DTC brands struggled with profitability prior to COVID-19. Now what?

Linda J. Dodson

For certain direct-to-consumer brands, the pandemic invited some of their highest sales as consumers were forced to shop online while physical stores shuttered.

In May, Chewy’s first quarter net sales grew 46% year over year to $1.6 billion, Casper’s rose 26% to $113 million and Wayfair’s direct retail net revenue increased 20% to $2.3 billion.

While revenues are up at these retailers, profits continue to lag. Chewy’s loss in the first quarter grew 62% to $48 million, Casper’s loss grew 98% to $35 million and Wayfair’s loss grew 43% to $286 million. But as consumers became more comfortable with making purchases online during the pandemic, DTC brands may have received the much needed boost they had been waiting for.

“It’s pretty easy to make a sale online, but not easy to make a profitable sale on a normal basis and COVID provided a stellar relief to that,” Wedbush analyst Seth Basham told Retail Dive.

The rising cost to acquire customers online

The cost to acquire customers online has gotten prohibitively high, and as a result, many direct-to-consumer brands have shoveled millions of dollars into their marketing quarter after quarter.

Chewy spent $106 million on advertising in the first quarter, or 7% of total revenue, from $102 million in the year-ago period; Casper spent $38 million, or 33% of total revenue, from $30 million a year ago; and Wayfair spent $276 million, or 12% of direct retail net revenue, from $244 million a year prior.

“Obviously in recent months it’s come down a fair amount, in terms of customer acquisition costs because media costs have come down,” Basham said. “Consumers have been seeking out these types of companies to purchase things online.” However, he added that he doesn’t think advertising will remain at the current levels for long, especially after the pandemic subsides. “I think that we’ll see customer acquisition costs go back towards levels they were at pre-COVID.”

In recent years, the direct-to-consumer space has become saturated with competition, Tyler Higgins, leader of the retail practice at global management consultancy AArete, told Retail Dive in an interview, adding that “the barrier to entry is really small.” He said that oftentimes when a consumer looks up one particular mattress brand once, “all of a sudden they’re getting mattress ads from three or four different brands.”

As a result, brands are forced into spending a significant amount on advertising and marketing, and implementing other sales tactics, in order to try to one-up their competition and win those new customers, according to Chris Ventry, vice president in the Consumer and Retail practice of SSA & Company.

“A lot of these companies have basically spent a lot of money to acquire,” he said. The customer’s first purchases, though, “tend to have a high promotional discount associated with it just to grab market share. And then the trick is … how can we keep this person and help drive future conversion?”

Building lifelong loyalty among customers

In the quarter ended May 3, Chewy said its number of active customers grew 33% year over year to 15 million, and Wayfair said in its quarter ended March 31 that its active customers grew 29% to 21 million. And though it did not disclose specific numbers, Casper’s president and chief commercial officer, Emilie Arel, said on an earnings call the company saw “strong” growth in new customers throughout April.

But even as these brands attract new consumers, that doesn’t necessarily mean they will be lifelong customers to the brand.

“A lot of the customers they acquire are going to make one purchase and then not come back,” Basham said. “So you don’t really make money on those customers.”

As the coronavirus spread further, schools and offices were forced to shutter. With physical retail closing its doors as governments issued stay-at-home orders, Wayfair received a sales boost from consumers looking to outfit their homes to accommodate their new normal. CEO Niraj Shah told analysts on a call discussing the retailer’s earnings results that the company saw increased sales from categories like home office, cookware and kitchen appliances, and children’s furniture and play items. But even though the brand received an influx of new consumers, Wayfair faces its next challenge: retaining those customers post-pandemic.

“The key thing for them going forward is to get the customers who have become Wayfair customers over the last few months during the pandemic to become lifetime customers and make additional repeat purchases, beyond their immediate needs for their home office or something else small for their kitchen,” Basham said.

Casper faces a similar issue as its core product is a mattress — a purchase consumers generally make infrequently.

