Is direct-to-consumer really a strategy?

middlemen matter...

middlemen matter…

Many years ago I started a career in consumer investing. I enjoy working with founders to figure out how to make products that users love, and I follow a few of the iconic brands closely. A few years ago, John Donohoe, CEO of Nike announced a direct-to-consumer strategy. This strategy was designed to own and strengthen customer relationships and to improve Nike’s profitability by eliminating retail middlemen. On the surface, this logic seems robust, but when you double-click things become a bit more complicated.

I’ll provide thoughts on why I think DTC is hardly a strategy for most, but rather a way to enhance customer experience with broader distribution.

Consumer Philosophy

Relationships: Much of the reasoning for direct-to-consumer assumes a relationship before the work of building one has been put in. It sometimes disconnects product, customer development from the mechanics of commerce. Enduring businesses don’t buy customers. They earn them by consistently delivering on a compelling value proposition over time. Encounters that become transactional too quickly won’t have sufficient time to ferment and create the intoxicating relationships that build brand loyalty…

First-party data: In today’s markets of banana stand businesses, competitors who are subsidized with investor capital are sponsoring a promiscuous customer culture of trying everything on discount — You’ll be astonished by how many times I tried Blue Apron… This makes first-party data noisy and overkill. Meanwhile, data at wholesale level is more actionable because it provides broader insight that is informed by real purchase behavior and across different customer segments over time. And the ancillary benefits of data, e.g., customer collaboration for precision in product development seem far-fetched. I’d posit that most customers only know what they want when they see it.

Retention and loyalty: Customer behavior cannot be fully understood after a few purchases. Also, behavioral patterns are usually inapplicable across different cohorts. And, while brands try to force it e.g., assuming regular seasonal purchases in fashion or selling subscriptions for vitamins, consumers rarely buy products on a set cadence. Consumer businesses are not SaaS businesses.

Economics: The design of DTC businesses makes it difficult to benefit from scale e.g., operating leverage, more customers. Imagine the sheer work of selling one million pairs of shoes, and shipping one million boxes (plus returns!) vs. delivering a single truckload to a retail customer. It’s death by a thousand paper cuts.


Contribution margins: On an apples-to-apples basis, most DTC businesses have lower profit margins than wholesale. Most calculations for contribution margin include variable costs but not the full fixed cost (and time) burden placed on the organization.

Acquisition costs: CAC has few key challenges:

  1. Towards zero CAC: A common assumption that acquisition costs will go down as customers refer their friends for free is reserved for a few very special consumer earthquakes, where the product is so compelling that customers feel obliged to become evangelists.

  2. Attribution: Most companies use last-click attribution models that aren’t representative of customer journeys and that often understate the true cost of acquisition.

  3. Marginal cost: The low-CAC customers were already motivated buyers. The further you go out of that concentric circle, acquisition costs rise, sometimes at exponential rates. The penalties to growth can be fatal.

Loyalty and retention: Many models underestimate engagement costs. They don’t include costs and time of the work done internally to execute retention programs, the non-variable incentives offered to lapsed customers, and the true cost of handling returns.

Balance Sheets

Working capital: Founders highlight the working capital advantages of credit card swipes. However, large retail customers can provide customized, lucrative working capital benefits and in volumes that individuals customers cannot.

Infrastructure: The demise of retailers was greatly exaggerated during Covid and many companies wrongly cut them out. The value of wholesale partners in: understanding real estate, subsidizing distribution, providing local touch points for brands, merchandising, and curating cross-brand assortments cannot be underestimated. Many DTC brands have failed badly when they attempted physical retail.

Robust businesses are just hard to build…

DTC appears easy and superior on paper. The idea of looking at customers as a cumulative of tiny DCFs with initial investment and then a long stream of cashflows misses the complexity of customer behavior and business operations. It might (subconsciously) also make brands lazy to invest in the hard work of earning customers. I encourage our founders to be patient and focused on developing killer products and delivering them consistently and widely to end-customers in a superior experience. That is how enduring businesses are built.