so today I want to comment on the Harry’s exit from last week. If you haven’t seen it, this is the news snippet:
- Razor startup Harry’s was acquired by Edgewell Personal Care for $1.37bn.
Harry’s is just one example of a tidal wave of startups in what has been termed the direct-to-consumer (D2C, DTC) or digitally native vertical brand (DNVB) space. It’s this fleet of niche brands, which are delivering products to consumers primarily online and outside of the traditional retail and CPG landscape. Warby Parker, Casper, Glossier and Allbirds are just a few of the best known examples.
Harry’s is notably the second large exit in this vertical after Dollar Shave Clubs’s sale to Unilever three years ago. Henry McNamara, partner at Great Oaks VC, put out this tweet last week comparing some of the largest DNVB brands in terms of the last valuation (or exit valuation), the amount raised and the multiple, which is sort of a deal-by-deal Total Value to Paid In (TVPI) multiple.
Further down in the twitter thread he corrected the equity figure for Harry’s from $461m to $375m and then later today to $211m, as most of the money raised seems to have been raised as debt. It’s not unusual to see some of these later-stage DTC companies raise in non dilutive trade financing, given the working capital requirements of the business, which may involve building up inventory. So if we use these adjusted equity figures, this would brings the Harry’s exit in the region of 4-5.5x, edging closer to the Dollar Shave Club cash-on-cash 6x multiple.
These returns are not bad at all, but with the exception of Allbirds, on a deal-by-deal TVPI multiple basis they don’t look like the 30x winner multiples that can return your VC fund. Obviously, these overall cash-on-cash multiples don’t really reflect the risk and return differences along the stages, but it’s still some indication the DNVB vertical may not be all that juicy as we are made to believe with every new raise. As a reaction to the Harry’s exit, consumer investor Ryan Caldbeck from CircleUp voiced some concerns:
As I will show in this piece, the high LTV/CAC ratios for which DTC has become famous in the last years, may be subject to erosion over time.
But I want to go even a step further and compare the strategy and the return multiples from the ‘novel’ DTC playbook deals to the return multiples of the more traditional Amazon-style online store playbook.
I call the DNVB approach the ‘plant-and-expand hipster brand strategy’ and the traditional e-commerce strategy the ‘spray-and-pray penny pincher strategy’.
Plant-and-expand hipster brand strategy
As I see it, the plant-and-expand hipster strategy can be broken up into four main stages:
1. Start out with a single product to build brand recognition
The modern DNVB brands typically start out in a single product category and then expand the offering from there over time:
- Casper sold $20m worth of mattresses in the the first 10 months by limiting the options to just one type that came in six different sizes. It became known as the online mattress store with the 100 day return policy.
Similarly, the Harry’s initial product was a simple shaving kit including a razor, two replacement heads and a tube of shaving cream. Nothing fancy, not a lot of choice. Who wants choice anyway?
2. Growth hacking underpriced attention
The DTC playbook then goes on to suggest that the product should be growth hacked to the max. In particular through non-traditional channels, online or offline strategies and typically already before launch:
- Dollar Shave Club famously received more than 12,000 orders in the first two days after this viral video.
- In the case of Warby Paker, before the company had even produced a single pair of glasses, it was already getting flooded with 20’000 orders (its first year sales target) through a GQ coverage. The marketing had written a check that the production line couldn’t cash later. Not a rare thing among the DTC vertical (aka operational mess).
In the case of Harry’s, whose co-founders include a Warby Parker co-founder Jeff Raider, they did a pretty intricate pre-launch social campaign, which included a teasers that compelled viewers to register their emails and get their friends’ to do the same through a tiered rewards system (aka rewards-based multi-level marketing). For example, if you got 50 friends to sign up, you could win a year of free shaving kits. On launch day, they could push out a mail to a list of 100,000 emails, which had been collected in just one week…It’s the whole “the waiting list is the new MVP” FOMO marketing kinda thing.
If it flies, it’s a super low CAC acquisition channel strategy that makes for great LTV/CAC ratios on your Series A deck. But it’s definitely not sustainable over the long-term.
3. Cut out the middleman and source directly
A key aspect of the of the DNVB vertical is that, because the initial product range tends to be super limited, there’s potential to cut out the middleman and go directly to the source:
- In the case of Dollar Shave Club, co-founder Mark Levine was originally sitting on a massive pile of razors in a California warehouse and was looking to get rid of them, when he told Michael Dubin about it at a dinner party. So ‘direct sourcing’, or in this case leftover inventory, was in a sense the initial USP.
- Warby Parker famously started out as an MBA case study, where the founders were trying to figure out why eyewear was so expensive. It turned out that monopoly pricing, aka Luxottica, was the reason and that direct sourcing could help to drive down pricing.
The case of Harry’s is next level when it comes to direct sourcing. After being in business for just 10 month, the company acquired a German razor factory for $100m, Feintechnik GmbH. This full vertical integration gave them major defensibility on the sourcing side early on.
