FMCG CEOs: 7 things you must know about Direct-to-Consumer, Why not acting is not anymore an option and How to go about it

Having a Direct-to-Consumer (DTC) strategy is not optional anymore in 2017. Yet, it is surprising to see the number of FMCG CEOs that are still hesitating on the route to pursue. Over the last 12 months, I had the opportunity to discuss extensively DTC with FMCG executives, the same concerns came back again and again:

  • Is it a fad or a lasting trend? DTC companies are small and none are making money. Their only game-plan is to steal market share and to sell to a large FMCG company. Why should we care? In few years, they will be all wiped out. We just have to wait and sit tight. Worst case, if DTC gains momentum on our categories, we will have time to react. Last, the requested multiples are simply ridiculous in regard of their current profitability
  • Why should we risk to harm our valuable retailers relationships which still accounts for 95% of our sales?

If all the above concerns are understandable, the facts suggest a much more balanced picture: not only it is critical to take actions now but it is even possible to leverage the exponential growth potential of DTC profitably without having to risk retailer relationship. Here is why and how.

1. DTC is already attractive on some categories (it is big, growing & sometimes already profitable)

  • At a macro level, DTC penetration on food categories (everything you find in a supermarket including household, personal and beauty care categories by opposition with non-food such as consumer electronics…) is still small and estimated at less than 1%

DTC is small at a macro level (less than 1% share on Food categories) but already large on some categories… DTC is expected to reach 40% value shares on blades & razors in North America by 2020

  • At a micro level however, DTC is already a strategic channel on some large categories that have in common to: have large space in the P&L/high spread Retail Shelf Price (RSP)-Cost of Goods Sold (COGS), be cheap to ship/high value by cubic meter, be non perishable. By 2020 for example, DTC is expected to reach 40% value shares on blades & razors in North America (Gillette Club, Dollar Shave Club, Harry’s, 800razors.com, Bevel…). On skincare and make-up categories, new comers are taking by storm the industry (Honest Beauty, Younique, Beauty Counter, Glossier and many more) and DTC sales already accounts for significant double digits shares depending the segment.

DTC companies are currently growing at an exponential rate

  • After having grown often exponentially and reached hundreds of millions of dollars in sales within 4-5 years after launch (2016 revenue estimates: $250mn for Dollar Shave Club created in 2011, $400mn for Younique created in 2012, $300mn for Honest Beauty created in 2011…) most of those companies are still experiencing a healthy high double-digit growth

Profitable business models do already exist but some have yet to turn a profit

  • Some companies have already demonstrated profitability could be reached (Honest Beauty) and sometimes profitable exponential growth could be delivered without external funding (Younique, please refer to my previous article on the topic: 7 reasons why Coty acquired Younique ). So profitable business models do already exist although some others have yet to turn a profit (Dollar Shave Club). DTC profitability is mostly a result of quantitative and qualitative factors:

– The theoritical gross profit: the gap between Retail Shelf Price (RSP) and Cost of Goods Sold (COGS) multiplied by the average number of items shipped per order minus the Last Miled Delivery Cost (LMDC) per shipment

– The pricing power/ability to resist to competitors’ deflationist pressure: which all comes down to the quality of the consumer eco-system (platform, apps, service/products…), the switching costs for consumers and the value of the alternatives.

2. DTC will only become increasingly attractive… all the profitable growth is ahead

Last Mile Delivery Cost (LMDC) could decrease by up to 90% in the next 2-3 years and will enable many categories to become financially ripe for DTC disruption. Considering that LMDC can account for up to 30% of net revenue in DTC channel. This will be a breakthrough improvement in DTC P&L

  • We are only at the beginning of the disruption curve: all the profitable growth is ahead: with the growing penetration of last-mile-delivery cost (LMDC) reduction technologies (driverless vehicles, Starship robots , drones…), LMDC could decrease by up to 90% in the next 2-3 years and will enable many categories to become financially ripe for DTC disruption. Considering that LMDC can account for up to 30% of net revenue in DTC channel. This will be a breakthrough improvement in DTC P&L.

3. In fine DTC is only a channel and it is not the end game. It is about assembling a frictionless, unique and valuable consumer eco-system with high switching costs…. like Apple?

  • In fine, the profitability of DTC business will greatly depend of the quality (value brought to the consumer/uniqueness) of the consumer ecosystem and the corresponding switching costs. The more a DTC business will deliver value to consumers and the higher the switching costs will be; the better a DTC business will be in a position to command a premium pricing and generate a profit. This is exactly why it is not about DTC, but in fine, it is about assembling a unique and valuable consumer ecosystem with high switching costs.

