The Rise, and Fall, of the Direct-to-Consumer Model

There was a brief period in the early 2010’s when a new business model – dubbed “direct to consumer” emerged and threatened to upend established incumbents.  A decade or so in, the assumptions underlying the model are in tatters and we’ve come to realize, as we always should have, that Strategy 101 still applies.

Image Source;  Peter Moore

Strategy 101 and the direct-to-consumer business model

Let’s start with strategy basics.  In order to create a profitable business, you need to have customers who are willing to pay more than it costs you to create whatever they are buying. To scale and keep that profitable business, you need some way of staving off imitation and matching on the part of competitors, in other words, a barrier to entry, as Michael Porter told us decades ago.  If you don’t have a barrier to entry, competitors can offer something similar, often undercutting your price, particularly if they didn’t have to make the investments in learning or R&D that allowed you to create the business in the first place.  In novel circumstances, it’s easy to forget that this iron law applies.

As Leonard A. Schlesinger, Matt Higgins, and Shaye Roseman tell us in the Harvard Business Review, the direct-to-consumer, or DTC business model took the world by storm in the early 2010’s.  After decades (literally – 1923-1983!) in which major retail categories were sustainably dominated by just a few brands – such as Gillette in shaving – a new approach became viable. Cheap and variable-cost computing power let startups run Internet operations and operate web sites with low investment. No need to buy servers or hire developers – all that stuff was readily available on open markets. Social media channels such as YouTube, Instagram, and Twitter made getting the word out about your business inexpensive – no need for expensive TV ads.  Facebook let you identify and sell to specific target consumers, the ones most likely to buy your products, without expensive salespeople.  And so on.  

Entrepreneurs took note.  So did venture capitalists, drawing on seemingly endless pools of investment capital.  Buzzy startups began sprouting in every category imaginable.  As Schlesinger et al note, “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.”  

By 2013, the model was starting to attract attention.  As a New York Times overview observed, somewhat breathlessly, “Warby Parker is part of a wave of e-commerce companies that are trying to build premium brands at discount prices by cutting out middlemen and going straight to manufacturers. They make everything from bedding (Crane and Canopy), to office supplies (Poppin), nail polish (Julep), tech accessories (Monoprice), men’s shoes (Beckett Simonon) and shaving supplies (Harry’s).  The result is generally cheaper products for consumers and higher profit margins for the companies.”  

But…

Many of the founders of these imaginative businesses failed to take into account that if it was cheap and easy for them to start up, it would be cheap and easy for competitors to do so as well.  Further, that eventually, the cost of customer acquisition was likely to go up as more and more competitors flooded the markets, each seeking scarce attention from potential consumers.  Moreover, that just because a venture capitalist thought your concept was awesome, that didn’t mean that customers would.

The cautionary tale of Casper

The Casper story, to me, captures the essence of the transient advantage phenomenon that the whole DTC concept has fallen victim to.  Meaning, a concept that is innovative, that emerges and scales, that enjoys its moment in the sun, but that eventually faces erosion of its original success formula, as I’ve written about elsewhere.  

Casper was founded in 2014 by 5 founders, right at the perfect moment to attract substantial capital.  It took aim at the $13 billion mattress industry, almost instantly raising $1.85 million in seed capital, with the vision of becoming the “Tesla of Sleep.”   The concept was a mattress in a box, made with technology that allowed it to be compressed enough to fit in an ordinary car trunk – a big selling point in places like New York.  You unboxed it (videotaping the event, of course) waited a few hours and voila!  To allay fears that you might not like it, Casper let you keep the thing for 100 nights and return it, no questions asked.  

It’s ads in the New York City subway were ubiquitous, unescapable and kind of fun.  The business took off.  By 2015, the startup raised $55 million in a Series B financing round, with a post-money valuation of $555 million.  By 2017, they closed a $170 million series C round.  By 2019, the company joined the so-called Unicorn Club and raised $100 million, leading to a valuation of $1.1 billion.  It opened physical retail stores, expanded internationally, struck a partnership with American Airlines and proclaimed that it was going to completely reinvent the future of sleep.  The company was set to launch an Initial Public Offering in 2020 and went public at $12 per share.  That translated into a market cap of … um … $476 million.  

By the time the company limped into its IPO, there were 175 competing mattress-in-a-box companies with consumers observing that you really couldn’t tell them apart.  NYU Professor Scott Galloway opined that there was no way the company should have gone public.  As he somewhat snarkily observed, “The economics work better if Casper sent you a mattress for free, stuffed with $300.”  The company was bought by a private equity firm, Durational Capital, in 2021 and de-listed.  

The bump back to reality is a reckoning.  “We’re not in the business of not making money anymore,” Casper CEO Emilie Arel recently said at eTail’s Boston conference. “VC money is not falling from the ceiling anymore, we need to be very specific on what we’re working on. And so moving from being a lifestyle brand — being sort of the Nike of sleep, selling to everybody — to: ‘We are a mattress retailer.’”

The Empire Strikes Back

Competition everywhere. Few entry barriers. Rising customer acquisition costs. And, interestingly, a resurgence has occurred among incumbent, traditional competitors who have learned how to operate direct to consumer themselves.  After initially being a bit shell-shocked by the early success of Dollar Shave Club and Harry’s, among others, Gillette has regained its footing (although it did suffer a drop in brand value).  Walmart has figured out omni-channel, sunsetting many of the sparkly DTC brands it acquired to prompt the transition.  

The reality, as Neil Blumenthal, a co-founder of Warby Parker observed, “It’s never been cheaper to start a business, although I think it’s never been harder to scale a business.” 

The DTC flurry is a vivid representation of the transient advantage phenomenon.  Even dramatic early success doesn’t guarantee a lasting advantage.  It turns out, strategy 101 was a prescription that shouldn’t be ignored.  

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