Top 10 Mistakes Direct to Consumer (DTC) Retailers Make that Hinder Success
Many of the fastest growing retailers of the past decade are direct to consumer (etc) brands. They include Away, Allbirds, Kylie Cosmetics, Dollar Shave Club and Glossier. The ability for these companies to quickly grow and take market share has spawned many companies that want to get in on the action. While there are many shining stars the direct to consumer segment of retail is relatively new and many retailers are still trying to figure out how to standout in what is quickly becoming a crowded marketplace. Ask Casper or Blue Apron. Both of these direct to consumer companies have grown quickly but they are struggling to have the profits that traditional retailers like Target or lululemon enjoy.
While the direct to consumer segment is still finding its way many of the fundamentals of retail are the same. Profitable growth, retail stores and brand building overtime are still some of the keys to success. As direct to consumer retailers continue to vie for their share of consumer spending there are a number of mistakes they should avoid making in order to have a greater chance of success.
1. Focusing on growth at the expense of profitability
The direct to consumer playbook has largely focused on early stage companies taking large sums of venture capital funding. The idea is to get to scale quickly by investing in areas like marketing with the belief that profits will come later.
But many direct to consumer brands have found profitability elusive. Take direct to consumer mattress retailer Casper. Before its IPO Casper raised $340 million in private funding. It also spent more than $400 million in marketing within nearly a four-year period. It has been very successful in acquiring new customers. In Casper’s first month in business it sold $1 million in mattresses and in the first three quarters of 2019 it generated $312.3 million sales. But Casper has yet to earn a profit since it has been in business. It lost $67 million on $312.3 million of sales in the first nine months of 2019.
Investors have taken notice. Based on private funding Casper was valued at $1.1 billion. But with disappointing financials Casper priced its February 2020 IPO at $12 giving the company a market cap of close to $500 million, nearly half the previous value of the company. Speaking about Casper’s IPO, a top venture capitalist, Kirsten Green said: “I think it’s a confirming signal that when at scale, [public market] investors value growth balanced with profitability,”
Another direct to consumer company that has grown quickly but failed to achieve profitable growth is Blue Apron. Blue Apron which received $135 million in venture capital funding reported a lost of $26.2 million in the third quarter of 2019. It suffered from high customer acquisition costs and an inability to turn the customers it acquired into repeat customers. Blue Apron’s stock as a result has taken a beating, falling to below $3, down more than 97% since its IPO. Now the company is "evaluating a broad range of strategic options" including a potential sale of its assets.
2. Investing too much in marketing
Marketing is an enabler not a business strategy. The best brands are built on a solid foundation of great products and services and then marketing is used to amplify what already exists. lululemon exemplifies this best. When Chip Wilson founded the company just a little over twenty years ago he focused on creating athletic clothing that is engineered for maximum performance. lululemon’s apparel wicks away sweat, dries quickly, reduces bacteria causing odors and feel greats. lululemon has done all of this without sacrificing style.
lululemon had very little money to spend on marketing in the beginning so instead Wilson’s goal was to drive brand awareness via word of mouth with customers spreading the word about the quality of lululemon products. He also gave free lululemon products to local yoga instructors who then taught lululemon classes to yoga enthusiasts for free. Although Wilson came up with the idea more 20 years ago it bares clear resemblance to what we know today as an influencer strategy. Not having money to spend on marketing became a blessing in disguise as Wilson was forced to come up with novel ways for drumming up interest in his product.
Many direct to consumer retailers see digital marketing as their path to growth. In the early days of direct to consumer businesses there was less competition for digital ads making them more economical. But overtime the marketplace has become crowded. It is estimated that the amount of paid advertising has increased by 42% in the past two years but click through rates have only increased by 11%.
Speaking about digital marketing, Nick Brown, Managing Partner of Imaginary Ventures said: “it was maybe dangerous 10 years ago but it’s definitely dangerous today to invest in a business where the only real driver of growth is performance marketing.” “The era of funding new businesses where the only opportunity for growth is to plow money in Facebook and Google is over.”
If you plow enough money into marketing eventually people take notice. But that doesn’t mean that you have the products and finesse required to create a loyal customer base. Consumers can be enticed to buy a product but that doesn’t mean they will keep coming back for more.
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3. Lack of a compelling business model
The best businesses have healthy profit margins and if not the volume to make up for it. They fulfill a genuine need by either improving on what already exists or by creating a need you did not know existed. They build trust over time and have a loyal following that keeps customers coming back for more. That description could be used to describe many great retailers, from Walmart to Apple to Target.
By sprinting in search of growth what often gets lost in the shuffle is creating a business model that works. Casper built its business on a single mattress model which was sold in an instagramable friendly box. Casper sells more than one mattress model now but the challenge it faces is customers don’t have a reason for making repeat purchases since a mattress is a long term purchase.
