Direct-to-consumer (DTC) brands such as Allbirds, Casper, Peloton, and Warby Parker have creatively found a weakness in the marketing citadel of incumbent brands. By using data gleaned from daily interactions with customers, these brands have been able to adapt how they serve their unique customer communities across a start-to-finish purchase journey. The best of them have parlayed that ability into a profitable business model applied across multiple channels and customer segments. But as successful DTC brands mature, they must recognize the need to evolve. The authors offer four principles for continued success: (1) Focus on deepening customer relationships, not just making comparisons with competitors. (2) Accompany the customer beyond the initial transaction. (3) Omnichannel is about value addition, not cost reduction. (4) Strengthen the core first; consider extensions later.
Emily Weiss’s personal blog was never supposed to become a $1 billion brand. The 24-year-old Condé Nast assistant considered Into the Gloss a hobby, a stage for her personal beauty recommendations for fellow Millennials. The blog, which she started in 2010, featured how-to tips, daily routines, and information typical of beauty publications. By 2014 it was attracting more than 10 million page views a month. Using Into the Gloss as a springboard, Weiss founded Glossier, a direct-to-consumer (DTC) line of beauty products. By providing both recommendations and home delivery of the products they featured, Glossier disrupted the traditional two-step distribution chain, in which a customer might receive advice from a department-store beauty consultant and then buy a product from the shelf. Endorsed by Kim Kardashian, and with product waiting lists that have been more than 10,000 customers long, Glossier has surpassed $100 million in annual revenue and has been valued at more than $1 billion.
Success stories like this one led to the burgeoning of upstart DTC brands. As of 2018, Inc. magazine reported, more than 400 of them had sprung up, including unicorns such as Allbirds, Casper, Dollar Shave Club, and Warby Parker. Since then the number has continued to grow. The potential for DTC brands to steal market share from incumbents has inspired venture capitalists to invest $8 billion to $10 billion in them since the start of 2019, according to TechCrunch. Commentators hail DTC’s online-only, social-media-promoted, no-middleman model as the future of marketing. At the peak of the hype, the Interactive Advertising Bureau announced the advent of a “direct brand economy.”
But the success of these brands has inspired intense competition from incumbents and new entrants. Whereas Casper was among the first to sell mattresses online, in 2014, today it has more than 200 rivals. The advantages of being an early mover on digital media have been eliminated, as incumbents with vast resources have copied and mastered DTC strategies on blogs, search engines, and social media. Many brands have also struggled as they’ve grown. Much of what they achieved early on was possible because they challenged traditional marketing principles and chose new avenues for customer acquisition and distribution. Marketing principles may be bypassed some of the time, especially when entering a new market, but they cannot be ignored all the time – and especially not when trying to scale up a profitable business. As they have faced new challenges, DTC brands have had to reevaluate the direct-to-consumer model and adapt their strategies to remain successful in a field of aggressive and diverse rivals.
In this article we will show how successful DTC brands violated some of marketing’s sacred principles during their early years, and we’ll analyze the core challenges they faced as they attempted to grow. We’ll also propose four principles they should follow to ensure continued success.
A New Breed
Allbirds is a success story powered by product innovation and a keen understanding of customer values. Athletic footwear is a $65 billion industry, with heavy advertising, prominent logos, and advanced technology accompanying its various products. In contrast, Allbirds footwear is unpretentious: The shoe uppers are constructed primarily from merino wool fibers, the soles manufactured from materials that substitute sugarcane for petrochemical foam, and the laces made from recycled polyester. The shoes lack unnecessary detailing and are priced at a reasonable $95. By providing sustainable, affordable, and comfortable products, Allbirds built an emotional connection with consumers. With annual sales above $100 million, it is valued at more than $1.7 billion.
Brands like Allbirds are digitally native challengers. They interact directly with consumers via social media, they build and refine their products on the basis of continual customer feedback, and they rely on quality customer service to help promote their value. DTC brands are a small subset of the nearly 6 million enterprises that peddle their wares online. They have no presence beyond the digital: The brand is the channel, and the channel is the brand. In fact, selling through third parties can erode the uniqueness of a DTC brand.
Several major forces helped these brands penetrate their respective markets. The rise of the internet and mobile telephony, coinciding with the demographic shift from Baby Boomers to Millennials, sparked a revolution in how people consumed media and behaved in the marketplace. Changing demographics also led to the rapid growth of social media. Younger consumers are less likely than Baby Boomers to take shopping advice from celebrities in paid commercials and more likely to heed influencers on Instagram and TikTok. In keeping with the rise of digital media over the past 15 years, advertisers shifted their spending to channels such as Google, Facebook, and Twitter, where they were increasingly able to target and microsegment in a manner that the mass media never allowed. And when one channel became expensive, they could shift to newer ones, such as Instagram, Snapchat, and TikTok.
