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To Survive Amazon, Direct-To-Consumer Startups Will Become Luxury Brands

The next wave of VCBs will look more like Apple, than Amazon

Jay Kapoor
Nov 29, 2017 · 10 min read
This is Swole Bezos. He likes what you’re selling… and he’s about to start selling it too.

The last five years have seen an explosion in the number of e-commerce startups offering to sell you a variety of products delivered directly to your door. From apparel to toiletries to luggage to makeup, thanks to these vertical commerce brands (or “VCBs”), entire retail categories have been disrupted by digital upstarts vying for a fraction of your monthly spend.

For a while — this all worked really well with over $3Bn in venture capital flowing into VCB companies like Casper, Warby Parker, and Bonobos, since 2012. The earliest movers were able to differentiate from their laggard retail incumbents by both, vertically integrating production and building brand followings entirely online — back when that kind of thing was still a novel idea. But not anymore. These days, even previously bullish investors have taken notice of the struggles in e-commerce, and thus, venture funding in space fell to a 5-year low in Q4 2016.

Launching a vertical commerce brand in 2018 will be exponentially harder than it was in 2012. For starters, the laggards are lagging no longer. Through a combination of acquisition (Unilever-DSC, Walmart-Bonobos), investment (P&G), and partnership with Amazon, incumbents have made it so that being direct-to-consumer is no longer differentiation enough. Complicating that matter, the ever crowded landscape of VC-funded VCBs has steadily driven up customer acquisition costs (“CAC”) making it harder and harder for new brands to break through the noise. And increasingly, the ones that do breakthrough find themselves at the barrel end of Jeff Bezos’ guns.

“The Shroud of [Amazon’s] Dark Side Has Fallen. Begun, The Clone Wars Have”

In March 2016, Amazon launched its own line of of private label fashion brands (such as Find, Lark & Ro, and The Essentialist) and since then the e-tailer has continued to get more aggressive with their launch of Prime Wardrobe and via brazen copycatting of competition . When it comes to low-cost production, distribution, product discovery or retention, it would seem Amazon can’t be touched.

In order to survive, e-commerce upstarts and incumbents alike will have to focus on products and aspects of the purchase process that Amazon can’t or chooses not to do well — namely aspirational branding and memorable customer experience, both of which, ironically, are fortes of another untouchable technology behemoth. Given high costs to establish both factors, it stands to reason that new vertical commerce brands with staying power in the face of Amazon, will look more and more like Apple.

What Happens When “The Bear” Learns Jedi Mind Tricks

Some years ago, Andy Dunn wrote E-commerce is a Bear (named Amazon) and survival as a company means differentiating your VCB and product offerings across a host of factors where Amazon can’t catch you. But in the years since, some of those factors haven’t turned out to be the impregnable moat Dunn predicted.

Now, the latest conventional wisdom, outlined well by Sophie Bakalar, for achieving high customer lifetime value (“LTV”) in direct-to-consumer commerce has been that only two types of models will function:

  • High frequency, subscription products e.g. razors, toiletries, accessories, etc. where despite low margins, recurring revenue and a longer lifetime relationship with the customer eventually covers your acquisition cost (provided they don’t churn out first)
  • Low frequency, high price/high margin purchases, like mattresses or high-end apparel and accessories, where the high average order value covers CAC and shipping expenses

But, in fact, it may only be the latter. The more time I spend looking at these two options against the market landscape, the less convinced I am that the low-margin subscription products will actually survive Amazon in the long run. Here’s why:

For starters, retention and churn in subscription businesses is still really hard to manage at scale. “Monthly box” companies all eventually struggle to attract and retain users. In fact Stitch Fix listed “cost-effectively acquiring new customers” as a primary risk factor in its S-1 filing this year.

Meanwhile, Amazon leverages comparatively cheap public capital to play the game by its own rules — namely the ability to emulate the competition at a zero (or negative) hurdle rate for profitability, absorbing more losses for longer periods in the name of growth and market dominance. In a price race to the bottom, Amazon will win. Every. Single. Time. Acknowledging this reality, venture capital is drying up fastest for new consumer goods startups that offer price arbitrage as their key point of difference.

