of all the ingredients, all the packaging, and all the suppliers and specifications that go with that. When you start consolidating that part, then you can really get some savings. Now, to your point about, where are people focusing their innovation, as I mentioned before, people aren't asking for more packaging. But they want a better experience the packaging can bring with a product, and it's really the best example for packaging innovation.

Some of the ones in the report, Dawn's EZ-Squeeze bottle or West Paw's squeezable pouch, about packaging, delivering a better product experience through convenience. The baby food and the pet food categories have changed substantially with packaging innovation. They have made parents and pet owners lives easier, and when you're a smaller or medium-sized company trying to get in all that expensive marketing channels, the package is a nice way to provide a different experience. If you look at refillable packaging, it's about bringing a different emotional experience with the product and package afterwards, and let's face it. It's often less convenient to do refillable packaging, but people are getting a different emotional reward when they do that.

Now, going back in time, just to show my time in the industry, but when I was one of the original packaging developers at Oscar Mayer Lunchables back in the 1980s, basically, we took meat, cheese, and crackers, and made it cool for kids to take to school. Now, meat, cheese, crackers has been around a long time, but the power of packaging to bring that into a unique experience, I think, is what we're looking for in a lot of innovation across brand owners, et cetera. People don't necessarily need another flavor of whatever, but to have a different experience that they enjoy more and willing to pay for. That's what I think the business teams and the marketing teams are understanding, that the product can be lifted through the package.

Thilo Henkes:
That's awesome. I like that, Roger, the idea of the packaging making something cool, like meat, cheese, and crackers. That's fantastic. Well, you're cool in my book, Roger. Let's move on to the third major trend, and we already alluded to it earlier on. The third major trend here is, of course, the trend in and around sustainability. No question, sustainability continues to be a significant driver within the packaging sector and mix shifts within the packaging sector. What are brand owners, Roger, telling us, is sort of a four part question, if you will. What are brand owners telling us about, A, how they define sustainability, B, their sustainability goals, C, where they are in their journey to meeting those goals, and D, how they feel about access to sustainable packaging solutions?

Roger Zellner:
Well, Thilo, thank you, and I know you and I could talk for hours on this. But I will try to be a much briefer. So to your first point, how they define sustainability. It's really driven by what consumers and stakeholders are accepting and expecting. We can debate biodegradable, versus recycled content, versus greenhouse gas emissions. Biodegradable is something that resonates with consumers quickly, so it'll always have an aura about it. But from an environmental standpoint, closing the loop with recycled content and minimizing emissions into the environment have scientific staying power and as those broader environmental issues will continue to evolve in a broader society conversation.

Packaging is a lightning rod for our challenges with the environment, so it's visible and creates emotions. But brand owners are looking for what resonates with consumers, what's easy to understand, and yet, they don't want to be accused of greenwashing, making sure it makes sense with NGOs. So you're going to see a variety of things depending on the packaging format, the materials, et cetera. In terms of their goals, what's really evolved over the years is a move from, let's call it individual company goals to broader industry goals, which brings the benefits of consistency and alignment. As broader environmental issues continue to pack society and citizens, I see the pressure for companies. They will be asked, what are they doing, especially with their brand, so these goals can continue?

As we look at the ambitious targets that were set for 2025 ... I remember getting calls from some of my colleagues in the industry, as I was involved with setting public targets, and trust me, the targets we set were not sandbag targets. But we were expected to be able to achieve these. A lot of these 2025 goals are quite audacious, and if you step back, what's been the big benefit, industry has really aligned around that. Now, whether we hit those goals or not remains to be seen, but I'm a strong believer that because these goals have been set, a lot more progress probably has occurred than if we go back to before this time when each company had their own. It was kind of a, how do you compete with the different shareholders and other groups to see who could come across the best?

So in terms of their sustainability goals and their journey to meeting those goals, a lot of people obviously ... and this is what's exciting about this. It's coming from the top of the house, and I think the top of house is really understanding that there's factors that are beyond their control with the whole recycling infrastructure and let's call it composting infrastructure, et cetera, that make it challenging in some of these places. But the consumers see packaging as the gateway to making their sustainability choices. As these goals are now front and center, the push and, I think, the accountability will be there industry-wide versus individually from a company standpoint. But it brings a different set of pressures as we get to there. What's next? But this journey will continue, and this is why I had such good friends and corporate affairs when I worked at those companies.

