Not Milk? Considering the opportunity for dairy replacement startups

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With today’s note, we initiate our coverage of the Dairy Substitutes startup sector. We have identified nine companies that compete in this market by producing and selling a variety of dairy replacement products, including replacements for milks, cheeses, yogurts, and more. Venture-backed startups in the category include Califia Foods, Ripple Foods, Kite Hill and Ruby Rockets, all of which have raised more than $5.0m.

The dairy substitutes story shares a number of similarities with that of the Meat and Fish Replication sector (which we will launch coverage of next week) and even the Insect-Based Protein market that we already cover (see our note from 9/7 here). That is: if you take (i) environmental issues associated with and (ii) health concerns relating to cows, primarily but other livestock too, and add in (iii) widespread daily consumption habits, you get the math for big potential markets.

Indeed, by our bottom up market sizing, which we benchmark against a composite of other analyst estimates, the current total addressable market for dairy products globally is over $400b. The trend line is actually

Here’s the thing…

Something on the order of 65% of the world’s population and as much as 90% of people of East Asian descent suffer from lactose intolerance. In fact, the term lactose intolerance itself is biased. The abnormal thing is to be lactose persistent (that is, continue to produce lactase enzymes past weaning).

There are a few ways to interpret this:

1. The upside: A dairy-like product (if affordable, which is a big “if” that we’ll get back to below) may appeal to a huge, global population for whom “dairy” has previously been inaccessible based in part on their lactose “intolerance”. If the dairy market is currently $400b excluding 75% of all non-Caucasians, this argument would go, then imagine what happens if you gross that up to account for the lactose intolerant community. The total addressable market could double (or more).
2. The alternative: The non-dairy consuming population has gotten by for a long time without dairy or dairy-like products. The option to adopt a new behavior is not sufficiently compelling to expand the market, so dairy substitutes are playing a relatively zero-sum game against dairy and dairy substitute incumbents.

In both cases, however, we believe the primary question when considering the serviceable addressable market (SAM) for dairy substitute startups will be one of accessibility. For example, in our analysis, when we factor in the relatively expensive price points of the products offered by startups in this sector, the rates of interest in dairy substitutes demonstrated in our surveying, and more, we estimate the SAM for dairy alternatives to be ~$9.7b — obviously a fraction of +$400b, but still a large market that will depend on startups making their products more accessible over time.

How accessible can dairy replacement products be?

There is no question that dairy substitute products in this sector are significantly more expensive (to the consumer, at least) than traditional dairy products.

• For example, Califia Farms, a leader among companies in this sector (and among almond milk brands more generally), sells almond milk for 12.5 cents/oz.
• In comparison, in 2014, consumers were outraged over the price of a half-gallon carton (64 oz) of 2% milk reaching $4, with organic milk costing $4.60. On a per-unit basis, this equates to 6.25 cents/oz and 7.10 cents/oz, respectively — almost half the price of Califia original almond milk.
• And Califia’s is not even the most expensive of products sold by startups in this sector.

Further, the products offered by companies in this sector (noting how early they are in their growth) are even priced at a premium to incumbent dairy-replacement products.. For example, a 64 oz carton of Silk almond milk (the Silk brand is owned by Danone (Ticker: BN.PA), sells on Jet for $4.59, implying a price of ~7 cents/oz (the same as the 2014 price of organic 2% milk). In other words, it’s possible to price dairy replacements at a level that’s competitive to organic dairy products. This is important on two levels:

1. A lower price expands the serviceable addressable market to individuals with less disposable income, increasing the overall category’s likelihood of success in Western markets.
2. It increases the possibility of adoption in more lactose intolerant markets, which we view as a relative non-starter if the price is not competitive.

Even if dairy substitute prices can achieve competitiveness, we are still left asking how well positioned startups in this category are relative to incumbents. When we consider the main strategic advantages of a digitally native e-commerce startup brand (i.e. Warby Parker, Casper, Harry’s Away, etc), we think first about value (cut out the middleman and pass along a better price), convenience (ship things directly to your door), customer service (connect you to an actual human being when you need help) and authenticity (build a company on principles and with practices that customers will be proud of).

If dairy replacement startups are not able to deliver meaningfully on the value dimension, will they be able to make up for that through authenticity and other differentiators? Seeing as products in this sector are largely sold through traditional channels, we believe executing on these strategic differentiators (outside possibly the authenticity component) will be challenging. So color us relatively skeptical.