Customer Love Framework: what we look for in digital brands
At Samaipata we invest in exceptional founders leveraging on tech to make the world more human.
We think of a brand…
…as any product, content or service that establishes an emotional connection with the end user/customer (be it B2C or B2B) and create communities, a sense of belonging, a lifestyle that goes beyond a specific product or service.
I feel like I use this example a lot, but it´s just such a great one. I like to host a lot of my work meetings at Rapha Cafe in Soho and sitting there you understand that Rapha is more than a cycling brand, it stands for a lifestyle and a community people want to belong to. Being there just makes you want to wear their clothes, travel their trips, drink their coffee and eat their avocado toasts. So much that you might even consider start cycling.
We invest in brands…
…because in businesses where tech is an enabler, you need to build additional barriers of entry. And we believe that the emotional connection you build with your customer base, the community and the sense of belonging you create around the experience you provide, is a strong barrier of entry and a driver of growth.
We look for customer love…
And here — like in life — there´s a bit of magic and a lot of science. And that´s the beauty about direct-to-consumer digital brands: it´s about emotions as much as it´s about metrics. Because metrics are the reflection of customer behaviour. Going direct and being digital enables brands to translate pure human behaviour into KPIs that can be measured and tracked to test, analyze and understand customers. Hence, (most of) the magic happening around a brand can be measured if you know where to look.
Given our German nature (see here for more on our love for processes), we couldn´t resist the temptation to develop a Customer Love Framework for D2C digital brands. In this post I will outline our CLF (note we also couldn´t resist given it an acronym) and briefly explain each of the five key points we look for in D2C digital brands. Posts detailing how we analyze each of those points to follow.
- WOW customer experience (market opportunity)
When we invest, both in marketplaces and digital brands, we look for businesses that leverage on tech to fix crappy customer experiences. These tend to happen in: i) highly concentrated markets with very large dominant players controlling supply and hence pricing; or 2) highly fragmented markets with lots of intermediaries adding mark-ups. Overall, there´s usually a lack of transparency in the supply chain.
By being end-to-end, D2C digital brands have the potential to deliver an overall better customer experience: more customized, more convenient, more engaging and at more competitive prices. A great example of this is Dollar Shave Club, a shaving and grooming D2C brand that made a sexy affair out of the previously frustrating and over-priced process of buying a razor.
Where to look: Market dynamics and TAM to spot the opportunity. NPS and product reviews to confirm the WOW customer experience. Customer feedback is gold and is of course also relevant for the rest of points we track.
- Unique value proposition (differentiation)
Fixing a crappy customer experience is a must, but it´s not enough. Many D2C digital brands operate in very crowded spaces (i.e. how many D2C fashion brands can you name off the top of your head? Just think of your IG feed), with powerful incumbents and plenty of newcomers.
Thus, brands need a straightforward and unique value proposition with a compelling storytelling that connects with their target market and differentiates them from the growing noise. Everlane has managed to build a differentiating brand on radical transparency of the supply chain. Reformation has built a brand around stylish sustainability. And like them, many other brands that stand for a specific value, related to but bigger than their product or service.
Where to look: brand positioning/strategy and customer love metrics (see below)
- Customer love unit economics (growth & defensibility)
The uniqueness of the value proposition and the WOW customer experience translate into metrics in the form of organic growth and strong engagement, high retention, strong repetition and increasing AOV.
In a nutshell: customer love in the form of scalable acquisition means lower blended CAC; customer love in the form of high retention with strong repetition and increasing AOV leads to higher LTV. Hence, customer love translates into a more attractive LTV:CAC ratio. And voila, the magic happens!
a. Scalable customer acquisition requires a healthy mix of organic and paid acquisition and is ultimately driven by customer love:
- Virality and word of mouth (WoM) to drive organic acquisition. Viral organic acquisition driven by WoM and non-paid referrals show the brand has a community of advocates that love the product and help spreading the love. A high percentage of organic sales is a clear sign of customer love, especially at the beginning. Moreover, organic acquisition brings down the blended CAC.
Where to look: % of new customers/sales coming from organic channels (i.e. non-paid), blended CAC, engagement in social media (i.e. Instagram comments, avoid vanity metrics such as likes or followers)
- Deep and not saturated channels to ensure scalable paid acquisition. Brands should also (eventually) have open paid channels that show no sign of saturation and act as i) tested and predictable channels you can turn on and off ii) anchors to trigger and amplify viral organic growth in what should become a virtuous cycle. The bigger the customer love, the deeper the paid acquisition channels.
