- The direct-to-consumer market was on the brink of a meltdown. Now, smart brands have a fresh chance to take flight.
- Short-term shifts poised to become long-lasting D2C changes include the surge of essential brands, independent supply chains, a new growth strategy and intense consumer loyalty.
- D2C retailers that predict which coronavirus-driven behaviors will stick long term have a golden opportunity to grab market share.
“Direct to consumer” has been a retail buzz-phrase for a decade, and what a decade it was. The Internet leveled the retail playing field. Plentiful platforms made e-businesses easy to spin up. Online shopping was cementing itself as a pillar in the commerce sphere, with Amazon hitting its $100 billion valuation in 2012. Cash was finally getting cheap again after the 2008 financial crash. The D2C concept was fresh enough that competition was low. And funding flowed when, following a recessionary drought, venture capital firms started spending big in 2010.
“Back then, it wasn’t too hard to succeed as a smart person with a mediocre product,” said Ben Lehrer, managing partner of venture firm Lerer Hippeau. “A lot of MBA projects turned into real businesses.”
Plus, the decade ushered in a social media boom that tore up the old marketing playbook. LinkedIn, Facebook, Twitter and Instagram were founded in 2003, 2004, 2006 and 2010, respectively. That meant a massive influx of remnant inventory ad units — now, using “advertising arbitrage,” D2C startups could flood social media platforms with inexpensive ads.
A big, sleepy total addressable market plus low barriers to entry made for heady times. No wonder so many of those smart people missed the warning signs.
Cracks in the Foundation
As 2020 dawned, a reckoning seemed imminent.
Few barriers to entry led to overcrowding and fragmented consumer demand. A sharp increase in social media advertising prices pushed up customer acquisition costs (CAC). As the number of social media users grew, so did the expense to reach them.
VC funds started drying up. Then came a series of high-profile D2C failures, distilled to their essence in the shuttering of Brandless, which we’ll use as our poster child. Its closing announcement stated what had become obvious: “While the Brandless team set a new bar for the types of products consumers deserve and at prices they expect, the fiercely competitive direct-to-consumer market has proven unsustainable for our current business model.”
We can’t blame Brandless’ CEO, Tina Sharkey, for going along when Softbank’s Vision Fund asked her to share the most ambitious version of her business plan — or for taking funding based on that pie-meets-sky vision.
“They were like, ‘Come on, show us your real plan,’” Sharkey told the New York Times. So she outlined an expansive proposal to use machine learning, big data, curation and community-building to create “efficiencies.” In July 2018, SoftBank invested $224 million.
By February 2020, Brandless had joined the ranks of D2C retailers falling victim to overfunding and the “grow at all costs” mentality that permeates the startup sphere. Mega-rounds of venture capital had saddled the brand with impossible expectations that not even $224 million could bring to fruition.
By March, the D2C business model had reached a critical juncture — just not the one we all expected.
The Month Everything Changed
The effect of the pandemic of 2020 on all sectors of the economy will be studied in b-schools for decades. A major theme will be its toll on brick-and-mortar retail: Neiman Marcus filed for bankruptcy. Nordstrom opted to permanently close more than a dozen stores. J. Crew, Pier 1, Modell’s, True Religion, Roots, J.C. Penney and many others are waiting to start their liquidations. And with just 25% of Americans saying they feel safe in stores, that list likely isn’t complete.
Analysts agree that coronavirus accelerated the structural changes we’ve seen coming across retail for the last decade. But D2C sellers shouldn’t get overconfident.
COVID-19 fundamentally changed consumer habits, with a report by Deloitte showing that net spending intent has increased in less-discretionary categories, like groceries, everyday household goods and utilities. Discretionary goods — apparel, footwear, electronics, restaurants, travel — have all seen a significant decrease. The financials confirm a trend toward frugality. According to a report from the Federal Reserve, revolving credit outstanding collapsed at an annual rate of 31% in March; that’s the largest one-month decline since January 1989. The U.S. Bureau of Economic Analysis reports that the savings rate surged to 13.1% in March, up from 8% in February. That’s the highest rate since November 1981.