Now, the last part, how do you feel about access to sustainable packaging solutions? In a phrase, better than before. As I speak with private equity investors, I tell people, "This is the spot where there's money to be made." Why is there money to be made? Because there haven't been a lot of great solutions, because it's a very challenging environment. But the push is there, and the push isn't going away. You can see it in some of the introductions across various material innovations. You can see it if you work with the recycling industry, where artificial intelligence is coming into play. It allows, with infrared readers and optical scanners, maybe materials that weren't picked up before.

I'll go back to my Lunchables days again. We were looking at making that plastic tray out of high-density polyethylene so it could be recyclable like milk jugs. Well, in hindsight, that was a fool's errand, because really, that stuff back then was manually sorted by shape. No plastic tray, no matter what it was made of, was going to be pulled out. But nowadays, as you look at this equipment, this technology with AI, those possibilities might come into play much more than ever before. So people are feeling better, and I think some of this is a better understanding of what technology is playing both for materials and also from an equipment and infrastructure standpoint.

Thilo Henkes:
Got it. Well, I think this is one of the more interesting points coming out of the study, is that brand owners actually do feel like they have sufficient access to materials. I think there's been so much discussion in the marketplace around the disconnect between the supply and the demand. If all of these brand owners were to hit their 2025 targets, there wouldn't be sufficient supply to satisfy all of that demand. So it remains interesting to me that they're quite optimistic that they have the access, the sufficient access to supply.

Roger Zellner:
I can't wait for 2025.

Thilo Henkes:
A corollary here. I'm going to slightly change the direction here, but for a while now, brand owners have been telling us that the e-commerce channel does require different packaging demands. What is the opportunity here for converters, Jeff, specifically related to changes in e-commerce packaging that brand owners require?

Jeff Cloetingh:
So there is a lot of opportunity for converters in thinking about how to help brand owner customers meet the more rigorous channel demands associated with e-commerce. In some cases, it's related to labeling. In other cases, it may be related to protection. One example, in the food service environment, there has been an increase in ready-upon-delivery, mobile order type profile of food being produced so that when you are able to order the food online, it's ready for you to pick up, grab and go, or consume in store.

There have been labeling as an innovation in the food service environment, where an online order, or an item modification, or an individual beverage item now receives a label to have a connection between the purchaser, the order of that food or beverage product, and the food service operator, where they can use it to improve workflow in order flow to be able to track special changes to that order with oatmilk or the specific creamers that ensure that the item has assurance that it's exactly what the patron ordered when they ordered it online.

The second is around protective packaging for transit, and this is including product that is sold by the brand owner direct to consumer, includes goods that are sold through a traditional brick and mortar store, through a retail channel, and also includes product that's sold through e-commerce marketplaces such as Amazon. In many instances where you're able to, as a brand owner, identify the channel that that product has ultimately ended up towards, there's been innovation, and converters have been working with brand owners to design inside-of-the-box protective packaging that facilitate both protection, but also offering a elevated brand opening experience, so that when you order a three pack of specialty jams, that you see them nested inside of their own compartments, which not just increases your engagement with the brand, but also gives you assurance that those three jars of jams have not jostled around inside of the container that ultimately gets to your door, creating the risk of spillage or breakage, which is a very unsatisfying experience as a consumer.

Thilo Henkes:
In addition to sustainable offering and in addition to e-commerce-ready type packaging, brand owners are also telling us that they expect converters to be able to offer specific digital tools. Jon, what specifically are brand owners looking for here when they talk about these digital tools?

Jon Moss:
Yes. This was an interesting one. So when we looked at the data, and largely in parallel with or in common with our discussions with the market, there's a whole host of tools that brand owners would like. This can include B2B customer portals, digital prototyping software, and in general, everything that we proposed within the survey was extremely well-received. But thinking back to when we did the survey in 2023 and on the back of multiple challenging years of delivering product to the marketplace, the two digital tools that mattered most were both supply-chain-related.

