Rumblings, musings on supply chain and greed in dietary supplements

This article is part of Natural Products Insider’s series of opinion columns from industry stakeholders. The op-ed commentaries represent the views from the author(s) and/or the organizations they represent, not necessarily the views of Natural Products Insider or its editorial staff.

 

It’s rare that I pick up the proverbial pen to write articles for industry publications these days—I tend to limit my musings to Facebook only; it’s like rage therapy for me.  However, today is different; I’m trying to channel my “rage” into a more useful purpose (I hope) than mere venting on social media.

As you slice your way through this, keep in mind these two insightful quotes from Edward Abbey, American author and essayist:

Growth for the sake of growth is the ideology of the cancer cell.

There is no force more potent in the modern world than stupidity fueled by greed.

Setting the stage for sin: Supply chain disruptions

For more two years now, we have seen serious and unending disruptions in that abstract thing we call the supply chain. These disruptions are not limited to the dietary supplements market; virtually any and all “stuff” that has to be manufactured and then moved more than 100 yards from there to here has been disrupted, causing the costs of these goods and services (COGS) to increase substantially. In fact, COGS continue to spiral upwards as I write this. 

Those of us who have been in the supply side of the industry for a minute or two saw all this coming as far back as Spring 2020, just as Covid-19 was fulminating all over China and becoming a nascent, global a public health menace.  For me, the big tell was that, as usual, all the Chinese manufacturing facilities we rely on for “stuff” closed down for the Lunar New Year and Spring Festival at the end of February 2020, sending their blue-collar manufacturing employees home to celebrate the season with their friends and families. This is not a huge problem on its face; it happens every year. And just like every year, a substantial portion of the dietary supplement industry forgets the holiday and scrambles at the last possible moment to get orders in for raw materials to ride out the three to six weeks of silence these Asian holidays bring. But 2020 was to be different, being astrologically the Year of the Rat: How apropos!

The Chinese employees went home to various parts of China for this holiday and simply never came back to work after the holiday. Covid-19 had struck, and China’s Zero Tolerance policy for the virus forced the lockdown of people all across China—over 100,000,000 people affected—for weeks and months on end.  Wuhan, Hubei Province, likely the ground zero for Covid-19 and certainly China’s most affected city/province, also happens to be a major hub where substantial portions of dietary ingredients for export are produced.  And Wuhan was put on the strictest of lockdowns. 

With no employees back at their stations in the various factories to make the stuff we rely on to produce our finished dietary supplements, shortages and price increases became the rule.  It was, and to a degree still is, a giant and unprecedented hot mess. And with the Omicron variant burning through China now, we’re about to see a severely distorted and damaged supply chain really get leaned out even further. As once again, millions of quarantined employees being barred from traveling to their jobs equates with manufacturing coming to a halt. Are you ready?

But it was not just manufacturing in China that was decimated by the pandemic. The logistical aspects, moving this box here to somewhere over there, also came to a grinding halt. Again, there were no employees to pilot the trains or planes, drive trucks, load the slow boats, etc. Not just in China either, as we had and still have the same problems in America; it’s a global phenomenon, in fact. The problems grew and continue to grow today due to inefficiencies, rising costs of fuel, inflation, the unfortunate situation in Eastern Europe and another problem that is an open secret in our industry, albeit rarely noted in public company, a 900-pound pink elephant in the room if there ever was one: Rapacious greed!

There is no torrent like greed

Every industry evolves, changing dramatically over time.  I have been in our industry since the late 1980’s, and I have seen more apple-cart-upsetting changes than I can remember. But one constant since my entry into the industry has been the unhinged levels of greed. , Despite internal and external pressures attempting to push down margins and profits (e.g., Amazon, Walmart, D2C buying, expensive-lightning fast shipping demands by consumers, the fall of the brick and mortar stores, etc.), I must admit I am both awe-struck and disappointed as to how clever and to what levels—absurd and often illegal as they are—companies are willing to go in order not just to keep margins super high, but to actually improve and increase them.