Gone are the wild west days of vertical commerce. The times, they are, a-changing…

Don’t get mad at the VCs just yet. If it’s any consolation, the public markets are equally, if not more un-forgiving. As L2 Inc. founder Prof. Scott Galloway puts it Amazon’s “Jedi Mind Tricks”:

Jeff Bezos could take 10 or 20 percent of the market cap away from any Fortune 500 company tomorrow just by announcing he’s going into their business.

He’s not exaggerating. When Amazon bought Whole Foods, the market made every competing grocer pay for it, while bidding up Amazon’s stock by more than the announced purchase price. Not a week after IPO, Blue Apron stock tumbled 38% below it’s IPO price on July-6th announcement of Amazon’s meal kit service. To date, $APRN stock has currently lost 70% of its value since IPO. Most recently, Amazon announced intentions to enter the pharmacy business, and the shares of CVS, Walgreens and Express Scripts all fell ~5%.

The Amazon Effect, in Four Charts

So, if you’re going to build a lasting commerce brand in today’s “Age of Amazon” it is better to focus efforts (and your investors’ capital) on building a hold-fast that Amazon hasn’t figured out how to breach.

Amazon Can’t Do Mass Luxury Like Apple Can

What is the margin value of irrationality?

I believe that to be the question at the core of a $250 billion-plus global luxury goods industry. First and foremost, traditional luxury brands succeed by cultivating “prestige” and then allowing consumers to purchase association for a hefty price tag. As consumers, we’ve been trained by marketing to associate the higher prices of luxury products with things like unique craftsmanship, impeccable quality and ethical production. These brands thrive precisely because of their exclusive aspirational nature — scarcity begets status and being able to afford a pair of Louboutin feels like a sense of accomplishment. These brands endure across generations and borders because the desire to signal status and wealth is a universally human one.

Apple is a luxury brand because it meets every key criteria, namely (1) An iconic founder, (2) Artisanship, (3) Vertical Integration, (4) Global Reach, and (5) Premium Price — as outlined in Scott Galloway’s phenomenal best-selling book The Four.

But Apple also defies a lot of conventional wisdom. When an entire industry is trying to “go digitally native” and brick and mortar retailers are closing more stores every quarter, Apple sustains nearly 500 physical locations across 19 countries — and are opening more every year. They sold almost 47 million iPhones globally last quarter and enjoy a 35% market share across mobile phones in the US — hardly exclusive. Apple has margins like Hermès and Prada but does fast fashion volumes. Its products are simultaneously irresistible, unattainable, and ubiquitous. Apple is in the business of Mass Luxury. Whatever the hell that means, its a great business to be in.

So what can enterprising VCBs learn from Apple? For starters, let’s look at Matt Heiman’s excellent points on the value of brand association in predicting success for commerce startups:

The best brands are those which make their customers proud to be associated with them, which happens when a brand can become associated with a customer’s identity. Brands whose customers effectively market on their behalf — either by word of mouth or more recently via social media — have a built-in advantage in the form of dramatically lower customer acquisition costs.

Apple’s customers make association with the brand a cornerstone of their identity (remember: “I’m a Mac — and I’m a PC”) and public perception. Better still, these customers actively evangelize and proselytize on the brand’s behalf with only social commission to gain. Their earned media is a thriving cottage industry unto itself. Their products have daily utility, meaning brand has constant share of mind with the consumer. Their stores are pristine cathedrals to the brand with iconic customer service representatives knowledgeable about every minutiae of the products offered.

But while high-end designer heels, suits, and handbags are non-essential (but damn nice to have), Apple’s products are indispensable — or at least they’ve been marketed that way. The notion of Apple’s as essential is as strong as it is irrational which is what makes it so powerful. The best luxury goods turn irrational purchase behavior into margin expansion, which is a powerful lesson Apple is teaching all would-be consumer commerce contenders.