The DTC entrants targeted mature markets – including shaving, cosmetics, sneakers, eyeglasses, and mattresses – featuring a few dominant players that commanded high prices and margins. (Before Dollar Shave Club and others entered the razor market, for instance, Gillette held a 70% market share, and many consumers complained about the high cost of blades.) Little R&D or product design was built into the entrants’ offerings. Their supply chain strategy often consisted of locating factories that could sell them excess inventory and offering it to customers at a lower price than traditional brands were charging at retail stores. Another important trend was the rise of scalable fulfillment options to make shipping online orders easier. Shopify and similar online platforms provide storefront and back-office operations. Flexe and Loop joined the ranks of UPS, DHL, and FedEx. Payment providers such as Stripe and Plaid, and email marketing firms like Mailchimp, stepped in to provide on-demand distribution and fulfillment for a wide variety of DTC brands.
As the brands implemented this strategy, they deviated from traditional marketing approaches and took shortcuts to deliver products to their customers. Those tactics were instrumental in achieving their early success, but they caused problems as the brands attempted to scale up. Let’s consider how their original decisions came to complicate their journeys.
The “Iron Law Of Distribution”
This law dictates that consumers be able to learn about, see, buy, and service a product somewhere along the distribution chain. It argues that although the stages may be rearranged (for example, the consumer might view a product in a store before researching it online, or vice versa), all of them are necessary for a brand to be successful.
Casper completely upended this law when it began selling its mattresses online and shipping them directly to customers. Brick-and-mortar retailers had been charging large markups for a stage of the buying process that seemed essential: permitting customers to test or lie down on mattresses in a showroom before deciding which one to buy. Instead, Casper gave customers up to 90 days to return their purchases if they were dissatisfied.
DTC brands have consistently ignored the iron law of distribution. Warby Parker, for instance, has shifted part of the optician’s job to the customer. It asks new customers to take a selfie while holding a credit card under their nose to measure pupillary distance – a key step in fitting someone for eyeglasses that once required assistance from an optician in the store. Shortcuts like this have enabled DTC brands to cut costs and offer products at a lower price. But they work only for customer segments that don’t value whatever function has been cut. Casper succeeded because lots of consumers didn’t care about sampling a mattress in a retail location. But over time the company found that many other people do want to test one for firmness or softness before buying it, which is why the company began opening pop-up stores in 2018, only four years after its launch.
Although DTC brands showed ingenuity in finding ways to break the iron law of distribution, they did so at a cost. As they became successful and attempted to scale up, service gaps limited the size of their markets, so many of them had to find alternative distribution paths.
Fundamentals Of Branding
Before Hubble, a DTC retailer of contact lenses, knew anything about its customer base, it secured a supplier of contact lenses in Taiwan. Next it defined the right price point to persuade consumers to switch from rivals. Later it engaged an agency to develop the brand, the packaging, and the digital experience. Realizing that it needed optometrists to prescribe and fit its contacts, Hubble recruited doctors online. Only then did it start selling lenses on its website. After discovering that most of its early customers were suburban Millennial women, the company used social media and data-driven marketing to retain them while seeking to attract new segments.
Hubble reversed one of marketing’s fundamental rules, conveyed by the acronym STP (segmentation, targeting, and positioning). This systematic three-step rule had always been key to brand development. Ordinarily STP holds that a marketer should assess the addressable market segment to gain a sense of the commercial possibilities and then carefully target a subset of customers within that segment with whom to differentiate itself from competitors. With its unique value proposition on offer, the company should begin to acquire conversions. Over time, as it consistently delivers value, a relationship is built.
Hubble turned this sequence on its head. It took a fast track to filling a perceived gap in the market, which is what venture capitalists traditionally look for when investing in start-ups. But that approach is a poor substitute for the fundamentals of STP. Certain customers are so easy to reach through digital channels that an initial wave of sales occurs before the brand even understands the buyers’ motivation for purchasing.
Hubble’s method brings no insight into how customers view a product and its benefits. Only after that first wave of sales occurs can a brand learn who its core customers are and why they made a particular purchase. In other words, some DTC brands back into a value proposition. They skip the up-front marketing effort and expenditure and replace it with a learning-by-doing approach. Because digital media is initially cheaper and more precise than mass media, this approach leads to efficient customer acquisition and a temporary advantage. Unfortunately, the competition has caught up, as incumbents have dedicated their vast resources to driving up the price of digital advertising and acquiring customers through similar means.