These efforts are almost universally a detriment to the consumer; while profits may stay constant or even improve in the short term, in the long term, I am literally waiting for the other shoe to drop, for consumers to wake up one day and say something like: “Seriously, this is what you guys consider to be a legit pre-workout powder?  It cost THIS much for only 16 servings in this container instead of the 30-28-24 servings in the container I bought last month and the month before that?  Why the heck is this ingredient even in this product, what does it do besides occupy space and add weight?”

There is going to be a market correction in my opinion.  Many brands are not going to like this.

The storm of consumer revolt may be just over the next hill.

Historically, the net margins many brands in our industry reap would make Mexican cartel members blush. In fact, I am shocked that some of these infamous criminal gangs have not given up pushing cocaine, heroin, methamphetamine and even fentanyl in order to enter the dietary supplement spaces—let’s face it, the margins are usually better and the risks of (serious) punishment for doing something illegal are much lower; FDA and even DEA are seemingly quite willing to overlook all but the most obnoxious, overt and repeat offenders in our industry. When I started out in this industry back in 1988, I worked at the GNC store at the South Shore Plaza in Braintree, MA. I remember The Cybergenics® Total Bodybuilding kit had just come out. Our store received six of these slick looking kits (complete with a VHS videotape). I also remember the MSRP was $199! This was an outrageous sum of money in 1988 but even by today’s standards, that is way above the high end for most dietary supplements. As I stacked the six boxes allocated to our store in a neat little pyramid in the GNC window, I remember thinking: ”These will all still be here in six months collecting dust, and then they will be sent back; they will never sell, not a one. Nope!  $199? Fuck you L. Scott Chinery! (he’s the genius who came up with this idea).”

The Cybergenics kits in my store, all six of them, sold out in less than one day. The same situation was true for every other GNC store within a 50-mile radius that I called for my customers pleading in desperation to buy a Cybergenics kit. Suffice it to say, Mr. Chinery made what I refer to as a ton of “F-you” money from this idea.  One might even say in the sports nutrition realm, Chinery was the original “market disruptor.”

My personal opinion was that the contents of the Cybergenics kit—the excellent and effective workout/training methods provided on the videotape aside—were worthless snake oil that had no clinical effects for the consumer.  My educated guess was the entire kit cost Chinery maybe under $20 to make. I suspect (but do not know for sure) he sold them for $80 to $100 each to wholesalers and maybe GNC, who flipped them as fast as they could get them for $199! So Cybergenic’s gross margin was somewhere in the 400% to 500% range.  Nice, eh?  Great money if you can get it.  And in our industry, you absolutely can!

Chinery was legendary in the industry for living a lavish and somewhat eccentric life out of Tom’s River, New Jersey. Private jets, extravagant soirees in trendy NYC venues, etc.  A friend of mine, an original “before and after” photo model for Cybergenics, once was in Europe on business and had a craving for a particular restaurant in NYC’s Chinese food. Chinery sent an employee from Jersey to NYC to “buy take out” and flew the spring rolls and dumplings, along with the employee, to Europe by chartering a private jet out of Teterboro Airport (across the Hudson River from NYC). But not a lot of people outside the industry knew of the opulence, extravagance and some might say, utter waste of money, by Chinery.

I mention Chinery’s apparent greed and absolute success at satiating said apparent greed because he was the first industry guy I knew of who pulled this type of thing off. I actually admired and still admire the guy; he was a pioneer.  He saw an opportunity, and he jumped in feet first. Gutsy move.  In the ensuing decades, I have come to know several dozen people who have made 8- to 9-figure money in the industry by marketing questionably effective (and questionably safe) products.  No need to mention them all here. Suffice it to say, I do not admire all of the people who have followed Chinery’s pathway of avarice and decadence.

Greed also affects other brands in the space

In 2010, I was the #2 guy at arguably the most successful sports nutrition company in America. I believe that while some of the products we sold were at least “questionable” as legal dietary ingredients/supplements, a lot of the products were absolutely air-tight compliant and were “halo” type products. They were quite simply the best of the best, and we won virtually every GNC award that year in the sports nutrition category. Either way, customers loved the products, and so did GNC.  Then something happened that I never saw coming.

