Rethinking DTC Strategy Through the Lens of CLV

DTC, or direct-to-consumer, is a new variation on the .COM idea, where new brands have been created from scratch that pursue a single-item retailing strategy. DTC allows brand control through product, packaging, brand message and digital merchandising. DTC enables proposition control through aligning the brand with the customer experience and delivers insight through having direct access to the consumer. Examples include mattress retailer Casper.com and homewares retailer Made.com.

A subset of this is subscriber-based business eCommerce models. Subscription models that deliver recurring revenue are part of the DTC world; for example, Dollarshaveclub.com. Consumer goods brands such as Starbucks and Sephora have added subscription boxes to reduce friction by automatically sending the customer to the next package.

Silicon Valley investors loved subscriber businesses because customers once signed up, provide dependable monthly cash flows. For internet businesses, there is little additional cost in providing the product to a new subscriber. Business software groups SalesForce and Slack, for instance, fit the bill.

Looking for the next big thing, venture capitalists, will often compare the estimated lifetime value of a customer to the cost of persuading them to sign up (or in the jargon, the customer acquisition cost).

The promise was that brands gained direct access to customers and promoted repeat purchases across a variety of products, ultimately allowing for a higher customer lifetime value (LTV). More than ever before, companies are discussing and disclosing data on the number of customers acquired and lost, customer lifetime value, and more.

Now, regardless of business model or channel choice, all ecommerce sites have, at their heart, a relatively simple revenue model:

● Customer acquisition cost (CAC)

● Conversion rate (number of visitors who buy).

● Average basket size (the typical order size).

These are core ‘levers’ for all ecommerce businesses.

If you think through the number of customers acquired over time, then how customers are retained after they are acquired, how many orders they place over a period of time, and combine this with the revenue associated with each order (basket size or AOV), then one can model the customer lifetime value.

And it is on this point that the VCs in Silicon Valley became unstuck. They started seeing CLV everywhere. Emory University marketing professor Dan McCarthy is one of the biggest names in CLV analysis. He believes that by probing data about customer acquisition, retention, and spend, one could see that some DTC brands are not in for a soft landing.

McCarthy takes the example of Casper Mattress: Casper sells a product people buy very infrequently but which had nevertheless been growing quickly because of huge advertising spend. All that spending left Casper with a high customer acquisition cost and little profit per customer. Their pre-IPO data suggests they spend approximately $320 in CAC for each new customer with a profit of 40%, and net EBITDA losses of more than 17% of their revenues. In the run-up to their IPO, even direct sales growth fell to just 13% — not that exciting for a hyped IPO brand. McCarthy does an equally good takedown of Blue Apron — the leading eCommerce meal kit delivery business in the United States who were spending $140 to acquire customers.

What was the problem? From a strategy perspective, the analysis was not looking at the right customer metrics. In other words, a poor diagnosis.

In fact, most of the high-profile DTC brands that got all the PR sold items that have a high CAC: think Warby Parker with spectacles or Harry’s with razor blades. These categories make it difficult to reach a high CLV due to low repurchase rates for a product a consumer already owns.

As Prof McCarthy has been pointing out, once you look past the glitz of the DTC category’s cool branding and trendy influencers, maybe it’s difficult to make the unit economics work at scale.

DTC analyst, Alex Song writes of another egregious strategy error: applying the same expectations of a DTC startup as technology companies. Unlike other tech categories, like social media (Facebook, Instagram), digital marketplaces (Airbnb, Alibaba), and enterprise SaaS (Salesforce, Microsoft), that have produced incredible venture returns over the past quarter-century, DTC is not a winner-take-all market with low cost of scaling. Song believes that ‘there is a natural ceiling for scaling consumer brands, as evidenced by the fact that it took Procter & Gamble almost 200 years to build 22 brands worth more than $1 billion without being able to build a single $10 billion brand.

When Mike Tyson was asked by a reporter whether he was worried about Evander Holyfield and his fight plan he answered: “everyone has a plan until they get punched in the mouth.” The entire DTC game is being punched in the mouth with the reality of what happens when consumer demand falls off a cliff and cash starts running out.

The Tyson quote summarises the reality of these neophyte DTC brands:

First-time founders focus on product,

Second-time founders focus on marketing,

Third-time founders focus on distribution.

This is the second part of the strategic diagnosis that was missing. DTC eCommerce brands focussed on paid acquisition traffic and SEO — and were religious about this. Selling direct improves margins, it results in a high CAC due to focussing on one channel. No wonder big DTC brands are now opening in retail outlets and expanding into new marketplaces.

With proper strategic thinking, a smarter marketing plan and some creativity, DTC brands that survive out of C19 and come back into the ring stronger.