The term “direct to consumer” (DTC) refers to companies that make products and sell them to consumers, usually online but also in their own branded stores, avoiding traditional multibrand retailers like department stores. The best known examples are Warby Parker, Casper, Dollar Shave Club and Glossier, but there are many others. The concept is simple: sell the product to the consumer at a price above traditional wholesale, but lower than retail. Use the premium over the wholesale price for marketing to replace the attention-getting function that retailers traditionally performed (along with their store rent and promotion costs). The consumer pays less, but the producer makes the same profit and builds a direct relationship with their consumer. Everyone wins.
Two Key Numbers
It doesn’t always work out that way. To succeed in DTC, two numbers have to line up in the right place. The first is gross margin: what’s left over when you subtract the cost of what you’re selling (not including overhead) from the price you sell it at, aka the variable cost of a product. Successful DTC companies have a gross margin of at least 50% and it can get as high as 85% depending on the product.
Many companies got into DTC businesses telling investors that as they scale, their gross margin will rise. In reality, you can improve gross margin incrementally as you grow, but never enough to make a bad business ok. If the gross margin is wrong, nothing much else matters. Improving gross margin by 10 percentage points or more is almost never realistic.
The second number is CAC, or customer acquisition cost. DTC brands have to attract consumers to their website, store or app and CAC is the cost of that. CAC used to be advertising on Facebook, Instagram and other social media but now those companies know how much value they’re adding and have adjusted their costs accordingly. DTC companies that rely primarily on social media advertising are often now unprofitable.
Sometimes founders believe they’ll get economies of scale in CAC as they grow. That almost never happens and the opposite is often true. The first customers are the most receptive and therefore the least expensive to reach. To convince other customers takes more impressions—and that means more CAC. Worse, CAC is often erratic and can vary widely month-to-month. (Uniquely, during the pandemic, general media demand has dropped and CAC for most companies has declined.)
Managing two numbers sounds so simple and yet when you hear of a DTC company failing, it’s almost always because of gross margin or CAC. If one those numbers are wrong, the business won’t make it.
How They Do It
Successful DTC companies have a number of strategies to minimize their CAC. But you can’t copy another company’s CAC strategy. What makes customer acquisition most effective is that companies have their own unique voice, their own unique channel, their own unique strategy for reaching customers. Consumers will sense that a copied strategy is fake and it will fail; it needs to be custom-fitted to each particular company. Here are what some companies are doing.
A DTC newborn clothing company called Monica and Andy presents itself as an event-driven business. That event is the birth of a child, usually a couple’s first. Monica and Andy offers education about pregnancy and parenting, both online and in its three stores, and makes consumers feel more like members than customers, and that leads to buying products. That feeling creates repeat customers and Monica and Andy sells products up to size 8.
A young company selling inexpensive suits online for wedding groomsmen called, appropriately, The Groomsman Suit, likewise presents itself as event-driven, focusing on the weddings of friends. Remarkably, this focus has enabled the company to maintain its sales and profitability, even during the precipitous decline of weddings and other social events during the coronavirus shutdown.
Both companies rely on getting their customers to tell their friends about their event experiences, and that often includes their experiences buying products. Word of mouth has always been the most effective advertising—and the cheapest—but it is the hardest to get. By ingraining themselves into the important event and leveraging it to reach new customers, both companies keep their customer acquisition costs at attractive levels.
Alo Yoga studio COURTESY ALO YOGA
Alo Yoga, which sells yoga-related apparel in its own stores, runs yoga studios inside all its stores and online and consumers don’t have to buy product to go to their classes. The concept is the same as every theme park you’ve ever been to: You can’t get in or out without passing through the store and inevitably, product sells. Importantly, the experience consumers have in the yoga studio solidifies their identity with the brand.
Some DTC companies have used the most counterintuitive strategy possible: They sell wholesale. The idea is to use third-party retailers to expose consumers to the brand and drive customers to the brands’ websites. DTC companies with a wholesale strategy are extremely selective; they choose only a few wholesale customers and only allow their product to be sold in certain stores of that customer.
Some DTC brands open their own stores. On the surface, that seems like the reverse of what direct-to-consumer should be. But stores now have a different purpose. Of course selling product is part of that purpose but another part is brand awareness and to help consumers find their website or app. Joey Zwillinger, CEO of footwear brand Allbirds, told me, “Discovery is an element that is very important when there’s newness and the product looks and feels different and they need to experience it… consumers are telling us they’re having an incredible experience in our stores.” Of course, opening stores to sell a brand’s own product isn’t a new idea at all, think about Lands’ End LE +11.9%, Williams-Sonoma WSM +3.4% and many others, but it’s a twist for companies that started as online-only.
There’s a temptation among DTC brands to focus entirely on new customers and assume the rest takes care of itself once they buy. But customers don’t always come back without encouragement and targeting existing customers has lower CAC and higher effectiveness and value. Tomas Diaz, CEO of post-purchase marketer FlexEngage, calls this “leaky boat syndrome.” As he describes it, new customers leak out because they’re not being marketed to appropriately.
Like other companies, DTC companies also expand the dollars they get from existing customers by growing horizontally with new products. But choosing the right kind of product to expand with is challenging. A DTC company called Made In sells high-end cookware, like pots and pans, at direct-to-consumer prices. Wanting to expand, they needed to choose a product with an association to cookware that could benefit from their credibility. They focused on plates, something consumers could easily see was within their expertise and that would help grow the average order value.
We are also seeing numerous brand collaborations. There are now marketplaces to help brands find marketing partners, like Wove and Dojomojo, that help DTC marketers find complementary brands they can share costs or run promotions with. A DTC company founder named Greg Ashton created a network called GrowExperiences.co with its own Slack channel where brand leaders exchange ideas, advice and trends. Examples of collaborations that come out of these facilities are:
- Wine retailer Winc including inserts from fashion discounter RueLaLa and luxury bedding company Byourbed in its delivery boxes.
- Bicycle brand Jenson USA sending inserts to the customers of shaving brand Harry’s.
- Apparel brand Everlane partnering with the New York Times to generate attention about climate change and create interest in both their brands.
Of course, influencer marketing also allows brands to have a unique voice, but convincing consumers that influencers are authentic is a major concern. A great example is a beauty company called AshleyBlackGuru, where the founder herself is the influencer, the most authentic kind of influencer marketing. Ashley Black herself told me, “Founders have to speak for themselves…they can’t hire out social media and affiliates…How can someone else be you online?”
We are clearly not done seeing the creative ways that brands can use to reach their customers. Especially as new technologies develop, brands will find new ways to market while holding costs down. Brands that keep on using established methods will watch their costs rise until the effort is no longer economic. Adapting to change rapidly, especially in customer acquisition, is one of the factors that makes DTC brands successful, but one thing will not change: gross margin and customer acquisition costs have to be right or the whole effort will fail.