The first was traceability features, so ensuring that you can monitor products as they move through the supply chain. You can understand how much inventory sits in distribution, versus in the back of a retailer, versus on the shelf at a retailer, and can start to understand what might even sit downstream at your consumer, given normal consumption behaviors. Then, the second was around some combination of RFID sensors or QR codes on packaging, each of which can help unlock incremental information to the consumer, but also enable greater tracking by the brand owner as products move downstream through the supply chain.

So this is a bit of an area where they'd like to have everything digital, but it really was these supply-chain-specific tools that bubble to the top. It'll be an interesting one to keep an eye on in coming years as supply chain pressures wane to see if these continue to be important or if they fade more to the middle as brand owners start to get greater comfort with their post-pandemic supply chains.

Thilo Henkes:
This topic of supply chains is an area I'd like to go to next, and it is the fourth and final key theme that's come out of the brand owner packaging study here. That is really related to brand owner packaging sourcing strategies. Jon, let's continue with you. As you pointed out, some of the supply chain shocks and the stocking and destocking dynamics that we've seen over the past 24 months have created some great complexities for forecasting demand for converters. What are brand owners telling us in this study about their inventory levels in 2024, and how do we think that that might impact converters?

Jon Moss:
So I think it's worth taking a step back before we get into the 2024 answer and just providing the elongated narrative starting at the beginning of the pandemic and understanding what led us here and why. Looking back to 2020, it was the time when there were only a sparse number of potatoes on the shelf at the grocery store, and it was tough to get all of your consumer staples. This obviously led to significant accumulation of inventory in consumer shelves, down the road, surges in packaging production and goods production. This dynamic continued as supply chain pressures took hold. There was an increasing demand for all sorts of packaging and as much finished product as you could possibly sell down channel with limited consequence and understanding of any sort of bloat that had built up.

By 2023, the channel and downstream was fully overstocked. We do believe that the channel and retailers destocked through 2023 and that on an overall basis, we expect this to abate by mid-2024. In terms of what the survey has shown us as well as our broader work, it's important to think about this through a few different lenses. First, what is the packaging format that a brand owner is buying? Second, what is the end market that they're participating in? Then, third is around, what's the type of brand owner? Specifically, are they a tier one Kraft or a Mondelez that has tremendous buying power over their suppliers, or are they a plucky upstart? Similarly, for end markets, certain categories like dairy are quite perishable, and then certain packaging formats, such as rigid containers, tend to be difficult to store. So from our perspective, if you're looking at a category like labels-

Thilo Henkes:
Jeff, just as a corollary to that, I think the brand owner study has also gave us some interesting insights as to how brand owners think about nearshoring their supply chains.

Jeff Cloetingh:
Sure, and it's all relative here. Packaging and the supply chain associated with food, beverage, beauty, personal care tends to be largely domestic to begin with. The 2023 study showed that 84% of packaging materials for brand owners surveyed came from domestic sources. With that being said, there is expected to be an increased uptick in those materials that are used for packaging that are sourced from the US. We anticipate, based on the study, that it'll increase another two points over the course of the next four years after increasing about six points over the course of the last four years, and there are a couple of reasons for that.

If you were to ask brand owners this question last year in the study, the most important reason was the security and the continuity of supply. It's no longer a story about security and continuity of supply. That's actually dropped on the list in the current study. This year, it was about responsiveness. It was about improved cost profile, about improved lead times. So we're out of the period that Jon spoke about where there was an urgency to be able to get supply, because the supply chain was so constrained. Brand owners have moved, now, more into a, what is the right way to optimally configure the supply chain, including packaging converters? That is ever so slightly tilting more towards domestic sources of supply at the expense of imported packaging materials.

Thilo Henkes:
Excellent. Well, this concludes the podcast as we evaluate some of the key themes coming out of the packaging study, brand owner study from 2023. I want to thank three panelists here who've been discussing this with me, Roger Zellner, Jeff Cloetingh, and Jon Moss. Thank you all very much. Appreciate everyone listening.

Host:
Thank you, our listeners, for joining us today at the Insight Exchange, presented by L.E.K Consulting. Links to resources mentioned in this podcast can be found in the show notes. Please subscribe or follow for future episodes wherever you listen to your podcasts. Also, we encourage you to submit your suggestions for future insights online at LEK.com.