Why Direct to Consumer Brands Struggle with Profitability

Over the past decade direct-to-consumer businesses have popped up in nearly every corner of the retail sector. From mattresses sold by Casper to prescription eyeglasses from Warby Parker ambitious founders have taken a page from Amazon’s playbook hoping to sell goods directly to consumers online.

With companies like Shopify it has never been easier to set up shop online. But is it really as easy as it looks? Anyone actually running one of these businesses will tell you it isn’t. A key challenge is profitable growth. The ease of setting up a direct-to-consumer business means that it’s not only easy for you but also for your competitors to get started, something Casper knows all too well.

Then there’s the cost of acquiring customers. It’s expensive when you don’t have stores. Then there are those pesky returns. How often have you bought something online, then returned it without a second thought? For the retailer that’s a cost that eats into profits. As Andy Dunn, founder of digitally native menswear brand Bonobos has said, e-commerce is a "tremendously challenging, frequently unprofitable business." If you are curious about the profitability of some of the direct-to-consumer-brands you know and love, then take a look under the hood of these four brands.

1. Warby Parker

Warby Parker which was founded over a decade ago in 2010 is often looked at as the crème de la crème of direct-to-consumer retailers. The eyeglass retailer famously disrupted the market for prescription eyeglasses with a slick website and a try-before-you-buy from home program which captured the hearts of millions of customers.

Fast forward thirteen years and Warby Parker is now a public company. It filed to go public in 2021 and now that we have access to Warby Parker’s financials we can finally answer the question: does Warby Parker make money? Surely the retailer which many look to as the gold standard for direct-to-consumer brands has a profitable business after a decade in. But alas the results paint a different story.

Warby Parker, rich in venture capital, raising over $500 million has yet to generate a profit. Most recently Warby Parker lost $110.4 million in 2022 on $598.1 million in revenues. “We will need to generate and sustain increased revenue and manage our costs to achieve profitability. Even if we do, we may not be able to sustain or increase our profitability,” Warby Parker said in its IPO filing. Not exactly a glowing view of its future prospects.

One of the drags on profits for most direct-to-consumer retailers is advertising expenses. Warby Parker spent $43.3 million and $58.5 million on advertising in 2019 and 2020 respectively. In Warby Parker’s IPO filing it said that customer acquisition costs increased 49% in 2020 to reach $40 per customer up from $27 per customer in 2019 as a result of a “deliberate investment in media spend.” “It’s really hard to acquire customers online,” said Sucharita Kodali, a retail analyst at Forrester. “The way you get in front of people is that you resort to traditional tactics like being in places where people gather.”

What is interesting about Warby Parker is that while it began as a direct-to-consumer retailer the name is a misnomer since prior to the pandemic, in 2019, 65% of Warby Parker’s sales came from its stores and 35% came from eCommerce.

Many direct-to-consumer retailers open stores as a way to grow the top line but also as a path to profitability. But even with a growing store network of over 150 stores Warby Parker still can’t find a profitable business model. Amazon has been in business since 1994 and it largely makes its profits outside of its core retail business from Amazon Web Services. This demonstrates the difficulty retailers with a large portion of online sales have in making profits. “They’ve [Warby Parker has] been around for a while, and they’ve been very good at marketing themselves,” said Kodali. “The challenge is that it’s an unprofitable consumer-facing company in the retail space, and the retail space isn’t fundamentally growing.”

2. Casper

Casper is another direct-to-consumer brand onlookers have watched closely since it launched in 2014. Not too long after its inception Casper became a cult favourite with celebrities like Kylie Jenner posting photographs of herself on Instagram standing next to Casper’s cute bed-in-a-box packaging encouraging legions of her followers to go out and get their own Casper mattress.

But the hype around Casper was short lived. It turns out it’s not as easy as it seems to sell mattresses online. The first issue, and this is one that all direct-to-consumer retailers face is how do you get consumers to know that you exist? Casper has long leaned into digital marketing to drive awareness of its brand. In 2019 Casper spent $154.6 million on sales and marketing or 35% of its revenue. Then in 2020 Casper’s sales and marketing expenses were $156.8 million or 32% of its revenue. That is significantly higher than what companies typically spend on sales and marketing. Take department store Kohl’s, last year its marketing costs were only 4.9% of revenue. A survey by Gartner found the average marketing spend as a percentage of a company’s revenue was 6.4% in 2020 highlighting the high customer acquisition costs direct-to-consumer retailers often face.

