The Hyperfragmentation of Retail and Why the Biggest Winners are Digital Ad Platforms, not Microbrands
If you looked at retail trends a few years ago, you probably would have predicted all ecommerce to have consolidated under Amazon by now. While Amazon has certainly conquered the mass part of the market, what I find surprising and more interesting is two parallel trends: the explosion of direct-to-consumer (DTC) brands and the hyperfragmentation in many categories. Even as Amazon has pushed the envelope on selection, service, convenience, and price, coaxing us to buy more commodities online, we are increasingly discovering and buying conspicuous consumption goods directly from indie brands, splitting our dollars across many different sites.
Over the past six years, while I ran product and design at Minted (an ecommerce destination for high-end custom stationery and home goods), online shopping has evolved in a few different ways: on the one hand, consumers want a rich, emotive discovery experience and brands that resonate with their values. At the same time, they expect an efficient shopping experience and huge breadth of choice (which they have grown to expect from years of shopping on Amazon). This, coupled with the marketing and operating inefficiency of a hyperfragmented ecosystem, leads me to believe that the current state is not likely to be the steady end state.
I’ve been thinking a lot about how we got to this state of hyperfragmentation, where we now regularly shop from a long tail of microbrands, and what it means for the future. In this post, I attempt to understand the key drivers of the current state and emerging trends. Then, I offer some thoughts on who the winners and losers are, and where things may be headed next.
What’s the current state of play?
On the supply side, it has never been easier to manufacture and distribute a new consumer product. The complexity of managing a global supply chain, building an online store, and generating distribution was the main moat surrounding the retail monoliths of the twentieth century. However, we’ve seen those traditional moats disrupted because:
- It is easier than ever before to discover and partner with supply chain manufacturers globally, thanks to companies like Alibaba.
- The supply chain has been commoditized and leveled up in terms of technology and productivity such that it can support small-batch, just-in-time, or make-on-demand manufacturing.
- You can launch a store on Shopify in minutes. No coding or design skills required.
- Visual social media created a distribution platform for new and emerging brands and transformed shopping into media entertainment.
- Entrepreneurs have the opportunity to test upfront for demand and market validation, unlocking product experimentation and innovation.
- There is more knowledge-sharing among entrepreneurs, making it possible to learn all of the above very quickly.
There are countless examples of companies that have exploited these tailwinds to their advantage. They can be identified by their stories of cutting out the middleman to create value for customers and their corporate values of transparency. A few of the best known include Warby Parker and Everlane, which were among the first to crack open supply chains paving the way for others. Then there are emerging brands like Outdoor Voices, M Gemi, Away, Parachute, MMLaFleur, etc. as well as a long tail of microbrands and product manufacturers that rode these trends. The proliferation of DTC mattress companies (Casper, Tuft & Needle, Saatva, Eve, Helix, Bear, Leesa, 4Sleep, etc.) in the past five years illustrates the difficulty of stopping others from following once the moat is forded.
On the demand-side, consumers want small brands that signal their affiliation with their communities. Of course, conspicuous consumption is nothing new; it is an age-old way of expressing identity and signaling belonging to a specific community. But what’s changed is that:
- Consumers are no longer signaling on a local scale, but rather on an internet scale.
- Visual social media has up-leveled consumers’ design sensibilities.
- Together, these two changes have accelerated trend cycles…
- And stoked an equally powerful countercurrent toward “better, fewer” embodied by brands like Everlane, Cuyana, and AYR.
What consumers want to signal has completely changed too. At Minted, my friend and CEO, Mariam, often talked about the idea that the 2008 recession catalyzed a distrust of legacy institutions including big banks and big brands. Consumers, especially recent grads strapped for cash, needed to save money. Internet savvy and trend-conscious, they were not willing to sacrifice style, but they were willing to sacrifice labels. I think this drove a flight to quality and value and threw open the door for micro-brands to compete.
More now than ever, consumers, particularly millennials, are spending their money on products not only for the functionality they provide, but also for the meaning they convey. Purchase of the product signals not just your taste, but also your personal values (that you care about promoting sustainability, environmental protection, global consciousness, economic development, and fair wages, or supporting local makers, independent artists, female founded companies, etc.).