Business Profitability Metrics
Marketing has traditionally assessed financial success by budgeting all the direct costs up front. Even advertising and other long-term investments are usually expensed. On the basis of those figures, and knowing the potential range of margins on a product, marketers usually estimate how much of the product they need to sell, over what time period, to recover costs and make a profit. When that number, a projection of break-even volume, has been determined, marketers intuitively understand the size of the market, their target market share, and the sales effort required to succeed.
DTC brands use a different logic. They base their calculations on projected customer LTV (lifetime value) and how much headroom the LTV margin affords, given projected customer acquisition costs (CAC). Calculating LTV requires making several significant assumptions. One is that the customer will stay with the brand for an average amount of time (the “lifetime”) and make purchases at regular intervals. But such estimates can vary tremendously: Razor blades are replenished regularly, sneakers less often, and mattresses as infrequently as once a decade. As a result, most LTV calculations are speculative at best. They also don’t account for competitive dynamics and natural price erosion. In their eagerness to justify their growth strategy, DTC companies often transfer what should legitimately be part of their CAC, such as up-front payments or commissions to influencers, to the selling, general, and administrative (SG&A) expense bucket. That allows investors to feel secure that the LTV is a healthy multiple – usually triple or more – of the (underestimated) CAC. Even a cursory analysis of the income statements of a few DTC companies that have gone public reveals that the true CAC is significantly higher than they admit.
Direct-to-consumer brands should be wary of being drawn into the traditional retailing business model, whereby their products fight for scarce space on store shelves.
What exuberant DTC brands often appear to forget is that costs incurred are real, but future revenue is just a projection. Unlike conventional accounting calculations, which frame the unit economics within the context of quarterly or annual profit-and-loss calculations, the financial projections of these brands extend over multiple years. The moment of truth occurs when one of two things happens as the brand transitions from launch to growth. Either LTV stabilizes and then starts to increase faster than CAC does, or LTV can’t keep pace with CAC, and cash flow is negative.
DTC brands shouldn’t abandon their reliance on customer valuation metrics. That data is useful for projecting cash flow. But relying on customer valuation without critically examining the sensitivity of underlying parameters can lead to an overly optimistic view of unit economics. Good, old-fashioned queries regarding the path to profitability and the payback period should not be passed over.
Four Principles For Continued Success
Despite the counterintuitive ways in which they managed their marketing and operations, shrewd DTC brands learned valuable lessons about using their business model to help them build, grow, and sustain success. Some of them determined that it would be critical to provide value for customers beyond the purchase transaction. Offering a cheaper alternative to incumbent products would not be enough to earn long-term brand affinity. So some brands built intimate connections all along the customer’s journey. Some also selectively expanded the channels through which they sold their products, as Casper and the bedding vendor Resident did when they moved from online-only to include brick-and-mortar retail. Finally, some DTC companies improved on their core product to increase wallet share – as Warby Parker did when it introduced premium additions to its line of eyeglasses.
As DTC brands continue to scale up, they should keep four principles in mind.
Focus On Deepening Customer Relationships, Not Just Making Comparisons With Competitors
In 2011 Dollar Shave Club’s founder, Michael Dubin, concentrated on selling inexpensive razor-blade subscriptions to digitally savvy customers on social media. By producing a simpler product and skipping retail margins, he was able to offer his company’s products at a steep discount. In less than five years Dollar Shave Club had stolen significant market share from the once-invincible Gillette, shrinking the profitability of the grooming category and eventually forcing Gillette’s owner, Procter & Gamble, to lower prices and take a multibillion-dollar write-down on a century-old brand. In 2016 Unilever purchased Dollar Shave Club for $1 billion.
Despite its tremendous success, Dollar Shave Club got one thing wrong: It built much of its brand identity on differentiation from its incumbent competitors. It claimed that its razors were less expensive because they didn’t have “the shave tech you don’t need” (meaning Gillette’s). Negative comparison with rivals can serve a purpose in the initial stages of a brand’s introduction to the market, but eventually the brand must develop its own identity. Luckily for Dollar Shave Club, its initial success came from targeting a younger audience at a reasonable price on social media, and it delivered its products through a convenient and unique subscription model. It stayed connected with its base by regularly responding to both positive and negative feedback on social channels.