A smaller, hungrier and greedier brand came along.  They began to market, to my surprise and horror, something called a “concentrate,” as if this was a good thing—“We’ll give you all the benefits of the big scoop product in that big can but in a smaller scoop, and smaller can at a “slightly” lower price.” Basically, they put a potent stimulant and illegal drug in their fat burners and pre-workout powders—a drug that was exceptionally euphoric—and heck yeah, it “worked,” but they put in little else worth remembering.  So, people “felt it almost immediately” and merely feeling it, aka immediate gratification, is a metric into which consumers fall for over and over again when evaluating too many products in our industry. 

Less is now more. In some ways it was, because this tiny container was essentially just an illegal stimulant drug and little else formula-wise; it’s cost of goods sold (COGS) were about five bucks per unit (another important point for later), This was less than 1/3rd the cost of our halo pre-workout that was loaded with cutting edge legit ingredients and backed by decent science, or at least science as far as the Dietary Supplement Industry understood the meaning of the word. But that staggering COGS difference flushed this concentrate brand with money not just for advertising but for outright bribery too. 

“Spiffing” an employee is common or was common in the industry in the between 2004-2014+. A spiff or PM (a financial incentive) might be 2% to even 5% of the sale price of a product. These concentrate guys, figuring the average and underpaid sales guy was at least as greedy as they were, pushed that spiff to 10% or even higher, in some cases, when you factored in the “plus one” and “plus two” deals they made. Who does not want to sell the product they make the higher commission on, correct?  Consumer be damned. “You’ll buy it and like it! Trust me bro, this is the can you want.” The concentrate company made well over $100 million in like two years.  Unfortunately, most of the executives at the concentrate company, all who owned multiple luxury, million-dollar homes (a lot of money back in 2010), British and Italian high-end cars, $100k Patek-Phillipe watches and the like, they all ended up in prison for … you guessed it … fraud and violating a bunch of other statutes meant to protect the consumer from this sort of behavior.  A clear case of Icarus flying a little too high for a little too long. But there were other similar companies, dozens in fact, that didn’t make quite as much money, flew under the radar and were left completely alone by law enforcement—much to the detriment of the consumer and, maybe, the industry en masse.

Today, with the rise of social media, we can easily see the unending, transparent greed of many supplement company owners:  YOLO bro! They are “living their best life” and, rather than trying to hide it, they want to snap pictures and videos of the private jets, the Lamborghinis and Bentleys, the $5000 dinners at Michelin starred restaurants, etc., for their exacting, curated social media feeds.  

Let’s be clear about something.  I have no issues with capitalism and people earning obscene, garish amounts of money.  I do think advertising this on social media reeks of a parvenu, but that is a relatively minor quibble.

What makes me uncomfortable, however, is the person/people selling a misleading lifestyle—the guy with the spray on tan, whose body was built by steroids, research peptides and cocaine/Adderall and, clearly, not the dietary supplements he is hawking—making videos in the gym explaining that if you buy his product you, too, can look like him (or her, plastic surgery notwithstanding), and your similar success in life is just around the corner, only a $39.99 purchase away.  Sell them the dream, right?

What has all this got to do with the supply chain?

As ingredients become scarcer and COGS go up, companies are looking for ways to preserve margins or even increase them to maintain their Lifestyles of the Rich and Famous (80s TV reference), in order to “grow their companies” so they can cash out to some hedge fund and then bro’ up on the beach somewhere for the rest of their lives. 

How does one accomplish such a feat in the time of the Great Pandemic?

I got a phone call a few months ago from a long-term friend and company executive.  His company has a great reputation for putting out pragmatic products backed by reputable science.  Let’s say he also “lives well,” as does the athlete who is the titular head of the company. My friend was looking for a (cheaper) source of both citrulline and creatine monohydrate—prices per kg went from about $10 per to $30, and $4 per to over $30, respectively, during the pandemic. Both ingredients are well validated as safe and effective at certain/known doses. My friend’s company was well known for using both ingredients at the validated doses.  But as the COGS skyrocketed and no alternate and less expensive sources were to be had anywhere, my friend was faced with a choice: either learn to live with a smaller profit and a slightly more frugal lifestyle or find some way to cheapen his product.