4. Expand the product categories and sell through brick-and-mortar
To keep the CAC low and the LTV high, the DTC playbook then goes on to suggest, that after the brand seed has been planted, the product categories have to be expanded. Also, because the initial low CAC channels have been tapped out, selling has to occur through brick-and-mortar partnerships in addition to online:
- In the case of Casper for example, in 2017, after almost buying Casper for $1bn, Target decided to invest $75m in Casper to allow the brand to sell through brick-and-mortar. Similarly, their product offering has expanded significantly around the core sleep-focused brand. They are selling all kinds of sleep-related items and furniture now, including beds and dog beds.
In the case of Harry’s, they now selling a wide range of men’s grooming equipment, including accessories. Notably, at the time they were sold, it appears that 80% of the sales actually came from offline sales through Target and J.Crew.
In other words, at the late stage, these startups seem to become ‘digital-natives-partner-with-incumbents-brands’ (DNPWIB). Sounds like some kind of badly-put-together business model. And quite frankly, it’s pretty far off from the initial DTC narrative, aka ‘online is disrupting retail’. But I guess that’s the natural consequence of scaling, where the niche and growth hacking strategy needs to give way to a more mass market approach. And the reality of things is that in 2019, most sales still occur offline.
Spray-and-pray penny pincher strategy
Now let’s look at the other strategy, the traditional Amazon e-commerce, online shop strategy. Amazon has clearly led the way in this space and is now the ever-more-powerful owner of e-commerce.
But there still are a handful of challengers and I want to look at this new breed of online stores a bit closer and compare their model to that of the DNVB brands. In particular, these include:
- 🛩 Jet.com $3.3B- $820m raised (4x)
- 💭 Wish $8.5B- $1.3B raised (6.5x)
- 🔎 Brandless $0.5B- $292m raised (1.7x)
- 📸 Fab $0.9B(at peak, then down to $0.08B)- $330m raised (0.24x)
Compared to DTC brands, the returns of this small sample look like they are lower than in the DNVB vertical. But given the scale required to go against Amazon, the amounts raised are also staggeringly large and a decline in returns is thus no surprise. Only one of these companies has exited: Jet.com was sold to Walmart in 2016 for $3.3bn. There was one failure, with Fab, which burned through $250m before it folded in 2014. Two companies, Wish and Brandless, are still in the race to prove that there’s room to grow despite Amazon.
The strategy here looks quite different from that of the new fleet of DNVB brands. It involves two main steps:
1. Find a category with lots of different individual items
In this famous interview, Jeff Bezos explains why he chose to go after books initially: His basic explanation is that books were unique, because it had more than 3 million individual items. This was much more than in any of the other 20 categories he looked at. So creating an online store that would offer all these items created a natural advantage.
Similar category thinking is part of the spray-and-prayers approach of the new breed of Amazon challengers:
- Jet.com launched with 10 million items. Obviously a huge operational effort to launch with such a broad category of items. If Marc Lore, the founder of Jet.com hadn’t been a serial entrepreneur with a prior exit (Quidsi, sold for $540m to Amazon), this wouldn’t have been possible. The company came out of nowhere with a $80m Series A in 2014 before the first product was shipped.
- Wish had a much scrappier approach to offer a wide range of items. The Wish predecessor of Wishwall.me was using ads on Facebook to invite people to come and browse a very broad collection of products curated by Wish. The company didn’t actually sell these products, but people could “wish” for things they wanted and create a wish lists. This allowed Wish in a way to simulate or growth hack a broad category and identify products worth storing in the beginning.
- Brandless launched with a pretty broad palette of staple household items. Although it was only a of couple of hundred essential items, it was by far broader than the typical DNVB brands initial offering.
- In the case of Fab, which initially was a curated design-centric online store, the number of products it had on its site was rapidly scaled, jumping from 1k products, or stock keeping units (SKUs), per day in 2011 to 11k just 6months later.
2. Find a loss leader and start selling dollars for a dime
The second step of the broad spray-and-pray strategy is to find a ‘loss leader’. The best way to explain what a ‘loss leader’, is to let Marc Lore explain it in the context of Diapers.com, which was part of the Quidsi portfolio, his company prior to Jet.com:
“And so we started with selling the loss leader product [diapers] to basically build a relationship with mom. And once they had the passion for the brand and they were shopping with us on a weekly or a monthly basis that they’d start to fall in love with that brand.”
In a way, it’s similar to the plant-and-expand approach. Only that in this case, instead of using a premium product as a Trojan horse, the penny pincher approach is to use certain products that are sold below cost at a loss as a way to lure in the customer and then cross-sell them on other items.
- Finding relevant loss leaders is exactly what Wish did in the beginning, by running the FB ads and letting consumers create the wish lists.
- In the case of Brandless, the initial items all sold for 3$. Some of them are probably sold below cost, some at cost and others above cost. But the below-cost items are used as loss leaders to lure in people and cross-sell them across a broader category of items.
So, long story short, what’s my conclusion from all of this? Well, first of all, as DNVB brands mature, the low CAC/high LTV narrative seems challenging, as digital marketing needs to be gradually replaced with brick-and-mortar partnerships. On the other hand, the broader spray-and-pray e-commerce approach doesn’t necessarily seem to offer much better multiples either. The loss leader approach is super costly and requires the firms to raise aggressively from the beginning. The power of Amazon is clearly felt across both of these strategies and is reflected in the multiples.
That’s it for today,