Despite its bottomless war chest, Amazon can’t build that kind of luxury brand association overnight. I don’t expect them to get there by acquiring it, either. Luxury brands don’t want to be listed alongside fractionally-priced knockoffs, which makes a sale to Bezos downright masochistic. Per WSJ last month:

One of the biggest worries for these luxury companies: The difficulty of segregating their product listings from the rest of the goods sold through the site. That means a $5,000 suit from luxury Italian menswear company Brioni, a subsidiary of Kering, can appear next to a $200 suit from Kenneth Cole.“That contradicts the essence of luxury selling and shopping, where the product is the product also because of its environment”

Don’t get me wrong, Amazon desperately wants to get into — by which I mean sell you — your pants. But the company’s entire value proposition relies on the ability to bring you “more for less” and to pivot to luxury is antithetical. Amazon knows you won’t buy an “Amazon Basics” branded handbag, which is why it has launched more than a dozen private labels. But for all its cloning experiments, most of Amazon’s success has been in “Basics”, “Casuals”, and “Essentials” where the lowest price often wins out.

Building a successful high-margin brand means carefully cultivating a unique, memorable brand experience, a loyal customer base and an association people are dying to buy into — even if that means spending money they don’t have. Amazon doesn’t have a product like that but your budding vertical commerce startup just might.

E-Commerce is not a Bear. E-Commerce is a Terminator.

This is Amazon. He will take your bullets, walk through iron bars, and never, ever stop coming after you.

Amazon now collects more than 40 cents of every dollar spent online in the U.S. per research firm Slice Intelligence, and more than half of all product searches start first on Amazon — a percentage that continues to grow over time. Swole Bezos may physically look like the T-800 from Terminator but in actuality, his company behaves more like the T-1000 from Terminator 2 — malleable, ingenious, cutting-edge, and, in a word, relentless. Just like in the movies, to fight the T-1000 head on spells certain doom. But victory is (theoretically) possible.

Over a year ago, I wrote that the next great vertical commerce brand will (1) be an essential — that you only need one of (i.e. 100% share of wallet), (2) challenge assumptions about what people are willing to buy online (3) view technology as an extension of its brand, and (4) have multiple touch points with the consumers each year. I thought it was so prescient then, but never realized til now that I was basically just describing the latest iPhone…

Today, my advice to the next generation of vertical commerce brands deciding between low-margin subscription volume and low frequency high-margins is to focus their efforts on the kind of quality craftmanship, iconic simplicity, and memorable service exemplified by Apple. Then, work really hard to find the right niche audience of influential, early adopters for your flagship products. Tell them your brands story so well that they sell others on your product in ways you wouldn’t have imagined yourself. When done right, exclusivity is an aperture that can be widened over time with negligible loss to brand perception.

Building a luxury direct-to-consumer brand is easier said than done, but take comfort in the fact that it can be done. Every generation has its share of holdover brands from the last, but millennials, like our parents before us, have a cadre of all new logos and experiences we want to be seen in, on, and around. Unlike our parents, we care about the experience of the purchase as much as product itself and are willing to pay serious premiums for individualized VIP treatment. Use that to your advantage. Provide a level of service your competition won’t, and tack that additional cost to the end of the price tag.

It’s time to stop futilely firing bullets into the T-1000. It’s time to stop challenging Swole Bezos to arm wrestle. It’s time to stop burning cash in the name of customer acquisition, just to see your subscriptions churn away before you can realize the requisite 3x–4x or even 1x return on CAC.

The future’s not set. There’s no fate but what we make for ourselves. But for the ones who can’t adapt in the face of Amazon — it’s hasta la vista, baby.

Thanks for reading this article! If you liked it, go ahead and *clap* 👏 then share or leave me a comment below with your thoughts on other ways vertical commerce survives against Amazon. Also, please follow my Medium site for more musings and actively researched theses on commerce, consumer technology, digital media and live entertainment!

Jay Kapoor

Thoughts on Sports, Media, Tech & Guacamole

Jay Kapoor

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VC investor at LaunchCapital | I read and write about Tech, Media, SaaS, & Investing | Don’t be afraid of failure. Be afraid of being ordinary.

Jay Kapoor

Thoughts on Sports, Media, Tech & Guacamole