A DTC shift is on the horizon.
Over the last few years, many companies have risen to prominence with the promise of being direct: They would sell products directly to customers, mostly will start online and will have lower costs, therefore being able to offer better products at cheaper prices.
It’s a good theory. But market forces are changing. These brands cropped up at a time when customer acquisition costs used to be much cheaper, with Facebook and Google inventory plentiful. But as those costs have risen, many businesses that considered themselves to be digitally native and direct-to-consumer are hitting a growth wall. Quietly, VCs and founders alike have agreed that the companies that once relied on that low-hanging fruit may begin to starve.
It’s changing what it means to be a successful DTC brand. For companies that have raised multiple rounds of venture capital, they are in many cases expected to provide a 10-times return, meaning they need to develop and sell products very quickly. A few unicorn brands have led the narrative. SmileDirectClub, for example, went public earlier this year. It reported $423 million in revenue in 2018, but according to one report the company spent over $200 million in marketing between Q1 2018 and Q2 2019. Away most recently raised $100 million, giving it a valuation of $1.4 billion. This brand sells luggage that retails for a little over $200 — and it’s now in the throes of trying to prove to investors that it’s much more than just a bag company.
Both of these are highly-publicized examples of scaling brands expected to keep growth apace. The reality of a successful company in the DTC space is that quick growth is no longer economical; a venture-backed company that’s raised anything beyond a Series A is likely expected to exceed $100 million in annual sales. And many brands over the last year have begun realizing that this quest may be impossible — especially as customer acquisition costs only increase.
“It is very challenging to grow,” said Zak Normandin, the founder and CEO of conversational commerce platform Iris Nova. “Next year is going to be very interesting,” he went on. Brands in the direct space, “are going to find they can’t grow and sustain anymore.” And what led them to this moment was quite simply the drug-like high of internet-enabled growth hacks.
For many companies that were able to grow quick via online channels, things begin to change once they hit a revenue wall of between $30 million and $45 million, according to Michael Duda, managing partner at Bullish. “Even the strong DTC propositions are starting to have some degree of concern of changes [when they hit that point in revenue].”
Both VCs and founders alike are often looking for a presaged guide for how to grow a solid company. “We are always looking for a holy grail playbook,” said Duda. “Do Google and Facebook to $20 million to $30 million, then this… but there is no playbook.” And now that customer acquisition costs are going up, companies that relied solely on a few channels are beginning to see budgets dry up. “It just blows my mind how some very smart companies are way behind the times in realizing this,” he said.
What happens next isn’t quite clear. Companies that don’t have a solid value proposition and relied solely on quick and dirty digital marketing will likely hit some snags. Similarly, new CPG brands with a few solid products and raised a Series A or beyond will certainly feel VC pressure to grow. At the same time, other smaller brands that raised only a seed round will likely feel content staying right below the wall while figuring out other retail channels to stay sustainable.
For VCs, the growing realization is that DTC as the sole path doesn’t exist. As Lerer Hippeau principal Caitlin Strandberg said at Modern Retail’s Summit this past November, the first two questions she asks any potential portfolio company are “What is your Amazon strategy?” and “How do you get on the shelves on Walmart?” The ones that can’t answer that question likely won’t have a solid pathway to scale. In her estimation, the revenue wall is somewhere between $20 million to $50 million.
This doesn’t mean that it’s all gloom and doom for the next year, just a newfound realization that there’s no silver bullet. Some businesses may shut, and others may just plateau. “It will be a healthy thing to find out what businesses can stand on their own,” said Duda.