Few learnings to draw from the above chart:

  • It is not about having scale on owned physical assets but it is about acquiring scale on consumer relationships and builing valuable consumer ecosystems (apps, consumer communities, connected objects, platforms, mix of products and services…)

Current profitability is rarely a good indicator of future profitability. Let’s take Facebook for example, it was not profitable in 2005 and it is now delivering a steady 35%+ EBIT. On the contrary, Uber continues to record losses after losses

  • Consumer ecosystems are rarely profitable as of day 1 as they need to reach critical mass to deliver value to all stakeholders (members, advertisers) and being able to monetize this value. Current profitability is rarely a good indicator of future profitability. Let’s take Facebook for example, it was not profitable in 2005 and it is now delivering a steady 35%+ EBIT. On the contrary, Uber continues to record losses after losses with no indication of future profitability
  • In fine, critical mass is key but ‘the make or break’ is about the switching costs and the value of the alternatives. If those costs are greater than the value delivered by the alternatives (Facebook for example has no real contender), then there is pricing power. On the contrary, irrespective of the great value delivered, if the switching costs are low and alternatives plentiful, then profitability is much more difficult to achieve (Uber).

That is why most FMCG DTC companies are currently trying to build unique consumer eco-system with high switching costs

That is why most FMCG DTC companies are currently trying to build unique consumer ecosystem with high switching costs. Younique’s products for example can be found only on the Younique platform and some are truy unique like the 3D Fiber Lashes. Products are recommended by trusted friends. When Honest Beauty made its first acquisition in 2015, it did not acquire a contract manufacturer or another brand, it acquired Alt12 Apps, the makers of popular apps such as Baby Bump, Pink Pad and Kidfolio.

FMCG companies that will succeed to create an omni-channel, frictionless, unique (with little alternatives) and valuable consumer ecosystem (products/services/platform/apps/connected objects…) with high switching costs will become the ultimate winners. Well, they might just start strangely looking like Apple…

FMCG companies that will succeed to create an omni-channel, frictionless, unique and valuable consumer ecosystem with high switching costs will become the ultimate winners. Well, they might just start strangely looking like Apple…

4. There is a variety of DTC models to choose from and understanding their respective pros/cons, their best fit with your business will be critical

There is not a single recipe for success in the DTC space but several as demonstrate the most successful companies in this space:

i. Younique is exclusively a peer-to-peer (P2P) DTC beauty company (a multi-level marketing company like Avon or Amway but exclusively digital that leverages 200,000+ independent presenters to sell its products online)

ii. Dollar Shave Club sells exclusively online through its own website whereas Harry’s sell online and in-store

iii. Beauty Counter is the ultimate omni-channel champion and sells on its own website, on some selected platforms, through retailers and through its own pop-up stores and has even 20,000+ presenters (peer-to-peer model)

Most FMCG leaders believe that getting into DTC comes down to selling one (sometimes even their own) category through their own website. The reality is that there is a diversity of models to choose from (from pure DTC through pure P2P DTC to fully omni-channel) to leverage the exponential growth potential of DTC and all have their respective pros/cons.

From pure DTC through P2P DTC to fully omni-channel, there is a diversity of models to choose from to leverage the exponential growth potential of DTC and all have their respective pros/cons

5. DTC does not have to come at the expense of your retailer relationship

Most FMCG leaders fear that launching a DTC business will damage their retailer relationship. This is not necessarily true if their company does not use their existing brands. Unilever succeeded to leapfrog to the blades & razors category with the Dollar Shave Club acquisition. Coty acquired Younique (skin-care, make-up). Both acquisitions enabled both companies to take advantage of the DTC exponential growth while offering plenty of value creation opportunities (scale-up to new countries, addition of margin accretive categories under the acquired brand name) with none to little retail exposure. Surely a time will come when those companies will be tempted to propose their own brands through this channel but it will be surprising to see them doing so in a near future as they might want first to ‘test the water’.

Both acquisitions enabled both companies to take advantage of the DTC exponential growth while offering plenty of value creation opportunities with none to little retail exposure

6. Successful FMCG companies will be master at balancing both offensive and defensive DTC strategies while minimizing the impact on their retailer relationship

Few examples:

  • Coty acquisition of Younique is a perfect example of a ‘side-attack’ (existing categories but different brand name) on categories already ripe for disruption (make-up, skin care) with the aim to get critical mass on female beauty and to create value through scaling-up to new countries and driving up shopper basket value through the addition of more categories (fine fragances, shampoo…)
  • Unilever acquisition of DSC is a good example of a ‘leapfrog’ to an adjacent category that is already ripe for disruption (blades & razors) with the objective to build critical mass on male beauty and to create value through scaling-up to new countries and driving up shopper basket value (body wash, deodorant, balm…)
  • The Procter & Gamble Tide Wash Club (subscription based laundry detergent service) along with its Tide Spin initiative (full end-to-end laundry service) can be seen (as of now at least) as a ‘proactive defense’ strategy to deter new entrants on a category that is not yet financially ripe for DTC disruption (likely to have not enough space in the P&L to accomodate LMDC and generate a profit)

