How DTC Startups Like Casper and Harry’s Can Survive This

Even before the pandemic hit, DTC brands were undergoing an economic reckoning

Photo: Rachel Murray/Getty Images for Casper Sleep Inc.

The past decade has produced hundreds of direct-to-consumer (DTC) companies aiming to sell products straight to consumers online at a more competitive price than traditional retail. According to eMarketer, there were more than 400 DTC brands as of early 2019, including companies such as Warby Parker, Casper, Glossier, and Away.

In theory, this was a sound strategy: Brands gained direct access to customers and promoted repeat purchases across a variety of products, ultimately allowing for a higher customer lifetime value (LTV). The reality, however, is that most of the high-profile DTC brands were built on selling a singular type of product — think Warby Parker with glasses or Harry’s with razor blades — making it difficult to reach a high LTV due to lower repurchase rates for a product a consumer already owns. Once you look past the glitz of the DTC category’s sleek branding, it turns out it’s extremely difficult to make the unit economics work at scale.

Even before the coronavirus brought the world to a standstill, flaws in the long-revered DTC model were already being exposed by wake-up calls like the disastrous Casper IPO, the implosion of Outdoor Voices, and the Brandless shutdown. The coronavirus pandemic may be accelerating the adoption of online services from companies like Zoom and Peloton and nearly any brand that falls into the wellness category, but it’s also truncating the life cycle of businesses that aren’t built for long-term growth.

DTC vulnerabilities

According to CB Insights, DTC brands have received a cumulative $3 billion in venture capital funds since 2012, and more than $1 billion of that was invested in 2018 alone. But applying unicorn expectations to a DTC startup is fundamentally misguided given the very different business fundamentals of consumer brands compared to other technology companies. Unlike other tech categories, like social media (Facebook, Instagram), digital marketplaces (Airbnb, Alibaba), and enterprise SaaS (Salesforce, Microsoft), that have produced incredible venture returns over the past quarter-century, DTC is not a winner-take-all market. There is a natural ceiling for scaling consumer brands, as evidenced by the fact that it took Procter & Gamble almost 200 years to build 22 brands worth more than $1 billion without being able to build a single $10 billion brand.

Venture capital’s “growth at all costs” mantra has been replaced with a solemn focus on survival.

The very act of pouring millions of dollars into immature DTC companies can have perverse effects on operating discipline. Founders become incentivized to “go big or go home” regardless of whether the category can actually achieve the level of growth required to make returns work. The pressure to grow even faster and achieve greater scale to meet venture expectations was already overwhelming to the DTC model. Now, with the impact of the coronavirus pandemic, the entire DTC ecosystem is being smacked in the face with the reality of what happens when consumer demand falls off a cliff and cash starts running out. Venture capital’s “growth at all costs” mantra has been replaced with a solemn focus on survival. As startups strap in for what will be a very challenging remainder of 2020, it’s imperative that DTC companies examine the vulnerabilities of the business model and identify the advantages that will enable the fittest of species to live on.

Create multiple contingency plans

As with many companies, the first step for any DTC startup is to maximize cash and extend its runway by actioning severe reductions in burn rates. The next step is to take a hard look at the supply chain. Many factories are already shut down or are experiencing partial shutdowns, resulting in a significant decrease in output. Fulfillment centers are running at minimum capacity, and shipments are drastically delayed, save for a small subset of products that are being prioritized due to their “essential” status. DTCs should take a long, hard look at their entire operations — sourcing, supply chain, fulfillment, distribution — and assume every part is at risk of failing. Brands must fully commit to building redundancies now and instituting contingency plans A, B, C, and so on across their entire operations.

Even if a DTC is lucky enough to be in a consumer category that still has demand, chances are the raw materials it needs are becoming limited and its ability to meet production goals is severely hindered. Overloaded customs processes for imported goods are further stressing the system. One way DTCs can survive is to scour the supplier landscape of their product categories and explore relationships with new partners.

Scale up without losing profitability

Growing well is better than growing fast. DTC startups shouldn’t sacrifice good unit economics, which include customer acquisition costs (CAC), gross margins, contribution profit, and customer lifetime value, despite how tempting it can be to spend more for exposure today with the intent to figure out how to improve LTV tomorrow. In the early stages of building a DTC business, CAC is going to be the lowest it will ever be, because early adopters are more willing to try out new brands, warts and all.

