The DTC Party’s Over. What Happens Next?
When Helena Hambrecht and her husband Woody launched a direct-to-consumer alcohol brand last year, they ticked the usual DTC boxes. Their brand, Haus, has a compelling origin story, Instagram-friendly packaging and a sleek e-commerce site where customers order booze for convenient delivery.
But the founders are deviating from the DTC playbook in one important regard: They are committed to being profitable.
“We don’t want to be like the previous era of startups,” Hambrecht told Built In.
That kind of startup, she said, raises tons of venture capital, plows it into paid advertising, grows at a loss and hopes that the lifetime value of customers one day offsets what it costs to acquire and service them.
“We don’t want to be like the previous era of startups.”
Haus is trying to keep margins high and customer acquisition costs low by owning its production facilities, being careful with digital ad spend and limiting outside investment — raising only when it wants to, not when it needs to.
Many more digitally native brands are exercising similar vigilance. They want to learn from the industry-wide reckoning that occurred this past year in the form of sudden shutdowns, stuttered expansions, CEO fallouts and underwhelming IPOs caused by untenable burn rates and unit economics.
Indeed, the next generation of successful DTC brands, it seems, is eager to throw out the old playbook — avoiding the grow-at-all-costs mentality in favor of sustainable scalability.
The DTC Playbook Worked...
For a while, the DTC playbook was golden: Start with a commodity product, something like dish soap or underpants. Give it a modern design and wrap it in minimalist packaging. Include a pastel background in the impeccably staged product photos, which splash across a Shopify-powered e-commerce site flanked by sans-serif fonts, punchy copy and a message about the company’s alignment with a social cause.
Then, raise venture capital and spend most of it on social, search and podcast ads until the customer base grows so big that the company scales up with it. Cross your fingers and hope you eventually get acquired by a legacy retail giant.
That’s a summary of the blueprint used by many DTC startups in the late-2000s to mid-2010s, when the market wasn’t yet flooded with competition and social media ads could be purchased for bargain prices. Back then, if a DTC brand followed the tried-and-true formula — and had a quality, differentiated product to boot — it could quickly make its way into some real money.
But it’s 2020 now. And launching a DTC brand isn’t the same thing as sustaining one.
...but Growth Tactics Hit a Ceiling
If you were a DTC brand in the early days, paid social media advertising was a highly effective way to acquire customers, especially if you constantly measured engagement and fine-tuned the ad copy, landing pages and checkout flow.
“Five, 10 years ago, you could go spend five dollars on Facebook and make 20 dollars in sales pretty darn quickly,” Kristen LaFrance, head of Resilient Retail at Shopify, told Built In. “That’s not the case anymore.”
Turns out, running ads on Facebook and Instagram worked too well. DTC startups flocked to these marketing channels like a gold rush, hoping to strike it rich by cheaply acquiring massive customer bases. But this movement drove up the cost of advertising; for many brands, it was no longer cost-effective to saturate social feeds.
“Acquiring a customer that is not break-even or profitable is almost as stupid as driving your car backwards on a highway.”
And for the startups who took on millions of dollars in venture capital, the imperative to grow was as present as ever. There was still pressure to amass more and more customers while finding a way to make the economics work as well.
“Everybody was blowing cash on acquiring customers in hopes that [customers] would come back and retain the lifetime value that [the company] somehow came up with on an Excel spreadsheet,” Nik Sharma, an investor and advisor to several commerce brands, told Built In.
Lately, though, Sharma is seeing some brands shy away from this model in light of the high-profile struggles of brands that pursued it.
“There’s been a complete shift, from what I’m seeing,” he said. “Acquiring a customer that is not break-even or profitable is almost as stupid as driving your car backwards on a highway. You just don’t do it anymore.”
Poor Unit Economics Come Home to Roost
Some DTC brands have struggled to square their high production and shipping costs with the average order size of their customers.
Many have successfully lured in a great deal of customers by offering generous coupons and no-questions-asked return policies. However, this often means the company has to eat a not-insubstantial amount of shipping costs.
This problem is exacerbated if the company’s flagship product is a one-time purchase. Even if they convert a curious onlooker into a paying customer, the cost of the product, plus labor, shipping and marketing, might exceed the revenue from the one-off sale — at least until enough customers are buying.
It’s a journey fewer investors are willing to take. And it may remain so for the foreseeable future.
“There will be a VC cooling,” Web Smith, co-founder of Mizzen + Main and founder of 2pm Inc., told Modern Retail.
