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GNC – Supplementation Gone Wrong

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Specialty retailer's troubled performance this year symptomatic of an outdated and ineffective operating model

With 2015 drawing to a close, GNC has missed earnings estimates in each of its first three quarters, and sell-side analysts are now projecting a >2% decrease in full year 2015 comp store sales.  Additionally, a lawsuit announced in October by the state of Oregon alleges that the company knowingly sold products that contained unlawful dietary ingredients.  All of this combined to make for a very bad year for GNC, as its stock price dropped from almost $50 at the end of 2014 to ~$31 now, representing a decline of close to 40%.  Was 2015 just an unfortunate year for GNC or is it a harbinger of worse times to come?

Business Model

GNC’s business model is quite simple.  In an increasingly health conscious world, it gives value to customers through providing high quality, trusted, nutritional supplements as well as helpful advice in identifying the correct supplements that fit their needs.

Operating Model

Go-to-market Strategy
The way GNC reaches its customers is not much different today than it was when its first store opened in 1935.  With a
network of 8,900 stores, GNC’s primary method of serving customers is through the brick and mortar channel.  In fact, its online presence is so small that the company does not even disclose the amount of sales coming from that channel.  However, the rationale for having a brick and mortar presence in the nutritional supplements space is becoming less and less compelling.  Supplements have a long shelf life, its use is easily predicted, and there is no need to try or test the product out before purchasing.  It is the ideal product for online ordering.  On the other hand, GNC would argue that the value of its brick and mortar presence lies in the service and helpful advice provided by its sales staff.  After all, the vast array of nutritional and dietary supplements can be quite overwhelming for the layperson to navigate.

Enter Bodybuilding.com.  Sports and performance supplements represent GNC’s largest product category but Bodybuilding.com is rendering its offerings in that category obsolete.  Instead of needing salespeople to explain the different supplements, Bodybuilding.com’s online community provides a wealth of knowledge that any aspiring gym rat can access.  And with almost 12 million members, it’s the largest forum on the internet by membership.  All of this supports a robust online store with pricing significantly below that of GNC’s.  Unless GNC dramatically reverses its strategy, it will continue losing share to its online competitors.

Procurement Strategy
Since having a high quality, trusted product is a key tenet of GNC’s business model, the company’s procurement strategy represents another important aspect of its operating model.  The company currently self-manufactures ~50% of its product, with the remaining 50% sourced from third party suppliers.  While the self-manufacturing has proven reliable and consistent, its third party products have caused multiple problems in recent years.  In addition to the Oregon lawsuit this year, GNC was forced to remove all products containing the substance DMAA in 2013, causing a significant hit to sales.  The damage caused by these incidents go far beyond just the in-period revenue hit, as GNC’s reputation and brand suffers as well.  Rather than being proactive in preventing these events by undertaking more stringent diligence of its suppliers, GNC has been extremely reactive.  In fact, even after the 2013 incident, GNC chose to continue doing business with the supplier at fault, USPlabs, and unsurprisingly, the lawsuit this year involved that exact same supplier.  Finally, after two heavily publicized incidents, GNC announced that it would drop all USPlab products in November of this year.  GNC’s brand and reputation are its most important assets, yet the company has been alarmingly cavalier in maintaining them.

Conclusion

GNC operates in the very straightforward business of delivering quality supplements to customers.  Yet its flawed procurement strategy has compromised the quality of its products, and its stubborn adherence to the brick and mortar model has eroded its customer base.  It comes as no surprise that 2015 was such a challenging year for the company and upcoming years don’t look to be any better.

Sources
GNC Q3 earnings release
GNC 10K
Barclays equity research report
Forumrankings.net

11 thoughts on “GNC – Supplementation Gone Wrong

  1. Really interesting example. I wonder how much of GNC’s recent failures are due to an antiquated, high cost brick-and-mortar distribution model vs. poor suppliers/ingredients damaging its reputation. I would be interested to know if GNC considered bringing in house all manufacturing due to the problems they had with external suppliers.

    Most brick-and-mortar businesses that are successful today seem to create an in store experience that is difficult to replicate online. GNC is a good case study to look at for brick-and-mortar businesses whose in store value proposition is educating customers. Education can be done so well online these days that having a physical store may present significant cost disadvantages.

  2. Great example! I have often felt like the main reason GNC continued its brick and mortar approach was to continually cross-sell people on new products, especially GNC’s internally produced products, which I’m assuming they have larger margins on. I have yet to go and shop at a GNC without being asked to try a different brand or product than what i came in to get.

  3. Great write-up! I worked in the e-commerce division of a vitamin and supplement company for over a year before attending HBS, so can provide some additional color on the issues you highlighted here.

    First – you are 100% correct that procurement strategy is critical to companies in this space. My company did all formulations in house, and worked with vertically integrated suppliers to manufacture our products – and tested them after each stage for quality. GNC got in trouble (alongside Target, etc.) because DNA tests on selected products revealed that they did not actually contain the advertised ingredients in any significant concentration. However, it is worth mentioning that the type of DNA testing used on these products was primarily designed for archeology and paleontology, so the relevance to supplement testing was questionable.

    Second – an online presence for a supplement company is tricky. While the economics are much more attractive online than in brick-and-mortar environments, you have to keep in mind the nature of your product. At the end of the day, supplements are usually pill-like, and remind people of medicine – and they have to actually swallow the things! It seems trivial, but persuading someone to swallow an unfamiliar caplet is MUCH more difficult than persuading someone to apply a new moisturizing cream, or try out a new brand of razor, or test a new nail polish hue. That barrier to trial makes selling supplements online extremely difficult – and industry conversion rates are consequently low. I kept tabs on the GNC website as part of my competitor analysis efforts in my previous role, and think they do e-commerce very well by leveraging product reviews, expert product recommendations, and A/B and multivariate testing. Yet there are significant obstacles to growth in that channel and I will be curious to see how the industry evolves in coming years.

