Investing in a new generation of brands

As digitally native generations grow older and become valuable consumers, companies are required to adapt their customer journeys to evolving needs and expectations in order to stay relevant.

This is a challenge for incumbent brands who are restricted by any, or all of the following:

• established brand identities
• shareholder expectations that prevent them from transforming their core business and potentially losing money and existing customers
• powerful internal stakeholders who stick to what they know
• technology stacks that are often fragmented and old
• non-digitally native workforce.

Investing in new vertical consumer brands (or as some call it — Digitally Native Vertical Brands, DNVB, but we prefer the Direct-to-Consumer term, D2C) might not be an obvious thesis for tech venture capital. However, at Luminar Ventures we find the business model attractive for 5 reasons.

Why should VCs invest in D2C?

1) Consumer companies can create value at the same pace as technology companies. Exit multiples are often lower than for tech but that is offset by less inflated valuations and need for less equity investments along the way due to early revenues and profitability.

A number of Swedish consumer and tech companies, annual revenue by years in operation

2) Gross margins are often 2x e-commerce (e.g. 60% rather than 30%). Contribution margins are 4–5 times higher in comparison. D2C businesses can acquire customers at a higher cost and can be flexible with promotions. They can afford to hire tech-talent with necessary skills in order to build unique digital customer experiences.

3) The user experience can be customized for individuals at a relatively low cost. D2C businesses can set up a slim and efficient technology stack from day one, immediately take action on customer feedback and iterate product features and offerings at a high pace. Consumer data enables low-cost customization, e.g. Curology who analyzes customers’ input and ships made-to-order products.

4) They can leverage existing traffic at super-platforms such as Instagram, Amazon, Tmall etc. By utilizing marketplace channels, they can sell a subset of products at a margin and drive valuable traffic to their own sites.

5) They can build communities that promote the brand while delivering additional value to customers by operating as a low cost, user-generated customer support. The founders themselves typically embody the brand’s mission, creating a sense of identity that inspires consumer advocacy.

6) D2C opens up for greater diversity of founders catering to niche markets, that historically have missed out on VC funding because their business model did not fit the traditional tech VC mould. These founders know their markets intimately and can often offer a very high value to consumers.

Yet, many investors still avoid D2C. Granted, it is difficult to know what team to back given the wealth of alternatives. At Luminar, we have developed a model that takes into consideration factors such as:

• The company wants to fix something that is broken with a far superior product and strategy compared to incumbents and leading challengers.
• It goes without saying that only stellar teams build category winners. Adding to the intellectual intensity and leadership skills we normally seek in founders, we believe that a meticulous attention to detail and obsession for customer experience is critical.
• The market needs to be very large (and demonstrably broken).
• The team has a clear go-to-market strategy including a credible thesis on how to grow mindshare very fast.
• Customer purchase frequency should be high. Could potentially be offset by high average order value but generally not. Recurring customers allow for added value in community, up- and cross sales opportunities, better inventory planning, a multitude of campaign concepts and much more.
• Low return ratio is a plus. Areas like beauty, health products, food and other consumables are examples where returns are inherently low.
• The company should build other assets than just beautiful products, such as proprietary data enabling further strengthening of the offering.

If you are interested in discussing new brands or business models for consumers, or if you are a founder of a D2C company with a clear vision to change a category, don’t hesitate to reach out to the Luminar Ventures team. Email me at daniel.karsberg@luminarventures.com. We look forward to hearing from you and growing the consumer-driven space together!