Hyper-targeting enables these brands to find customers and build niche communities. These brands target on geography, age, and data that proxy interest in certain categories, product attributes, or values on platforms like Facebook / Instagram and Google. The targeting gives them a cost-effective path to pay to reach their initial customers which in turn allows them to monetize quickly and get to a meaningful initial level of scale faster than ever before.
The problem is no longer initial distribution, but cost-effective, scalable distribution. Many of these brands have sliced and diced the market to avoid the mass feel of big brands and big retailers and to achieve the differentiation customers are looking for, but as a result (as my friend, Rebecca, a partner at USV has pointed out many times) these brands are in a sea of so many that to break through the noise is increasingly expensive. The irony is that while many of these DTC brands want to avoid paying retailers (Amazon or others) for distribution, they’re paying significant sums to digital advertising platforms for distribution. The ones that cannot escape the customer acquisition rat race stay small. The smart, creative, and lucky ones leverage their brands and customer communities as platforms for organic distribution. Some have even started as distribution platforms, like Glossier which originated from the blog, Into the Gloss, and then backsolved ecommerce after having aggregated an avid audience and learned what they wanted from a product, brand, and distribution perspective.
[Sidenote: the seedy underbelly of “fly by night” retailers that are exploiting some of these same tactics and trends to hustle consumers is also fascinating. See this story.]
What are the table stakes for retail today?
Some of these may be obvious points, but I think it is helpful to mention them as context before speculating on the future.
Brand values are the last battleground for differentiation. Consumers are bombarded with more information than ever before. Brands and storytelling are critical to breaking through that noise. (To be fair, there is still room for product innovation and differentiation, but they don’t afford as much runway as before due to the supply chain commoditization).
The interface layer is the key enabler of brand expression. Obsession and attention to detail throughout the consumer experience signal the quality of the product. We see this in how products and packaging are treated as creative canvases. Take chocolate, beer cans, or spray paint for example.
The interface layer extends beyond the product and purchase flow itself. Depending on how broadly and creatively a brand imagines that layer, they can successfully increase the surface area both physically and emotionally around the product and get more customers engaging with and talking about the brand. We see this in how companies are designing spaces and experiential marketing campaigns. Take Glossier, the Wing, or Peloton for example.
All of this facilitates the best possible conspicuous consumption — and hopefully triggers scalable distribution via community activation on social media.
Limited runs keep brands relevant in a crowded retail environment. As a consumer in a world where social signaling is amplified by visual social media, you better have the latest thing. Many companies are creating limited runs of product lines that play off of the cache and cultural exclusivity that comes from having something few others have. This tactic also has the benefit of keeping the brand relevant, creating a frenzied urgency to (repeat) purchase, and short-circuiting the natural replacement cycle. While definitely not a microbrand, Nike has long been one of the best at this game. They regularly drop limited edition sneakers. The long lines and overnight campouts to acquire these sneakers stoked sneakerhead culture and the large resale market. The DTC equivalent is M Gemi, a maker of “postluxury” shoes, that “drops” new “editions” of shoes every Monday that are available while supplies last.
How are the best brands differentiating?
The best brands are leaning into opportunities that channel more active forms of self-expression than consumption alone. They are enabling their customers to be merchants, product designers, and marketers, tapping a desire to voice and signal creative authority.
Crowdsourced merchandising provides demand signal. Some brands like Taylor Stitch and Minted leverage their communities to gather demand signal and curate what is ultimately sold. Taylor Stitch releases new products each month into its workshop. Products that reach their funding goal are manufactured and delivered. Minted runs monthly design competitions in which artists and consumers alike can vote. Only the top-voted designs are sold on the site.
Customization invites consumers to participate in the product design process. Other companies are enabling customers to customize products to their own specifications giving them a larger canvas for self-expression and creativity. Minted is a great example of this. A global freelance artist community creates the artwork for the designs sold on the site, but customers can tailor any given design template by playing with fonts, colors, photos, and design elements before they purchase. This participation gives them a stake in authorship of the product enabling them to authentically claim that they designed it too.
