The Past, Present, and Future of Direct To Consumer Distribution

With companies like Casper and Warby Parker redefining how to build a brand, we wanted to know a little bit of history about direct to consumer models. So we sat down with Bill Shope, CEO of Abound, to learn about where the direct to consumer model came from, how it was redefined with the advent of the internet and social media, and where he sees this strategy heading in the future. Bill co-founded Abound, and prior to that, he covered the technology sector on Wall Street, most recently as a Managing Director at Goldman Sachs.

R: Do you believe that direct to consumer (DTC) marketing is reaching its limits?

B: I think the DTC-world is becoming more crowded so that naturally introduces some challenges for emerging consumer brands. With that said, this shouldn’t be an unexpected event, and DTC is not a new phenomenon. If you go back to Dell’s rise in the 80s and 90s, it was one of the most important DTC success stories in the technology sector. I covered the computer industry as an equity analyst for nearly two decades, starting in the late 90s, and Dell’s direct distribution model was the envy of the industry when I first started. But a little over 10 years ago, their distribution model began to reach its limits and they had to evolve and support channel partners.

We’re now seeing another series of DTC success stories with the digitally native vertical brands (DNVBs) in major consumer categories, and obviously, that’s gotten a lot of attention. You’ve seen tremendous growth stories with companies like Casper, Allbirds, and Glossier, and that’s had powerful economic implications across several industries. With that said, there are certainly some interesting parallels with the rise and evolution of Dell and the PC industry that I personally find fascinating, particularly when you consider the inherent limits of current DTC strategies.

R: Is this new strategy around entirely because of the internet?

B: The internet, and specifically the power of social media. Fifteen years ago you obviously weren’t able to start off digitally native, find so many customers with targeted advertising content, and build a national or global brand quickly. So, of course, that’s become a popular theme because a lot of these brands as start-ups have been able to put a dent in markets that had been dominated by legacy brands for decades.

In the shaving category we’ve seen that, in the mattress category we’ve seen it, in apparel, in beauty, and the resulting speed of industry disruption has been amazing. This success has also led to a more crowded market in certain verticals, and as a result, we’re starting to see some scalability limitations for DNVBs. In particular, there has been concern that the cost of acquiring customers, the “CAC,” is increasing fairly rapidly, but I also think there is more to it than that.

R: How does a more crowded field affect new companies starting out with this model?

Well, not only does it make it more difficult to become the next Casper, it also starts to take away some of the economic advantages of cutting out the middleman, or cutting out the retailer. Because when you just look at it purely, you know the unit economics of cutting out the retailer and going direct to the consumer, you’re effectively keeping more of your margin, because you’re not giving margin away to that retailer. So that results in a gross margin advantage, which also fuels a pricing advantage.

If the operating cost of that strategy increases though, and you’re spending more to maintain DTC distribution through advertising and promotion, eventually you reach scalability limits. And the original advantages no longer make as much sense. And as we saw with Dell in the 2007 timeframe, identifying when a company or industry is reaching the limits of direct distribution is absolutely critical.

What’s interesting though, and the other angle of this that I think is very important, is that marketing costs are not the primary challenge for the DTC model. The real challenge, over time, is competition and limited brand differentiation within the DTC channel, both of which can erode pricing power. The barriers to entry to this new type of distribution model are extremely low, and that’s a double-edged sword. It’s an absolute gift to entrepreneurs with new products. If you have a great product, you can start to build your brand on social media right away, and you can build a remarkably large fan base in a short period of time. Even if you’re earlier stage and your product isn’t quite ready, you can outsource the design, the manufacturing, and get yourself an office in WeWork, right? It’s a lot easier for product entrepreneurs to get started today, in contrast to entrepreneurs building a business 20 years ago. It still takes grit and a great product, but many of the inefficiencies are fading.

But again, everyone with a cool product can enjoy these advantages, so over time, you’re going to see more and more competitors in your vertical. So the early success stories like Casper or Bonobos didn’t have as much competition in the beginning. Someone starting today has to recognize they’re going to see a lot of competition, increasingly expensive marketing costs, and they could hit a scalability wall pretty quickly. If you invent the next great mousetrap and market it on Instagram, you can be certain there will be a growing number of competitive mousetraps crowding consumers’ feeds in short order. The scalability limit for a pure DTC model may be $10 million in sales today, but it could certainly be $5 million in 12 to 18 months. This is an important trend that will dominate discussions around pure-play DTC models over the next several years.

R: Kind of like podcasts. The first 10 podcasts that started all became super popular, and those people are famous now. But if you start today, it doesn’t have that new shiny smell.

B: Right, because the barriers to entry are lower and people that never would have imagined they could be content producers may suddenly come out of the woodwork… Which if you think back about it, you know podcasts and digital media in general really sort of started this modern phenomenon of exposing the long tail, and dramatically increasing the variety of choices available for consumers.