7. Build or acquire? This is litterally the billion-dollar question

This is litterally the billion-dollar question for many large FMCG companies. To be clear, there is no one-size-fits-all answer. Usually, ‘buy’ is the recommended option if the following statements are true:

  • It is difficult to hire the right talents and to drive the requested change from within
  • There is a sense of urgency (the market inflection point is upon us)
  • The growth opportunities are too far removed from our prevailing business model

In reality, some companies are moving forward with ‘buy AND build’ at the same time to hedge their bets like Unilever and L’Oreal

In reality, some companies are moving forward with ‘buy AND build’ at the same time to hedge their bets. Unilever is a good example. It started its business model innovation group/incubator (The Hatch House) to nurture the Dollar Shave Club acquisition and it is also working on building from within DTC business models. L’Oreal struck a partnership with the Founders Factory to identify/acquire 5 beauty start-ups per year AND build from scratch 2 others. This is a good way to get the best of both worlds: getting a quick head-start while starting building knowledge in the organization.

Assessing the value of a DTC business remains an extremely difficult task: exponential growth and quickly evolving profitability make it a difficult exercise

The biggest challenge for large FMCG companies remain to find the ‘right’ acquisition for their business at the ‘right’ cost that will enable a sensible value creation case. Assessing the value of a DTC business remains an extremely difficult task: exponential growth and quickly evolving profitability make it a difficult exercise.

6. Let’s be clear, to reap the benefits of DTC, the key challenge will be to make the culture/organization evolve, not to amend the strategy

Strategy will most likely not be the most difficult part of the journey. The below chart summarizes well the organization/culture challenges/dilemmas FMCG organizations will face while tacking this new challenge

Some companies have started to tackle those dilemmas with more or less success:

  • GE launched its FastWorks program and trained 40,000+ employees on the Lean Start-up methodology to encourage innovation and increase speed-to-maket
  • Coca-Cola created end 2015 the Coca-Cola Founders Program that invests in Exponential Organizations outside of its core business
  • L’Oreal invested in May 2016 in the Founders Factory (a global multi sector digital accelerator and incubator) with the objective to invest and scale five early stage startups and co-create two new companies from scratch every year
  • Unilever created in September 2016 the Hatch House an in-house incubator and business model innovation group

7. The Jon Moeller’s objection (Group CFO Procter & Gamble)

On October 25th 2016, Jon Moeller, Group CFO of Procter & Gamble declared in an interview with financial analysts: ‘Direct-to-consumer accounts only for 0.3% on the categories we play in globally’, ‘It has to be put in perspective’, ‘How many people do you know,’ he said, ‘that want to satisfy their household shopping needs in a month or two by going to 40 different websites with 40 different passwords and 40 different packages that arrive at 40 different times?’

Good points… few thoughts though:

  • DTC is today 0.3% but it is growing high double-digit, even sometimes triple-digit
  • For all the reasons mentioned in point 1 and 2, it will become bigger and more profitable
  • Even the companies, that do not believe DTC will be a big thing (like P&G apparently), invest in defensive DTC strategies (cf. Gillette Shave Club, Tide Wash Club, Tide Spin initiative)

Don’t we think that companies that will succeed to build a valuable eco-system on well targeted consumer groups will not only succeed to survive but also to thrive?

  • Yes, consumers cannot have reasonably 40 apps / subscriptions but it will be possible for very targeted consumer groups to build holistic consumer eco-system that will resist to the concentration movement. Let’s imagine for example an overall eco-system built around new-mums that offer a subscription service with diapers and all required products for babies (like Honest Beauty), with apps to track the sleep of the baby and that help mums to exercise during and after pregnancy (both apps proposed today by Johnson & Johnson) and with artificial intelligence powered software/harware that can track baby activities during their sleep and the day (like Aristotle from Mattel). Don’t we think that companies that will succeed to connect all those dots, that will succeed to build a valuable eco-system on well targeted consumer groups will not only succeed to survive but also to thrive?
  • Last, as mentioned above, the future of the FMCG industry is to become omni-channel at heart and DTC has a role to play along with retail, peer-to-peer, platforms.
  • Finally, companies that will pass on DTC will miss the opportunity to build direct consumer relationship and acquire priceless consumer data, which will become no more no less the ultimate competitive advantage in the digital disruption age

Companies that will pass on DTC will miss the opportunity to build direct consumer relationship and acquire priceless consumer data which will become no more no less the ultimate competitive advantage in the digital disruption age

 In this context, how to go pragmatically about it? How to get started?

