Understanding Direct-to-Consumer

It is hard to scroll through Instagram nowadays and not see ads selling you mattresses, glasses, shavers, potted plants, gym apparels, or furniture. Ever since the glasses retailer Warby Parker became popular selling glasses from their website and not a store, businesses in many industries have been trying to replicate their business model of selling directly to their customers. Selling directly to consumers isn't new. E-commerce has enabled businesses to do that for many years. It's just that we have a new, catchy term for it now.

Direct-to-consumer (or DTC).

But to understand direct-to-consumer, we have to go back many years to before the Internet and e-commerce were a thing.

Traditional retail

In the past, when you want to sell your products, you would usually sell them through retailers with physical stores. If your business is much bigger, you would sell your products to wholesalers, who would sell to distributors, who would sell to retailers, who finally would sell to the end consumers, such as your family, friends, and strangers. This is assuming wholesalers, distributors, and retailers all want to sell your products. Unless you have compelling products or a strong brand name already, it can be hard to convince them to sell your products. The alternative is to set up your own physical store, which requires a lot of capital and people might not even visit a new unknown store.

Let's say the wholesalers, distributors, and retailers are all excited to sell your amazing new products. For the wholesalers to make a profit, they have to sell your products to distributors at a price higher than what they paid you to cover the cost of the goods, their employees' salaries, and other costs. The same goes for distributors and retailers. At the end of the chain, the end consumers pay a price that has been increased several times. You might have sold your products to the wholesalers at $10 a piece while the end consumer could have paid $30. Each increase is known as a markup.

How do people actually know about your products in the first place? Before the Internet, people had to walk into stores to shop, as most of us still do today. If you have a good relationship with the retailers (usually because of some incentives), they would place your products in an obvious location for shoppers to see [1]. The retailers might promote your products in their advertisements, often on TV or radio, to attract more shoppers to their store. You could also run your own advertisements and direct people to those retailers to purchase your products.

At the end of each month, you might get a report from the retailers, distributors, and wholesalers with the number of products sold. According to the sales numbers, you could adjust your production according to the demand, spend more on marketing to drive demand, and create new products to meet new demand. Then the process repeats itself.

The new way of distribution

The Internet brought about a new way of doing business. Instead of getting a bank loan and renting a physical store, you can set up a website to sell your products. People can buy electronically buy your products on the Internet. Hence the term, e-commerce. E-commerce platforms such as Shopify have made it even easier for you to set up your online store, without having to worry about building an actual website or dealing with servers and inventory management.

This changed how retail is done. Because people can buy directly from your website, you don't have to go through the wholesalers, distributors, and retailers anymore. In a way, you have become the wholesaler, distributor, and retailer. Or you have "cut out the middleman", as many would like to say nowadays. Customers order from your website, and you send them the products directly.

Without the markups by "the middleman", you can sell your products at $10 and pass the cost-saving to your customers. You could even increase the price to $15 to make more profits and still pass some cost-saving to your customers. Instead of aggregated reports, you get to see who your customers are, how much they have ordered, and how often they are buying from your store. This more specific information will allow you to refine your production and marketing better.

Talking about marketing, the Internet has also changed how you can market your products. Besides TV and radio, you can use social media, Google, email, and other digital channels to reach specific groups of people who would be interested in your products. But you have to do your own marketing because nobody will walk by your website like they walk by a retail store...

unless there are online retail stores that people would visit.

The online marketplaces

As the Internet made it easy for you to set up your store online, it also made setting up online stores easy for retailers. They, too, set up their store online and bring their customers online. Instead of doing your own marketing to attract people to your new website, you could sell your products on retailers' online store to leverage their existing customer base.

If there's one online retail store that most people visit, it's Amazon. Hundreds of millions of people buy things on Amazon every year. In 2019, consumers spent $280,000,000,000 on Amazon. To list your products on Amazon, you have to pay about $40 per month and a small fee for each item you sell. At that price, you are able to show your products to hundreds of millions of people (that's at least 100,000,000 people) instantly. That is a pretty good deal. And that's why there are more than 5,000,000 businesses and individuals selling on Amazon.

The upside of selling on Amazon is reach. The downside? Amazon is in control of the distribution of your products. Changes in the search algorithm could impact how often your products are seen by online shoppers. Amazon, knowing what people are buying, could replicate your products and compete with yours (and they have). Amazon could increase the price of listing your products there, thereby increasing your costs.