Only 16% of Casper’s customers are repeat customers which means that it is more dependent on acquiring new customers than other retailers. Casper is trying to address this by selling more frequently purchased items like lamps and weighted blankets but it is a long way from increasing the average lifetime value of its customers. It is easy to get lost in the excitement of top line growth and hope that everything falls into place later. But as companies like Uber are finding out that is easier said than done.
Brandless is another direct to consumer company that was successful in attracting a lot of venture funding but failed to create a sustainable business model. The company launched in 2017 and sells housewares and personal products with minimal branding. Its theory was that products have up to a 40% brand tax. That tax is used, for example, to create beautiful packaging which ultimately results in the customer having to pay higher prices. Brandless thought it could cut out those costs as well the middleman thereby providing high quality products but at lower prices. Most of Brandless’ products cost $3.00. Speaking about Brandless’ model, venture capitalist Kirsten Green has said: “on day one of starting a business, you should have a product that should be able to translate to a lot of different channels, by margin structure and category. Starting out with more doors closed than are open is tricky.”
Another challenge with Brandless’ business model is that cheap consumer packaged goods are typically sold by retailers such as Walmart as loss leaders. Experienced retailers know they won’t make a profit off of them but if Walmart can get you in its doors to buy a $1 package of soap it knows that often you stay longer and ended up buying higher margin items or a high enough volume of items to justify the loss leader. For Brandless there wasn’t an alternative for driving higher profits per transaction. Shipping and return costs also became an issue and when Brandless tried to increase prices to $9 for certain products, sales declined.
Speaking about its business model, Tina Sharkey, Brandless’ co-founder said “consumption is changing into a lifestyle for customers, and we’re getting out in front of that by building for ship, not shelf, even if the shelf is the lion’s share of the industry right now.” “Building for ship makes more sense — you can have price transparency, and you’re not competing alongside other brands and trying to manipulate customers into thinking they’re getting a better deal.”
In 2018 Softbank announced it would invest $240 million in Brandless. The investment valued Brandless at $500 million. Fast forward two years later and Brandless announced that it is shutting down. It is the first business in SoftBank’s Vision Fund that has gone under. Brandless ended up only receiving half of the funding promised by SoftBank since it failed to meet agreed upon financial targets. Speaking about the turn of events Brandless’ board said “the direct-to-consumer market is fiercely competitive and ultimately proved unsustainable for their business model.”
4. Underestimating the competition
Success breeds more success…er I mean…competition. The low barriers to entry for direct to consumer companies means that it is significantly easier to start a business today than it was 50 years ago or even 15 years ago. When Amazon first started 25 years ago it didn’t have a lot of competitors. But as it grew and became more successful it spawned an entire new class of companies all trying to sell things to you online. Direct to consumer company Dollar Shave Club’s success led to the birth of many subscription based retailers. Snapchat came out with Stories then Instagram introduced Instagram Stories even LinkedIn is testing its own version of stories. Sound familiar?
The success your business generates will eventually cause others to follow suit. So you have to be ready. Are you clear about what differentiates your product or service from potential imitators? Who would have thought that the founder of a business selling stretchy leggings could turn it into a company with a $30 billion market cap? Since lululemon pioneered the athleisure category there have been an endless number of companies trying to get in on the action. But lululemon is still on top. It’s on top because those leggings aren’t just leggings. They are made from technical fabrics many of which have been trademarked by lululemon. lululemon also has a cult like following starting from the first free yoga classes it offered existing and new customers over 20 years ago. The best antidote to competition is a great product, a loyal following and a little bit of magic that is hard for others to emulate.
5. Underestimating the need for stores
There is a lot of press about the “retail apocalypse”. As online sales have increased the number of store closures have also ticked upwards. The theory is that retail stores are not needed as people flock towards online shopping. But that view conceals the fact that the United States has too many stores per capita. At 23 sq. ft. of store space per person the United States has the highest amount of store square footage per person in the world. The United Kingdom has five sq. ft of store space per person, Spain has four and Germany has two.
Stores have to close in the U.S. to bring the amount of retail square footage into balance. But stores are still a critical part of every retailer’s arsenal. The most successful direct to consumer retailer, Amazon, has close to 600 stores. Close to 90% of retail sales in the United States happens in stores. If a direct to consumer brand hopes to grow overtime eventually it will have to venture offline.
Most of the biggest direct to consumer brands of the past decade either have stores now or their products are sold in stores. These retailers include Warby Parker, Glossier, Everlane, Away and Kylie Cosmetics. Even Rihanna who has a massive online following partnered with LVMH to develop her beauty line and when it launched it was immediately available in 1,600 LVMH owned Sephora stores.
Speaking about the need for stores Andy Dunn Founder of digitally native clothing brand Bonobos said: the brand's "most profitable business" is its partnership with Nordstrom where Bonobos clothing is sold in Nordstrom stores. Dunn has also said that e-commerce is a "tremendously challenging, frequently unprofitable business."
