It’s the math. And – as always – the CAC. Retailers (and by extension, ecommerce retail) has been in the drivers seat since day one of the web. They cultivate and own customers. Creating great customer experiences and great marketing it a skill set that manufacturers have struggled to replicate. But that is changing.
Traditional retail and ecommerce is usually built off keystone or keystone plus pricing. Keystone simply means you’re charging 2x the price that you paid for an item. I define keystone plus as anything above a 100% markup. From what I see, most ecommerce retailers now price around 2.5x what they pay for a sku, netting you 60% of the sale (40% goes to the manufacturer). Ecommerce also has tough unit economics because of the cost of shipping. Shipping from warehouse to customer can eat up profit margin fast and it’s difficult to control from a retail perspective (we all can’t build out a parcel delivery service). But it’s the CAC that is killing businesses.
On the other side, manufacturers are typically getting at least 50% margin on skus sold into retail. So simple math is that the customer pays $100, ecommerce company keeps $60 and pays the manufacturer/brand owner $40, of which the manufacturer nets $20. Retail ecommerce owns the customer, which is why they are able to keep most of the value. But as I mentioned, the hard part is attracting and keeping those customers. That’s why you see huge customer acquisition costs in those S-1’s that were filed recently. Out of the $60 retail ecommerce keeps, they pay for overhead, delivery, warehousing, customer service, returns, and customer acquisition costs. You have to run an tight operation to be profitable in ecommerce in 2021.
Here’s where the magic of DTC works so well. If you’re the manufacturer/brand owner and you can sell the same item for $100 direct to consumer, your cost is still only $20 for the item. Much better starting margin of 80% that allows you to handle the high unit economics costs and the higher CAC costs. For a long time, retailers and ecommerce merchants owned the expertise of getting customers. If it takes great real estate and retail operations, then it’s very hard for a manufacturer to break in. However, with AWS or Shopify, manufacturers can outsource some talent and get DTC pretty quickly now. This also explains why retailers require a lot of inhouse brands to stretch that margin.
At a $50 CAC and $100 AOV, ecommerce retailers are very unprofitable and need continued investment to keep the company growing. The biggest issue is that CAC costs are rising, even with scale (see Warby Parker’s S1). So retail ecommerce is getting squeezed. And they are squeezing down on the manufacturers/brand owners. Which makes it inevitable in my mind that we see more DNVB (digitally native vertical brands) who are building manufacturing and retail ecommerce shops together. But the easy win here is for current manufacturers to move into DTC ecommerce. Even if it’s only 10 or 20% of their net sales, it can be very profitable for them while at the same time giving them a customer base that provides data and insight they’ve wanted for years (retail ecommerce has selectively shared information with manufacturers).
From what I see DTC often picks up the most hard core brand advocates that want more connection and exposure to the brand. Nike, of course, is doing this beautifully. But lots of small manufacturers are now able to get in the game and start creating customer bases. Boxercraft is one great example. DTC seems like the long term play here. Especially as customer acquisition tactics become more accessible for more companies.
If you aren’t a platform or a brand manufacturer, you’re in an extremely tough spot these days. The reverse point of view here is that retailers need to start acquiring strong manufacturers/brand owners to augment their own margins. We are all competing for the same customer base and it’s getting harder and more expensive over time.