The Death of the Pure Play Direct to Consumer Retailer

Picture of people holding boxes
 

By Tricia McKinnon

For many years there was a lot of hype about direct to consumer retailers. You couldn’t follow the retail sector without hearing about Glossier, Warby Parker, Everlane and Casper. The way to succeed in retail seemed to be found in coming up with a great product and then setting up shop online. In the beginning this model can work, at times with great success. Take Warby Parker. Warby Parker launched to much fanfare following a media campaign that got the brand featured in both Vogue and GQ the day Warby Parker launched online on February 15, 2010. The brand was a runaway success. Warby Parker met its first-year sales target within three weeks and within four weeks it sold out of its top 15 most popular styles leading to a 20,000 person waiting list for its eye glasses. 

Fast forward to 2020 and Warby Parker is valued at $3 billion and has 120 stores. Dave Gilboa, co-founder and co-CEO of Warby Parker, in a 2017 interview with PBS, said that when they first launched in 2010 having an online business was an effective way to reduce capital costs. The four co-founders were still in college when they started the business. They did not have any external funding therefore opening stores was not an option. But by 2013 and over $100 million in funding at the time, Warby Parker opened its first store in New York.   

Since the vast majority of people buy glasses in-person trying to convert those customers to online only shoppers proved too difficult even for a breakout star like Warby Parker. This story now sounds familiar. Many founders set up a direct to consumer business only to realize that having stores is the only path to scale and profitability. 

Brandless is another digitally native 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 and 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. Most of Brandless’ products cost $3.00. Speaking about Brandless’ 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.” Brandless recently came back from the dead with a new owner. It’s selling its products online but is also in talks with several brick and mortar retailers.

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In the beginning it is possible to have a degree of success with a direct to consumer model. But over time these businesses tend to face similar issues. It’s hard to be noticed when you don’t have a physical store. Walk in traffic matters. It’s the way many of us discover new brands. Think about how many times you have walked home from brunch or dinner on a Saturday and notice a cute little bookstore and decided to give it a try. Before you know it you are a repeat customer. There is no walk-in traffic on the internet. How does a direct to consumer brand get noticed? One of the most popular methods used is digital marketing. 

In the beginning 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. Traditional brands jumped in as well looking to emulate the success of fast growing direct to consumer brands, 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, Dirty Lemon closed a deal that will see its beverages sold 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. Even Apple came out with a budget iPhone, the iPhone SE, retailing for $399.00, which is significantly cheaper than for example, the iPhone 11 which cost $979.00.

A niche is typically the best way to start a new business. By focusing on a specific segment of customers, in Dirty Lemon’s case, health conscious customers that are willing to pay a premium to ensure they are healthy can create a halo effect. Fans of Dirty Lemon which include celebrities like Cardi B, Karli Kloss and Kate Hudson helped the company to acquire over 200,000 customers in five years but if you want to be the next Coca Cola and have millions of customers you have to have an effective way to get to the masses. 

Normandin has called selling its product 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.”

After a while successful direct 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 digital native brand of all time, Amazon. Yes Amazon has stores, and lots of them. It has close to 600 stores, more than either lululemon or Trader Joe’s. In the middle of the COVID-19 pandemic Amazon even opened a new supermarket chain called Amazon Fresh. Who opens stores in a pandemic if they aren’t a good idea?

eCommerce is also expensive. When you shift activities consumers 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 or not so 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. Amazon spends billions of dollars in shipping costs, $15.1 billion in the third quarter of 2020 alone.

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 has revealed many things some have found hard to see. One of those things is the importance of omni-channel retail to a retailer’s success. Target’s sales were up 24.3% in the second quarter of 2020. 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, which is a true testament to the resilience of our team and the durability of our business model. 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 have had outstanding performance this year 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 your products is still something consumers are increasingly gravitating to. 

If you are starting out in retail you may chose to start out online but have your multi-channel retailing strategy in your back pocket because you may discover sooner rather than later that it is cortical to your success.

Tricia McKinnonStrategy & Growth, eCommerceComment