In the end, after our discussion, he opted not to change the formula of the product at all. Instead, he elected to cut the number of servings in each container by about 1/3rd and charge the same price for this product as before.  So, his margin per unit essentially remained unchanged, the price to the consumer for a can remained unchanged, but in the end, the consumer is getting only about 2/3rd of the product he used to get that that price point. When asked about this on social media by customers who noticed this discrepancy, the company’s response was simply, “Hey man, we’re all paying more and EARNING less; the supply chain problem is killing all of us.” 

Not exactly a completely true statement here on its face.

Another phone call I answered was from an industry OG (veteran) who called me to complain, again, that there is no money in protein, and why do we even bother selling it? I hate the protein game. It does not matter if the price per pound of whey protein isolate 90% (WPI90) is $4.00 per or $10.00 per pound; I receive calls like this at least once per week. The reason is it is well known that the protein game, whey protein in particular, is the least profitable segment in sports nutrition, if not of the entire dietary supplements market.  Notice I did not write that this space is unprofitable. It’s just less profitable than selling “crack-n-stim” weight-loss pills and pre-workout powders and useless “testosterone boosters” that are plain cringeworthy. Translation: You need to sell a lot more cans of whey protein than you do other items to maintain a Lifestyle of the Rich and Famous. 

Because protein is a high-demand product yet looked down upon as lower margin, the temptation to cheat—spiking or adulterating the product to fool the consumer and various testing methods into thinking there is a higher level or quality of whole proteins in the can—is very high. Amino acids (free form) historically used to spike protein include glycine, glutamine and oddly enough, taurine. This happens when the price of these amino acids becomes a lot less than the price of a whole protein. And spiking occurs no matter the wholesale trade price of protein, but it surely happens more frequently when that cost of WPI90 is close to $10.00/lb. 

[See related article on protein formulating shenanigans for more info.]

So, there is “money” in proteins, even expensive whey proteins. And there is supply. It just costs more now than in the past. Sure, we’re seeing container sizes shrink, so even one pound “baglets” of whey protein are popping up now even if consumers are used to seeing 2 lbs. and even 5 lbs. cans. Slack filling, a questionably legal practice by leaving increased space between the actual product and the lid, is also starting to trickle back into the industry. And as any class-action attorney worth his bar card and Brylcreem will tell you, merely putting the words “sold by weight, not by volume—some settling may occur during transport” on the label of your protein container likely will not save you in court.

The magical five-bucks threshold rears its silly head

The last two examples I want to discuss is what prompted me to write this Tolstoyish-sized article. 

A long-term client/friend of mine called me with a dilemma.  The company for which he is an executive is the OEM co-packer/designer for one of the most successful prebiotic gummy formulas in America, maybe even the whole world.  The original product was based predominantly on <expensive prebiotic ingredient redacted>, a soluble fiber usually extracted from chicory.  This ingredient has some preliminary to well-correlated data showing potential benefits to many areas of health and, to formulators’ delight, has an amazingly smooth and creamy mouthfeel. It’s great stuff, if you ask me; I like this ingredient so much that it is the prebiotic of choice for me when I go to formulate an MRP (meal replacement powder) or protein powder. 

Now this product my buddy called me about was doing seven figures in distribution sales to just one client month in and month out.  And yet he called to tell me they changed it. Not that they were thinking about changing it. Not that they were looking for advice on how to change it to reduce costs. They had already changed it.   In fact, he called me only for my help to justify why they lowered the <expensive prebiotic ingredient redacted> dose by more than half and replaced it with several, other prebiotic ingredients he knew ZERO about other than they cost less than <expensive prebiotic ingredient redacted> per serving.

“Bruce, I need to you to write a white paper on why these new ingredients make the reformulated product even better than the previous product, why we are coming out with a ’new and improved’ version,” he said. “I have a $1.7 million PO (purchase order) held up until I can convince the head of purchasing and VP of sales at <client company redacted> that the new product is a better product, bro!”

I guess “better” like all adjectives are relativistic.  Better for whom?