As consumers deal with the ongoing effects of the crisis, D2C brands are going to feel the heat, just like their old-school counterparts. Some won’t be financially stable enough to hang on, though those with VC backers have more options than most.
“Now wait,” you may be thinking. “You say that the market is now working in favor of D2C and e-commerce. But you also say D2Cs are not immune from the financial impact of coronavirus?”
Yes. The problems D2C firms face didn’t magically disappear. Yet at the crux of this juxtaposition are some lessons to guide recalibration.
And by the way, these insights can also help traditional retailers retool.
What do we see as vital to success going forward? Essential D2C offerings, an independent supply chain, a focus on sustainable growth and consumer loyalty prioritization.
Brands that stay agile and take advantage of a once-in-a-generation, rulebook-out-the-window reality will be equipped to make a successful leap to the new retail normal. Let’s begin.
Don’t Underestimate Essentials
Old decade: a D2C market characterized by luxury brands. Lunya intrigued us with a deluxe silk sleeping set. Prose didn’t just sell shampoo; it offered us products custom tailored to our hair. And Reformation purveyed $250 sundresses with “effortless silhouettes that celebrate the feminine figure.”
Perhaps attuned to their VC funders’ psyches, D2C has been characterized more by “nice-to-haves” than “need-to-haves.”
Now, if you had asked consumers — even millennials — at the beginning of 2020 if they bought necessities like food, household cleaners and, yes, toilet paper online, much less from D2C brands, you would have gotten mixed responses, as we found in our recent deep dive into the future of groceries.
Then panic-induced hoarding, sputtering supply chains and rapidly changing behavior left shelves bare and shoppers scrambling. Distributors weren’t set up to meet an almost-overnight shift in demand, so many sellers started leapfrogging middlemen and going straight to consumers.
Case in point: Aaron Doades, CEO of Peach, a D2C provider of bath tissue, said that as of March 12, sales had gone up about 267% in two weeks. Wholesale food businesses have started shipping direct to consumers. Meal kit providers like Blue Apron, whose numbers were rather lackluster previously, have seen a significant bump in demand. Beyond Meat is combating chaos in the beef aisle by building a D2C operation. The number of households shopping for groceries online jumped from 16.1 million in August to close to 40 million in March, says Brick Meets Click.
Even farmers are getting in on the D2C action.
Are these temporary ripples made by an unprecedented black swan event? Once supply chains are restored, fear has decreased and shelves are restocked, will consumers revert back to spending their Saturdays at Costco?
We’re willing to bet that at least some of these buyers will stick around even after TP is again plentiful. In many ways, the crisis just accelerated trends that were already in play, like an emphasis on sustainability, local products, health and personalization — all of which the D2C model is well-equipped to address.
Our take: Essential D2C companies don’t need to put Target and Wal-Mart out of business; they just need to keep some of those 20-odd-million new households to come out ahead. Which brings us to Rule #2.
Prioritize Customer Retention
Consumer loyalty was hard to come by in the old normal. Hypercompetitive D2C brands jockeyed to swipe rivals’ customers at any cost, and an oversaturated market meant that a consumer could easily jump to another brand if it offered a better experience, product or deal.
Establishing strong relationships is crucial for retention. And now, three factors make the loyalty factor even more critical than before:
Consumer spending is down — and no one knows for how long: In March, consumer spending, the U.S. economy’s key driver, posted its steepest monthly decline recorded since 1959. The Commerce Department said consumer spending fell 7.5%, while personal income fell by 2%, the largest decrease since 2013. And many analysts say the picture will get worse before it gets better. Companies must closely monitor the pulse of consumer behavior to ensure that they cater to changed spending habits.