Co-creation helps brands scale content production and distribution. Brands willingly trade control (by encouraging customers to share their own stories of the product and even remix products) for outsourced content creation, distribution, and product development as well as engagement and relevance. Skincare brands like Glossier and Deciem are two of the companies I’ve seen excel on this dimension. Glossier is still as much a content platform as a DTC ecommerce business because of how customers photograph and share the Glossier products and retail spaces on social media knowing that Glossier will often re-post them to the brand’s social media accounts.
Deciem is a skincare brand that sells functional compounds commonly used in beauty products in their pure, isolated forms. Efficacy notwithstanding, their customers, savvy beauty fans turned chemists, mix and match ingredients to concoct bespoke potions and share them with one another online in forums, blogs, and Instagram.
Who are the winners and the losers today?
Consumers are better off because they have more selection and choice than ever before. Entrepreneurs and product designers are better off because they have the ability to get started, rapidly test, build brands, and monetize. On a revenue basis, platforms like Facebook / Instagram, Google, and to a lesser extent, Shopify and Pinterest are the biggest winners because they can collect rent and tolls from each new microbrand. The losers are mass brands and retailers whose customers defect and whose sales erode, with the exception of Amazon which, my guess is, is not really impacted yet given that its largest retail categories (electronics, home and kitchen, books, etc.) do not overlap with the categories with the most hyperfragmentation (apparel, shoes, accessories, beauty).
What are the implications of this hyperfragmentation?
If you’re asking, hey, “it seems really exciting that there are all of these companies with great products and hip millennial marketing democratizing commerce, but how are most going to break through?” then you’re asking the same question I did. Unpacking that question led me to more questions as well as a couple observations on potential ways to improve the ecosystem.
Why are these brands all paying full freight to acquire potentially the same customers and run their businesses? Some of these brands have overlapping customers, but each brand pays to acquire the same customer independently. Take an extreme example, Anomalie, a maker of custom wedding dresses, and Black Tux, a service that rents tuxedos and suits. One pays to market to brides and the other to bridegrooms. They may even pay to cross-target each other’s customers to drive awareness and indirect referral. There has to be some leverage if you could pay to target one and get them to talk to other.
Some brands see this issue and are reacting with marketing “co-op” efforts in channels like direct mail (coupon bundles), email (swaps), or collaborative contests. The more sophisticated marketers share cookies or customer lists. But, overall, it seems like there is incredible inefficiency in customer acquisition that these brands are struggling alone or together to overcome and in the meantime Facebook and Google are winning.
Another way to think about this is to ask in what areas a house of brands like Gap Inc gets operating leverage across its brands (Gap, Banana Republic, Old Navy, Athleta, etc.) and product lines. These areas include finance, supply chain, retail operations, customer service, etc. each of which these highly targeted brands has to independently build.
Where can you go to discover these brands? Instagram? Kind of, but not entirely… Push marketing only reaches a segment of the demand curve, the part that happens to be reading the right blogs, following the right influencers, and getting the right targeting at the right time. Otherwise, good luck discovering these brands.
Just last week, I wanted to buy a new pair of leggings. I’d heard of Outdoor Voices (one of the most successful of these DTC brands), but I knew there were probably others making great products that I should check out. I tried searching Google and Instagram and was met with big brands, blogs, or photos of people wearing leggings. Once I realized how much work I had cut out for me, I gave up and texted my friend, Annie (I could have scaled this approach up by posting this question more broadly on Instagram, Facebook, or Twitter). She promptly replied with two other brands (Girlfriend Collective and Live the Process) which she had discovered on Instagram, but I had never heard of. Maybe I didn’t have the attributes those brands were targeting against or maybe I scrolled past their paid posts. But in either case, I was a customer who wanted to find new brands in this category and I couldn’t.
How can we make shopping these microbrands more convenient? In addition to discovery, it’s just annoying to shop across several small brands’ websites especially for frequent purchases. Between registering, logging in, and entering credit card / shipping details on each site as well as clearing your inbox of all of the emails you’re bound to subsequently receive, shopping indie brands can quickly become a chore. Those of us that are shopping online for these microbrands are probably also shopping Amazon for our basics, and Amazon is setting and constantly raising our expectations for convenience and service. I don’t think consumers will be forever content having different standards for these two shopping experiences which creates opportunity for an interface layer that removes friction from microbrand transactions (eg, checkout with Paypal or Apple Pay).