DTC’s Path to Profitability
Despite the recent fallout, direct-to-consumer commerce isn’t dead yet. Not even close. Forecasts from eMarketer suggest DTC sales may account for nearly $18 billion in 2020, a 24 percent jump from the previous year.
In the next era, though, brands will have to be smart and agile. To forge ahead, they’ll likely employ several strategies:
Many early DTC companies that got big quickly contracted out the manufacturing of the physical products they were branding and selling. But that didn’t serve them well in the long run.
Brands playing the long game go to great lengths to become vertically integrated. That is, they own and control their production and supply chains. This requires plenty of upfront capital, to be sure, but the move plumps up a company’s margins and allows for quick product development and iteration.
The next generation of DTC superstars will be known for their vertical integration and operational prowess.
Harry’s, the razor company born online in 2013, eventually bought its manufacturer. Owning the end-to-end operations gives Harry’s full control of its business. And the proof is in the pudding: Harry’s is a billion-dollar company with a wide suite of grooming products that sit on retailers’ shelves right next to Gillette.
Haus, too, is thinking along these lines: “We own all of our infrastructure. We own the tanks, we own the production equipment and we make everything ourselves,” Hambrecht said.
A lot of Haus’ capital went to infrastructure and product — not paid advertising. That might spell slower growth, but it’s growth that’s more sustainable.
The next generation of DTC superstars will be known for their vertical integration and operational prowess.
Moving Offline (Not Completely)
Even though lots of people buy their clothes and personal grooming products online, most people still do most of their shopping in physical retail stores. The brick-and-mortar shop is where they discover new products and develop affinities for certain brands.
IRL stores for Casper, Away, Everlane, Bonobos and plenty others have sprouted up in recent years, to great success. But why? Wasn’t the point of launching a DTC brand to avoid the trappings of brick-and-mortar stores in the first place?
Turns out, going analog is helpful for growth in a number of ways. Chief among them is boosting brand equity and awareness.
“If you’re going into a new market, a physical presence is a solid stamp of validation,” Sharma said. “It’s not just some Alibaba drop shipping. Like, this is a really legit business.”
Opening a physical storefront is a smart marketing play. Just ask Casper. It found that when it opens a physical store in a certain city, that city’s online sales get a boost.
Plus, at the end of the day, selling products in a retail store is an additional revenue source.
“It’s not just some Alibaba drop shipping. Like, this is a really legit business.”
DTC brands don’t have to open their own stores to access many of these benefits, though. They can strike partnerships with the very retailers they bypassed upon launch. That’s why you may spot Birchbox in Walgreens, Happy Socks in Macy’s, Harry’s in Target and Native Deodorant in Walmart.
These brands, which all started online, are gaining access to more customers than they would reach with online-only models, even with their massive paid social media presences.
Lowering Paid Social Spend
The most common way DTC brands hemorrhage money is by spending too much on marketing and recouping too little from the people who become customers. In other words, the customer-acquisition cost to customer lifetime value ratio (CAC:LTV) is unsustainable.
One way brands are determined to make up for this is, naturally, by lowering their paid advertising budgets and looking for free or low-cost ways to get their names out there.
Haus used its would-be marketing budget on operational expenses, so it could produce its beverage product in-house. The company had to find a way to earn media coverage for free.
“Our biggest generator of customer acquisition in the beginning was just a Medium post that I wrote,” Hambrecht said. “I didn’t even say what [the product] was. It didn’t matter. I just told the story of the pain point that we were trying to solve. And so many people read it and had it resonate with them that the post went viral.”
Haus eventually got write-ups in outlets like Glamour, Fast Company and GQ, which highlighted the company’s aim to provide a “better way to drink” with its low alcohol content and straightforward ingredient list.
The company also worked with brand agency Gin Lane to craft its design and packaging, which helped make Haus an easily Instagrammable product.
“We put a lot into packaging. We never told anyone to take a picture of the packaging or the bottle, but everyone did,” Hambrecht said. “People thought we had some sort of crazy robust influencer strategy. We didn’t. We just put the effort into the experience, and people naturally wanted to share it.”
Hambrecht said the company didn’t spend a dime on paid social advertising the first six months of business.
Today, it carefully watches its return on ad spend, aiming for about 20 to 30 percent of its growth to come from paid ads, the rest from organic reach.
The company balances its ad spend and pricing so that it turns a profit every time a customer makes a first purchase, Hambrecht said.
“And we want to keep it that way.”