6 of the Top Reasons Online Businesses Fail
If you are thinking about starting an online business which is often called a direct to consumer business in retail then you are not alone. First Amazon disrupted traditional brick and mortar shopping by selling online then many entrepreneurs followed suit hoping to grab a piece of the pie. While these businesses have become very popular over the last decade or so success isn’t always guaranteed.
An innovative idea and a slick website might get customers excited but many founders eventually realize it’s actually pretty hard and expensive to acquire customers when you don’t have any retail stores. And when your customers demand free shipping or when return costs add up a promising business can be put into jeopardy pretty quickly. Casper and Brandless are a just a few high profile names that have struggled with this model. If you are curious about why these businesses fail then consider these six factors.
1. High customer acquisition costs. In the beginning beverage maker Dirty Lemon like many direct to consumer brands used Facebook and Instagram to market its products. But over time Dirty Lemon found that the success many brands found using Facebook and Instagram marketing attracted many competitors leading to higher customer acquisition costs. Zak Normandin, Dirty Lemon’s founder said cost per action on Facebook increased by a factor of three between 2017 and 2018. The company used to incur between $20,000 and $30,000 per day on advertising for Dirty Lemon on Facebook and Instagram alone.
“Having advertised with Facebook and Instagram since very early on, we saw the cost to acquire customers rise significantly, and it's at a place now where it's just unsustainable. I think that's happening because brands that have historically relied on traditional advertising methods are now shifting their ad dollars to online and to Facebook and Instagram. When that marketplace gets flooded with demand, it raises the price to connect with and acquire customers. As the prices rise and more advertisers enter the marketplace, there was a point for us that it no longer made sense to spend millions and millions of dollars on Facebook and Instagram” said Normandin.
To combat increasing costs of acquisition online Dirty Lemon decided to focus on other channels. “So as the pendulum swings from traditional brands going to digital and away from retail, we're doing the opposite, shifting to retail and away from digital. As a young brand, there's only so many levers we can pull to reach the broader mass market. Shifting to retail is a great way to connect with a local audience but also have an impact on the national scale,” said Normandin.
Seeing the writing on the wall, in 2020 Dirty Lemon started selling its beverages at over 500 Walmart stores in the Unites States. While some argue that this may hurt the cachet of the brand, to reach high levels of growth you can’t stay niche forever.
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 can’t acquire customers in a profitable manner you are going to burn through cash making it difficult to keep your business a going concern.
2. Intense competition. Any time a direct to consumer business rises it’s not too long before someone says…I can do that, but better. Just ask mattress retailer Casper. Casper’s cute bed in a box packaging became a viral hit when celebrities like Kylie Jenner bought a Casper mattress and showed it off to millions of her Instagram followers. Selling mattresses online, something Casper took mainstream, made many entrepreneurs and other retailers feel like they could do the same, spawning many competitors. Casper launched in 2014 and during the period between 2015 and 2018 an average of one new bed-in-a-box business launched each week. There are now over 170 mattress companies that sell online.
Flailing under the weight of intense competition and a challenging business model, after two years as a public company last month Casper was bought out and taken private for $286 million. At one point Casper was valued at $1.1 billion.
Birchbox is another direct to consumer company that suffered from heavy competition. When the company launched over a decade ago in 2010 it had a novel idea, a subscription box where customers could get a small number of sample sized beauty products for $10 per month. Birchbox was one of the first movers in the subscription economy and the concept took off as it allowed beauty lovers to discover new products at home. Then they could try on those products from the comfort of their own homes and later buy a full sized version of their favourite products. At one point Birchbox was valued at close to $500 million.
But the company’s success spawned numerous competitors including heavy hitters like Sephora, Ulta and Target who all launched their own beauty subscription boxes. Another challenge for Birchbox was that companies like Sephora could afford to subsize the cost of their subscription boxes from other revenue generating parts of their business. $10 per box doesn’t leave a lot of room to cover the costs of assembling the boxes, buying product samples and logistics costs.
Birchbox ultimately couldn’t persevere in the face of intense competition and it conducted rounds of layoffs in 2016 and 2020, a sad fate for a company which has raised close to $90 million in funding. Then Birchbox was purchased for $45 million in 2021, a fraction of its previous valuation.
