Business Model: Direct-to-Consumer

Direct-to-Consumer

Direct-to-consumer (DTC) uses digital marketing and merchandizing to build a direct relationship with the consumer. Here we are highlighting the DTC E-Commerce Business selling physical goods.

Business Models in Use

Allbirds | Away |  AYR | BarkBox | Bonobos | Boohee | Casper | Chubbies | Dollar Shave Club | Everlane | Glossier | Harry’s | Keep | Leesa | Lola | Nanit | NatureBox | Quip | Reformation | Ritual | The Honest Company | Tuft and Needle | Warby Parker | Winc | Xiao Shong Hu

Valuable to Customer

Benefits

Challenges

Key Performance Indicators

Benefits

Challenges

Key Performance Indicators

When it Works Well

Strengthened Relationship Going Direct to Customers

The direct-to-consumer model has been embraced by businesses that want more control and who want to eliminate having to pay a retailer a huge fee. For example, retailers like Target and Nordstrom often receive a fraction of the total retail price for any product sold, and the product seller is not in control of the customer experience. From the start, businesses can ensure the customer experience is delivered exactly as they intend, allowing them to learn more quickly and have deeper insights into customer data.

Large Variety, Algorithmic Personalization

Amazon is best known for its ability to cross-sell products that fit with your current search and your purchase history. Using algorithms to analyze user behavior, and past and predicted future behavior, is critical to increasing average order value and frequency of purchase.

Strong Marketing: Acquisition, Retention, and Upsell

The best E-Commerce businesses are expert online marketers and spend a great deal of time optimizing their marketing “funnel” – monitoring how time, effort, service, offers, and paid media affect customer acquisition, retention, and the ability to upsell new products. E-Commerce marketers aim for a critical ratio: ensuring that their cost of acquiring a customer (CAC) is substantially lower than that customer’s predicted lifetime value (LTV).

Niche Direct Brands

The other type of Direct-to-Consumer company that has an easier time competing is those that deliver niche products to distinctive market segments. Examples include Tuft and Needle, Caspar, and Bonobos. Customer acquisition costs are kept low at the start because the product truly serves an unmet need, and customer referrals drive initial growth. But as the business scales, these same companies will still need to invest in marketing acquisition.

Free Shipping, Free Returns

If margins and growth plans allow, E-Commerce sites that are able to offer free shipping and free returns tend to outpace those that charge for shipping. Customers are also willing to wait for free shipping, or pay to have the appearance of free shipping, and often balk at E-Commerce companies that have shipping fees of any kind.

Margin Pressure

Most Direct-to-Consumer E-commerce entrepreneurs learn that profitability is hard to attain at the start. While there are margin advantages in going direct-to-consumer, it still costs money to acquire customers, often with higher inventory costs, and higher product return rates than brick-and-mortar channels.

 

In terms of investor valuation, E-Commerce businesses are less valuable to investors than ad-supported businesses or software-as-a-service other types of business models in terms of future growth, because of unit economics. For each unit of product sold, there are inherent costs (costs of goods sold, marketing cost, operational costs) versus a purely digital product.

Marketing Economics

Many first-time Direct-to-Consumer merchants are surprised to confront the marketing economics required to build and sustain a healthy business. Suffering from the “build it and they will come” syndrome, these startups (or established indirect sellers venturing into direct) spend their efforts on-site design and merchandising, but do not plan for the required ongoing marketing investment.

Facebook’s ad prices have increased as a result of Apple’s increased privacy practices, and DTC marketers have started to experiment with other ad platforms, but this makes it harder to optimize around a stable cost of customer acquisition.

 

Mapping out customer acquisition costs by stage (awareness, sign up for email list, purchase), channel experiments (Snap, TikTok, Instagram), and comparing to customer lifetime value will give Direct-to-Consumer managers the framework needed to see if the business can be profitable.

Amazon Service, Shipping, and Delivery Expectations

Amazon is the leader in business to Direct-to-Consumer E-Commerce, and the company’s breadth, depth, and market dominance must be considered for any new entrant. Customers of Amazon, who are able to have their products delivered as soon as one day after shipping, with Saturday and Sunday delivery, have heightened expectations from other online shopping experiences. Companies are keeping warehouses closer to buying hubs.

 

Amazon’s most radical shift was setting the expectation of same-day or next-day delivery in key metro areas. For example, Amazon Prime customers can get a product shipped within one hour in NYC.

DTC Reality Hit

A gloomy mix of rising digital ad prices, soaring shipping costs, and newly-sober public markets are dealing DTC companies a harsh blow.

Community Commerce

Chinese commerce brands like BabyTree and Keep started as communities first before launching DTC brands. Brandless in the US is a community-first brand that co-creates DTC products with its engaged audience.

Social Commerce

Influencers that have amassed followings through Instagram, TikTok, YouTube, Xiao Shong Hu, and other social networking sites have been able to create their own product brands. and take advantage of their following to sell directly without a retail partner.  

Challenging Logistics

Direct-to-Consumer leaders invested in their logistics flexibility: adaptable delivery of products, and on-demand global fulfillment, but struggled during COVID19 with supply shocks from around the globe. Soaring shipping costs have added to the cost and eaten into margins.

On-Demand and Subscription Direct-to-Consumer

One of the fastest growing forms of Direct-to-Consumer is the monthly gift-in-a-box made popular by Birchbox and similar companies. These business models differ from the standard direct-to-consumer model because of the revenue smoothing that can occur. See Reason Street’s Subscription Business Model description to learn more.

Key Direct to Consumer Mechanisms to Test

KPIs depend on your unique business attributes and business model combinations. DTC companies tend to focus on increasing AOV or average order value and finding ways to keep and grow customer relationships by measuring LTV or lifetime value in comparison to the total cost of customer acquisition or CAC. 

Before you consider D2C

  • Do you have a vision beyond your initial product offering or feature idea?
  • Do you have a well-defined value proposition beyond your first product that attracts a uniquely defined customer segment?
  • Have you tested your ability to acquire customers without overspending?
  • Can you maintain the quality of the product?

Testing the Model

  • Is there a well-differentiated value proposition that attracts your well-segmented audience?
  • Do your online marketing efforts have high engagement, not just conversion?
  • Can you achieve your target shipping times?

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