The Sweet Smell of Success? Will the direct-to-consumer model work for fragrance?

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In today’s Rad.Daily, we initiate coverage of the D2C Fragrance Sector. Globally, fragrance is a huge market, with about $40b in annual sales. In North America and Western Europe, where startups in our sector are located, we size the market at ~$27b, with the opportunity these startups are chasing — online and skewing younger — roughly half the size at ~$13b.

Despite a +$10bn market opportunity, multiple direct-to-consumer playbook pain points, and a concentrated group of incumbents, surprisingly little (~$10m) has been invested into the eight leading startups we profile in our sector analysis. Of that $10m, 60% has been raised by Austin-based Phlur, and only one other startup has disclosed funding of more than $1m. Compare that with the D2C Beauty sector, in which startups have raised ~$60m in aggregate with the leading player, Glossier, having raised over $30m.

In addition, with all respect to investors like Austin-based Next Coast Ventures and SF-based Harrison Metal, no prominent or “name-brand” investors have disclosed investments in D2C Fragrance brands. In the D2C Beauty category, on the other hand, investors include Thrive Capital, Index Ventures, Lerer Hippeau Ventures, IVP, TPG Growth, Slow Ventures, and Vayner/RSE.

What gives? Is this a sleepy sector ripe for opportunity? Or is there something structural that will make scaling a startup a challenge?

Checks the D2C boxes

In many ways, fragrance is the perfect market for a direct-to-consumer approach. There are multiple pain points, the top 8 players have ~75% share, and the margins are HIGH. These pieces suggest gross margins of between 90 and 99% but seem only to account for the direct costs of fragrances, i.e. the actual perfume ingredients — water, ethyl alcohol, and fragrance, itself a mix of botanical and synthetic chemicals. Taking into account overhead and other operating costs, as this piece does, suggests high margins and a “cutting out the middleman”, D2C 1.0 opportunity.

Various costs of a $100 bottle of perfume:

Cut out the retail margin, and you’ve got a $60 bottle instead of $100. Modern consumers increasingly seek value and are less likely to pay a brand premium simply because it has always existed. Warby Parker and Casper are clear analogs. Fragrances, like eyeglasses and mattresses, do not offer obvious justification for the pricing differences between various brands. Why is one fragrance $50 and another $400? As we demonstrate above, these price differences aren’t ingredient driven. Startups that can deliver attractive fragrances at a big discount to legacy brands’ prices should see their products resonate.

Besides value, there are other direct-to-consumer value propositions. Ingredient transparency/quality is a major one. Today, there is little transparency into fragrance ingredients. Details on what chemicals, natural or synthetic, make up a fragrance are difficult to come by. Bloomingdales, as an example, does not display fragrance ingredients, as shown here with Lancome’s La vie est belle Eau de Parfum Spray. There’s no information as to what’s in the bottle.

Millennials and modern customers are increasingly health conscious. And customers today have resources to research the quality and safety of product ingredients. Legacy fragrances tend to use more synthetic chemicals, yet consumer preferences are fueling the growth of products with natural ingredients or those with more transparent formulations. We’ve seen transparency and the use of natural and organic ingredients play out successfully for brands like Honest Co. Phlur positions itself as transparent about ingredients. The company lists the ingredients for each of their products. We’d expect this to be a key driver of new brand’s value propositions, providing a comforting answer to the question of “what am I spraying onto my skin?”

Whither the fragrance startup?

With multiple opportunities to offer better consumer experiences and value and a multi-billion dollar market, why aren’t there more startups in this space?

Likely: concerns around CAC. While there is a long history of legacy products being sold online that consensus suggested would never happen (furniture, luxury goods, etc.), images do the products substantial justice. “I don’t know how this sofa will feel, but I can get a good sense of what it looks like, which is — at the least — part of the product experience.” When it comes to fragrance, approximating the experience is much more difficult.

Yes, fragrances can be described, but describing something as “fresh” and “airy” and “a minimalist scent” or having a “a citrusy burst,” while helpful, is much more subjective than an image. And thus, fragrance startups selling online will have to figure out cost-effective ways to convince customers that they will like what they are buying ahead of actually smelling it.

And that will likely be costly and require creativity. The swatch is common practice with furniture, and the sample is the swatch of fragrance. Phlur offers a sample package of 3 scents for $18 ($18 that can be applied to a full price purchase). Swatches de-risk the purchase for consumers and lead to higher conversion. In this episode of This Week in Startups, Benchmade Modern Founder/CEO Edgar Blazona discussed how swatches converted into customers at a 16% rate.

Samples should convert at a higher rate than swatches given that the sample provides a potential customer with the entire experience of the fragrance, while swatches provide just one part. If samples can offset their cost, they may be a valuable conversion tactic.

However, CAC will likely be high to convince customers of something they can’t yet experience through the web. That is that a fragrance smells good.

What about LTV? 
This research suggests that the lifetime value of customer depends on the customer’s age. Using this data, the D2C fragrance customer’s average life is likely between 2.5 and 6.8 years.

If we assume the D2C fragrance customer skews younger, suggesting an average life of 3.5 years, and using some assumptions based on Phlur’s pricing and product descriptions, we estimate a customer LTV of ~$200.

The key question then will be whether companies in this sector can acquire customers in the range of $50–60 (3–4x LTV/CAC). If they can, there’s a real opportunity to build a brand that will result in higher conversion, lower CAC, and presumably a valuable business.