No.18: "The Direct-to-Consumer Reckoning"
A newsletter about entrepreneurs building sustainable businesses and the investors who want to finance them.
Hi folks,
A few months ago, I wrote about how Direct-to-Consumer (DTC) companies represent a great opportunity to build a bootstrapped business. While we can count a few VC-backed DTC exits in the billion $ (e.g. Dollar Shave Club, Harry’s), the majority of exits were of more modest sizes because acquirers and public investors do not value DTC companies the same way they value software companies.
Which brings us to today’s Mereo edition. The Business of Fashion has a great piece about the current state of VC-funded DTC companies.
“Over the last decade, thousands of companies selling everything from shoes to T-shirts to toothpaste have followed the Silicon Valley playbook of aggressively raising capital and pursuing growth at all costs. They cut out middleman retailers and undercut established competitors’ prices. Their investors tolerated years of losses because the goal was scale: secure a big enough share of the market, steer clear of wholesale, drive down unit costs, and profits would follow.”
But you already know the story: most of the funding was used to buy digital advertising on Facebook and Google, pushing acquisition costs to unsustainable levels and making it harder and harder for DTC founders to grow at the speed required of VC-backed companies.
Photo by Mike Petrucci on Unsplash
The interesting part is that now investors are expecting exits to happen. But in the current environment (hello WeWork), unprofitable DTC companies will have a hard time to generate interest and existing investors start to recognise it.
“We got lucky with Harry’s because there hasn’t been a tremendous number of exits and even fewer venture-type exits,” said Sean Judge, a principal at Highland Capital Partners, which invested in Harry’s.
“This business model, at this point, has shown itself to not really work,” said Sam Kaplan, a venture partner at Burch Creative Capital, whose portfolio includes Baublebar, Chubbies and Solid & Striped. "Brands are fundamentally different than a software product or a healthcare product."
“Brands need to breathe,” he added. “If people don’t stumble upon it, discover it organically and form that emotional connection with it, then it will die.”
So, if venture is not the best funding solution for DTC, what can make the DTC model work?
First, founders can choose to raise moderately and build a sustainable business. Such founders focus more on building profitable businesses from day one than on raising rounds after rounds of funding.
“We didn't do the traditional VC playbook, which was, you raise a lot of money in a big round, you put that money into growth, marketing, and at the next milestone, you raise the next round, and you're on that treadmill,” said founder Connor Wilson [founder of online shoe brand Thursday Boots Company]. “At any point along the way you could fall off … We've benefited from being able to see this first generation of direct consumer brands, and seeing some of the mistakes they’ve made.”
Second, you might want to explore other channels such as wholesale, which, ironically, might have lower acquisition costs than some digital advertising strategies.
On, a Swiss running sneaker brand that never took on VC money, sold both direct and via wholesale since its 2010 founding. “The expertise of retailers is necessary for consumers, especially in the performance category,” said Chief Executive David Allemann. “We have 5,000 doors which means that if 20 people per day in each store touch our products, that’s 100,000 contacts. Comparing that to digital acquisition, if you’re paying for 100,000 clickthroughs and it costs $3 per click through — that’s $300,000 per day.”
Finally, there is the holding company option. Most DTC companies have the same needs: supply, logistics, marketing, customer services, etc… Bundling all these activities together can generate a cost advantage. For DTC companies with the unicorn status, setting up a holding of brands might the be only option left to scale.
Some companies are also pitching themselves as platforms to launch new brands or expand into new product categories, to show their model is scalable and can be replicated. Glossier launched a sub-brand, Play, earlier this year, for instance.
“If you look at the brands with valuations above $1 billion, we’re building something that’s much bigger than what we are today,” said Away’s Rubio. “We’re bigger than just luggage. [Glossier’s] Emily Weiss has talked about how she’s building a beauty empire and Allbirds have talked about how they're a sustainable materials company, not just shoes.”
If you are DTC founder, I highly recommend to read whole the BoF article. As usual, drop me a message if you have any comments - via Twitter DM or simply reply to this email- and don’t forget that sharing is caring.
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About Mereo
Mereo is a newsletter-driven publication about entrepreneurs building sustainable businesses and the investors who want to finance them. Mereo is written by Michel Geolier, an entrepreneur and former venture investor based in Munich, Germany.