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Feeling like DTC is dead? Drew doesn't totally agree. Here are his predictions for the future of ecommerce.
There is this fascinating and relatively new business model that everyone is calling “Direct to Consumer”. You can now buy many of your favorite products on the internet, for almost unbelievable prices. “This is too good to be true”, you think to yourself. “These products must be crap!”
“There, there”, whispers the founder of Dollar Shave Club, Michael Dubin, into your ear via Youtube video. “We’re cutting out the middleman. That’s how we are so cheap. Our blades are f****g great.”
He then gently caresses your face, pulls your credit card out of your wallet, and completes your purchase of a razor for just $1. “This is the life!”, you think to yourself. “I’ll never get tired of fast moving consumer goods being delivered directly to my door every single month. I might never cancel this subscription. In fact, Dollar Shave Club should model me to a 5 year LTV.”
Then, the great surge happens. “Retail is Dead!!!” screams The Wall Street Journal, as a host of DTC brands pop up and attract massive amounts of venture funding. Dollar Shave offers razors, Warby Parker offers glasses, Ritual offers vitamins, Hubble offers contacts, and after just a few years, it seems every consumer goods category now lives on the internet.
Amazon, Facebook, Apple, and Google have all eclipsed $1,000,000,000,000 (yes, trillion) market caps. Dollar Shave Club has been publicly declared a failure. Mark Zuckerberg instantly knows every time you are considering making any sort of purchase, and it seems like you have to ask Jeff Bezos for permission to use the bathroom.
It is the post iOS14.5 world. “DTC is Dead!!!” screams every major news outlet. Hundreds of DTC businesses fold every month, Shopify’s stock price is down 75% from highs, and Triple Whale has become as important to your business as water is to your body.
So, what the heck happened?
Well, it can all be explained by the middle man.
Way back when, pre-internet, consumer goods companies could only get sales in one way: partnering with retailers who attracted shoppers. The advent of the internet brought with it a few very key players that enabled ecommerce: Facebook, Amazon, Shopify, Magento, and Google. For the first time in history, you could sell things directly from a brand to a consumer via the internet. This was extremely lucrative as you could cut out retail; you could cut out the middleman who was eating up massive amounts of your margin.
Facebook was new and growing like a weed. You could reach tens of millions of customers looking for your products on the platform, and because Facebook only cared about growing its user base, it was willing to sell advertising slots for insanely cheap prices. It was pure arbitrage – and made many people extremely wealthy.
Over time, Facebook’s growth began to slow, and they began to charge more and more to advertise on their platform.
What we saw was rising CPM’s; what we missed was the emergence of a new middleman.
Around the same time Facebook CPM’s started to take off, Amazon started taking a larger and larger cut of each sale made on the platform. However, despite these market forces, online sales remained generally more profitable. Today, Amazon’s take rate is about 35%. That means if you make a sale of $1 on Amazon, on average, you lose 35 cents of it to Amazon.
I used to be a public equity analyst covering Amazon (and a variety of other ecommerce businesses) and take rate expansion was always top of mind for big public market investors: just how much money Amazon can generate from the merchants selling on its marketplace.
What we saw was Amazon building out two day shipping, generating more demand, and building an advertising business; what we missed was the emergence of a new middleman.
Google’s role in the evolution of the middleman is effectively the same story as Facebook’s. The internet was still quite young when Google was born, and Larry Page and Sergey Brin were focused famously on only one thing: “Organize the world’s information and make it universally accessible and useful.”
Note that this does not exactly say “monetize every user as aggressively as possible”, which is eventually what the goal became as Google reached a more mature stage of its life, similar to Facebook.
This will cause debate, but my opinion is that SEO as we think of it today more or less does not exist. That isn't to say that massive publishers with an abundance of content can’t rank in search organically, but for the most part, if you are a new entrant into a space selling consumer goods on the internet, Google isn’t as willing to give you free placements as it once was. Increasingly and inherently, each digital platform that serves as part of our funnels relies on a ‘pay to play’ model.
What we saw was Google centralizing the world’s information, what we missed was the emergence of a new middle man.
Okay, so by now, you get the point. I could go through and do that for a few others like USPS/FedEx/UPS, but after writing it a few times, I think we get it.
Next, let’s think of a standard ecommerce profit and loss statement. I’ve included a quick outline below. (And yes, this is the proper way to chart your gross profit on a P&L – with this P&L simplified for illustrative purposes):
We just discussed the inflationary pressures on DTC from the likes of Facebook, Google, Amazon, UPS, etc. Now consider these impacts from a P&L perspective. Line by line, as you go from gross revenue down to net income, these online platforms are slowly growing as a % of your revenue – all while squeezing all the net profit out of your P&L.
Did you have low shipping/freight fees back in the day? UPS wants some of your profit.
Amazon fees used to be nominal back in the day? Bezos is coming for your wallet.
Used to have good CAC’s and low marketing expenses as a % of revenue on Facebook? Not anymore.
Line by line, the ecommerce enablers slowly started to take all the dollars, until one day, there were so few dollars left that DTC began to feel like an unsustainable business model at scale.
Right before our eyes, we went from cutting out the middleman to creating an even bigger, wealthier, and powerful cartel of middlemen in ecommerce. If you want to build a successful business online, it’s incredibly hard to do it without paying the Facebook/Google/Amazon/USPS tax.
If you said retail was dead in 2015, you were wrong. If you are saying DTC is dead in 2023, you’re probably going to end up being wrong as well.
The truth is that the answer, once it shakes out, is probably going to be ‘a little bit of everything.’ What we are seeing is a series of market corrections, much like a SIN wave.
Everyone got really high on DTC until it crashed. Now it’s ‘dead,’ and all of sudden Target and Walmart hold the keys to profitability.
We’re facing a market correction, and from that standpoint, DTC is not dead. In fact, I believe it will play an important role in many successful omni-channel brands. That being said, I do believe that DTC as a business model is generally a challenge, and that retail channels will prove to be more profitable than online channels from a contribution margin perspective until ecommerce reaches a critical level as a percentage of the overall economy.
Retail distribution is usually required for robust profit margins because of one core line item in the P&L: shipping.
Last mile shipping in DTC is absolutely killer. As it turns out, shipping heavy things is expensive. This is why you are seeing the heavier item DTC categories struggle first; they had the least amount of P&L to be gobbled up after shipping. Once the iOS14.5 changes came and changed CACs, they were doomed.
Casper got taken private, Liquid Death and Super Coffee stopped selling DTC, and many other examples of heavy items were identified as too hard to sell via ecommerce.
The thing is, for many of these items, it actually costs much more to send them through the mail than it does to even make the actual goods. When Facebook/Amazon/Google costs were lower, absorbing expensive shipping costs was much easier for brands, because contribution margin held up. But as soon as those platforms’ costs crept up, brands began to run out of variable profit pretty quickly.
The beauty of omni-channel distribution is that you can build your brand offline and build your business offline. So if you get significant distribution into a Walmart for example, you may not actually have to change too much around your sales and marketing as a percent of revenue. You’re still building your brand and reaching your audience on those online channels.
When you go into retail, you don’t have to pay ludicrous amounts in last mile delivery. Leverage in a consumer P&L opens up, so you can expand contribution margin and generate cash flow.
Check out the sample P&Ls below. I’ve charted expense accounts as a percentage of revenue in a DTC-only model versus an omnichannel model.
The year is 2023. While the middleman is more powerful than ever before, we as operators must survive by being agile and pursuing sustainable growth. Your P&L’s life depends on it.
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