Younger consumers are less likely than Baby Boomers to take shopping advice from celebrities in commercials and more likely to heed influencers on Instagram and TikTok.
The lesson is clear: DTC brands must convey value along the entire purchase journey, beginning when customers first encounter them as market innovators and continuing into the postpurchase relationship. Many entrants fail to realize that the initial stage of the process is as much about knowing the customer as it is about differentiation, if not more. Those that come on the market proclaiming how they are different may never be more than a cheaper alternative. Even worse, as wealthy incumbents manage to lower prices by reducing the costs of production and customer acquisition, DTC alternatives are left with no brand identity or differentiating characteristic whatsoever.
Accompany The Customer Beyond The Initial Transaction
Although few entrants have the deep pockets to lead with revolutionary product innovation, they have a process-innovation advantage that incumbents can’t match. They can accompany their customers all along the decision journey, following through on product use and experience after a sale. Because DTC companies don’t rely on middleman retailers, they have access to customer information, which allows them to conduct intimate and direct conversations with customers – something with which incumbent brands struggle.
Founded in 2012, Peloton has transformed its business model to follow DTC sales of hardware, mainly its $2,500 exercise bikes, by offering annual subscriptions costing roughly $500 for access to exercise classes via livestream and on demand, delivered by expert, charismatic instructors. The company is more than a retailer of fancy exercise bikes. Its model revolves around the notion of “consumption by a community.” When Peloton customers exercise with a virtual community of peers and instructors, the brand’s meaning extends far beyond what they would experience with the bike alone. Even though its customers are in different locations, Peloton can use data from the workouts to improve and refine its content and features and to provide personalized training plans for each rider. These features help foster a strong sense of personal connection. But they also do much more: Peloton generated $1.8 billion in revenue last year.
DTC brands have the benefit of being in direct communication with their customers as they consider, evaluate, choose, and experience products. As a result, the brands sit on troves of information about shopping and usage preferences – data that incumbents only wish they had. The brands should actively use the resulting insights to spur innovation, strengthen the value chain beyond the initial transaction, and deliver satisfaction at every possible touchpoint.
Omnichannel Is About Value Addition, Not Cost Reduction
Resident was founded in 2016 as an online brand of memory-foam mattresses. Like Casper, it started by delivering mattresses directly to consumers. But the two were early movers among online mattress brands in becoming omnichannel. Within three years Resident’s mattresses were available in more than 250 brick-and-mortar stores. Today they’re available in more than 1,000 stores in the United States.
The two companies’ shift to omnichannel selling represented a conscious attempt to acknowledge the iron law of distribution. Although both brands had success selling online, a large segment of consumers still absolutely want to touch a real mattress before they order it. As the online market matured, and the industry increasingly ran out of first-time Millennial customers, Casper and Resident began serving the needs of the traditional consumers who dominate the $17.3 billion mattress industry.
Omnichannel ought to be anathema to DTC brands, because it is the opposite of how they came into existence – with a clear focus on a singular method of reaching customers. However, because of the reach and convenience of third-party merchant platforms on Amazon, eBay, and Walmart, DTC brands have rushed to market in any way possible. That’s fine for the thousands of small merchants and entrepreneurs who simply want to engage in profitable e-commerce, but it’s a flawed strategy for any brand that wants to build a strong DTC personality. Amazon provides instant scale but simultaneously commoditizes brands with uniform merchandising and intense price comparisons.
Even for the most differentiated DTC brands, Amazon’s gravitational pull has become difficult to resist. By the end of 2020, reportedly 63% of all product searches on the internet were beginning with the e-commerce giant. To avoid forfeiting that demand to a competitor, many DTCs have begun to embark on a hybrid strategy. The idea is to protect their core offerings by selling limited selections of merchandise on Amazon with the goal of intercepting product searches and migrating the relationship back to owned channels. This strategy is not risk-free. The DTC brands must be highly confident and disciplined about regaining customer relationships and resisting the temptation of sales volume.
Mass merchants have recently started selling DTC brands in their physical stores to appeal to Millennial shoppers. Lola, a DTC brand that sells sustainably sourced products such as tampons, sanitary pads, and condoms, chose to make its products available in 4,600 Walmart stores. Casper sells its mattresses through 1,200 Target stores. Public Goods, a maker of sustainable home goods, sells through 2,000 CVS stores. But DTC brands should be wary of being drawn into the traditional retailing business model, whereby their products fight for scarce space on store shelves. There, the supplier with the deepest pockets usually wins. Such arrangements may give the brand an initial boost powered by the retailer’s reach, but the long-term advantages are questionable.
