Direct-to-consumer models are coming under pressure. Here’s what the leading companies are doing about it.
In the immediate aftermath of the pandemic, the merits of a direct-to-consumer (D2C) model seemed obvious. Native D2C brands were enjoying growth rates of around 40 percent and established brands’ D2C channels boasted 30 percent growth rates or more.
Yet the market dynamics very quickly started to change. Customers started to return to physical stores, undermining the digital advantage held by D2C. As importantly, logistics costs increased significantly, forcing many D2C brands to raise prices and start charging for shipping. Advertising and marketing costs also soared, in some cases jumping more than 300 percent, pushing up customer acquisition costs. And now the current high inflation environment is putting pressure on margins.
DTC – failure to launch?
Looking at the IPOs in last few years, very few DTC companies have created shareholder value since flotation over the past 5 years with failures across most sub-sectors from F&B to Apparels.
While macroeconomic factors have played their role in this under-performance reflecting the decreasing wallet size of consumers, squeezed margins and more difficult financing conditions, the truth is that investors have fallen out of love with D2C after the initial excitement died down with the failure to deliver the growth it promised.
Looking more closely at the sector, most D2C failures reflect one or more weaknesses in their underlying business model, being
- poor unit economics
- failure to offer a differentiated product or experience
- low ratio of Customer Acquisition Cost (CAC) and Customer Lifetime Value (CLTV), and
- inability to attract talent or scale.
Pillars to help make D2C successful
Indeed, these weaknesses in my view are now becoming must-have factors that are cornerstones of successful D2C businesses:
Attractive unit economics
Attractive unit economics that allow significant margin to be generated from each order when average order value, gross margins, and handling and delivery costs (packaging and shipping) are all factored in. I see an informal target being used by investors of a gross margin above 50%.
Differentiated consumer proposition
The need for a differentiated consumer proposition has always been key. This can be in the form of making a consumer’s life easier, offering them something unique or fun, or providing them with value at particular price points. The retrenchment in the sector has quickly highlighted those D2C businesses which had a shaky proposition or one that didn’t scale beyond initial adopters.
LTV > CAC ratio of at least 4 and repayment of CAC in less than 1 year
While strictly being a KPI rather than a success factor, there are many investors that have moved to only consider businesses that have a LTV:CAC ratio above the hurdle of a 4-5 range and ideally repayment of the CAC within the year.
Ability to scale
Last, but not least, the ability to scale the proposition, both externally in attracting new consumers and expanding into new geographies as well as internally from a technological and talent perspectives is crucial to investors.
These increasing challenges to the D2C model have resulted in record low M&A in the D2C sub-sector as investors have become increasingly selective and several large companies either shutting up shop for their D2C ventures or disposing the assets.
Surviving and thriving in the new reality
In this market, evolution is key. And the leading D2C brands are exploring a range of options to reinvigorate their strategies and resuscitate their margins.
Many are focused on building scale. Some are rethinking their channel strategies, either creating physical stores in order to complement their online presence or partnering with existing retailers to expand their footprints. And in some markets – particularly where D2C brands are fragmented –companies are building ‘house of brands’ business models through acquisition and partnering.
Others are striving to innovate. Many D2C brands are exploring how they might apply new technologies to achieve greater efficiency and enhance the customer experience. A recent survey conducted by KPMG International indicates that 57 percent of organizations expect AI and Machine Learning will be key to enabling them to achieve their short-term goals. There are also many D2C companies who are experimenting with AR/VR, chatbots and IoT solutions in order to enhance the customer experience.
Leading D2C companies are also looking for opportunities to differentiate. For some, that means working with influencers who might elevate their brand awareness and appeal within certain segments. Others are offering innovative credit solutions that help lock customers into a purchase while enhancing the longer-term relationship.
Like others across the retail and CPG sectors, D2C players are also focusing on eco-friendly manufacturing processes, products, and packaging in order to position their brands as sustainable. In fact, the same survey by KPMG International found that more than half of all companies expect ESG considerations to become the driving force behind their transformation initiatives over the coming years.
