“The most serious mistakes are not being made as a result of wrong answers. The true dangerous thing is asking the wrong question.” Peter Drucker
Direct-To-Consumer (DTC) has been emerging over the last 36 months as a key strategy across FMCG verticals. Over the 2016-H1 2019 period, almost half of the acquisitions completed by the top 50 FMCG companies involved DTC/ digital assets (177 transactions).
If the strategic intent makes sense for obvious reasons (we have now been advocating it for years), not all DTC assets are valuable and future-proof. Actually, most of current DTC assets may not be valuable and future-proof. Here are our (very summarized) views on the DTC landscape and some thoughts about the future of DTC.
If the value creation part is usually well understood, the value retention part is often not assessed properly. The best example may well be Dollar Shave Club (hard to create barriers-to-entry, mounting competition driving CAC inflation, strong incumbent response narrowing the value created for consumers…).
Not only it is important to understand value creation and retention, but it is also important to understand them in a dynamic manner. We are yet to understand for example the rationale behind the $200m investment from SoftBank in Brandless, a start-up with a flawed business model that has now completely pivoted to stay alive (see article below). In the Firm, that is what we call ‘Casino Circus’.
The creation of most DTC businesses was the result of an arbitrage. We are now seeing the end of this arbitrage. Few examples:
(i) Mounting competition drove up the consumer acquisition cost and drove down prices,
(ii) Digital marketing costs (CPM) steadily increased by 15-25% p.a. eroding steadily the CLTV-CAC equation,
(iii) It turned out to be quite difficult to durably change consumer behavior and get their loyalty
It is a safe statement and basic math. A well-known illustration is Glossier, it started as a beauty blog, it built its audience and it now reaps the benefits: stellar growth, great consumer engagement and looking at the endless queue to get into its Manhattan store it has a very likely low CAC.
We believe DTC start-ups should really start owning first Awareness-Consideration and then only move to Purchase. As digital marketing inflation continues, it will be increasingly a winning strategy.
This is increasingly clear. THG and NYKAA are great examples (cf. ecosystem charts below and links to case studies).
It is already a reality with Walmart (cf. its successful Allswell mattress brand) and other retailers will follow once they succeed to scale-up their e-commerce operation. With a huge scale/ traffic advantage, more and more (r)-etailers will choose to build (and sell – cf. ModCloth) (vs. acquire) their own DTC businesses wherever there is a large profit pool to disrupt.
On the paper, they have it all: unique products (hyper-personalized), higher barriers-to-entry (the greater the amount of data, the better the product is – AI/ Machine Learning network effect), economies of scale on supply side… Unsurprisingly, we are noticing an increasing number of initiatives (organic and inorganic) in this area. But as usual, successful companies will have to solve unmet consumer needs where consumers have a high willingness to pay. Hyper-personalization in itself will not create value.
In an environment with limited alternatives and where the breadth and the depth of assortment is still largely constrained by a fragmented retail landscape with high Rate Of Sales per Point Of Sales requirements and where many categories are still largely under-penetrated (by affordability/ access/ availability); DTC has a formidable potential. The most successful DTC businesses will likely focus on the most under-penetrated categories.
P2P DTC in particular will play a great role (cf. article below detailing our thoughts on DTC P2P in emerging markets).
Looking at the last 36 months M&A transactions, it is already a reality. Unsurprisingly offline DTC assets dominate (mostly because of the nature of the consumer job to be done and the unit economics of most F&B categories).
And it is not about to stop anytime soon. ABI strategy (below chart) to accelerate Owned Retail across countries/ formats illustrates the need for impulse F&B companies to protect/ expand at scale their share of profit in the value chain wherever they can develop a right-to-win. Such retail businesses are not necessarily doomed to record a 5% or so EBIT, especially through leveraging e-commerce to make instant deliveries from the stores and through squeezing adjacent categories to finance store operations.
For FMCG companies, success will come down to their ability to shift from a category to a ‘holistic consumer job to be done’ lens (complementary categories, hardware, services..) and follow the profit. One of the best example to-date is surely the P&G foray into Laundry On Demand. If the jury is still out, it will not be surprising to see more and more DTC businesses having a holistic approach on their offering and proposing also services.
Maybe time has come to reflect on the strategic objectives of DTC and to explore whether those objectives could be met through other means. Maybe a winning strategy could also be:
i) To identify the scarcest and most profitable assets in the path-to-purchase and own them or even control them. On some categories like make-up, we predict that more profit will soon sit on the influencers’ side than on the product’s side. Another great illustration is Richemont, it acquired last year Watchfinder, a platform enabling luxury watches owners to resell their watches. Understanding finely profit distribution across the path-to-purchase is becoming a competitive advantage
ii) That instead of iterating from the unmet consumer needs, we should focus more on the unmet store owners’ needs, especially on fragmented channels like convenience, on-trade, professional beauty, pharmacies… and assemble innovative business models inspired from New Retail to create value for all stakeholders while increasing our grip on the channel/ path-to-purchase. That is maybe where sits most of the value.
Bringing it all together, to thrive and survive, DTC companies will have to make evolve their business models:
FMCG companies that will invest into DTC as an end in itself will end-up writing-off most of their investments. Instead, FMCG companies that will iterate from the unmet needs of all stakeholders, finely understand where the profit (will) sit and assemble new business models accordingly, will end up protecting and expanding their share of profit in the value chain.
As Peter Drucker used to write:
“The most serious mistakes are not being made as a result of wrong answers. The true dangerous thing is asking the wrong question.”
To continue this conversation, we will host an Exclusive FMCG Senior Executive round-table on January 17th 2020 in our Zurich office from 11 am to 4 pm (lunch will be served), The theme will be: ‘This is the future of the FMCG industry – key predictions for 2020-25 and key strategies per FMCG verticals’. It will be our unique conference in 2020. As usual, the attendance is strictly limited to 12 Senior C-level FMCG leaders (P&L responsibility > $1bn or Group Head of Strategy). Please contact firstname.lastname@example.org to RSVP
Frederic Fernandez does not own any stocks or financial instruments of any FMCG companies or companies mentioned in the above article. All the above information are public information.
About the author:
Frederic Fernandez is an expert and thought leader in the FMCG industry. He is the Managing Director and Partner of Frederic Fernandez & Associates a global bespoke Strategy Consulting Firm exclusively focused on the FMCG industry. Its purpose is to co-create the future of the FMCG industry, one client at a time. The Firm helps the CEOs and the Boards of the world’s largest FMCG companies on selected areas: Growth and Profit turnaround, Exponential Growth strategy (New Retail, Omnichannel, DTC, Ecommerce, Business Model Innovation), Disruption Hedging/Leapfrog and M&A strategy. The Firm’s head office is located in Zurich, Switzerland. The Firm’s team intervenes all across the globe. To know more about the Firm, please visit its website: www.fredericfernandezassociates.com