Brands should follow Resident and Casper’s strategy: Channel extensions that address gaps in the customer’s journey should be the real purpose of omnichannel selling. Providing important presale or postsale services such as inspecting, fitting, repairing, or upgrading is symbiotic and furthers the DTC brand mission. Omnichannel extensions must be carefully thought through and part of a deliberate growth strategy – not merely an attempt to reduce CAC by increasing reach.
Strengthen The Core First; Consider Extensions Later
Warby Parker introduced nationwide product sampling in 2010 with a program called Home Try On. Customers can go online and choose five pairs of eyeglass frames to be delivered to them for inspection, free of charge. Since the try-on frames feature clear-glass lenses, not corrective ones, the program is well suited to customers with minor vision problems who prefer an online shopping experience. They choose the frames they want to buy and upload a prescription to fill the order. They can also choose not to make a purchase and return the frames without charge (which costs Warby Parker approximately $15).
Because Warby Parker maintained close relationships with its customers, it learned that people with complex prescriptions preferred to shop for glasses in person. The same was true for customers who preferred a wider selection of frames than they were able to sample through Home Try On. That provided a good rationale for shifting to an omnichannel strategy, and after three years of selling exclusively online, Warby Parker opened its first brick-and-mortar locations.
But the company learned another valuable lesson from interacting with and listening to customers: People were willing to pay a premium for products it wasn’t selling. So it extended its inventory to include more-expensive progressive lenses, blue-light-filtering lenses, and light-responsive lenses. It also launched a line of contact lenses. In this way the retailer extended its product line and added revenue sources without weakening its core value proposition.
Product line extensions are a great way to increase order sizes and keep customers coming back for more. But many brands routinely make them without first ensuring that the core value proposition is on a sound footing. Brands must be careful with extensions: Sometimes they have a tendency to creep over into items that don’t connect well to the core product. Almost every DTC mattress brand offers pillows, sheets, and accessories. Some even offer glow lamps and dog beds. While many of these are fine products, few would pass muster as a robust addition to the core brand. Worse, some may lead to a proliferation of SKUs and add to supply chain costs.
Allbirds started out by selling sustainable shoes, but it recently added a clothing line of T-shirts, sweaters, jackets, underwear, and socks. The first three categories make sense, since customers could potentially wear shoes and clothing as an ensemble while making a statement about sustainability. Allbirds shoes and clothing share supply chain principles regarding natural raw materials, so the clothes have the potential to contribute significantly to revenues. But underwear and socks don’t fit. They belong in a different basket.
If managed well, product extensions are useful for bolstering customer loyalty. But if they are ill-conceived, they can feel like inauthentic cash grabs. Brands must carefully weigh potential incremental revenues against supply chain costs. For a DTC brand to succeed, the market must be large enough for the core product and its direct extensions beyond the launch period. If a stretch into accessories and product extensions becomes critical to profitability, then the original business model was untenable.
The Future Of DTC
DTC brands are here to stay. They have creatively found a weakness in the marketing citadel of incumbent brands. By using data gleaned from daily interactions with customers, these brands have been able to adapt how they serve their unique customer communities across a start-to-finish purchase journey. The best of them have parlayed this ability into a profitable business model applied across multiple channels and customer segments.
But as successful DTC brands mature, they must recognize the need to evolve. They must closely monitor their strategies, revise when necessary, and maintain an intense focus on customer loyalty. They should not take on the cloak of a technology player or base their entire brand identity on negative comparisons with an incumbent competitor. They should not rush to align themselves with large e-commerce platforms like Amazon or base their business models on adding accessories and extensions. They must first focus on product and service innovation while maintaining the ideals of their core customer base. From marketing to production to postsale services, DTC brands should embrace their independence and their direct connection to customers in everything they do.
originally posted on hbr.org by V. Kasturi Rangan, Daniel Corsten, Matt Higgins, and Leonard A. Schlesinger
About Author:
V. Kasturi Rangan is a Baker Foundation Professor at Harvard Business School and a cofounder and cochair of the HBS Social Enterprise Initiative.
Daniel Corsten is a professor in the Department of Technology and Operations at IE Business School and an investor in retail start-ups.
Matt Higgins is an executive fellow at Harvard Business School. In 2012 he cofounded RSE Ventures, a private investment firm, through which he has investments in Glossier, Warby Parker, and Lola.
Leonard A. Schlesinger is a Baker Foundation Professor at Harvard Business School, where he serves as chair of its practice-based faculty.