Not having stores might be a great way to start since a brand doesn’t have to invest in the capital costs required of a store network but with spiralling marketing costs investing in stores tends to be a good option over time.
6. Underestimating the financial impact of returns
The initial excitement of building a direct to consumer business can quickly turn to worry as returns start to come in. Returns are a part of any eCommerce business. It is estimated that the return rate for returns of online orders is three times that of orders made in store. For categories like clothing and shoes the return rate is between 30% to 40%.
Liberal return policies that are used to boost growth can also attract a customer that is less interested in making a purchase and is more interested in trying things out. This is great for the customer but comes at a high cost to the retailer. It is estimated that returns cost retailers 10% of revenue. In the retail industry as a whole it is estimated that returns will cost companies in the U.S. $550 billion in 2020, up 75% within only four years. That’s a lot of money for an industry with thin margins.
7. Thinking that if you build it they will come
Part of the lure of starting an eCommerce businesses is that it has never been easier to create one. You can easily set up an online store using a platform like Shopify. But once that is done the hard work begins. Getting people to find your website is often more difficult than it seems.
Speaking about the early days of M.M.LaFleur, a direct to consumer clothing company, Co-Founder Sarah LaFleur said “I foolishly had this notion that if you launch a website your customers come and they shop and you become millionaires, of course I think we have all learned that is not the case. But at the time there was such a media frenzy around these new d-t-c businesses and I just thought wow this is so easy let’s launch a site.”
After launching the company’s eCommerce website in 2013 M.M.LaFleur only received 10-15 orders on the day of launch. In the following days there was even less interest, on some days there were no sales at all. M.M.LaFleur hoped by putting up a website people would find it, but that was not the case.
To increase sales M.M.LaFleur held trunk shows which were quite successful. Then in 2014 M.M.LaFleur came up with a new sales concept. It created a quiz where customers outline their clothing preferences. Based on the results of the quiz M.M.LaFleur sent customers a box of 4-6 clothing items called a Bento Box. Customers only pay for what they keep and they are also charged a styling fee. The Bento Box concept took off. By 2016 M.M.LaFleur generated $30 million in sales.
8. Not understanding which categories sell better online
eCommerce sales by category vary quite a lot. Commodities like books, music and video have a high eCommerce penetration rate but it’s much harder to sell health, personal care and beauty products online. An even harder sell is food and beverage products. Only 2% of food and beverage purchases are made online. This is one of the reasons why Amazon purchased Whole Foods and is now opening up a brand new brick and mortar grocery chain under a different banner. Especially when it comes to selecting produce consumers like to see and touch it before buying it. Even with the best product if a company is attempting to sell products online in a category where the online penetration is low it will be hard to be successful.
Taking a look at Amazon’s fastest growing categories provides some insight into which categories hold long term potential. Off of a small base food and beverage is the fastest growing category followed by apparel and accessories then health, personal care and beauty.
9. Underestimating the time it takes to build a great brand
How long does it take to build a brand? The digital era has ushered in some of the fastest growing companies in history. But every company is not growing as quickly as Google has. In some ways the growth of these internet darlings has distorted the view of how long it takes to create a great brand. It still takes time for a company to introduce a new product to the market, for a customer to hear about, to learn about it, to think about and decide to buy it. That chain of events for just one customer can take years.
The truth is Google is not the norm. It takes time to build something that is truly great. In the first year Nike was in business the company made $8,000. It took McDonald’s eight years to sell its millionth hamburger and 25 years for beauty brand Bobbi Brown to generate $1 billion in sales.
10. Lack of a product market fit
Mark Zuckerburg once said “ideas don’t come out fully formed. They only become clear as you work on them. You just have to get started.” The business idea you start with may not be the one that brings success. It takes time to see if your idea has legs.
LaFleur said that it wasn’t until three years after she launched M.M.LaFleaur that they figured out their product market fit. Instead of just relying on its website to drive dales, the product market fit was achieved when the company started sending Bento Boxes of clothing for customers to try on. That eliminated the fear that customers had when making a decision to purchase merchandise online when they did have the opportunity to see and touch it first. The demand for M.M.LaFleur’s Bento Boxes ended up being greater than anything they tried in the past. LaFleur says that after the service launched they went from being unable to pay for rent to tripling their revenue.
Direct to consumer brand ThirdLove also found that implementing a try before you buy clothing service was critical to increasing sales. Speaking about the program, ThirdLove Co-Founder Heidi Zak said: "we had an amazing product, but how would we get women to actually take that chance and try the first bra?. 75% of customers who tried the try before you buy program ended up becoming ThirdLove customers. Zak has also said: "[The program] allowed a woman to take a risk on a brand she hadn't heard of and that truly changed the course of our business. It made us profitable.”