The D2C Growth Paradox in the Time of COVID-19
D2C brands have unique advantages to survive this crisis, but not all are primed to effectively leverage them
Born from Crisis
Crop top spaghetti strap tanks are back. So are wide leg jeans. Teenage girls walk around in oversized flannels reminiscent of the Kurt Cobain-era of grunge. Everything old is new again. There’s comfort in what we know, and beyond comfort we can look to the past to understand what will become of the world, our cities, and our clothes, when everything seems so out of control.
In many ways, the direct-to-consumer (D2C) brand evolution has roots in the 2008 financial crisis. Industry consensus is that 2008 kicked off the “bad behavior” the retail industry is plagued with today. Retail still heavily relied on a physical footprint for sales — ecommerce represented only 3.6% of total sales in the US. The wholesale retail model, along with many contemporary brands such as J.Crew, became addicted to deep discounting as a method of attracting consumers, although this tactic didn’t quite work as planned. To compete with each other and fast-growing ecommerce players, retailers began offering more seasonal rotations, exclusive products, and capsule collections, flooding the market with excess inventory. While volume increased, consumers began to de-value full-price merchandise from department stores and contemporary brands, because they had been conditioned to expect a 40% off already marked-down sale merchandise midway through a season. Consumers were primed for brands that provided luxury for less, but were also overwhelmed with how many options they had.
Consumers were primed for brands that provided luxury for less, but were also overwhelmed with how many options they had.
Couple the wholesale crisis with a desire for minimalism and the rise of mobile-driven discovery and commerce, and you have the market conditions for a new set of brands to disrupt retail. Warby Parker kicked off a wave of brands claiming to be “the Warby Parker of _____” — everything from shoes to deodorant to purses, bringing disruption to categories whose share had been consolidated for decades because of supply chain dominance and control over offline distribution channels. After a couple years recovering, since 2012, over $4 billion in funding has been invested into D2C brands, with nearly half coming in 2018. Venture capitalists gave credence to these brands’ upside to capitalize on consumers’ evolved desires for functional products, that weren’t overpriced for the value they provided, that were at the same time easy to buy and cool to carry around. As a result, a new class of brands, following a nearly identical playbook, has been stealing share and cultural relevance for the last decade.
Theoretical Advantages Amid COVID-19
While ecommerce now represents a higher share of total sales, the wholesale model is again under strain as the result of the supply and demand crises brought on by COVID-19. While multi-brand retailers across the board are going bankrupt, shutting stores, and cancelling orders, D2C brands look well poised to ride out the crisis given their ecommerce prowess and direct access to consumers. With 41% of consumers saying that if an item is out of stock, they’ll turn to less familiar brands, D2C brands are well positioned to turn empty shelves (and e-shelves) into an advantage. In North America, revenue for digital-native brands increased 30% year-over-year from March 22 to April 4. D2C brands’ relatively low reliance on wholesale means they aren’t as susceptible to factors plaguing retail such as delayed shipments, discounting, and cancelled orders. Given their ability to “stack their supply chain” and direct communication with consumers, they’re faster at pivoting production, marketing, and product offering to meet consumer demand; the same performance-based approach applies to more nimble marketing tactics. And with 71% of consumers stating they would abandon brands who place profit before purpose in their COVID-19 responses, the fact that D2C brands have embedded social good in their brand DNA from inception gives them a unique strategic communications advantage to survive the crisis.
As emerging designer Havva Mustafa said to WWD, “By connecting one-on-one with the consumer, we are now able to control the entire shopping experience from brand discovery through our socials, to product packaging and delivery. Being direct-to-consumer has also allowed us to expand outside of just products. We can interact with the customers more directly with things such as our ‘Cool Girls Don’t Sleep’ radio playlists to our newly introduced Instagram Live drawings lessons.” In theory, the leeway that D2C brands have built into their business model, product, and communications should give them a strategic advantage to weather the storm.
The Bubble Burst
As we discussed in our analysis on the future of D2C brands, even before the pandemic we were seeing signals of the D2C bubble beginning to burst. A large part of the D2C playbook was using VC infusions to spend ahead of consumer demand, expecting spending on short-term expenses like marketing, physical retail, and manufacturing to pay off with longer-term customer acquisition and lifetime value. Like many tech startups, they forsake profit for expected return, guaranteeing to provide that return in the long run through wholesale, international, or Amazon expansion. For example, Casper’s IPO filing revealed that the mattress brand was losing $157 on each sale, in part because their customer acquisition cost per unit was $305. In 2018, Outdoor Voices lost $19 million and was forecast to be operating at a loss until 2021, mostly due to plans to open 5 stores by the end of 2018 and 50 over the next few years. In doing so, D2C brands didn’t leave themselves much room for a crisis that would severely impact their ability to acquire customers and recoup losses.
Only D2C brands with super-strong brand identities and business models will survive.
The pandemic has already accelerated a thinning of the retail herd, and D2C is no different. Across D2C companies, revenue is down 50% to 90%, and only D2C brands with super-strong brand identities and business models will survive. If we look at past economic downturns, retailers that fail during recessions are often overleveraged. Brands with manageable amounts of debt are better able to invest strategically outside of the organization to drive growth, as opposed to having to focus internally on servicing their debt, and tend to outperform debt-laden competitors when the economy recovers.
If we look at D2C brands with recent, late-series capital raises, many brands who used funds on capital-intensive expansions like wholesale, pop-ups, or physical retail aren’t faring well, even those operating in seemingly pandemic-proof categories like loungewear and intimates. According to Nadaam CEO Matt Scanlan, “brands that are backed by venture capital are expected to reach certain growth milestones on an annual basis. This means ramping up their staff and production months before they’ll reach that target, which means they might be carrying a lot of extra overhead right now”.
Luggage brand Away, who raised $100 million in series D funding in May 2019 and planned to open 50 stores in three years in addition to expanding internationally, has laid off 10% of staff and furloughed another 50% as revenue has declined by 90% since the pandemic hit. ThirdLove used its $55 million raise in February 2019 to open their NYC flagship, with plans to open “many more”; the brand has since laid off 30% of its staff, citing challenges presented by COVID-19. When raising these later rounds, retail expansion was seen as a key driver of customer acquisition, as D2C brands had maxed out growth via digital marketing and ecommerce. Call it bad timing, call it poor fundamentals, call it capital being too readily available — D2C brands’ overleveraged debt positions and reliance on physical retail for growth will hinder their ability to respond and recover to crisis.
Survival of the Fittest
It’s not all doom and gloom for D2C brands — the ones who remained disciplined about burn rate and didn’t load up on cash to spend forward are enjoying the flexibility that many digital-native brands built their success on. Ministry of Supply, which launched in 2012 and has been growing steadily since, has only taken a modest $9.2 million in funding since entering the market. Even though sales are down, co-founder Gihan Amarasiriwardena said the company isn’t planning to lay off any of its 80 employees. In fact, they’ve been able to keep retail employees employed by repurposing them to handle digital inquiries like styling advice and product recommendations. Dagne Dover is another good example. Launched in the midst of the 2008 financial crash, the D2C fashion accessory brand has maintained its scrappy approach to spending, season-less product line, selective wholesaling, and aversion to discounting its core products; the brand similarly is not planning layoffs due to the pandemic.
It would be short-sighted to say the pandemic is causing the death of D2C — rather, we’re seeing a market correction, where the brands with strong fundamentals, sustainable debt positions, resonant brand identities, and flexible sales models will emerge as survivors during recovery.