Michael Felice, a principal in the consumer practice of Kearney, also pointed to the fact that many direct-to-consumer brands offer durable goods rather than consumable goods. “I’m buying the product once a year,” he told Retail Dive in an interview. “How do I deepen my basket with my consumer? How do I expand the frequency of purchase and repeat rate of purchase? Are there tangential products I can offer to a mattress? I can offer my sheets, I can offer bedrooms, I can offer sleepwear.”

As a result, Casper has pushed into adjacent categories to fill in the gaps between purchases. The brand now sells items like pillows and dog beds, but it has also entered into non-bedding categories with the release of a smart nightlight and CBD gummies intended to help consumers fall asleep — all in an effort to capture more share in what it calls the “sleep economy.”

Chewy on the other hand, sells several non-discretionary items, like pet food, that consumers need to repurchase on a regular basis. It can leverage this into getting customers to sign up for its Autoship subscription program, which sets up frequent purchases to be recurring, Higgins said.

Chewy said sales from its Autoship customers increased 48% year over year to over $1 billion in the first quarter, and represented 68% of total net sales.

“If you set up Autoship orders, all of a sudden you’re retaining your customer every month or every six weeks or every two months — whatever the recurring occurrence is for their specific items,” Higgins said.

The pet retailer in the summer of 2018 also launched its pharmacy vertical, which the company said in its latest shareholders letter is delivering “robust growth.” Its pharmacy business has allowed Chewy to better position itself against other competitors in the space, like Amazon’s Wag private label, and drew in “increased demand from customers who no longer had direct access to their vet’s office during the lockdown,” CEO Sumit Singh said on an earnings call with analysts.

What brands can do to move closer toward profitability

Many DTC brands have been pushed into physical retail as a means of lowering the cost of customer acquisition and driving higher order values because “historically, people spend less per order online than they would in a store,” Ventry said, noting though that it is retailer dependent.

“If they had physical locations, such as Warby Parker, that also acts as a form of advertising,” Ventry said. Warby Parker and Bonobos have more than 100 and 60 stores, respectively. Direct-to-consumer intimates brand AdoreMe in 2018 said it planned to open between 200 and 300 stores over the next five years and Casper around the same time announced plans to open 200 stores across North America, something it reiterated when it filed to go public in February.

“However, obviously with COVID-19 and the potential for continued re-closings, that’s not necessarily a wonderful tool going forward,” Ventry added.

The mattress brand in May said it was backtracking on those plans, at least temporarily, and is “reducing the number of planned new retail store openings in 2020.”

Other than opening their own stores, brands can look to third-party channels to sell, which allows them to put their product in front of a new audience and “acquire customers less expensively,” Basham said. “They’re not really paying that much to market to those customers.”

Casper in 2016 formed a partnership with West Elm and a year later teamed up with Target, and has since formed partnerships with Amazon and Costco. However, selling in a third-party channel does come with some caveats: In order to be recognized by a major retailer, the brands generally already have to be pretty large, which leaves a lot of smaller digitally native companies out of the equation. Selling through these channels might also hit the brands’ gross margins, which for some, are already suffering.

“Take somebody like a Wayfair with a low 20% gross margin rate where most players in that space have gross margins closer to 40%,” Basham said. “That makes it more difficult for them to achieve material levels of profitability.”

In the face of the COVID-19 pandemic and the uncertainty that comes with it, Basham said brands in the immediate term should focus on the channels they’re currently operating in.

“There’s room to improve their online acquisition strategies, by being more efficient on the channels in which they’re spending,” he said, adding that companies should seek to “[drive] more organic customer acquisition through people coming directly to them, or finding them through organic search on Google.”

For some this might mean using augmented reality to make the virtual showroom experience memorable, or it could mean investing in customer support and communication to provide transparency throughout the transaction process and build trust. “I don’t have to ship it to you in one day,” Felice said. “I can keep you aware, keep you alert and make you feel like you’re part of the process.”

Both Basham and Felice suggest that customer loyalty is driven by the overall shopping experience rather than heavy promotions.

“An experience will last longer and create more loyalty in the long run than a 30% discount, because the next day, someone will give them 40% and they’ll be gone,” Felice said.

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