May 3, 2019 by Sujay Seetharaman

Over the past half a decade, the tidal wave of niche brands delivering new styles of merchandise to consumers and doing so online has modified the retail and CPG landscapes forever. This shift has in a way caused a shakeout in traditional retail, with once-popular retailers announcing store closures (JCPenney, Sears) or even liquidation (Payless, Toys R Us) sending fashion houses and CPG brands on a soul-searching journey. This grim scenario of retail is in contrast to the emergence of the  Digitally native – Direct to Consumer (D2C) brands that continue to grab the attention of shoppers, legacy retailers, and brands, investors, tech and logistics companies in the same way. Some have become successful unicorns like Casper, Rent the Runway and Glossier and some get acquired for huge sums of money like ModCloth. There is no questioning the impact these DTC companies have created but we need to focus on some pertinent questions like – How are these D2C brands going to evolve and how can they sustain as businesses? Like always, the pioneering companies find their path and we then derive the playbooks out of them. From PipeCandy’s analysis of several D2C brands, we see the following approaches taken by D2C brands.

Playbook 1: Brand’s purpose anchored around one product category

Playbook 2: Brand’s purpose anchored around multiple product categories

Playbook 3: Brand’s purpose anchored around aggregation of other brands (for sale or rent)

D2C Brand’s Purpose anchored around one product category

Many of these DTC brands have experienced early success by maintaining an authentic relationship with the customers that is built on the promise of one product. These companies identify and target one particular product category, have a small set of SKUs and anchor their brand identity around it.

An example where a brand stays within one category and continues to grow would be Glossier. They play in the ‘beauty’ space. Their purpose is to give its customers’ opinions a voice when it comes to beauty. And the beauty market is over $500B in size, giving Glossier a big ‘target market’ to continue focusing on.

If you look at another success story, Allbirds, it’s a ‘Merino wool’ company with shoes being a category where the material innovation has been applied to. ‘Shoes’ is a sufficiently large category where they found a mega-niche of shoppers who believe in ‘comfortable shoes made from natural materials at an affordable price’.

D2C Brand’s purpose anchored around multiple product categories

This playbook is increasingly coming to be seen as the norm wherein a DTC upstart first establishes itself in one product category, anchoring its core purpose around that category and eventually expands to other categories. Casper is a good case in point. It’s a brand that has a singular purpose (Better Sleep) which manifested so far through a single product (Mattress). But we’ve already seen the product categories expanding – Glow, their range of light products that help you sleep better.  Harry’s, a DTC razor company followed the same strategy by moving beyond razors to launch their own Face wash, Lip balm and Face Lotion.

D2C Brand’s purpose anchored around aggregation of other brands (for sale or rent)

If a d2c brand’s motivation is to provide a sampling of the best clothing collection out there, it matters less whose brands are being suggested. The story isn’t about one brand. It’s about how well the products are curated and personalized for the shopper. Stitchfix understood this right off the bat. It’s this neighborly style attendant that associate brands with customers, however, curates the experience for each customer utilizing the data about that particular customer.

It’s nothing unexpected that when your product is ‘recommendations’ and the revenue comes for your ‘wise counsel’, the manner in which you make sustainable revenue is when there is a subscription element. Stitchfix, Ipsy, and Birchbox – which is like the initial two – are all subscription box companies, even as they are ‘direct to customer’. ‘Rent the runway’ is a pioneer in utilizing this playbook and weaved the trend of ‘renting’ rather than ‘owning’ the wardrobe. But to pull off such a change in behavior and to invest in the merchandise, you need capital.

And that brings us to the question of how these playbooks are impacted by the availability of capital.

Access to Capital and how D2C playbooks are impacted by access:

The D2C movement is in an interesting stage of evolution. There was a lot of capital, M&A and a sense of despondency among the investment community about the increasing CAC and capital costs. But there have also been companies that have crossed the billion-dollar valuations recently (Rent the Runway & Glossier). Add to these, the fact that there are going to be a lot of IPO millionaires, at least in the valley getting D2C brands out of the drawing board isn’t going to be a challenge. For the D2C brands, there are several ways to get from zero to the IPO or a private market exit.

The VC route to scale:

The success stories where the brands have taken VC investments have either had really large markets (Allbirds) or really strong following among the core audience (Glossier) or a very strong, differentiating tech that led to an asset-light way to grow revenue and margins (Stitchfix). Often, it is a combination of more than one of these factors that have led to these companies to billion dollar valuation or IPO.

Lack of large markets are fixable (Casper). Lack of purpose and a strong purpose that connects the audience is not. Also, many of the early-day VC investments in the category were based on the thesis that the brands can acquire customers online and there is no cap to that behavior. However, that has become prohibitively expensive over the years with many more brands fighting for clicks from the same cohort of customers. We looked up a couple of D2C brands across popular categories like fashion, beauty, travel, and sleep and found that between 2017 and 2019, these d2c brands have increased their pay-per-click budgets by as much as 10-20 times.  

