Reinventing the Direct-to-Consumer Business Model

by Len Schlesinger, Matt Higgins, and Shaye Roseman

March 31, 2020

Eugene Mymrin/Getty Images

For decades, a handful of brands dominated consumer retail in the United States. Whether Kodak in cameras or Gillette in razors, the top brands in more than 10 categories were unchanged from 1923 to 1983.

Then the internet democratized the tools required to start and scale a business. Over the next two decades, a new class of startups emerged. From Warby Parker (eyeglasses) to Everlane (clothing) to Casper (mattresses) and The Honest Company (baby and beauty products), this first generation of “direct-to-consumer” (DTC) companies was defined by borrowed supply chains, web-only retail, direct distribution, social media marketing, and a specific visual brand identity (the now ubiquitous “blanding”) that favored sans-serif type, pastel color palettes, and scalable logos that were easily adapted to a variety of digital media.

The direct-to-consumer startups’ rise was enabled by an environment of abundant venture capital, low competition, and above all, the advertising arbitrage that could be exploited on under-priced social media platforms. “Back then, it wasn’t too hard to succeed as a smart person with a mediocre product in a big, sleepy TAM [total addressable market],” says Ben Lehrer, Managing Partner of venture firm Lerer Hippeau and an early investor in Casper and Warby Parker. “A lot of MBA projects turned into real businesses.”

Fast forward to today, and many of those businesses are looking less viable than they once were. “Casper was a unicorn to private investors. To the public markets, it is only about a third of one,” Quartz wrote of the brand’s February IPO, which valued the company approximately $600,000 lower than its last private fundraising round. Within days, Brandless — akin to a DTC dollar store — ceased operations and laid off 90% of its employees. Glossier suspended its color cosmetics line Play after lackluster sales and Outdoor Voices CEO Tyler Haney was forced to resign amid a reported $2 million monthly burn rate on $40 million of annual sales.

So, what happened? The landscape is almost unrecognizable from even a decade ago (save for the sans-serif fonts). For one, competitors have flooded in, spurred by the early success of a few standout brands. This has driven up the price of social media ads, eliminating any arbitrage and making the customer acquisition math that much more challenging. “Ninety-eight percent of DTC brands are out of business, they just don’t know it yet,” said Gary Vaynerchuk, founder and CEO of VaynerMedia. “They don’t have the fundamentals to continue to acquire customers at a value that’s right, and the [venture] money will eventually dry out.”

Now-established players have learned that Instagram advertisements and influencer campaigns only scale to a point: they can net no more than a few hundred thousand of a brand’s “first best” customers. This has driven a shift toward physical retail and prompted founders to agonize over if and when to peddle their wares on Amazon, making direct to consumer brands look more like their predecessors each day. Competition has also caused demand to fragment in attractive markets such as cookware, where Equal Parts, Made In, Misen, Great Jones, Caraway, Our Place, and others all compete to sell premium pots and pans to design-conscious millennials. Further complicating the picture, legacy consumer mega-brands have caught up, launching their own DTC lines such as P&G’s Native Deodorant and chic bandage brand Welly, which launched in exclusive partnership with Target in 2019.

Meanwhile, investors have grown more sophisticated. Not only are there more consumer companies competing for venture dollars than ever before, but funders now have a decade’s worth of industry data to rely on when assessing performance. And if the initial flood of capital into the space prioritized revenue growth over profitability, the pendulum has begun to swing back the other way. After Casper’s lackluster February 2020 IPO and the FTC’s intervention to block Edgewell’s acquisition of Harry’s (the DTC razor company), we are witnessing something of a correction: unit economics are all of a sudden in. Sustainable growth carries the day.

It is far harder to become a standout success in 2020 than it was in 2010. As Neil Blumenthal, CEO of Warby Parker noted in The New York Times, “It’s never been cheaper to start a business, although I think it’s never been harder to scale a business.” To say nothing of the lasting effect all this has had on consumer expectations. What was innovative in 2010 is now table stakes. E-commerce paired with Instagram ads and a modern logo is no longer a novel experience. “DTC was an insight 10 years ago,” said Ben Lerer. “There’s still a lingering idea that DTC is innovative. That simply isn’t the case anymore…It’s about how you do it now that’s innovative.”

Moving Beyond DTC

Given how much things have changed, what has worked in the past almost certainly won’t work in the future. The path forward must include both a return to management fundamentals and a move beyond the existing DTC playbook in order to incorporate the learnings of the last decade. The specific shifts that DTC leaders must make involve the following principles:

Omnichannel is a necessity. As DTC distribution becomes a bottleneck to growth, digitally native brands must cross the chasm into IRL retail (even if physical retail is on hold during the current coronavirus pandemic). A new crop of retail concepts have sprouted up to meet this emerging need. Showfields, Bulletin, Story, and Neighborhood Goods are all variations on the same theme, curating and aggregating DTC concepts under one roof without requiring long-term lease commitments and expensive build-outs. Although it’s unclear how viable or scalable this new incarnation of master-lease retail will prove to be, many DTCs who have dabbled in at least some offline presence report customers who interact with their brand in the physical realm have lower merchandise return rates and more repeat purchases than their online counterparts. Whether a brand’s retail strategy should include company-owned stores, national retail networks, Amazon listings, or some combination of the three depends on the strength of its community, the level of control it requires in storytelling, and the scale it aims to reach.

Differentiate through community. A unique advantage of DTC brands stems from their ability to have one-to-one relationships with their consumers while capturing valuable data that would be impossible to glean at traditional retail. Increasingly, this looks like a two-way relationship in which community members collaborate with brands in order to co-create new products and services, something that Pattern Brands calls “direct with.” While community will remain a strong differentiator from incumbents going forward, the challenge for modern brands with mass ambitions is to successfully scale that intimacy as they move beyond DTC.

Expand margins via vertical integration. Borrowed supply chains may work at launch, but not over the long run. As mature brands compete for the same digital impressions as scrappy upstarts, they obliterate the arbitrage that was once a DTC’s competitive advantage. And any margin that early DTCs preserved by cutting out middlemen was ultimately lost to expensive, individualized distribution. As customer acquisition costs (CAC) increase across the board, brands must plan to vertically integrate (by, for instance, creating their own manufacturing operations instead of contracting it out) in order to preserve margins and survive past Series B.

Prepare for the voice revolution. In the next decade, voice interfaces stand to reshape commerce in much the same way that the internet did 30 years ago. Existing supply chains, marketing strategies, and brand systems are optimized for the screen-based way that we currently interact with the web. Companies that are not thinking ahead to the next platform shift will inevitably fall behind.

As brands begin to engage with these strategies, the term direct-to-consumer feels less relevant by the day. “DTC” was the product of a specific moment that catapulted a handful of early entrants to stardom. But today’s environment suggests that that model is no longer sustainable. Success today requires an understanding of both evergreen business basics and also the lasting ways in which the DTC model has permanently reshaped the industry.

About the authors:

Len Schlesinger is Baker Foundation Professor of Business Administration at Harvard Business School. He previously served as the 12th president of Babson College and the vice chairman and chief  operating officer Limited Brands (now L Brands). He is the coauthor of What Great Service Leaders Know and Do.

Matt Higgins is CEO of RSE Ventures.

Shaye Roseman is a  member of the 2021 MBA Class at Harvard Business School.