Death to DTC? Enabling the future of cross-channel commerce
The Head Fake of E-Commerce Acceleration
One of the most emphatic transformations we’ve seen across the sectors we invest in has been the acceleration of ecommerce penetration, rising from 11% of all purchases to 15% from 2019 to 2021, representing ~20% per year growth. COVID pushed this transformation forward by at least 5 years. Shutdowns and quarantines forced consumers, some for the first time, to turn to digital channels in order to purchase groceries and household necessities. Many consumers flocked to retailers with larger assortments and existing brand recognition - Amazon’s sales were up 44% yoy Q1 of 2021, and newer entrants like Target’s and Walmart’s 3rd party marketplaces also put up astonishing numbers of 3x yoy and 2x yoy respectively. Grocery, the largest category of consumer spending after housing and transportation, experienced a once in a lifetime shift in digital penetration, and U.S. adoption skyrocketed to 43% in 2020 from 24% in 2018. Over 600 grocers turned to Instacart as their lifeline to consumers; the tech platform drove 50%+ of overall digital grocery growth in 2021.
However, the start of 2022 has seen a pullback in online spending. Consumers are heading back to stores with Mastercard SpendingPulse reporting in April that U.S. ecommerce transitions dropped 1.8% yoy while in-store sales rose 10%. In perhaps the most dramatic sign of a slowdown, Amazon posted its slowest revenue growth since 2001. While these pullbacks were harmful, they pale in comparison to what we’ve seen for Direct to Consumer (DTC) businesses.
Death to DTC?
Even pre-COVID, the DTC 1.0 model was starting to falter. Rising customer acquisition costs and fulfillment costs (particularly associated with reverse logistics) resulted in razor-thin margins. The pandemic had initially given some temporary relief in CAC for some brands as the overall market pulled away from marketing spend. However, with CPMs now back to pre-COVID levels, coupled with Apple’s monumental decision to change privacy controls, things are more difficult than ever. Not only are customer acquisition costs painfully high again, Facebook, Instagram, Google are no longer the reliable, if inefficient, channels they used to be. Conversations with a few leading brand-focused venture investors reinforced that omnichannel is no longer a “nice to have” but table stakes for modern brands looking to survive and thrive.
Shopify, an undisputable winner of COVID, had seen record growth as many brands turned desperately to the platform to power their DTC sites. In the recovery, Shopify has fallen back down to earth, now trading at ~$400 (as of June 3rd), a stunning 23% of its November 12th high of $1,700. While the sharp turn in market sentiments across tech stocks is the primary culprit, Shopify’s numbers also indicate a slowing of growth. Shopify’s Q1 2022 revenue grew to $1.2B, a 21% yoy growth vs. the 110% yoy growth for Q1 2021 (source). The DTC OGs are in similar straits - Warby Parker is trading at $17, 29% of its $58 peak, Allbirds is trading at $5, 18% of its IPO price.
Source: Yahoo Finance
A New Hope
While DTC may look bleak, we are seeing bright spots in the retail landscape. Interestingly, both Warby and Allbirds pointed to their brick & mortar stores as the sole bright spots in their Q4 earnings and committed to expansion of their physical presence in order to diversify away from their digital businesses (source, source). We are seeing additional proof points in the Equal portfolio. Starday Foods, a next-gen food conglomerate, is already seeing wholesale channels (get it at your local Kroger!) outperforming DTC, both in volume and capital efficiency. Leap, a retail-as-a-service platform that abstracts away the brick & mortar channel for their customers, is experiencing record demand (slated to open 250 stores this year) from brands (DTC and omnichannel) looking to expand into physical retail stores to grow their businesses more efficiently and sustainably. Marketplaces, in particular, exploded during COVID. More than 40% of all post-pandemic online spending globally is taking place on marketplaces and as Chris Cantino told Modern Retail, “when brands opt out of marketplaces, they cede market position to competitors.”
Next-gen models are already taking advantage of these tailwinds. Today, there are 1.9m active sellers with ~2k new sellers joining the Amazon marketplace daily, creating more pathways to self-sustaining entrepreneurship than any other platform in the US. As the marketplace has evolved, acquirers such as Thrasio and others have taken advantage of the growing availability of data on 3rd party sellers and the ease of synergies implemented between these companies to successfully roll-up companies. Nearly $15 billion has been raised just since January 2020 as these platforms like Thrasio seek to wrap technology services around acquired properties to optimize their operations, including marketing, logistics, and financing, and launch them across multiple channels, even broadening their coverage to international markets.
Source: Marketplace Pulse
Unfortunately, these capabilities remain woefully out of reach for the long tail of merchants, who still struggle with the basic operations of their businesses. The numerous available point solutions fail to speak to each other, and merchants have demonstrated an almost irrationally low willingness to pay for software, hampering their growth. Most brands are unable to optimize between marketing, logistics, and financing functions, leading to over- or underspend on marketing, stockouts or excess inventory, or even liquidity problems, the kiss of death for many brands. In addition, smaller merchants are more susceptible to channel dependency because it’s too difficult for them to build for multiple strategies so they end up being beholden to Shopify / DTC platforms or Amazon as single channel merchants. The better answer is both - Shopify AND Amazon. The best answer is those and MORE! Our team believes that there’s white space for a powerful counter-position model - giving away a multi-channel management software for free, and monetizing through marketing, logistics, and financing services, represents a multi-$B opportunity.
The Great Unbundling
As we previously published in August 2020, “Our biggest focus within the Retail category has been “The Great Unbundling”: a focus on businesses that enable brands and retailers to take activities off their balance sheet that are not core competencies. We see opportunities to do this across a firm’s operations, but especially in areas such as marketing (reducing CAC), logistics (forward or reverse) and manufacturing to be more agile in a fast-moving market environment.” We believe democratizing access to leading marketing, logistics and working capital capabilities (along with great software to run the business) is an incredibly powerful way to facilitate this unbundling, enabling the long-tail of merchants to become significantly more profitable, but also significantly more independent.
We are incredibly excited about a platform that is a cumulation of our thesis within the space and in typical Equal fashion, we have synthesized our research and findings into a redacted version of our “Prepared Mind” Deep Dive on the space here. If you are, or know anyone, building in the space, Rick (email@example.com) and Chelsea (firstname.lastname@example.org) would love to chat!
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