Another concern is that people might not remember your brand. When people buy products on Amazon, they would think "I bought this on Amazon", and not "I bought this from Brand X on Amazon". They would remember Amazon as the brand they were shopping from, not yours. Without the connection to your brand, they might not be as likely to buy from your brand again, especially since your products are always displayed alongside your competitors'.

Digitally Native Vertical Brands (DNVBs)

Andy Dunn, who founded the men's clothing brand Bonobos, took a different approach. He called the new wave of companies digitally native vertical brands (DNVBs).

They take control of their own brand and distribution.

There are three key parts to this concept, which make it different from "traditional" e-commerce and selling on online marketplaces like Amazon:

1. Digitally native: The brand is born on the Internet. It interacts and transacts with its customers primarily online. Think websites, emails, social media.
2. Vertical: A DNVB controls or has a strong influence over the manufacturing and distribution process so that it can keep the cost low.
3. Brand: E-commerce businesses are businesses while DNVBs are brands. The latter cares much more about the customer experience and can charge a premium for its product. With a low manufacturing cost and high price, DNVBs have higher margins.

The notion of selling directly to consumers isn't new but I believe the popularity of DNVB contributed to the attention direct-to-consumer has today. Sadly, I think because DNVB is much harder to say than DTC, it became less popular as quickly as it became popular. But the idea of selling directly to consumers and the power of having a brand continue to live on under the new movement, direct-to-consumer.

Direct-to-consumer is a distribution strategy

When people talked about direct-to-consumer, they often refer to DTC brands such as Warby Parker, Dollar Shave Club, Casper, and Allbirds. It is not entirely wrong. These brands have been selling their products directly to consumers, which, by definition, makes them "DTC brands".

But direct-to-consumer is a distribution strategy, not a business model.

You can use direct-to-consumer as one of your many distribution strategies for your business. For example, Disney is not a direct-to-consumer brand but it has a direct-to-consumer strategy, which includes the recently announced Disney+. Apple sells directly to consumers via its beautiful Apple stores and websites but also through countless retailers. Nike has a direct-to-consumer strategy since as early as 2012 (likely even earlier).

Direct-to-consumer and other distribution channels are not mutually exclusive.

Many new "DTC brands" focus on direct-to-consumer first before expanding into other distribution channels, which strictly-speaking makes them no longer "DTC brands". Harry's, a successful shaving DTC brand, eventually started selling its products in Target and Walmart. Soylent, a meal replacement DTC brand, partnered with 7-Eleven to sell offline. Even though online spending is growing at a healthy rate of more than 10 percent per year, it currently only makes up 16 percent of total retail spending in the US. In-store sales are in the trillions, which makes it a powerful distribution channel that shouldn't be dismissed right away.

If you are a huge business like Disney, you can have multiple distribution channels. But that still comes with trade-offs. To sell its content directly to its customers, Disney is pulling its content out of Netflix and losing hundreds of millions in licensing deals. By selling its shoes on Nike.com, Nike risks its relationship with thousands of retailers. Why would they do that?

Control.

Wait, so what is direct-to-consumer?

At the heart of direct-to-consumer is control.

When you are selling your products through retailers, you are giving up control of many things: price, messaging, branding, data, and relationship with your customers. Retailers set the final price after many markups (unless you are a big company like Apple who can control the retail prices). They might offer discounts on your products to attract people to their stores, which can have a negative long-term effect on the brand, as it did on the Michael Kors brand. Retailers can unintentionally alter your brand messaging through their own advertisements or simply placing your products beside another brand's products.

Most importantly, you don't get to form a relationship with your customers. They interact with the retailers but not with you directly. You won't know who bought what, how much, and how often. You cannot follow up and connect with the customers unless they reach out to you, such as for customer support or warranty registration (yes, some companies still require that). Without the data and the connections, your marketing will be broad and generic because it will be for the entire market. It's wild to think that you cannot even send your customers an email about new products that they might be interested in.

Direct-to-consumer flips that altogether.

Because you are selling to consumers directly, and not through any third parties, you have much more control. You set the branding, messaging, and prices. You own the relationship with the customers. You have their contact information, purchase history, and buying pattern. With this control, you can send more relevant marketing messages to customers based on their purchase history, create better products through direct customer feedback, and build a brand that charges a premium for higher-quality products.

That all sounds great. But it is missing half of the story. The first half.

Getting in front of customers

In traditional retail, you can depend on retailers to attract people to their physical store and maybe see and buy your products. For direct-to-consumer, you don't get that. It's almost impossible for anyone to stumble upon your website if you are a new brand and aren't marketing your business.