The price of that cool, creamy, prebiotic fiber has increased a fair amount over the pandemic but not at the rate of say creatine, citrulline or milk proteins.  And this prebiotic fiber gummy had a COGS of just under $5/per packed out unit the profit on this product was well into the triple figures.  But once the COGS crossed the “magic line” of five bucks, it tripped an algorithm at some bean counter’s desk and was flagged for “reformulation.” That the increase beyond $5 COGS was maybe $0.77 per unit is irrelevant. It seems $5 is a magic COGS point for a whole host of products and sub-categories in the dietary supplement space, from vitamin and mineral formulas to fat loss pills and even prebiotic gut health stuff. What is so magical about that amount?

Since as far back as I can remember, our industry has been firmly and rigidly entrenched with the idea of profits as solely a percentile or qualitative look and never a hard-dollar or quantitative look. If I want to get a product into the hands of a consumer where the price to the consumer is between $29.99 to $49.99, what is called the “Goldilocks Zone?” Unless I am selling off a Shopify-type platform D2C (direct-to-consumer), I need my product to have a COGS of around five bucks to maintain triple-digit margins. 

Consider this—and I know I am letting the cat out of the bag here, a cat that can’t ever be put back in the bag—if it costs me $5 to make, I’ll sell it to a distributor/wholesaler for $10 to $15, giving me a gross margin of 100% to 200%. I’d make even more in D2C-land, obviously, but I’d rather drop container-loads off at a distributor and profit a little less per unit.  The distributor/wholesaler then flips it for $20 to $30 to the internet/B&M retailer who sells it for $29.99-$49.99.  Or it ends up on Amazon.com or Walmart.com for that price if they are the 3PL (third party logistics) partner and primary internet site driver, maybe even less if it’s a Groupon.com type of thing.  Once a product exceeds fifty bucks it is out of the Goldilocks Zone and no matter how useful or amazing the product may be—our Cybergenics example above notwithstanding—sales volumes drop off precipitously. 

There are huge pressures from sales platforms to keep the price-to-consumer in that Goldilocks Zone while maintaining the profit margins I have already noted. Thus, most companies start there when designing a product and then work backwards with regards to what they can put into the product based on which segment of the distribution pie needs to see what percent in profits to push or move the product along up-chain. It’s not “best product” for the consumer, usually.  Sure, there are exceptions of course. Usually, it’s best product for funding my new Bentley and fishing boat.

This is why people whine that there is just no money in protein: ”Why do we even bother doing it?”  There is literally no way to make a protein powder having a COGS of only five bucks. So, while there is a good and stable margin in protein, a sub-category that is super-high in demand in the business, a lot of brands either overlook it completely or minimize its impact in the brand product suite.  Hey, maybe one day soon one of those concentrate companies will find a slick way to make a “protein concentrate” where 5g of protein per serving somehow gives you the “same benefits, bro,” as 20g to 30g of protein?

After all, to the uninitiated, which many venture capitalists and hedge fund decision makers surely are, why would you waste your time on pushing proteins with a lower margin, a vastly lower margin, than fat loss pills or any other non-protein, triple-digit percentile margin product?  The goal is growth – grow the company MoM (month-over-month), YoY (year-over-year) so it’s EBITDA (earnings before interest, taxes, depreciation and amortization) is as high or appears as high as possible and you can sell it off, cash it out max and bro down on the beach in the tropics somewhere.  Yeah, I want Dan Bilzerian’s life too, folks. I get it:  Shark Tank mentality.

I’m working with a company now. The owner is another legacy brand, albeit a smaller one from the Golden Age of sports nutrition. He is trying to reformulate his pre-workout; he thinks he can reformulate it into a mega-success.  What he does not have and does not realize is that he could put saw dust and caffeine in the can if he could just get the correct social media influencers behind the product to really push it—this would make it a mega-success for a minute or two. 

He needs to save money because the COGS on his carefully etched and crafted formula are about 20% ($1.25) per can too high. I advised him to just eat the $1.25 and learn to live with a smaller margin while selling the better product. I might as well be speaking ancient Babylonian. His idea: We call it “malification”—there are some ingredients that are supposedly available as “malate” salts (malic acid is the anion part of the salt, which is cheap or cheaper than the other part of the salt, the cation part which is the legit active ingredient portion that does something.) 

