DTC 2.0: From Arbitrage to Profit-ability

Hey Folks,

I hope the holidays are treating you well. Sending the best of vibes your way.

Newsie #33 comes to you from an Aroma coffee shop in a quiet corner of Tel Aviv. I am spending the week out here with family, and it’s been a great change of pace after the last few hectic months.

Noah is thriving in these wide-open fields, he might just not be a city boy after all.

It’s been a perfect mix of family and work so far. I finally met our most recent CX hire IRL, ate my body’s weight in hummus, bread, and falafel, and gave a talk to the incredible team at Finaloop.

As we head into the new year, I’ve spent the last few days reflecting on how much the DTC landscape has changed.

With a much-debated possible recession looming on the horizon and the increasingly difficult capital-raising environment, DTC companies are being forced to focus on first-order profitability and find ways to stand out in a crowded market.

Despite these challenges, the DTC space remains vibrant and dynamic, with new trends and opportunities emerging.

As the great Nik, aka The DTC guy, said back in February:

In this newsletter, we will explore some of the key trends and developments to watch out for as we move into the new year.

1. DTC 1.0: The Good, the Bad, and the Not-So-Profitable2. The DTC Dilemma: Big CAC, iOS 14.5, and Soaring Shipping Costs3. DTC 2.0: From Arbitrage to Profit-ability4. Practical & Tactical: Three tips to thrive in ‘23

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    DTC 1.0: The Good, the Bad, and the Not-So-Profitable

    Let’s back up a bit, to the heyday of DTC. Let’s go back to more than a decade ago.

    Dollar Shave Club and Warby Parker launched with much fanfare. Both raised $10-$15m right out of the gate.

    The premise was simple:

    • Great quality goods, but cut out the middleman

    • Direct relationships with customers

    • Staunch focus on brand and experience

    Warby disrupted the eyewear industry by offering stylish, affordable glasses and sunglasses that could be ordered online and shipped directly to the customer, and also by offering a "home try-on" program that allowed customers to try on glasses before making a purchase.

    Along came Harry’s and Bombas in 2013, Casper and Glossier in 2014, Away in 2015, and Allbirds in 2016.

    They all copied a similar model.

    It was straightforward to grow as long as you could crack FB ads and put together a good team. It was a game of arbitrage.

    You buy a customer for $50, they spend $100 on their first order, and you profit on the CLV (Customer Lifetime Value).

    They became obsessed with growth at all costs, even while hemorrhaging cash on acquisition costs, and banked on LTV to solve all the problems.

    Instead of focusing on sustainable growth, investors were totally okay with a lofty CAC-LTV ratio.

    Hims is one of my fav examples. They were spending $161 to acquire a customer with a first-order avg of $39, and posting 3-yr LTV numbers.

    Speaking about profitability, one of my favorite moments ever is Adam Neuman talking about WeWork's profitability (or lack thereof) at a TC disrupt in 2017, insinuating that profitability is as easy as flipping a switch.

    The funny reality?

    Most of these have sold or IPO’d over the last few years, and are still posting record losses YoY.

    Some of these DTC purist brands are no longer very pure either, but more on that in a bit.

    The DTC Dilemma: Big CAC, iOS 14.5, and Soaring Shipping Costs:

    The last year or so has completely changed the DTC game in multiple ways

    First, as the DTC space has become more crowded, it has become increasingly difficult and expensive for brands to reach and convert potential customers.

    This led to a rise in customer acquisition costs, making it even more difficult for brands with low margins to grow solely on paid acquisition.

    Second, in addition to rising CAC, DTC brands have had to navigate the impact of iOS 14.5, which introduced new privacy controls that affected the way brands could collect and use data for targeted advertising.

    This change has made it more difficult for DTC brands to reach and engage potential customers through digital advertising channels, further increasing the challenge of acquiring new customers. (Some would say that attribution tools have put them back in the driver's seat and they are doing as well as they did pre-iOS 14.5, but who really knows…)

    Lastly, if all of this wasn’t enough, DTC brands have also had to contend with soaring shipping costs, which have been driven by several factors including a never-ending global pandemic, rising fuel costs, and increased demand for online shopping.

    The MeDiA has had lots to say about the demise of DTC:

    We saw brands that never discounted start discounting, and we saw buzzy brands let go of half of their team. We saw heretofore DTC purists start selling on Amazon, selling wholesale, and selling across many retail locations.

    *Profitability joined the conversation*

    Things needed to change.

    As Alanna Gregory eloquently put it:

    “Ultimately, convenience, cost, and customization — all hallmark features of DTC 1.0 — are not enough; it’s mission-driven communities that are now setting brands apart.”

    DTC 2.0: From Arbitrage to Profit-ability

    Which brands will survive 2023?

    I’m by no means qualified to answer the question, but I reckon it’ll be brands that put the old-school arbitrage game to rest.

    • Focus on profitability vs. arbitrage

    • Obsession on brand and CX

    • Have a real reason to exist

    When the “DTC is dying” conversation was happening, lots of the great folks on Twitter shared their feedback on this, and Cody and I even covered this on a podcast episode a short while back.

    I loved this blurb from Michael, SVP of CX at Figs.

    Brands will need to operate differently than they did in the DTC heyday.

    • First-order profitability will be a necessity (if it isn’t already)

    • Lots more brands will be focusing on wholesale, retail, & marketplaces (AMZN, Faire, etc.)

    • The only successful DTC-pure brands will need to have built-in owned audiences (e.g. celebrity founders) or sensational media-buying prowess + fantastic margins

    The future of DTC is flexible, and maybe even mostly omnichannel. Ju from Hero proved that with a $630m acquisition earlier this year.

    Practical & Tactical: Three tips to thrive in ‘23

    Not all of this is fluff though, here are three practical tips almost every business can use to thrive in ‘23:

    1. Focus on customer experience: In today’s day and age, customers expect a seamless experience when interacting with a brand. You can easily differentiate yourself by consistently delivering a high-quality customer experience across all touchpoints. Be thoughtful about what you promise, and ensure you can deliver. E.g. Wonderment is a low-lift way to do this on the shipping and delivery side of things

    2. Invest in strategic and trackable ROI-driven marketing: If you are not swimming in cash, forgo the bougie brand-driven TV ads, and instead invest in marketing that you can easily see an incremental lift from. E.g. Direct Mail

    3. Get more juice from the squeeze: Instead of one-off customer growth, focus on increasing LTV to create more sustainable growth. E.g. This could involve introducing new product lines, but could also be as basic as testing and implementing a thoughtful post-purchase upsell/cross-sell strategy.

    That's it for this week!

    P.S. Any topics you'd like to see me cover in the future?

    Just shoot me a DM or an email!

    See ya next week,

    Eli 💛