The last five years have been a ‘coming-of-age' period for several DTC brands  - at least 12 DTC brands went public between 2019 and 2021. Even as IPO’s were being filed, the direct brand economy got caught in a snowballing effect of changes as retail endured multiple headwinds through the pandemic. The playbooks began to be redrawn as brands hit a reckoning and long term profits were still a mirage for many. 

Scalability of revenue aside, the accumulated losses did not sustain investor confidence. Most brands saw their stocks fall at least 60% in the last year.  

‍_{“I’ve tried to make us the opposite of Nike almost,” said Tim Brown, founder of Allbirds in early 2021. Allbirds back then sold only three running shoe models made from sheep’s wool, with very limited variations. Today, Allbirds’ eCommerce site lists seven different types of footwear made of four different types of material and 12 color variations.  Allbirds also increased the number of physical stores it operated by adding 20 new locations since September 2021 taking the store count to 51. It is planning to go wholesale and its products have already started appearing in select Nordstrom product catalogs.
‍}It has been a year since the last of those IPO’s. DTC brands weathered inflation,  supply chain crisis, and the iOS cookie apocalypse. Projections for revenue and addressable market sizes had to be recast and so were cash flows, top lines and bottom lines. Brands had to diversify their channels as well as products to sustain their businesses. The last nine months provide an insight into what went wrong and what worked. Looking into the Q3 earnings of 15 brands, there are three takeaways.

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‍Spend on growth if you have predictable & profitable revenue growth from your best channels

Most brands clocked a YOY increase of at least 10% in the year-to-date revenues which is reassuring as consumers curtailed discretionary spending, focusing on essentials for the later part of the year. While marketing spend is also up for most brands,  some have managed to scale down marketing spend reading the signals while others are still grappling with high spending and low revenue growth. 

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Estimating ‘Life-Time Value’ is a lot like reading Zodiac signs, especially if you are an impressionable teenager introduced to astrology. A lot of wishful assumptions can be baked into the LTV calculations and they may need a huge dollop of macro factors to stay on course. But just like astrology, the impact of wrong LTV calculations is still a mess that brands have to clean up, in full public gaze, if they have IPO'd.

Blue Apron, Hims and Hers, Chewy, and Barkbox rely on subscriptions and repeat orders which helps them predict customer LTV. Hims and Hers’ subscriptions increased 80% YOY with increased investment in display, search, linear and streaming television markets. They beat the analyst estimates for revenue this quarter. The marketing spend has increased in lock-step with the increase in revenue. Growth itself is not a bad word but growth without profitability and growth without predictable revenues is. Hims & Hers has a predictable revenue and they are not holding back on marketing spend.

Blue Apron’s subscriptions decreased 7% YOY while the average order per customer and volume of orders went down despite an increase in marketing spending per dollar of revenue. A part of Blue Apron’s problem is buyers who do not convert to subscriptions. The meal kit subscription service is now placing its boxes in Walmart and on Amazon.

Warby Parker cut down marketing spending by 26% relying more on customer acquisition via stores. Solo Brands rationalized its ad spending to reduce its reliance on third-party advertising and use its proprietary, data-driven, sales and marketing engine to generating intent trends, purchasing history and establishing direct contact via email and text messaging. The DTC brand also increased its wholesale distribution by 39%. Allbirds deferred some spending to Q4 2022.  Its expanding chain of stores generated customer acquisition and increased SKU count while its foray into distribution is still taking off. 

If you are a DTC brand and the least expensive ‘online only’ model does not get you to profitable growth with high margins, it just says that the business is not supposed to be DTC – at least, not in this market.

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Sustaining Gross Margin and Cash Flow: It’s boring execution and it always has been – DTC is retail too

Still, 6 out of 15 brands have a healthy gross profit in 2022, down from 12 in 2021. But, their gross margins are shrinking YOY while they continue to burn cash. Higher supply chain costs including high inbound freight costs throughout the year has been a common factor for shrinking margins and increased inventory costs. External factors impact inventory costs and brands  are unable to manage the cost of sales through better inventory control and end up burning cash.

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Fearing further supply chain issues, YETI, like many other companies, stocked up on inventory. Yeti-branded coolers are premium products. When discretionary spending halted, Yeti had an inventory problem that ate into its cash. At the end of the first quarter of 2022, YETI's inventory was at its highest level since its IPO in 2019.

Smiles Direct Club has not diversified its product SKU, unlike HIMS. It remains a single SKU brand and as demand weaned due to curtailment on discretionary spending, SDC’s gross margins fell.

Warby Parker continues to build physical stores, aiming to be a full-service retailer for vision correction. The company offers eye exams and glasses and began selling contact lenses through a third-party manufacturer in 2019. Contact lenses are low-margin products; as their share in the product mix increased, Warby Parker’s gross margin reduced. Before the company sold contact lenses, its gross margin was around 60%. For the nine months ending Sep 2022, its gross margin went down to 17%.

Chewy has been an outlier. The presence of strong, at-scale, national pet-focused retailers has made the DTC channel unattractive for pet care brands. But Chewy has been an exception focusing on recurring revenue categories like pet food and health care which are low margin and non-discretionary but enable retention of customers to sustain demand and profitability. Chewy’s volumes are relatively higher and it has sought to be profitable by managing inventory placements and reducing freight costs which in turn improved delivery performance and customer experience.

If anything, Chewy reminds us that retail operations are about operational execution and a game of savings – built by adding one incremental basis point after another, relentlessly.

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SG&A Costs: Channel diversifications come with a cost

Low net margins are characteristically standard among all DTC brands. The bloat in the Selling, General & Administrative expense (SG&A) primarily arises from employee compensation, rents, order fulfillment, distribution costs, and depreciation. Brands that diversify their channel to open their stores will see a high SG&A uptick due to new store openings, rentals, and related distribution. Warby Parker, Allbirds, and Brilliant Earth have all added new stores significantly this year.

For Warby Parker the main purpose of its stores is to address gaps in the customer’s journey by supporting  pre- and post-sale activities like fitting, repairing, or upgrading eyewear. The stores, therefore, are important conversion rate optimizers for the brand. The increase in stores is, however, increasing rentals and employee costs, not to mention the cost of store build-out and hardware equipment. Warby Parker's SG&A is 78% of its net revenue. 

In a category like eyewear, it is hard to turn on subscriptions and even if you do, it is for low-margin categories like lenses. Then there are assumptions to be made about how many of those lens customers will eventually buy premium eyeglasses. Even if they do, they need a place to test the eyes and try the glasses. Ergo, stores.

Some DTC IPO darlings will go through a painful process of resetting expectations to being boring single brand retailers. A few will decide to do it out of the public gaze and go private.

The next year is going to be eventful. How fortunes change by then will be telling who will remain public and who won’t. We will continue the fortune-telling with data, until then. 

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