Most large brands such as Anheuser-Busch and Nike do not sell their products directly to the consumer. Instead, they create brand awareness through ads and sponsorships and sell products through established retail outlets like Kroger, Walmart, and Amazon. However, brands like Warby Parker, FIGS, and Allbirds pioneered a new form of retail, one that sells their products “direct to consumer” via the Internet.
Entrepreneurs need to understand the difference between being a direct to consumer brand and a manufacturer that sells products wholesale to stores or online retail outlets because the way each one earns revenue and the challenges that each one faces in sales are vastly different.
Many small businesses are built upon either a single product line and have adopted the direct to consumer model because of the promise of low overhead, no middlemen, and a seemingly infinite pool of customers. But what made that model a success yesterday is not driving the same success today.
With new challenges popping up in the direct to consumer world every day, many companies are struggling to keep up. In the face of constant competition, product companies need to keep their eyes on long-term, sustainable revenue growth. The confluence of rising customer expectations, increasing customer acquisition costs, worsening ad measurement and ad fraud, privacy issues, skyrocketing shipping costs, communication filtering, and smaller than anticipated customer bases are just a few things creating headwinds for businesses that are built on the direct to consumer business model.
Let’s examine a few of the biggest forces affecting a direct to consumer company’s ability to attract and retain customers and earn sufficient margins to succeed.
Customer Expectations
With automation, robots in warehouses, and seemingly endless access to resources, companies such as Amazon, with their end-to-end fulfillment model, have conditioned customers to expect from all direct to consumer businesses the same speed and efficiency that they get from Amazon. The biggest hurdles direct to consumer businesses face is the expectation for next-day or two-day shipping.
Large retailers have scaled beyond anything that even the most successful eCommerce company can compete with. Amazon, Walmart, and others continue to invest in areas to create a moat around their business empire.
Customer Acquisition Costs
While eCommerce is becoming a greater part of total consumer spending, it’s clear that the days of low customer acquisition costs are over. Even after a successful sale, the abundance of so many other options frequently leads the customer elsewhere before their lifetime value exceeds the acquisition cost.
“In two years, Facebook ads basically doubled or tripled. In the U.S., the cost to reach 1,000 people on Facebook jumped from $6 to as much as $18 in just two years.”
David Herrmann
According to Measured.com the year over year, CPM ad costs have gone up by:
Meta’s Facebook – 61%
Google – 75%
TikTok – 185%
Amazon – 14%
Operating largely without physical storefronts, direct to consumer businesses use ads to reach customers who may otherwise have walked into a physical store. These companies have long relied on affordable advertising costs for growth. Unfortunately, rising ad costs translate into higher customer acquisition costs that eat into the company’s profit margins.
Ad Fraud
Digital marketing was presented as the panacea to the long-standing problem of better targeting for small businesses. The promise that ads could be delivered to the ideal customer was an attractive alternative, especially to small business owners that could not afford to buy ads in national newspapers and magazines, prime-time TV commercials, or radio spots like big advertisers could. But as digital marketing got more sophisticated, it developed loopholes and became ripe for ad fraud.
As digital marketing technology has advanced, the digital ad space has been exploited by bad actors. The same technology used to better target consumers was used to defraud ad buyers out of an ever-increasing percentage of their ad dollars. Ad fraud is perpetrated in several different ways including hidden ads, click hijacking, bot ad fraud, and fake websites.
Apple iOS Privacy
Apple’s iOS privacy changes have added yet another obstacle, harming the ability of direct to consumer companies to measure the effectiveness of their social media ads.
“The iOS 14 privacy changes affected everything. The internal metrics and mechanisms that Meta uses for attribution are off somewhere 30, 40, or 50%. Unable to optimize effectively, direct to consumer businesses are spending more for worse results, eating into their margins”.
David Herrmann
Communicating with Customers
To drive repeat business, email has long been the staple. While emails may still be one of the most effective marketing channels, it has been so abused and overused by companies that consumer skepticism continues to erode the value of emails as a business-to-consumer communication tool.
Moreover, ad blockers installed by users and filtering by email service providers make communicating with prospects via email haphazard at best.
Many direct to consumer businesses are experimenting with new communication channels such as SMS text messaging and live chat tools with varying degrees of success. But ultimately, all of these efforts are just an attempt to raise the company’s voice above the overabundance of communications consumers receive daily.
Regardless of the level of personalization and initial consumer attraction, consumers are increasingly tuning out messages, emails, and social posts. Making matters worse, consumers who develop a dislike for a brand due to a perceived level of over-communication, become less engaged and are less likely to recommend the brand to others.
Promotions and Discounting
Discounts and incentives, while they can be effective in the short term, ultimately hurt the business in the long term. Over time, customers become conditioned to expect discounts and will frequently delay purchases in anticipation of a future promotional event. Bargain-hunting customers, like Gen Z, are far less likely to include full-price items in their orders, thereby reducing total order value and contributing to higher customer acquisition costs and a reduced customer lifetime value.
Moreover, tools such as PayPal’s money-saving service “Honey” automatically apply coupons to a buyer’s cart, which allows the consumer to always benefit from the greatest possible discounts. Also, Honey allows the consumer to see pricing history and set up automation to watch for price drops. Furthermore, tools like Amazon’s price tracking and sales ranking tool Keepa allow consumers to see pricing history for new and used products and manage price watches.