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3. A business model that does not work. You have a great idea but do you have the right business model? Brandless is another direct to consumer brand that received a lot of fanfare, partly because it was backed by Softbank, whose Vision Fund is the same venture capital fund that backed WeWork.
Brandless launched in 2017 selling 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. But most of Brandless’ products cost $3.00 making it difficult to make money on each item. Speaking about Brandless’ business model, venture capitalist Kirsten Green 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.
Softbank announced it would invest $240 million in Brandless in 2018. The investment valued Brandless at $500 million. Two years later Brandless announced it was shutting down. It was the first business in SoftBank’s Vision Fund that went 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.” In 2020 Brandless came back from the dead under a new owner.
Casper has also faced criticism for having a great idea but a poor business model. 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: “we have a history of losses and could continue to have operating losses and negative cash flow as we continue to expand our business.” 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 Casper is constantly looking for new customers to acquire which only contributes to more money spent on marketing. Casper has introduced new products including a night light and weighted blankets to make up for this deficiency but this is not enough to turn the business around. Flailing under the weight of a challenging business model and intense competition, after two years as a public company last month Casper was bought out and taken private for $286 million. At one point Casper was valued at $1.1 billion.
4. High logistics costs. When you shift activities customers used to complete on their own to a retailer, someone has to pay for it. Think about the last time you made a purchase online, say for groceries from Walmart. Walmart picked, packed and delivered that order to you all while you sat patiently and waited for your order to arrive. Even if you paid a delivery fee it is often not enough to cover those expenses. A study by the Capgemini Institute found that on average retailers charge their customers just 80% of the cost of delivering goods. 97% of those surveyed in the same study said that grocery delivery models are “unsustainable” without finding other avenues to eliminate costs.
The irony of online shopping is that the most economical model for a retailer is when consumers are not purely online shopping at all. As Bloomberg reported: “if retailers can continue to convert a meaningful portion of that demand into pickup versus delivery, it will provide an offset to the inherently higher supply-chain operating costs of a digital model.”
The COVID-19 pandemic revealed the importance of having multiple channels to a retailer’s success. In 2020 Target’s sales were up 24.3% in the second quarter. Target’s eCommerce growth was even more impressive with online sales up 195% in the quarter. “Our second-quarter comparable sales growth of 24.3% is the strongest we have ever reported…Our stores were the key to this unprecedented growth, with in-store comp sales growing 10.9% and stores enabling more than three-quarters of Target’s digital sales, which rose nearly 200%,” said Brian Cornell, Target’s CEO.
From Best Buy to Walmart these retailers had outstanding performance during the pandemic in part due to seamless multi-channel offerings. The reality is despite how you choose to bring your products to market the customer decides. Human beings like control and offering a variety of ways to receive online orders is something consumers continue to gravitate to.
5. A lack of a store network or wholesale business. After a while successful direct to consumer brands realize they have to do the once unthinkable…open stores. Almost all of the most successful direct to consumer brands have done so including the biggest digitally native brand of all time, Amazon. Yes Amazon has stores, hundreds of them. In the middle of the COVID-19 pandemic Amazon even opened a new supermarket chain called Amazon Fresh.
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 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.
Normandin has called selling Dirty Lemon beverages at Walmart as “the only way forward.” “If you look at the majority of beverage sales, they are either coming from Walmart, Target or Kroger, so we see this as an opportunity to acquire customers profitably.” “When you look at what’s happened with Casper and a lot of direct-to-consumer companies that are getting hammered in the public market, it is because they’ve focused so much on spending whatever it takes to acquire customers and drive-top line growth. They’re losing a lot of money,” said Normandin.
While eCommerce sales surged in the wake of the COVID-19 pandemic the majority of retail sales in the United States still take place in stores with 84.9% of retail sales in the United States in the first quarter of 2023 coming from stores. Consumers still like to touch and feel products and for many shopping is part of a social construct where people meet for a coffee on a Saturday afternoon and then shop as a way to pass time. If anything the pandemic has shown us how little we enjoy being cooped up inside and how much we like to have a place to go to where we can socialize with others.
6. High costs for 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 their revenue. In the retail industry it is estimated that in 2020 returns cost companies in the United States $550 billion, up 75% within only four years. That’s a lot of money for an industry with thin margins.
Customer returns have been a thorn in Casper’s side. In Casper’s IPO filing it disclosed it spent $80.7 million on “refunds, returns, and discounts” in 2018.
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."