How direct brands to consumers can avoid purgatory startup

We are entering a new phase in which the smartest direct-to-consumer businesses are finding that there is a better way to grow than just relying on venture capital funds. In recent years, we have seen only a small number of Consumer Payment Services (CIP) products that could be considered effective. Most find themselves stuck in a purgatory startup, waiting to enter the doors of liquidity.

Do not mistake yourself; Venture capital has been a huge badet for many DTC brands. Products that feel tangible have access to the first friends and family investors, as well as angels who make up the highest level of funnel venture capital. Less than a decade ago, a plethora of DTC companies emerged with strong earnings growth, considerable venture capital and a high growth acquisition through paid social marketing. Think of bonobos, Casper, Warby Parker, Honest Company and Birchbox, to name a few.

But in a few years, the market has become saturated and social media acquisition channels have become less effective in facilitating capital efficiency. Nevertheless, these companies have had to continue raising funds at higher valuations to satisfy their existing investors. The problem was that the funding was contingent on the promise of continued revenue growth, which encouraged companies to prioritize growth at all costs.

Of course, when the sole purpose of the company is to maximize shareholder returns by virtue of its size and speed, it develops undisciplined operational habits and is unable to build a sustainable and profitable business.

Which brings us to the current landscape – one in which many of DTC's largest startups are sitting on major capital increases with no exit in sight. Companies that have started in force, like Casper and Warby Parker, are now locked in a "purgatory". The main problem with these brands backed by a venture capital chain is that they have mobilized too much capital to slow revenue growth in their current business model. Acquisition is not a viable option, as valuation expectations are too exaggerated to allow acquisition at a reasonable price for a strategic buyer. In addition, because they are dependent on their direct distribution channels and differentiated supply chains, the cost synergies or vertical integration opportunities required for a transaction are limited. The irony is that the same distribution channels that have been at the origin of the rapid success are now blocking strategic outflows.

Need new approaches

None of this means mainstream brands lose their appeal. Consumer tastes continue to be subjective and ever-changing, offering huge opportunities for new brands to enter the market. The difference now lies in the fact that the most typical approach has failed, which brings us to an important crossroads as DTC companies are developing new approaches to create and resize their brands. They can continue to try to accelerate revenue growth to drive up valuations, even at the cost of being able to develop a sustainable business in the long run, or to slow down growth to focus on building a business model sustainable in the long run.

A successful approach is the holding company model, in which companies build a portfolio of product lines to create shared cost savings internally. Harry's Ventures and Glossier are two excellent examples. They both recognize this model as an opportunity to avoid purgatory and to create an autonomous and sustainable business. In February 2018, the popular shaving company Harry's raised $ 112 million to go beyond shaving. It went from Gillette's competition in the razor sector to Procter & Gamble's takeover through strategic venture capital investments. Similarly, Glossier, a first digital beauty brand, has launched Glossier Play on the path to becoming the next big beauty conglomerate. Harry's was acquired by Edgwell for $ 1.37 billion in May 2019 and it is likely that Glossier will be the next brand vying for a big paycheck given his appealing portfolio approach.

Another common tactic is to test wholesale brands in the hope of acquiring more customers. Allbirds and Reformation sell through Nordstrom and Bevel on Amazon. In each case, these brands used Nordstrom and Amazon as a marketing funnel, helping them to be more efficient in front of a new consumer group.

These new approaches minimize the need for significant risk capital, allowing companies to focus on profitability. And while many DTC brands have had to suffer in stagnation to demonstrate the need for a new model, I'm sure many of the companies that are currently fighting for an exit could find themselves in a very different situation today if they had raised less capital and concentrated early on the efficient growth of capital. That's why I predicted that the situation was evolving and that we were on the brink of a new era of DTC growth, a period that was less risk capital driven and focused more on innovative growth strategies. It is only then that companies will be able to avoid joining the ever-growing population within the purgatory startup.

Alex Song is founder and CEO of the Innovation Department.