Supply Chain
Then there are the supply chain issues. As the pandemic settled in, the cost to import containers from China exploded. Given the dependence of many direct to consumer companies on imports from China, rising shipping costs are difficult to make up for in terms of price or volume.
According to the Freightos Index, the median cost of shipping a standard metal shipping container from China to the West Coast hit $16,353 in March 2022. This cost is almost triple what it cost just a year earlier when it cost $5,680.
Interest Rates
The Federal Reserve’s interest rate hikes couldn’t have come at a worse time for direct to consumer companies either. Since many direct to consumer businesses use debt to pay for inventory, higher borrowing costs are eating into their margins.
Moreover, with rising interest rates, investors are less interested in investing in companies that struggle to turn a profit, even if there is evidence of future growth on the horizon.
A Path Forward for Direct to Consumer Companies
The path forward for a direct to consumer company is three-fold, build a recurring revenue model, separate your business from the pack with a great customer experience, and offer unique products in an uncontested market.
Recurring Revenue Model
Consumers have been well-conditioned to purchase online subscriptions thanks to companies such as Netflix and Spotify. Direct to consumer businesses should look at ways to augment or replace the legacy transaction-based revenue models with ones that support a recurring revenue model. Product companies can be inspired by the Software as a Service (SaaS) playbook. In the past, Microsoft Office was only available on CD or by download using a transaction-based purchase. Today, you can purchase Microsoft 360, the equivalent of Microsoft Office, in the form of a subscription.
Nearly 50% of all online shoppers have purchased a subscription of some sort, and 15% of those were subscriptions for physical goods. Product subscriptions will continue to grow, both in absolute numbers of consumers and as a share of total online purchases.
According to recharge, there are three basic types of subscription models, curation, replenishment, and access.
Curation
Curation is a subscription model where the business and not the customer chooses the specific product(s) included in each order.
Recently, my grandson Dominik celebrated his 11th birthday. Rather than buying him a single birthday gift, we went to KiwiCo and purchased him a Eureka Crate that allows him to receive a unique, age-appropriate gift each month that focuses on engineering and design. Last month’s crate included all the materials to create slime and used the electric properties of the slime to allow him to perform a series of experiments that taught him the basics of how electrical circuits work. Each month throughout the next year, he will receive a new educational oriented crate curated by KiwiCo.
In another example, sites like HelloFresh and Blue Apron allow users to select from a bunch of menus developed by chefs to meet consumer preferences. The company selects all the ingredients needed to prepare the dish in the right quantities and sends them to the consumer to prepare at home.
The curation model is very popular in the apparel, beauty, and food verticals.
Replenishment
Replenishment is a subscription model primarily for commodity items, although exceptions do exist. Unlike curation where the company chooses the products, in the replenishment subscription model, products are chosen by the customer and these products do not change on an order-to-order basis. Replenishment subscriptions have revolutionized product lines such as razors and hygiene products.
In our home, we have used both PetFlow and Chewy to have two 30 lbs bags of dog food delivered every 11 weeks, which is about how long it takes Luger, my German Shepherd to go through 60 lbs of dog food.
Access
Access is a subscription model that offers exclusive access to some products and special pricing to members. Access subscription models are employed in a wide variety of industries from luxury apparel to food.
Amazon offers Prime members exclusive access to their video streaming service, deals on selected products, and free 2-day shipping. Companies such as Peloton were able to sell access to exclusive content in addition to a high one-time purchase.
Being an outdoor enthusiast, I am a member of SportsmansGuide where I receive exclusive Buyer’s Club pricing on all products that is not available to non-members.
Offer a Great Customer Experience
Offering a great customer experience starts with a website that is optimized to create a great user experience during the purchasing process. Webpages need to load fast, be mobile-friendly, have clear calls to action, easy to navigate and offer ease of purchasing.
Providing a great customer experience requires that the business offers frictionless communication with prospects during and after the purchase by offering either 24/7 phone support or a live chat feature where prospects and customers can ask questions and get immediate responses. Larger online retailers like Amazon and Walmart fail to provide this level of support.
Providing a great customer experience does not end once the purchase is made. As a small direct to consumer business, you have a superpower to make the unboxing experience exceptional. Instead of simply shipping the product like Amazon, add something a bit unexpected to the package. It could be as simple as a handwritten thank you note, custom packaging, a free extended warranty, or a coupon for their next purchase.
Offer Specialized Niche Products
Small direct to consumer businesses should focus on offering products or services in an uncontested niche market. Large competitors fail to cater to these more specific consumers and prefer to target products or services that appeal to a broad audience. A direct to consumer website that caters only to German Shepherd Dog (GSD) owners might offer stylized coffee mugs, T-shirts with memes that only GSD owners can relate to, and other assorted GSD-specific merchandise. Such a site would create a powerful following of customers unmatched by other sites simply offering products for pets. In another example, when we needed a dog trainer for our young GSD, we found a trainer that only trained GSDs. He commanded a higher fee and won our business because he didn’t train just any dog but only GSDs, stating that the breed had a unique temperament and that he had developed a unique training program to address the specific needs of the GSD breed.
Small direct to consumer businesses that cater to unique demands not met by mainstream providers have less competition, develop fiercely loyal customers, and generate higher revenue with higher margins that are largely overlooked by their larger competitors.
How can your direct to consumer business compete in this rapidly changing landscape?