Today, there are predominantly three “malified” ingredients in sports nutrition.  I am not going to mention them by name but in my 25+ years in the industry, the dozens of samples of these malates I have paid to have analytically tested have never tested out as to being true malic acid salts. All of them have tested out to being just “shake and bake” admixtures of cheap, malic acid and the more expensive, desirable active ingredient. 

So, this guy does not think the consumer is going to notice that he put in a much cheaper “malate” instead of the original, expensive compound, and he’s probably correct. Do malate salts of ingredients really exist? Let’s just say I can’t prove that unicorns exist or do not exist. I mean, just because I have never seen a real, live unicorn … but there is another problem for him.  Actually, he has two problems.  By mollifying through malification, he’s possibly mislabeling his product. You see, if he claims that the cheaper malified stuff is legit ionic salt on the label and it’s not, that’s mislabeling and consumer fraud. That’s the first issue he has.  The second issue is if he really has found that unicorn, is it even legal to put into the formula as a dietary ingredient? Is it an ODI (old dietary ingredient)?  Is there an NDI (new dietary ingredient) notification on file with FDA?  Are there any public studies/data to support its GRAS (generally recognized as safe) status as a food? 

I mention all this, but he does not care. His idea is low risk and, sadly, nobody will test it. His brand and the co-packer have a legal obligation to perform ingredient identity testing as well as finished product testing but currently FDA apparently is pretty much only conducting inspections/audits of brands and facilities via video-conference call due to COVID-19, so they would be easy enough to bullshit through an inspection anyhow (While the cats are away…). He is going to use “di-something malate” instead of the real ingredient so he can shave a buck and a quarter off the COGS of his super cool pre-workout powder—which is destined to be the next big thing in the space—and maintain his margin to the dime. Five bucks, right?

Private jets, palatial domiciles, high-end luxury cars and gold Swiss watches in our industry require margins like this, behavior like this. It is just how it is.

For more than 25 years I was begrudgingly OK with this type of thing even if I was forced to swallow it with a metaphorical sword over my head. But as I grow a little older and maybe wiser, my goals truly morphed into something more honest and more forthright.  I want to help build companies that produce stuff people actually want and need, not stuff they “think” they need because a ditzy, 18-year-old “influencer” on social media spent 20 hours doctoring video and stills to get that perfect angle and filter effect of the product and the life. I would prefer to build a company that creates good, lasting jobs in America for generations, white and blue collar, rather than sell out to a corporate raider who will lay off workers while I get on my fractional ownership Gulfstream with bags of money in order to buy more high-end watches. How many Swiss watches does one really need?

Fiduciary responsibilities notwithstanding, I think I have —I would hope we all have— some responsibility to try to leave this industry in a better place than I found it and certainly no worse.  I prefer this over a “damn everyone else, I am getting paid out every last ducat I can pull out of this ride” attitude.

But as prices of the edible ingredients, plastic containers and paper labels, and the costs to manufacture climb— due to “global supply chain crises,” what you used to get in a $5 COGS product last year or in 2020 now may have a COGS of $10 or higher. This causes the qualitative margins/percentile-look margins to really nosedive.

You already know what happens if you have been paying attention. Brands reformulate downwards to make the $5 COGS again. That means less-desirable ingredients in the formula, lower ingredient amount per dose in the serving and fewer servings in the can or container, all for the same “buy it” price the consumer paid for the better product maybe two years ago.

Eventually you’re going to run out of numbers-of-servings to cut out. You can’t sell a product with negative servings nor a product without any active ingredients. And yes, consumers eventually really are going to notice this and take their dollars out of the industry.

Bruce Kneller is a longtime sports nutrition formulator/developer and currently is a principal (the “K”) in Millstone, NJ-based KLZ Holdings LLC along with Hector Lopez, MD, (the “H”) and Tim Ziegenfuss, PhD (the “Z”). KLZ is an early-stage R&D company with two US patents and one commercialized product in the sports nutrition space (3D Pump Breakthrough).

 

 

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