As a brand scales past the early stages and must acquire customers from the mainstream majority, CAC increases, which requires higher LTV to justify spend. DTC brands are realizing that it only gets harder to expand LTV during later stages of their business life cycles. While DTC is a phenomenal channel for building a direct relationship with customers, it must be scaled methodically, with thoughtful precision around unit economics, throughout the customer journey. Just look at Casper, which famously revealed in its IPO that it had managed its unit economics so poorly that it was probably better off sending customers a mattress for free, stuffed with $300.

Warby Parker, one of the first DTCs, chose the eyewear category primarily because of its attractive product margins and scalable unit economics. The company has dedicated itself to maintaining an ongoing relationship with its customers through a delightful purchasing experience and is now able to expand into a tangential product category — contact lenses — with arguably even better unit economics due to the frequency of repurchase. By maintaining a consistent level of engagement with existing customers through continuous marketing campaigns and retention strategies, Warby Parker has gained far greater insight into the behavior of its existing customers and the levers its can pull to maximize LTV.

Digital ad spend during the pandemic is already down 33%, making customer acquisition costs lower than they’ve been in years. This is a prime opportunity to actively explore new channels like mobile marketing to decrease CAC, optimize margins through promotions, increase average order value through bundling tactics, and improve conversion rates. If being a patron of a brand isn’t a fantastic experience, new customers won’t have a reason to stick around — even if companies were able to convince them to purchase the first time. Ensuring that you’re providing a strong value proposition to maximize retention makes every new customer far more valuable in the long run.

Strengthen the community bond

Back in 2014, Mary Meeker introduced what she dubbed the “internet trifecta” known as the three Cs: content, community, and commerce. For DTCs, creating their own content allows for a deeper connection with customers. For example, Glossier founder Emily Weiss created Into the Gloss, an online beauty publication that helped the Glossier community congregate around shared issues and interests, which, in turn, helped propel sales at Glossier.

In an undisrupted economy, building a strong community around content allows DTCs to reduce their reliance on paid advertising in order to scale the brand. In the current climate, the role of content is critical in creating a sense of connection and community with customers. In any case, keeping existing customers engaged and connected pays far more dividends, considering that acquiring new customers is five times more expensive than getting an existing customer to repurchase.

Be less DTC

There is a common saying among venture investors that seek out serial entrepreneurs: First-time founders focus on product, second-time founders focus on marketing, and third-time founders focus on distribution. DTC brands have become overly reliant on driving paid acquisition traffic to their websites. Although selling direct maximizes product margins, it also means paying more to get customers to visit a website, which hurts the lifeblood of your business — contribution margin — because of the increased marketing expense. It’s never been sufficient to focus solely on one channel, as evidenced by several notable DTC brands expanding into new marketplaces to sell their products.

DTC brands should become a little less DTC and seek out new distribution opportunities ahead of when demand comes back.

Online marketplaces like Amazon, Chewy, Thrive Market, and Walmart offer various selling opportunities that can be fruitful for a DTC brand. These online marketplaces will either buy goods in bulk at wholesale prices and then set the price themselves or allow brands to list their products and set prices as a seller on the marketplace in exchange for a commission fee. Amazon is a marketplace that allows brands to do both, but the seller model provides superior flexibility and control to manage customer demand, which is worth the commission fee. Since customers are already shopping on those digital platforms, brands reap a greater net benefit from saving on customer acquisition costs and absorbing the commission fees or lower wholesale margins.

In short, DTC brands should become a little less DTC and seek out new distribution opportunities ahead of when demand comes back. In this current economic environment, it’s more imperative than ever to diversify your distribution early into online marketplaces and retailers, because your customers are already shopping there, which makes new customer acquisition more capital efficient. There will be unique opportunities within retail as the consumer landscape shifts and failed incumbents have left shelf space for new entrants.

Ready for any situation

The next year in the United States could closely mirror the aftermath of the 2003 SARS epidemic in China, which caused schools, factories, and shops to close. Some of China’s bustling cities quickly turned into ghost towns, but that period was also a catapult for a new breed of digital businesses. Prior to SARS, Alibaba was doing just $10 million a year in sales, but within a few years, Alibaba grew to become one of the largest e-commerce companies in the world, worth more than $500 billion.

No matter the size of your company, how much capital you’ve raised, or how long your products have been in the market, this is a critical moment to strategize and determine how to best prepare for survival. With a disciplined operational plan and a little luck, DTC brands that survive will come out of this struggle stronger than ever.

Co-Founder & CEO of Innovation Department / DojoMojo

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