Brand loyalty is markedly down: As many as 65% of U.S. consumers said they have tried new brands after sheltering in place became commonplace, according to data from AlixPartners. Most, 79%, did so because their usual products were out of stock — emphasizing the importance of supply chain resilience, as we’ll discuss. Think they’ll come back? More than one-quarter of those consumers expect to stay with the new brands post-crisis. If they play it smart, some of those firms could up that percentage. Work with marketing to identify recent new customers and cement those relationships.
Experiences are paramount: People are seeking connections now, and in new ways and places. Customer interactions with a company, particularly during times of crisis, can trigger an immediate and lingering effect on their sense of trust and loyalty. Value, reliable service and quality products will always be important, particularly in a slow economy, but experience and connection are what set a company apart in highly competitive markets.
Especially given a post-coronavirus recession, these trends are unlikely to change. Consumers will be selective in their spending, meaning that cultivating loyalty through superb value, service and experience must be a priority.
Establishing that loyalty can lead to the (sustainable) growth that so many D2Cs are seeking. Customers who trust your mattresses or supplements are more open to trying your pillows or wellness programming.
Smart D2Cs that are working to meet the needs of their consumers through empathy, care and concern now are laying the groundwork to be at the forefront of longer-term shifts in consumer behavior. As they grow, brands need to continue to scale that intimacy with their communities. And that means being on the spot with popular SKUs.
Seize Control of Your Supply Chain
An emphasis on independent supply chains in the realm of D2C business almost seems oxymoronic. After all, part of D2C’s appeal is that you don’t have to own the supply chain — that’s a feature of a low barrier to entry. Instead of maintaining resources and capabilities in-house, companies buy individual functions in a supply chain as a service, or SCaaS, model, often going with the lowest bidder.
What could go wrong?
The upheaval coronavirus wreaked on supply chains solidified a notion into a full-fledged conviction: Even D2C brands need the control and agility of an at-least-partially owned supply chain.
Web Smith, co-founder and editor-in-chief of 2PM, a media company and growth consultancy, says direct-to-consumer brands with borrowed supply chains lack the control to shift their operations quickly in what he calls a “war-time economy.”
“The brands that don’t have control … cannot find a way to fit into this new economy,” said Smith.
Physician’s Choice, a D2C provider of health and wellness supplements, spent the latter part of 2019 fortifying its supply chain against the exact issues we’ve seen due to COVID-19, like shipping delays and factory closures. Prescient? Or just lucky?
Get the full story of how the company disruption-proofed its supply chain on Grow Wire.
It’s easy to peg the need for supply chain flexibility and control as another temporary side effect of a black swan event. However, in the hyper-competitive world of D2C — and in the context of a rapidly evolving economy, tariffs and increasing hostility between the United States and China — companies are likely going to find that they need the nimbleness afforded by more fully managing their own supply chains.
Vertical integration, defined as the combination, under a single ownership, of two or more stages of production or distribution or both, was anathema to D2C pioneers. It’s time for a fresh financial analysis, where resilience is properly valued.
“There are companies that have no control over their supply chains at all,” said Smith. “So, they’re missing out on shifts because they can’t get in touch with their one factory in Thailand. They’re dependent on outsourcing every aspect of their company’s operations to maintain this lean, front office, performance-marketing approach to business, and then when mayhem starts, they don’t have control.”
Here are six key areas to address for supply chain resilience:
Sourcing materials: Start by strengthening relationships with current suppliers. Just as “regulars” get better treatment at a restaurant, solid relationships with key partners should pay off when there is a disruption. Audit important suppliers to make sure they have adequate scale, geographic redundancy and downstream relationships. In some cases, you might want to vet these secondary suppliers.
Demand planning: Understand how not receiving materials from a given supplier will affect production. How would a missed purchase order from supplier A affect production of top-performing SKUs?
Manufacturing downtime: How could you meet demand when production teams and/or facilities are not operating at full capacity or face an unforeseen increase in orders? If the answer is “subcontractors or temp workers,” make sure contractors and agencies are lined up and preapproved.