With the internet and social media, and modern digital tech in general, you’re able to surface these micro markets. Markets that appeal to a smaller number of consumers, and markets that didn’t have a distribution model in the past.

This is all great news. It’s really an amazing story to watch unfold, and now it’s happening with physical products, not just digital products.  But we also have to remember that, by definition, as the system becomes better and better at surfacing the long tail, more and more competitors are coming in. And that’s fine, that’s still a net positive for consumers. They get more choice, and it’s a net positive for entrepreneurs because you get lower barriers to entry. You just have to recognize that as you scale the business, the rules are changing quickly, and the limits to scalability as a pure direct-to-consumer model are becoming increasingly severe. So it’s going to be harder and harder to rely on DTC as your sole distribution strategy.

R: I’m just curious, how did Dell do its DTC model before the internet?

B: It was catalogs, and it’s an incredible entrepreneurial success story. There were a ton of catalog-based PC companies when Michael Dell was ramping up the business model in the 80s, and you know, as a result of really incredible execution they were able to become the leader. In the early 90s they leveraged this success to gain a ton of share with large corporate customers as well. By selling direct, they had an economic advantage and a very efficient business model, which allowed them to price their way into very challenging markets.

Their economic advantages partially came from cutting out the middleman, but they also had tremendous advantages as a build-to-order company that allowed them to manage their business with very lean inventory and negative working capital. Effectively, they were generating cash before they shipped the product out, which is a massive advantage in a highly competitive industry like PCs. Meanwhile, their largest competitors relied on a build-to-forecast model, and they were exposed to significant costs from decaying inventory.

R: That’s really interesting. Have you ever seen Halt And Catch Fire?

B: Yes I have. Fantastic show. I’ve always been fascinated by the history of personal computing as an industry. I covered it from the late 90s until four years ago, so it was a great opportunity to see the evolution and maturity of such an important industry. While the current DTC revolution is happening on a different time scale, a much shorter time scale, I truly believe there are some common principles that make the overall arc of the stories very similar.

R: Do you have any guesses for the future, for the next 10 years of DTC? Now that social media is officially a thing, what do you think is going to happen?

B: If you’re a consumer product entrepreneur, you have to focus on social media and a DTC model at the start. You absolutely have to do that, and that’s not going to change.

What I think is going to happen though, is that people are going to focus on omnichannel earlier. We’re going to shift from a DTC-first strategy for physical products to an omnichannel-first strategy. Omnichannel will become an increasingly powerful source of differentiation for emerging brands.

Businesses will still start by developing a great product, getting their packaging in order, developing a manufacturing strategy, and building the story for their brand. Then the first sales and customer outreach will be with social media and direct e-commerce. Shortly thereafter, however, you’re going to need to start thinking about getting your product into physical retail. This will be the best way to maximize scale and delay the pressures of competition.

Now, this doesn’t mean you should expect to land on the shelves of Walmart a few months after your first sale. The most successful new brands will probably start with independent, mom-and-pop retailers. From there, build up your data, build up your business model, iterate on your product’s design, and then, when you’re ready, begin to connect with the experts that can get you ready for the big national retailers as well.

R: When do you think that transition from mom and pops to trying to get a sales rep and go national should happen? Is it 2 stores, 10 stores?

B: It depends on the product and industry, but the reality is that once you have some small retail success stories, sales data, and adequate manufacturing capacity, you should start preparing for the journey to large retailer shelves.  

It’s not an easy process, but the good news is that technology is making the retail journey more democratic. In the past it’s required a lot of money, a lot of connections and a lot of time to run around trade shows, to try and build up your initial customer base, to meet the right people and to meet the right manufacturers’ rep. At Abound, we’re making that process a lot more efficient so that after you’re only selling into a handful of independent stores, you can start to pitch a major retail rep about national placement. And even before you’re retail ready, you can start to lay the groundwork by consulting with a rep and gaining key insights from these industry experts. Small brands can compete with the mega brands now, and that’s exciting to see.

R: It’s been interesting as a consumer to realize that there’s so much interest in tapping into company’s stories. That really affects how I feel about products, and you get excited for the people and the fact that you’re seeing something new. It’s cool, and these new avenues have let companies do that.

B: I agree. Consumers not only want to hear great entrepreneurial stories, but they also want to be a part of those stories. Social media has enabled that, and ironically, the smaller brands have an advantage here: they can be more “authentic.”

This, and the lower barriers to entry for new entrepreneurial brands, should continue to have a tremendously exciting impact on the consumer market in the coming years. Consumers will be able to find incredible innovations and new brands on Instagram, Amazon and on store shelves. That last part is important. This is not about leaving traditional pathways behind for a pure DTC distribution model, but finding the best of both worlds. And technology will make that a reality for millions of consumers and entrepreneurs.