Although it may be easier than ever to start a moderately successful boutique brand given these trends, achieving scale is still difficult given the challenges achieving breakout, mass market distribution. If you consider parallel trends of unbundling and rebundling of media that have happened over the past few decades, what might follow the hyperfragmentation of retail is a wave of reconsolidation to leverage cross-brand marketing to solve some of problems of distribution that happen at scale.
One somewhat obvious way to create better economics is via a roll-up play where a consortium of brands can get some marketing and operational leverage. My friend, Hayley, partner at First Round Capital and co-founder of Birchbox, has often raised this potential strategy and pointed me to The Hut Group which led me to Kynetic, each of which own multiple ecommerce properties, and are doing this.
The other way is via a platform play that aggregates these brands in a “digital mall” or, even more analogous, on a “digital high street” that ideally enables cross-brand discovery. Platforms, like Instagram and Pinterest, that facilitate lifestyle discovery and reimagine the fun, social elements of shopping offline are best positioned to do this. YouTube could also be a contender, but it lags the others in repute for elevated aesthetics and consumer shopping intention. Amazon has consumer shopping intention in spades, but little emotion and aesthetic sensibility. It is not really a place where consumers linger, talk to one another, and discover new brands. It’s the place to buy what you already know you want.
It’s fair to ask if a “digital mall” is necessary. Cars are an interesting counterexample. There is no one-stop shop where you can view all models across all automakers. Instead, automakers spend a lot of money advertising on TV, radio, and other media to reach potential customers. Those same potential consumers trek from dealership to dealership or peruse consumer reports online to research their options. At Minted, our wedding customers similarly did a lot of research. Your wedding is a once in a lifetime event and it’s also one of the biggest expenditures you may make in your lifetime. And almost by definition, you’ve never planned one before. This type of research-driven experience makes sense for considered purchases of these ticket sizes and infrequency. But it is hard to imagine consumers doing that for shoes or sheets. I know I wouldn’t.
Who could aggregate the longtail of DTC brands?
I think the “digital mall” that combines social and lifestyle based discovery with the convenience of a consolidated ecommerce platform is missing in the ecommerce ecosystem today, and Instagram has an edge in achieving this vision for a few reasons.
The same data that powers advertising could help drive multi-brand product discovery. Instagram could leverage user behavioral and purchase data to help consumers discover new brands and products that match their preferences and aesthetics. If I’m an Allbirds shoe customer and follower and want a backpack, which brand is the Allbirds of backpacks? This could take the form of product recommendations functionality monetized via affiliate vs. ad revenue.
It allows Instagram to more elegantly walk the line of advertising and user engagement without sacrificing revenue. It seems like every margin dollar saved by these brands by selling DTC and not via retail is ultimately plowed back into paid marketing anyway to drive growth. All that would be different is that Instagram would capture that same dollar through two mechanisms: ads and ecommerce. This preserves or increases revenue while giving Instagram more flexibility to dial back feed ads if user disengagement increases.
Most importantly, it doesn’t feel like disintermediation. The challenge is that the business model of many of these DTC brands are predicated on cutting out the middleman and commensurate mark-up and giving that margin back to the consumer. This makes it hard to go full circle back to a distribution platform depending on that platform’s model and economics. Many of these brands have also forsworn selling via multi-brand brick and mortar retail or ecommerce because they want to “own” the customer relationship. But they are already on Instagram and Instagram is already enabling that customer relationship. I think this gives Instagram significant leverage to make a strong move into ecommerce without business and user revolt.
I expect this proliferation of microbrands to continue, because it is easier than ever to start a boutique brand. But, mass distribution is still expensive, so the biggest winners will be those that can collect rent and tolls like Google, Facebook / Instagram, or those that can consolidate microbrands under an umbrella to leverage cross-brand marketing efficiencies. Continued fragmentation of brands will only make the discovery problems and the poor customer experience worse, leaving a massive opportunity to reimagine the retail experience on the demand side.