When the direct-to-consumer segment of retail started growing years ago the drug of choice for getting more website traffic was social media marketing. At that time Facebook was less inundated with ads and direct-to-consumer retailers took advantage of that. But over time more and more companies started marketing on social media driving up the cost of advertising. Between 2018 and 2020 the cost of advertising on Facebook and Instagram more than doubled. “Competition for the new wave of mattress companies was quite fierce. They have had to spend a lot to try and stand out from the crowd,” says Dan Coatsworth, stock market analyst at AJ Bell speaking about Casper, “so they are burning through cash.”

As a way to spend less on marketing Casper started selling in wholesale channels like Target starting in 2016 and began opening stores in 2018. Casper now has more than 60 stores and several retail partnerships. Casper disclosed in its 2020 IPO filing that in 2019 in cities with Casper stores, sales grew twice as quickly as those without. But even moving into brick-and-mortar retail was not enough to create a profitable business model for Casper.

Casper has never generated a profit. In 2020 Casper lost $89.6 million on $497.0 million in revenue and in 2019 it lost $93.0 million on $439.3 million in revenue. In Casper’s 2020 10-K it wrote that: “we have a history of losses and could continue to have operating losses and negative cash flow as we continue to expand our business.” Sound familiar?

Speaking about Casper, Jason Stoffer, a Partner at venture-capital firm Maveron said: “for this company to become sustainable and profitable, they either need to become much more efficient on the marketing side, or they need to figure out how to generate more lifetime value out of their customer base.” They need “probably both.”

Generating more lifetime value out of Casper’s customer base is challenging since many consumers only purchase a new mattress once every ten years. That means the company is constantly looking for new customers to acquire which only contributes to more money spent on marketing.

Customer returns are also a thorn in Casper’s side as it is for many retailers. In Casper’s IPO filing it disclosed it spent $80.7 million on “refunds, returns, and discounts” in 2018. Returns go hand and hand with an eCommerce business. It is estimated that the return rate for returns of online orders is three times that of orders made in store.

Generous return policies are often given by direct-to-consumer retailers as a way to entice customers to try their product. But if conversion rates aren’t high then costs can quickly spiral out of control. Customers can try out a Casper mattress for 100 days and return it for free it if they are not satisfied. Generous return polices are really just another marketing tactic to drive customer acquisition. As David Hsu, a professor of management at the University of Pennsylvania's Wharton School said Casper has "a very expensive [business] model, particularly because of their guarantees."

Casper has also been a victim of its own success with competitors seeing an opportunity and trying to get a piece of the pie with an average of one new bed-in-a-box business launching each week between 2015 and 2018. There are now over 170 mattress companies that sell online. Flailing under the weight of a challenging business model and intense competition, after two years as a public company in 2021 Casper was bought out and taken private for $286 million. At one point Casper was valued at $1.1 billion.

Do you like this content? If you do subscribe to our retail trends newsletter to get the latest retail insights & trends delivered to your inbox

3. Wayfair

Home goods retailer Wayfair launched its business in 2002 and has grown into one of the largest online retailers in the United States. Unlike many direct-to-consumer retailers it has largely only served customers online. Similar to many direct-to-consumer retailers Wayfair has found it challenging to find a profitable business model.

In Wayfair’s history it has only had one year in which it generated profits and that was in 2020. Wayfair benefited enormously from the surge in eCommerce and home improvement projects during the height of the COVID-19 pandemic. As a result, Wayfair’s 2020 revenues were up by 55% to reach $14.2 billion and it generated $185 million in profits. But in 2021 and 2022 Wayfair was back to losing money.

Even Wayfair has questioned its ability to generate a profit writing in its 2020 annual report: “until fiscal 2020, we had a history of losses and we may be unable to sustain our recent profitability and positive cash flow in the future as we continue to expand our business.”