If you are a D2C company competing with Allbirds or Away, you know that your CPCs are going to be expensive. The offline expansion comes with capital costs as well, though the CAC is lower in the long run. But when a brand goes offline and competes with traditional brands or retailers that have figured out distribution, the battle for the shopper is fought in the terrain that is unfamiliar for most of the D2C brands. Besides, the incumbent brands are learning social and community-building and have realized that ‘direct to consumer’ is a business model change and not a segment that is impervious to them. For these reasons, the VC interest in the space is likely to be muted. But it will be interesting to see how it plays out, given that there are a handful of companies that are already in the billion-dollar valuation club or getting there.

The non-VC route to scale:

There are companies like MVMT, Native and Tuft & Needle that have either completely avoided venture funding or have done them at their growth stages making it a very viable approach. MVMT’s founders invested $5000 of their own money into their first Indiegogo campaign and raised over $290,000. This non-VC or VC-light strategy resulted in successful exits for all three companies, with Movado acquiring MVMT for $100M, P&G acquiring Native for $100M and Tuft & Needle merging with incumbent Serta Simmons for an undisclosed amount. Between the three brands, the average initial capital invested worked out to $400,000 and the value of exit averaged around $200M! Not all D2C categories are the same. In some, the cost of acquisition of customers and product development costs are so high that a capital raise is inevitable. The ability to stay bootstrapped/independent is also a function of identifying categories where there is a large spend, there are incumbents that have no brand affinity and there is a room for a capital efficient branded play.

Outcome without hitting scale:

Inevitably a lot of D2C brands are going to look for an outcome without hitting growth orbits. That’s just the way the pyramid is stacked in any market. We have seen examples of these that have gone well as well as gone bad.

Roll-ups by strategic buyers:

Jet.com is an active acquirer in the space, acquiring sub-scale brands. In 2016, Jet acquired Shoes.com (formerly Shoebuy.com), a once-leading online retailer of shoes, apparel, bags, and accessories. The company was making close to $300M in sales in 2013 but just three years later in 2017, Jet.com acquired it for $70M – raising speculations that online retailer may have been struggling to realize scale in a sustainable manner. The brand was eventually rolled up into Walmart’s portfolio of brands.

Walmart has made a number of strategic roll-ups in the Apparel and Fashion space like Bonobos, Modcloth and Eloquii

Roll-ups by financial buyers:

As is the case with any playbook, this path has examples that went well and didn’t go so well.

Julep was founded in 2007 by Jane Park as a physical retail concept. The company was operating four nail parlors in the Seattle area at the time and in 2008, grew into a multichannel online cosmetics brand, launching 300 new products each year. Investors such as Andreessen Horowitz poured more than $60M into the company. In 2016, Private Equity firm Warburg Pincus came along and paid $120M to acquire Julep and two other brands and rolled them up under a new banner called Glansaol. Due to differences in the core purpose of the participating brands themselves, this effort failed. Revenue dwindled until Glansaol filed for chapter 11 bankruptcy in December 2018. Julep was taken over by a company called AS Beauty. While the roll-up was a deliberate move, a bankruptcy filing and acquisition by AS Beauty was certainly not the path Julep or Glansaol envisioned.

A brighter example was L Catterton’s roll-up of swimwear brands Seafolly and Maaji. In a move to create the largest independent house of beach lifestyle brands, L Catterton in 2017 rolled up two of its umbrella brands – Australia-based ‘Seafolly’ and Colombia-based ‘Maaji’. The brands collectively have a revenue of over $100M, placing them at the forefront in an industry that is extremely fragmented with over 3000 brands worldwide.

Brand Incubators:

Like we’ve seen earlier, big corporations typically play the waiting game before reaching out and acquiring brands that fit their strategic interests. However, with the arrival of Incubators, these corporations are getting into the incubator game too! Kendo (owned by LVMH) and Seed Beauty were the first ones on the scene. They were the baking ovens of popular celebrity and influencer backed brands such as Kat Von D, Marc Jacobs, Fenty Beauty, and Kylie Cosmetics. These success stories stoked big corporations like Unilever, Revlon, and L’Oreal to set up their own incubators. They started pushing innovative brands from within the company rather than searching for external brands to partner with. Seed Phytonutrients, for example, was born out of L’Oreal’s incubator. Sephora’s Accelerate, P&G’s Connect+, The Unilever Foundry are few other examples. Not to forget, Amazon has an accelerator too and it spun out its first beauty brand called Fast Beauty Company in March this year.

There are three main reasons why corporations are going the incubator way.

  1. Firstly, it is just easier to invest in relationships with a range of early-stage startups through an incubator, with the assurance that the relationship and financial stakes will be maintained as the startups grow.
  2. Secondly, they are involved in every step of product development and fine-tuning, which helps fix mistakes early on.
  3. Thirdly, the time elapsed in execution from concept to creation is way more narrow in incubators than in traditional companies. Seed Beauty reportedly takes five days from concept to creation which is in some cases years fewer than what traditional companies would need. With the adoption of the incubator model, traditional companies are realizing that the fast fashion model can be replicated for other products too!

To conclude, we see a recalibration of what ‘D2C’ even means. Traditional, incumbent brands are realizing the need to own the customer experience and are embracing D2C channels either by launching their own online storefronts or experience centers, while modern digital native brands are getting acquired by incumbents.

Sujay Seetharaman

Market Analyst @ PipeCandy

Currently donning the Researcher's hat. Talks to himself.