Member Brief: Leaky Margin

Brands are better off, not as direct sellers but as middlemen. Individual brands are better set up for success when they’re part of a well-run marketplace. So no, not direct-to-consumer. This is the theory that we will unpack here.

We’re at a fork in the road of the DTC era and what defined the previous era of brands of the past will likely not be carried much longer. A big part of that will come down to where brands choose to do business.

For many brands, sidestepping retailers has meant falling into patterns of reliance on demand-generation tools. Facebook and Google have become increasingly expensive sources of customer acquisition. It’s become one of the most nefarious habits for retailers: they eat margins. They also are unpredictable in terms of how far advertising spend may go and how well customers are being reached. And thanks to privacy updates from Apple, retailer transparency and efficacy is lacking more than ever. In a piece for Moguldom, the leaky margin problem is explained, citing founder and investor Vibhu Norby’s DTC doubts as proof of a reckoning:

“To run a DTC brand today you install 50 different apps and platforms. Leak away all of your margin and more to Facebook and Google,” [Norby] said. “If there is margin left you give it to your supply chain, which is a mess. Nobody has the cashflow to overcome seasonality. It’s been 10+ years now where we’ve been saying DTC is the future of brand building. Revenues are there but is it working for anybody? Are there real positive cashflows, profitability, equity value?” Norby tweeted.

The role that Facebook and Google played in the front offices of DTC brands is, at this point, well known and much discussed. But what actually happens now? Has the DTC model failed?

IPO prices and earnings announcements suggest that changes are in store. Fledgling brands will find themselves in even harder times in the midst of inflation and this recession. Retail sales rose a scant 1% in June in the US – a better performance than expected, but customer anxiety and worries over what’s to come could mean doom times for brands that have less capital, less customer awareness and less efficient engines of operation. It says little about the quality of their product and even less about how compelling the brands’ story might be. The last ten years (the DTC era) were flush with innovation, much of it needed. But some of it less so, in retail that invited more founders and even more funding to flood the industry. When the economy takes a turn, the party stops.

The most profitable path forward is likely the marketplace model.

What customers want is aggregation, selection, efficiency and competitive costs. When you trade off the margin that’s going into the pockets of Facebook and Google to lure customers to your brand’s standalone site (typically with a discount code) and put it instead toward a marketplace that can get your brand in front of more people while managing operations like fulfillment and shipping, things can change. It’s worked for decades in the analog world, long before retail emerged as a digital offering. Part of the reason why DTC brands avoided the shelves was to not sit alongside competitors but now, competitors are online as well. The reasons to avoid going all-in on marketplace strategies is diminishing by the month.

That could mean brands get closer with Amazon, which this week helped merchants boost sales via its Buy with Prime feature that promoted discounts across non-Amazon sellers’ sites during Prime Day. After 2PM reported that Shopify brands were getting swept into Prime Day through the new feature that puts Prime checkout on brand sites outside of the Amazon ecosystem, we got confirmation from several DTC brands that their sales did improve on those two days.

The ecosystem is so fragmented with platforms that have “more market share” than Amazon, an acknowledgment of the volume of separate storefronts stored on its servers. But it’s marketplaces like Amazon who should be more of a focus for brands. At least, that’s the opportunity ahead.

Those brands that shun Amazon may find the latest developments to its private-label strategy of interest. According to the Wall Street Journal, Amazon is drastically reducing the number of private-label brands on its marketplace. Private label was once a serious growth engine for Amazon, which thought it could pull data from its sellers and recreate products and sell them for better margins and better prices. It was the cost of doing business on the site, and it kept many brands far away. From WSJ:

Amazon’s private-label business, with 243,000 products across 45 different house brands as of 2020, has been a source of controversy because it competes with other sellers on its platform. The decision to scale back the house brands resulted partly from disappointing sales for many of the items, the people said. It also came as the retail-and-technology giant has faced criticism in recent years from lawmakers and others that it sometimes gives advantages to its own brands at the expense of products sold by other vendors on its site.

That many of Amazon’s private-label products failed is proof that brand equity still matters and this is what the class of brands built over this era of retail may be best at – differentiation by brand development. The pivot in Amazon’s sales strategy could leave a door open to more challenger brands to find success on the platform. They still have the choice, and Shopify has been a valuable partner in having brands’ own sites succeed on their own. But costs are mounting and margin is leaking. Amazon may be there to clean up the mess.

By Web Smith | Edited by Hilary Milnes | Art by Christina Williams and Alex Remy 

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