    Thanks for contributing a great post!

  4. Thank you for the post, it was really interesting.
    It was curious to read what they consider is the differential for GNC in having brick and mortar stores, since they don’t actually have a huge sales experience differential. Whenever I go to GNC I don’t feel that the sales staff has the information I need to help me make a good purchase decision based on my needs. They state in the business model that they give “helpful advice in identifying the correct supplements that fit their needs”, but I feel that if they had a stronger online presence they would deliver better information with customer reviews than the current in-store experience they provide – as your write-up states!
    My only question in switching the retailing channel would be how to best compete with their own brand vs. current supplement market leaders. I feel that once you are in the store it is easier to be persuaded to buy something branded by GNC, but online the draw would not be the same.

  5. I’m a huge fan of seeing stuborn giants refuse to adapt to technology and completely collapse to more nimble, innovative companies (you should a have read through the Uber piece, I heard it was REALLY good). This is a great example of that.

    You hit all the right points, but on top of all these things, I still feel it’s quite intimidating to walk into some GNC stores because of the people they choose to hire in stores. A majority of the employees in Montreal were body-builders about twice the size of any other human being making it scary for me to walk in there as an 18 year old looking to start hitting the gym.

    And as you said, this is the perfect product for e-commerce which is exactly what I started doing back in the days!

  6. When I want to get jacked, I trust the bros on Bodybuilding.com vs. the GNC sales reps. As AJB pointed out, the store clerks are usually far more interested in selling you something different than what you came in for than really helping you achieve your goals. When I went into GNC one time to get pre-workout powder except without Creatine (which has been linked through some studies to cancer), the rep (A) was completely unaware of this linkage, (B) tried to convince me to buy something else with creatine, insisting it was worth it, and (C) had no idea which of their pre-workouts didn’t contain creatine. So I searched Bodybuilding.com later that night to learn what others online had found to be a good non-creatine supplement, and was far more satisfied with the depth of the answers there.

    In this case, the business model and operating model are no longer suited since the internet has disrupted this linkage. It’s possible that GNC’s best strategy may be to drastically reduce their brick and mortar footprint and instead shift to more online sales, complemented by an emphasis on online / telephone consultations from highly knowledgeable experts. That’s one way for them to start adding value again to the customers.

    1. I don’t think they have the cost base to sell online. Most of their own products are “manufactured” by company’s like Iovate who also own brands (like Muscletech). The ironic thing is that Iovate actually outsources manufacturing to another third party. The result is that GNC is paying far too many margins to be price competitive on a site like Bodybuilding.com. They can still sell their high priced products in the retail environment (to generally uninformed consumers), but are losing volume as customers like Yaro no longer visit.

  7. Interesting post. I agree that in general brink and mortar is losing to e-commerce, and nutritionals/supplements are no exception to this trend. However, I still believe that this situation has potential for a labor heavy operating model. First, health is an area where in-person knowledge is still valued (particularly given the wide variety of vitamins and supplements available). For example, I might read something on WebMD first, but I will still go in to the doctor’s office for a professional opinion. GNC might need to have an actual nutritionist on staff for this level of professional service to be successful (like a pharmacy but for supplements). Their second option would be to leverage more of their in-store food services. Many places like gyms are starting to incorporate smoothie/shake services as part of their offering. I see no reason why GNC could not do the same, particularly with their mall locations. In both cases, they would better justify their cost of labor and rent.

  8. Procurement quality control issues should not be hard to fix. What GNC did poorly was more of the crisis PR compared with other retailers. (Bodybuilding.com also carried USPlab products but was not so badly impacted).
    I think GNC’s issues more stemmed from its business model, e.g. the reliance on brick and mortar shops. One thing that makes a brick-and-mortar shop more appealing to a online shop is the trialability of its products. You are able to touch and try, and probably learn some tips from shopping assistants about the products, before purchase. Unfortunately, in GNC’s case, there is not much trainability involving supplements, as supplement facts and educating materials can be easily posted online and more professional than many SAs. Meanwhile, this business model also limits its profitability therefore ability to compete with online shops.
    It is time for GNC to adapt to e-commerce. This is probably its last chance.

  9. Do you believe that Vitamin Shoppe (GNC’s largest competitor) is suffering from similar shortcomings of large brick and mortar presence, low e-commerce penetration and lack of vertical integration? I would be curious how they are performing to understand if GNC’s recent stumble is an operating model issue or perhaps a management or other issue.

    GNC also has a very high franchise rate, so I would be curious how their company owned stores are performing versus franchised stores – perhaps the company owned stores are providing more of an “experience” than the franchised stores and those are driving down their same store sales?

    It seems like in the age of e-commerce, and the increasing trust associated with reviews and “experts”, that GNC has to more narrowly define its customer if it wants to maintain brick and mortar presence and perhaps cater to them with fewer, more experiential stores while growing their online presence and boosting those sales and adoption with Key Opinion Leaders.

  10. As you pointed out, GNC’s great asset is its brand. While I certainly don’t lift, I’d imagine this is an industry where brand equity is valuable and products are highly sticky. I wonder why GNC isn’t doubling down on their private label offering — perhaps there’s a significant manufacturing hurdle. I think there’s ample opportunity here for them to lock customers in to a subscription agreement for automatic refills and personalized supplements that are honed for personal goals and body types.

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