The Future of Direct to Consumer

#7

The Direct to Consumer world has changed.

Direct to Consumer darlings have been losing money year over year, and filing for bankruptcy in droves. Warby Parker and AllBirds both lost over $100M in 2022 and barely narrowed that in 2023. Lunya, HelloBello and SmileDirectClub all filed for bankruptcy last year.

Unfortunately, I bet that at least three high profile DTC brands go under this year (Rent the Runway, Peloton and Casper are my bets 😭)

What’s going on? Is every business at risk?

No, but there are three major trends that have changed the playbook for DTC businesses. They will accelerate in 2024.

1. Increasing Cost of Customer Acquisition

2. Increased Operational Expenses

3. Increased Speed of Competition

Here’s a deep dive into the trends and what to do about them. 👇🏻

The Trends.

First, why did Direct to Consumer boom?

Traditional Retail meant that you could split the costs and profits of sales. Retailers like Walmart, Target, and Macys provided the storefront while brands like Ralph Lauren or Nautica provided inventory to the retailer.

Traffic was created by the Retailer, who would spend advertising dollars on sales and have lots of other stuff in the store so that people would have many reasons to come to the store. Retailers also provided all the infrastructure — the storefront, retail staff, customers service etc.

The Direct to Consumer model cut out the Retailer.

The internet, specifically social media, suddenly allowed brands sell directly to their customers at scale. They could do this before in small bits with a company store, but not nearly at the level of social media.

Rather than giving 50% of the purchase price to the Retailer, brands chose to build the infrastructure needed to deliver it right to the customer.

Software and service providers like Shopify, Klaviyo, ShipMonk and the good ol USPS made this possible and profitable. You no longer needed to be in a Retailer to build a business.

The Challenges.

At first this model worked very well!!!

By cutting out the Retail middleman, Brands could almost instantly double their net profit.

But, it hinged on three things.

1. Low cost of customer acquisition

2. Low operational expenses

3. High Customer Lifetime Value

Those have begun to change.

1. Increased cost of customer acquisition - Marketing budgets have remained largely the same at around 10% of total Revenue, but the spend doesn’t go as far.

   

Cost of customer acquisition began to rise as competition for ad space on social media grew, and then sharply spiked upward when Apple change privacy settings in 2020. See this quote from now bankrupt Lunya’s CEO, Blair Lawson.

2. Increased Operational Expenses - The boom of DTC meant that there was a hand-in-hand boom for businesses who support DTC.

   • Software freemium to paid. -Software companies are often venture backed and start with a growth-before-profitability strategy. Over time, as users establish themselves on their platform, it makes sense to raise prices to push their own businesses toward profitability. I can think of 9 providers that I use in my tiny DTC store and all of them have raised prices in the last 3 years, with the most significant change moving from “free with transaction charges” to “$195 per month, with the same transaction charges”. I stopped that service.

   • Parcel Shipping Price increases - The volume of parcels shipped in the US has doubled in the last 8 years. When you have increased demand (parcels wanted to ship) and limited or slowly growing supply (how fast can you hire mailmen?) prices increase. Match that with rising fuel costs and you have an increase in prices that make their way back to the Brand.

     

     Parcels stayed nearly flat for 2022 at 21.8B in the US.

   • Freight Shipping Volatility- Freight shipping has been volatile in the last few years, where supply chain lock ups like the grounding of the Evergiven and bottlenecks at LAX Port both caused price increases and delays in receiving goods. If you needed to order in July, you might pay three times what you would have in January of the same year.

     

3. Increasing Speed of Competition - When you launch a brand, you hope that you’ll be able to create durable, or long lasting demand for your product. Think running shoes. I have bought Asics Gel Kayano running shoes year after year for at least a decade. I have a durable demand for their product. But if a product has a low barrier to entry (is easily knocked off) and high demand, you know that someone will copy it for cheaper. Amazon makes this easy now, both with their Amazon Basics line that actually knocks off best sellers, and with web-crawlers that can ingest user reviews in order to spin off a rival product. When Casper went to market in 2014, there was one other company selling a bed in a box. Today there are over 175. When competition for your customers increases, it’s more difficult to keep them year over year, so overall lifetime value goes down.

What to do about it?

When you can see trends, and know they won’t go away, what do you do about them?

1. Increasing Cost of Customer Acquisition

   When CAC rises, you need to nail your LTV/CAC ratio. I have an in-depth post about this coming soon, but you need to keep your LTV/CAC ratio above 5:1 at the minimum. If you don’t you’re risking negative cashflow, which soon leads to debt that can’t be refinanced, which leads to bankruptcy😭. If your LTV/CAC in a particular channel drops below 5, it’s time to look elsewhere. As any channel ages, people discover it and the value degrades. Because of this I actually push founders to search for an LTV/CAC of 50:1 to find where they can press the boundary. (One channel that is working well right now is actually post cards. I love the USPS. 📪)

   

   Great article on LTV/CAC here.

2. Increased Operational Expenses

   When expenses go up, there are two main ways to reduce them.

   1. Eliminate costs- How can you eliminate costs like shipping and pick and pack? Oddly enough, by going back to a traditional retailer through wholesale. Consider adding a wholesale arm to your business, finding retailers through wholesale aggregators like Faire. Wholesale is especially helpful for low AOV items that people like to order one at a time. If you have an item that costs $12, but you have to pay $5 for pick and pack, and $5 for shipping, you’re losing money against a wholesale price of $6.

   2. Streamline- Where you have consistent costs like salary, consider automating responsibilities into your existing tech stack and using AI to speed up the onboarding of contract labor. AI is very good at writing brief job descriptions, project plans and outlining milestones. Use this capability to right-source labor that is not essential to the strategic goals of your business. I use ChatGPT like an “associate consultant” to help me move faster without hiring and training an actual associate consultant.

3. Increased Speed of Competition

   As speed of competition increases, it feels like the only thing to do is increase your speed of new product production. That can work for some businesses, but in most cases it’s better to consolidate your investment dollars on your winning products. To create fewer products better, rather than just continue to churn out new ones. Here are two other strategies that can help when competition is coming fast to swipe your ideas.

   1. Launch a service - This sounds wildly counter intuitive for a product business. But you need to think about what your competitors can’t do. Can a mass producing manufacturer in China copy your product and sell it on Amazon for less? Yes. Can they lead a workshop for customers on how to do X for Y? Nope. Service arms of a product business (think Service and Parts for car dealerships) have long been used to increase the frequency of cashflow and create longer relationships with customers. Services also help keep the lights on, which shouldn’t be underrated when supply chain issues could stall product movement. You want to have those recurring monthly expenses covered.

   2. Incremental Innovation - When we think of innovation, we usually think of the “Big I” innovation like the launch of the iPod. But if you already have product market fit, it’s really difficult to find it again for a new innovation. So embrace “small i” innovation, or incremental changes to better your core products. Your competitors will be good at copycatting, but not good at innovating, so keep testing and using your product and make it 2-5% better than the last version. Apple does this consistently with the iPhone. We’re on version what, 15? You can do the same for your core products, instead of keeping them the same or letting them fade to focus on “Big I” innovation.

The end.

The golden era for DTC is over. You can’t acquire customers for pennies on Instagram any more. Costs will keep rising. There will be hundreds of competitors overnight if you have wide success.

But you’re resilient!!!

You’ve made it this far, what are a few more challenges anyway?

Just new problems to solve.

Every business has a new set of challenges that show up each year. You have more than what it takes to stride right over these and build a profitable business.

And if you can make your business profitable, almost nothing can kill it. Certainly not a couple of copycats.

I’m rooting for ya.

Catch you next week!

-Nate

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