Reduction of spend on middlemen, more efficient marketing channels, agility in reacting to consumer insight, and improved customer retention provide DTC companies of today a unique edge over traditional consumer players.
Back in 2016, FMCG giant Unilever acquired DTC (Direct to Consumer) player Dollar Shave Club for a billion dollars. This was a momentous occasion, validating the tremendous value that DTC firms had created. Mid-February this year saw FTC (regulator) block the deal for DTC company Harry’s acquisition by Edgewell on the grounds that the deal would eliminate one more player from the market, which through its innovations, had driven down the prices of razors over the last half-decade.
In today's piece, we look at the factors that make DTC companies tick, analyze the economics of DTC brands, and the metrics that can be used to identify good DTC businesses.
What makes DTC companies tick?
DTC (Direct to Consumer) brands refer to the brands which reach consumers directly without involving middlemen like distributors, agents, and retailers. Instead, these brands reach customers directly either through their website or through a third-party e-commerce store. This business model gives a DTC company a few advantages that elude traditional consumer companies.
Reduction in distributor margins: Since the DTC models do not involve any middlemen and reach directly to consumers, they save significant cost on the margins they would have otherwise paid distributors and retailers, thereby being able to pass on part of this directly to the customer.
More Efficient marketing: The traditional way of marketing involves finding shelf space in retail stores and advertising the brand through mass media. In the DTC model, the advertising is majorly done through online channels like Google, Facebook, & Instagram which involves auto-targeting of relevant customers for your product and hence potentially greater ROI on your marketing spend.
Sharper consumer insights: The ability to interact with the customer directly and hence tweak their offerings more dynamically as compared to traditional FMCG giants where the voice of the customer is majorly obtained through distributors and retailers, gives DTC players the benefit of being agile and nimble in responding to consumer wants and needs.
Improved retention: Due to an increasing phenomenon of 'showrooming' (where the customers try the products offline and then buy online), digital customers of today care about the brands they interact with. This leads to a recurring purchase of the products sold by DTC brands.
The economics of DTC brands
The Quickfix DTC - Due to the proliferation of DTC brands in the last half a decade, many entrepreneurs found a quick fix way to play DTC - They research low competition keywords for a product on google and sold the product directly to the customer via a website optimized for those set of words.
Their belief was that this loop would continue and hence they would be able to find the value and get it delivered to the customers. The drawback was when much larger incumbents came to the market and started bidding for those keywords, the cost of customer acquisition for these firms shot through the roof. With the incumbents entering with much deeper pockets, this was a game the newer DTC players were destined to lose.
The Enduring DTC - Providing an incredible customer experience is at the heart of a DTC brand that survives the test of time. For the dollar shave club, this came by simplifying the purchase process for razorblades. Operating in high repeat purchase - high gross margin categories helps as well. Repeat monthly purchases that a lot of successful DTC companies have converted into a subscription model enhances the value you can receive from any customer. A higher gross margin improves the money you make on each completed transaction, giving the firm more capital to grow and a longer runway to survive. Having a relatively small product line helps maintain inventory, which is another trait of successful DTC firms. Having excess cash locked up in inventory as a result of having too many products out there is one of the worst things for a young company.
Which are the metrics used to analyze DTC companies?
Churn, customer acquisition cost, and customer lifetime value are probably the three metrics you would focus most on to gauge the health of a DTC company.
Customer Acquisition Cost (CAC): This is effectively the amount a company pays to acquire a paying customer. Suppose a company spends $100 on FB and acquire 5 paying customers. Further, the company gives $2 as a discount on the first purchase, then the CAC would be ($100/5)+$2 = $22
Lifetime Value (LTV): This metric explains the gross margin which the customer would drive to the company over the time period with which the customer is associated with this brand. Normally this time period can vary from company to company, but on a conservative note, this is usually taken to be 2 years
Retention Rate: This metric explains how many customers get retained after a certain time period. This time period can vary across categories. For the razors, it can be a month but for the mattress, it can be 8 months to a year
These metrics ultimately define the long term viability of DTC brands. On backtracking these metrics, it becomes evident that the ultimate success of these brands is dependent on product categories and the customer purchase journey. Only the DTC brands which are into the product categories where there is inordinate and broken customer journey & provide a phenomenal customer experience would be able to transcend this wave and build the companies that would last a century.