D2Cs, a revolutionary model with extremely volatile valuations

7th May 2020  

by Ruggero Calamai



Over the past years Silicon Valley has discovered a new source of enthusiasm for the building of its portfolios: digital brands. The brands we are talking here are not the usual retail and wholesale brands that have always been there, but rather those online-based brands that cut out the intermediaries in their lower-supply chain targeting directly the end consumer. Therefore, these companies are able to drastically improve margins and to obtain very insightful information directly from the customers. These brands are called Direct to Consumer brands, or D2Cs. Some known examples are Casper (mattress maker with a $280 million valuation, founded in 2014), Allbirds (shoe brand with a $1.4 billion valuation, founded in 2014), and Warby Parker (eyewear brand with a $1.75 billion valuation, founded in in 2010).

Despite the fast growth and an evident competitive advantage, recently D2Cs have been strongly scrutinised due to their high customer acquisition costs and their extremely high valuations. Casper, being a perfect example, went from a valuation of $1.1 billion in March 2019 to a current valuation of less than $249 million. The reason for that drop is the same severe public scrutiny that led to WeWork’s IPO fiasco and Slack’s poor performance in its debut on the stock market.

Peculiar branding strategies

D2Cs have the crucial characteristic of cutting out intermediaries by having a very strong, and sometimes unique, digital identity. The D2Cs controlling the entire supply chain from raw materials to distribution are called Digitally Native Vertical Brands and they engage directly with the consumer to create a unique purchasing experience, gaining direct insights from the customers to enlarge the community around the brand.

Many of these brands owe their success to the relationship built with their consumers around one product, with Allbirds and Casper being good examples. However, this strategy can only be successful in the first stages of a D2C or DNVB life and has to be changed as soon as the market for the product eventually saturates. Indeed, the brand must be anchored around a clear identity in order to expand its product range once it has covered the initial product’s market. Casper for example, would have had to struggle more for its expansion had it only advertised itself as a mattress company, but decided instead to start selling itself as the “sleep company” which opened a whole new category of products to the brand.

A good strategy is to anchor the brand to multiple products. Indeed, the real value of a D2C brand is not the product itself, but the purpose the brand stands for and its capability to reach its audience. A greater product variety leads to new and less saturated markets, lower customer acquisition costs and increased lifetime values. An example is Harry’s (valued at $1.4 billion after 8 years from founding), a shaving company whose objective was to become the must-go place for all grooming products. Design, Production, Marketing & Customer Support are of course managed to provide a unique experience.

A change of perspective for VC funds

When Venture Capital funds started gaining interest for this market valuations were based on top-line growth, which is consecutively based on the number of customers. Adhering to that assumption, Venture Capital funds in the early 2010s believed that brands had as a main priority to acquire customers in order to gain market share. Of course a similar assumption foregoes profitability, at least in the short term. With investors pushing for such a behaviour, brands started investing heavily in marketing. Unfortunately, within a fairly short time also conventional brands started increasing their investment in marketing and, since the customer pool remained the same, they started competing for the same market cluster. These dynamics increased the cost of acquiring customers and therefore metrics such as pay-per-click rose drastically.

After a phase of fast growth, investors started looking more deeply into profitability and a sustainable and organic marketing strategy. Therefore, the most important metrics have now become repeat purchases, organic conversions and returns rather than pure growth. Also, new marketing strategies are being developed and it seems that some of them may be intertwined with traditional channels: for example, Glossier (a beauty company) and Mejuri (a jewellery maker) have been using billboards, subway ads, brick and mortar popups and tv commercials.

The Venture Capital landscape seems also to be changing with regard to D2Cs. Since the capabilities to scale at the same rate of technology companies are being questioned, funds have been redirecting their focus. This change in mentality has opened a window of opportunity for players such as Clearbanc, which recently announced it will lend $1 billion to companies looking for money to spend on Google and Facebook Ads. Instead of receiving equity in return for the investment, Clearbanc will charge a 6-12.5% fee for the loan, which will be paid through a revenue sharing model. The reason for such steep fees is that these companies are not profitable yet, and therefore institutional banks will not provide regular loans.

Concerning the stages of funding that will be impacted by the change in behaviour, middle and late stage investors will be likely the ones poised to face the most difficulties, while seed and pre-seed are believed to remain fairly stable.

The impact of COVID-19

The future of D2C brands does not seem to be in question, but, still, something in the model will have to be changed. Yet, the current pandemic that has caused chaos in the markets may lead the objective of profitability to become priority number one. Furtherly, it may accentuate the need for brands to relook their aggressive marketing strategies. Nevertheless, despite the decline in sales, such a pandemic has also increased the importance of the online sales channels and therefore the players that are skilled in navigating the digital world will be better off once demand rises again.

A bumpy road to exit operations

D2Cs have been raising capital at very high valuations in the past years and in order to make an interesting exit they either need an acquisition with a high multiple or an IPO. Yet, more than 85% of acquisitions are closed below a price of $250 million. Therefore, many brands have been forced to either reduce rounds or look for alternative exits. An option that is evolving is represented by the birth of D2C holding companies such as Innovation Department and Brandable. The model is similar to that of traditional players such as P&G or Unilever. By differentiating brands, pooling the brand’s resources, operational costs and institutional knowledge, companies have proven to accelerate growth and achieve profitability at faster rates. This could eventually represent one of the main exit opportunities for D2C brands.

The Direct-To-Consumer business model is considered revolutionary and most experts state that its impact will be long lasting, yet the past years have shown more of a rollercoaster ride than a smooth one. The doubts are definitely well-founded, but at the same time nobody seems to see this new reality fade away anytime soon. Quite the opposite: the market appears to be waiting for another change with regard to operational sustainability and a clear profitability path to begin re-investing in these businesses. 

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