Warehousing: Consider also having a third-party logistics (3PL) provider on call in case a warehouse becomes unusable, because of a flood or broken equipment, for example, or you need to increase production to meet surging demand.
Inventory management: Complete visibility into current inventory, including both finished and unfinished goods, is critical. By looking at available inventory, expected demand and incoming orders, a company can make informed decisions and prioritize appropriately.
Customer Service: When orders are delayed or can’t be fulfilled due to a supply chain disruption, you need a clear line of communication with customers. Use crisis management best practices to explain what’s causing the disruption and what you’re doing to resolve the situation.
If we’ve learned anything in 2020, it’s to prepare for the unexpected. D2C companies that come through the pandemic ahead are likely to favor owning their supply chains in pursuit of the elusive, yet integral, business resilience factor.
Shift from a “Grow at all Costs” Mentality
A common pre-crisis pitfall for D2Cs was overfunding. Venture-backed founders were pursuing growth at the expense of profit — and, for many, at the expense of their employees’ loyalty, with companies like Third Love, Everlane and Outdoor Voices facing criticism for low compensation, minimal benefits and long hours.
“Ninety-eight percent of DTC brands are out of business, they just don’t know it yet,” Gary Vaynerchuk, founder and CEO of VaynerMedia and a frequent speaker on entrepreneurship, recently told HBR.
Vaynerchuk’s logic is that it will be difficult for D2C companies without the fundamentals in place to acquire customers affordably. As a result, growth will dry up and with it, VC money as these firms start eyeing burn rates with alarm.
Judging by the events of the last several months, venture capital may indeed dry up — but it could also be abruptly pulled out. And that realization may have an impact on how D2C brands think about growth when we eventually come out of this crisis.
The IBUY ETF tracks a basket of global stocks issued by firms with revenues dominated by online retail sales, excluding Amazon. About 75% are U.S.-based, and all derive 70% or more of revenue from e-commerce. The ETF provides a view of overall market performance and is a one-stop shop for insights into market valuations of the largest D2C brands.
VCs were all about pouring in funds when times were good, so founders figured they’d stick around to protect those investments when things got tough. But many have been reminded that term sheets and valuations are, in fact, subject to change.
As a result, expect more caution. We’ve already seen the more measured growth trend in play. For instance, D2C mattress brand Tuft & Needle started with $6,000 of the founders’ own money and then took a mere $500,000 to grow its brand. That seems like a pittance compared with the mega-funding rounds to which we’ve become accustomed. However, Tuft & Needle went on to an estimated $500 million merger with Serta Simmons, and its focus on sustainable growth and frugality was key in the lucrative deal.
“There are a lot of companies out there with unsustainable marketing budgets and extremely high customer acquisition costs,” Michael Traub, CEO of Serta Simmons, said when discussing the merger. “What happened if we integrated a company that was based on that philosophy? It’s pretty clear it would collapse.”
We saw the Honest Company miss out on a Unilever deal due to an unsubstantiated valuation. Casper experienced significant price cuts on going public. Its lackluster IPO was explained by the fact that investors were looking for growth balanced with profitability — and a $157 loss on each mattress sold because of extreme marketing costs (partially blamed on extreme competition) failed to deliver.
In short: Unit economics are in. D2Cs with financially stable practices are most likely to survive and thrive.
The Bottom Line
The D2C landscape was always going to look markedly different in the coming decade. Those brands that were agile enough to react to the pandemic and can now embrace these four trends are poised to make the leap into “what’s next.”
Lehrer sums it up: “DTC was an insight 10 years ago. There’s still a lingering idea that DTC is innovative. That simply isn’t the case anymore … it’s about how you do it now that’s innovative.”
Megan O’Brien is Brainyard’s business & finance editor, covering the latest trends in strategy for CFOs. She has written extensively on executive topics as a former content creator for Deloitte’s C-suite programs. Got thoughts on this story? Reach Megan here.