Where to look: evolution of paid CAC, don´t forget about the LTV:CAC (paid) ratio
b. High retention is also a strong indicator that the customers you acquire love your product/service as they keep coming back. High retention has a positive impact on the LTV:CAC ratio, as customers who buy more than once have a higher LTV, and it’s especially important to sustain high levels of growth and increase the power of the brand.
- Sustainable high growth: In order to continuously grow revenues (ideally exponentially) you have to grow your customer base (at least linearly), adding new customers on top of existing. Hence, the lower the pool of existing customers (i.e. the lower the retention), the harder — and more expensive — it becomes to continue growing the customer base (as new customers replace leaving ones rather than adding on to existing), and the more challenging it gets to sustain high growth revenue rates. Back to basics: you cannot sustain exponential growth in revenues if your customer base stays flatish.
- More powerful brand: the higher the stickiness, the more room there is to create a stronger emotional connection with customers, reinforcing the defensibility of the brand and making it harder for new entrants to take away your customers.
Where to look: cohorts. The retention of your first-time buyers (FTBs) should be asymptotic. As you may have noticed, we are obsessed with cohorts. If you are struggling check out our model here and stay tuned for a post on how to analyze them.
c. Strong repetition and increasing AOV. Retaining a high percentage of customers is a positive indicator but ideally those who stay also spend more and more often, hence having a higher LTV. A higher frequency of purchase shows that customers increasingly need your product(s)/service(s) and an increasing AOV indicates that you are managing to cross-sell them other products from the same or different category, a strong indicator of lifestyle brand.
However, as per the above, note that there must be a healthy balance between revenue coming from repeat and revenue coming from new customers. Very high percentage of revenue coming from repeat shows customer love from existing but it also indicates a lack of new customers. And as we said, it is hard to grow your revenue exponentially if your customer base stays flatish.
Where to look: cohorts, again. Q (number of items per purchase) should be linear
- More unit economics (profitability)
Going direct to consumer doesn´t only enable brands to build a close relationship with their customers and offer them a better more customized experience. Owning the process end-to-end also means optimized costs (i.e. lower COGS) and reduced mark-ups. Some of the savings are passed on to the customer, allowing D2C digital brands to offer a better value-for-money proposition. And the rest of the savings stay within the company, leading to healthier business margins.
We like to look at contribution margin (CM = Price of sale — all variable costs) rather than gross margin (GM = Price of sale — COGS) as it allows us to compare a business´ cost structure across sectors and models on an apple-to-apple basis. CMs vary depending on the specific sector a brand operates in but can be as high as +80% in skincare. The higher the CM, the higher the LTV and the more attractive will the LTV:CAC ratio look. Also, with such high CMs it´s not uncommon to see brands reach break-even or even profitability at very early stages, which makes it harder for us early-stage investors to find them as many of them are not looking for investment.
Where to look: GM, CM, EBITDA, Net profit
- Inventory and working capital (scalability)
This is the big elephant in the room when it comes to digital brands and VC investors.
As per the above, D2C brands that sell products can build businesses with very healthy margins. But (with the exception of pre-order models) they need to order -and generally pay- the inventory before they sell it, which leads to working capital issues and the consequent financial risk. If not managed efficiently, the inventory risk increases with scale as the orders (and working capital requirements) grow in size.
VCs don´t like to invest to fund inventory or finance working capital. We invest in growth, we fund you so you build your customer base. In fact, many VCs think that the working capital requirements in consumer brands limit how big they can become. At Samaipata, we believe that inventory risk can be managed and financed efficiently at reasonably low interest rates. But it is definitely something we watch closely, especially when thinking about scalability.
When the brand sells physical products we also focus on understanding the potential operational and logistic issues as well as the product´s value to weight ratio.
Where to look: inventory days (the average number of days you hold the inventory before selling it) should be as low as possible and (almost) always lower than the day to suppliers (time you have to pay your providers) in order to have a healthy balance sheet structure. Also check payment terms with providers and inventory financing terms
This post is just a preliminary overview of the Customer Love Framework — what we look for in D2C digital brands and why. This is just a starting point and we continue to build on it every day as we meet more brands and continue learning new things. So keep the feedback coming and reach out if you are a D2C digital brand founder.