Fortunately, the Internet has also made marketing easier and more accessible than before. Back in the days, marketing often means buying an ad on the TV, radio, billboards, or newspaper. They are expensive and targeted at a broad audience, and the results are hard to measure. John Wanamaker, a pioneer in marketing, once said, "half the money I spend on advertising is wasted; the trouble is I don't know which half." If you are a small business with a limited capital, it'd be hard to justify spending a lot on marketing.

With Google, Facebook, Instagram, YouTube, reddit, and other online platforms, you can more easily reach your target customers and generally at a lower cost. Glossier started as a beauty blog, which garnered millions of views each month, and is now powered by millions of micro-influencers on Instagram. Daniel Wellington worked with thousands of social media influencers to promote the brand and encouraged customers to post their own photos of its products with its branded hashtag. Warby Parker asked all their customers to share images of the glasses on social media to get feedback; customers ended up creating thousands of YouTube videos. Casper created a website for every mattress-related term people search on Google and poured money into AdWords to get them ranking high on Google. Dollar Shave Club orchestrated a viral video through press and advertising; the video generated more than ten thousand orders and crashed Dollar Shave Club's website. Soylent first got its attention when its founder Rob Rhinehart's blog post made it to the top of Hacker News, which eventually led to an active community on reddit.

These are amazing stories of top direct-to-consumer brands. In reality, most new direct-to-consumer brands are using Facebook and Instagram ads to reach potential customers and sell their products. This is because of three factors.

1. Facebook has made it super easy for you to advertise on the two platforms. You can even create an ad on your mobile phone in a few clicks. My mother, who doesn't know how to use a computer, creates Facebook ads on her phone.
2. Facebook allows you to show your ads to people with specific interests or from specific demographics. People will more likely respond to an ad that is relevant to them. This level of targeting is not possible with traditional media channels such as the TV.
3. Facebook gives you data, almost immediately. You'll know how many people saw your ad, how many people clicked, and even how many people bought something from your website.

While these factors make Facebook and Instagram ads a powerful marketing tool, I personally think they are the wrong reasons for using those ads. As mentioned in my private letter, Facebook and Instagram advertising is not a sustainable option for many businesses, even for venture-backed companies, because of the ever-increasing ad cost. Venture-backed companies are pouring money into such ads at an unprofitable rate, saturating the marketing and pushing the prices of ads [2]. These ads can be used to support your other marketing channels but should not serve as the primary one.

What are better alternatives? Organic channels.

The top organic channel for most websites is search traffic (or simply clicks from Google). To get organic search traffic, you have to be ranking well for terms related to your product. This will required a lot of search engine optimization work (and patience) and is often achieved through content marketing (i.e. a blog). You can also get organic search traffic through word-of-mouth, where interested consumers will search for your brand and products on Google. Another organic channel is organic social media. This is more of a long-term branding play because people don't like to be constantly sold to on social media and it's almost impossible to attribute sales to organic social media. But it is a powerful way to engage your customers and let them connect with your brand at a level that's not possible on other channels. While it isn't directly measurable, a stronger brand image can increase your organic search traffic and help your ads perform better.

If you have the capital, an extreme organic channel you can explore is opening a physical store. This is essentially going back to traditional retail where you get foot traffic but you own the store (and the customer relationships). And you are still selling directly to consumers. Brands such as Warby Parker, Away, and Casper have opened stores to let people see, touch, and feel their products, which they can't do online. Because of this purpose, Nik Sharma, an investor in and adviser to several DTC brands, has noticed that opening a physical store is becoming a marketing expense rather than a sales channel.

Direct-to-consumer is here to stay

While I feel that "DTC brands" are a fad, direct-to-consumer as a distribution strategy is here to stay. More and more brands will adopt a direct-to-consumer strategy to get more control over their relationships with their customers to build a stronger business.

Marketplaces such as Amazon can help you reach consumers quickly, even without marketing. But the lack of control over your brand and distribution will cost your business in the long run. This is also true in other sectors such as restaurants (e.g. Uber Eats, Deliveroo) and hotels (e.g. Trivago, Booking.com).

Distribution is too important for a business to be handed to someone else. Control it yourself.

[1]: My parents run a small retailer store, and their suppliers often build new cabinets in the store to display their products.

[2]: Based on conservative estimates, Casper spends $302 on marketing to get one customer who would spent $428 on its products. As it tries to reach and get more customers who would be less interested in their products than their initial customer base, it will have to spend even more on marketing. And the numbers above do not included other expenses.