In our experience, few pragmatic yet decisive moves can give an organization a head-start

i. GET A CLEAR STRATEGY: determine which categories/consumer groups to defend/to attack and how

Which categories could be the best vehicles to build a winning consumer eco-system?

  • Assess category vulnerabilities and develop proactive defense plans
  • Determine which consumer groups are the most attractive to attack and which categories could be the best vehicles to build a winning consumer eco-system while minimizing exposure on retailer relationship
  • Build a thorough consumer eco-system strategy (apps, platform, products/services…)

All those activities can be performed by in-house or external consultants, by a business model innovation group at the edge (if it exists) or even by a black-ops team in some radical cases

ii. GET READY TO EXECUTE: Determine a clear governance to execute those strategies (existing business units, business model innovation group at the edge,which incentives/KPIs, partnership with external incubators…) and determine how best the organization can balance present/future while leveraging common assets/know-how and remaining fast/agile. Only a qualitative assessment combining both strategy and culture can bring a meaningful answer

Only a qualitative assessment combining both strategy and culture can bring a meaningful answer

iii. LEVERAGE M&A: give a clear brief (targeted consumer group, categories, size, growth rate, quality of the consumer ecosystem) to the M&A group to gear up the identification of a suitable acquisition target. In this exercise, it is critical to have a specific methodology to assess the value of those targeted exponential companies that incorporates exponential dynamics (growth and evolving profitability) and that assesses the quality of their consumer eco-system/pricing power. Acquiring companies that are still ‘below the radar’ (less than 1% market share) is still the best way to create exponential value. Too many M&A organizations fail to determine the full value potential of such deals.

It is critical to have a specific methodology to assess the value of those targeted exponential companies, incorporating exponential dynamics and assessing the quality of their consumer eco-sytem/future pricing power…  too many M&A organizations fail to determine the full value potential of such deals

iv. LEVERAGE YOUR CONSUMER DATA AND TURN IT INTO YOUR ULTIMATE COMPETITIVE ADVANTAGE: Too many FMCG companies still do not leverage systematically all their first-party data. Not only it is a lost opportunity to optimize exponentially marketing ROI with programmatic buying but it is also a missed opportunity to build valuable consumer eco-system. In the digital disruption age, consumer data will become the ultimate barrier-to-entry

v. BUILD AN EXPERIMENTATION CULTURE FAVORING SPEED OVER PERFECTION: From training employees the Lean Start-up principles like GE did through changing the corporate values and the standard hire profiles to amending organizational and incentives structure; there are many levers available. Only a case by case assessment enables to identify the most effective ones.

At a time when more and more FMCG companies struggle to grow organically, DTC is a must-do and all FMCG CEOs must have a robust game-plan

As often, I will finish this post with a quote, this time from Lawrence J. Peter (Peter’s Almanac, 1977):

‘Some problems are so complex that you have to be highly intelligent and well informed just to be undecided about them’

If you are interested in hearing and discussing more on the above, you can reach out at frederic@fredericfernandezassociates.com or attend one of my upcoming Senior Executive FMCG Conferences (each limited strictly to 20 attendees and exclusively reserved to senior FMCG executives on a pure first come/first serve basis – the attendance is free) – upcoming topics/dates for Q1 2017 include:

Q1 2017 Topic: FMCG CEOs: Managing (finally) for growth or how to stop ‘shrinking to glory’

– Zurich, Friday, March 17th 2017 from 8 to 10 am at Hotel Grand Hyatt

– Geneva, Friday 24th 2017 from 8 to 10 am at Hotel Des Bergues Four Seasons

Frederic

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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 bespoke Strategy Consulting Firm exclusively focused on the FMCG industry. His focus areas are mainly in growth and profit turnaround, corporate strategy, direct-to-consumer and business model innovation in the FMCG industry. His passion is to help FMCG leaders co-creating the future of the industry and to develop, achieve and exceed the potential of their business. He spends his time advising senior Fortune 500 FMCG leaders globally. He is based in Zurich, Switzerland. He is also a sought-after speaker and speaks across the globe at trade associations and for corporate clients (CEO strategy meeting, yearly strategic reviews, top management events) about the FMCG industry. Before joining the world of management consulting, he worked with Fortune 500 companies like Procter & Gamble, Reckitt Benckiser, PriceWaterhouseCoopers and Societe Generale in leadership positions across Europe (France, UK, Nordics, Germany, Switzerland, Austria), Central Africa and India.