Like many direct-to-consumer brands Wayfair spends large sums of money on marketing. In 2019 and 2020 Wayfair spent $1.1 billion and $1.4 billion on advertising respectively. “We have made significant investments related to customer acquisition and expect to continue to spend significant amounts to acquire additional customers,” Wayfair wrote in its 2020 annual report.

It’s not only marketing costs that are a thorn in the side of direct-to-consumer retailers, logistics costs are also a pain. Wayfair spends 20 cents of each dollar of its revenue on logistics for things like freight costs and last mile delivery. “In Amazon’s world, they focus on light, small packages,” says Wayfair CEO and co-founder Niraj Shah. “In our world, the packages are different, bulky, and prone to damage. Dollar per cubic foot is pretty low.” Wayfair has its own logistics network which by 2021 spanned across 18 million square feet of warehouse space across the world, not exactly a inexpensive venture.

It is estimated that Wayfair loses money on each sale it makes. In a 2017 study by Daniel McCarthy, assistant professor of marketing at Emory University and Peter Fader, marketing professor at Wharton found that Wayfair spent approximately $69 to acquire a new customer but lost $10 on that customer over time. “It’s not a fault of the company, it’s a fault of the category,” says McCarthy. “You just can’t say you’re going to be the Amazon of furniture. You need a way to make the model work.”

4. Allbirds

Allbirds is well known for an environmentally friendly wool sneaker it launched online in 2016. The sneaker was so popular it sold one million pairs in the first two years Allbirds was in business. Time magazine even called Allbirds’ woolen sneakers: "the world's most comfortable shoe." Fast forward seven years and now Allbirds is a public company.

Allbirds’ financials tell a story similar to many direct-to-consumer retailers. As we have seen, fast growth does not mean fast profitability or profitability at all. Since inception Allbirds has never made money. In fact, Allbirds lost $101 million on $298 million of revenue in 2022.

Allbirds does not have a sound plan for reaching profitability writing in its 2021 IPO filing that: "we have incurred significant net losses since inception, and anticipate that we will continue to incur losses for the foreseeable future." Allbirds was also quite transparent when it said that “we can provide no assurance as to whether or when we will achieve profitability. If we are not able to achieve and maintain profitability, the value of our company and our Class A common stock could decline significantly, and you could lose some or all of your investment.” This has become a self fulling prophecy with Allbirds valued at $4.1 billion at the time of its IPO in 2021 to only see its market capitalization fall to $123.8 million today.

Most of Allbirds’ sales still come from online transactions with 89% of Allbirds’ sales coming from digital and 11% of sales originating from stores in 2020. Like other direct-to-consumer brands Allbirds’ marketing expenses as a percentage of sales are on the high side but they are still much lower than Casper’s. In 2022 Allbirds’ marketing expenses were $59 million or 19.9% of its $297.8 million in sales.

To combat thin margins in its digital business Allbirds plan a few years ago was to lean into store expansion. Like many retailers Allbirds has realized that multichannel retail often pays dividends. “While our store channel already generates strong results on a standalone basis, the real power of our vertical retail strategy is the synergy between the physical and digital sides of our business. This synergy takes the form of increased brand awareness and website traffic in the regions where we open new stores, driving an overall lift in sales,” said Allbirds.

Allbirds also wrote in its IPO filing that “as an example of the benefits of our vertical retail distribution strategy, our Boston Back Bay store achieved standalone payback within eight months. Furthermore, in the three months after our Boston Back Bay store opened in March 2019, the Boston DMA region saw a 15% increase in website traffic, an 83% increase in new customers and, ultimately, a 77% increase in overall net sales, as compared to a comparable control market.” Allbirds has also found that its multi-channel repeat customers spend more than 1.5 times than repeat customers that only use one channel.

At the end of last year Allbirds had 58 stores. "We are in the early phase of a ramp towards hundreds of potential locations in the future," Allbirds wrote in its IPO filing. Allbirds believed this would allow it to profitability acquire new customers. But after last year when Allbirds had a substantial $101 million loss Allbirds announced it is going through a reorganization with the hopes of increasing profitability. As part of that plan it is slowing the pace of store openings and is focusing on adding more wholesale partners.