Memo: Retail’s 2021

Year two of the pandemic, 2021 saw what can be best be described as sustained disruption throughout the world of retail. Wave after wave of pandemic variant and ensuing outbreak continued a chaos that we was supposed to be over in 2020. And yet, retail found ways to make its products easier to buy, more experiential to discover, and more available than projected (whether physically or digitally). We’re looking back at the main themes from this past year that will influence the year ahead.

The prolonged effects of Covid-19:

The pandemic is far from behind us. While we didn’t see mass lockdowns like 2020, the retail industry continued to form around new ways of shopping, new customer needs, and developing behaviors. The pandemic is woven throughout the rest of the year’s themes, with the Delta and Omicron variants making it clear that new disruption is never off the table. From a December memo on “Resilient Retail”:

The pandemic has caused a substantial shift in how consumers behave. It has begun to impact brand preferences, the decrease in impulse buying, a reduction in non-essential purchases, and a 35% increase on the reliance of online shopping.

Winners and losers have been born along the way. Major retailers proved most resilient, with the ability to skirt around supply chain back-ups (which we’ll get to in a moment) and get inventory on shelves ahead of the holidays. One example is Target, who found a way to keep digital shelves stocked in case their physical ones came up short.

The supply chain delays

Supply chain backups dominated retail headlines this year. As a result, major retailers responded with 2021’s holiday season starting earlier than before, with customers hoping to get ahead of out-of-stock notices. Agile, digitally native retailers were able to compete as well. But no one was immune. With COVID expected to continue disrupting the supply chain, impacting staffing and inventory availability, retailers will continue to develop omnichannel and staffing strategies that provide enough flexibility and control to outlast another year or two of these consumer behaviors. In October, we broke down the year in cascading effects caused by supply chain disruptions.

There are currently 90+ ships drifting off of the coast of Los Angeles and Long Beach, California. Nationally, truck drivers are employed at historic lows. Internationally, retailers are concerned by the news that China has begun limiting power at its many factories and shipping facilities, further hindering import timelines. And some of the most fortunate brands are buying the ships necessary to move products from A to B with some semblance of reliability.

But Lowe’s and many of the retailers in its class are no longer optimistic that any of the current issues will find resolution in the coming weeks. That may mean that we will see an uptick in top CPG brands as some of the top gifts of the season.

Even so, the holiday season saw retailers in a better position than many analysts believed. Some of them found new ways to consolidate supply chain management, other brands and retailers opted to buy their way out of supply chain disruption. Here is American Eagle Outfitters for example, the company also acquired Quiet Logistics:

The AEO pattern of acquisitions breaks a decades long cycle of reducing costs by off-shoring blue collar business functions. Historically, the market punished companies looking to build more robust, fully vertical systems. But no longer. If this two-year period has taught us anything, it’s that inventory control is a necessary function for brands. But also, that eCommerce operations are no longer on the fringes of big retail. The largest companies are building systems for direct-to-consumer growth.

eCommerce kept growing

Online retailers and their enablers, including Shopify, benefitted from the shift from in-store to eCommerce shopping that continued in 2021. What was reactionary in 2020 became more intentional this year and that’s expected to continue in 2022. From August:

So here we are, back again. Though government mandated shutdowns are far from likely, corporations are instituting their own versions of them. CBS News reported that Walmart and Kroger will require masks as the second wave of worry is anchored by the spread of the Delta variant. Whether more or less dangerous than the first model of pandemic, businesses have to respond proactively. Few industries are as preemptive as retail; other industries will follow.

This means longer lines, shorter in-store supply, and a decrease in consumer satisfaction as customers lament the persisting inconveniences of mainstream physical retail. Like before, eCommerce will be there to pick up the pieces. It will look something like a j-curve.

The rise of the Metaverse and Web3:

One of the biggest stories of the year is the rise of interest in the metaverse and Web3, both will continue to develop into next year. I mean, Oculus Quest 2 was the number one gift for Christams 2021 according to the free app rankings in the Apple app store. The shift from Web2 to Web3 finds internet users delving into digital-first and digital-only spaces, where their avatars and PFPs define their status. Consider it the new country club.

Brands are going to join in more in the new year, following a lead well established by Nike, which has led retail brands into metaverse presence development (MPD). MPD will define the next generation of marketing and brand equity; these are the companies leading in the digital world. For Nike, it’s been a worthwhile play so far.

This trend will continue. In one prediction from this year, we explored the shift from eCommerce to simply “commerce,” which will account for any purchases made in any space – physical, online or digital. When goods can be bought digitally and their inherent value is also digital, that means new competition in retail that overrides physical demands and disruptions. Just look at what’s happening to the supply chain – it’s all connected.

DTC’s new store strategy

It was a big year for first-generation DTC brands. Of the many that went public was Warby Parker, whose growth strategy belies a more significant trend that will define the paths for other mature DTC brands going forward. Warby Parker is going to continue opening more stores, along with other brands including Allbirds, which also went public this year. In August:

No, DTC was never meant to be online only. Warby realized over the years that its customers wanted to shop for glasses in stores, and it built the infrastructure to meet them. Now, the question is whether they can leverage their growing consumer-base to achieve operating leverage. And can Warby Parker continue climbing the chart?

Expect more similar brands to expand their store networks in populated areas where they can boost their online business simultaneously.

And last, the acquisition boom

It was an even bigger year for exits. Companies including Manscaped, BuzzFeed, Milk Makeup and more went public with the help of special purpose acquisition companies. In March, retail vet Art Peck launched a $200 million SPAC to acquire emerging retail brands. Good Commerce Acquisition Corporation will focus on e-commerce and data-led companies that also have ties to wholesale and retail. What became clear this year is that retail is not a funding race, it’s an EBITDA one. From October:

Over the past few years, several categories have benefited from the tailwinds of the shift towards online retail. Suddenly, SPACs were interested in direct-to-consumer retailers. Private acquisitions became a popular headline. Companies like Figs, Warby Parker and Brilliant Earth debuted on the public markets; each share market capitalizations north of $1 billion. Warby Parker and Figs, both north of $5.3 billion in market cap, are setting the market for the brands suspected to follow: Allbirds and Away are but a few in the pipeline. Now, companies like Gymshark are mulling an IPO, signaling a final stage of sorts.

All of these themes will influence the next year and beyond for retail. Covid is still here, the supply chain ripple effects will be long lasting, and the metaverse will become more mainstream. What’s been proven at the same time is that retail is resilient, and DTC is a viable model with its biggest practitioners moving to the next stage. It makes sense – it’s a long game. We’re still in the thick of it.

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

Member Brief: Quantifying the DTC Market

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History has an interesting way of influencing the future. With enough historical context and data, observers can forecast outcomes. But for product manufacturers and retailers, the ability to anticipate outcomes is tantamount to success or failure. It was King C. Gillette who once wrote:

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No. 329: The MLM-ification of DTC

On Mavely and the unspoken opportunity ahead for the DTC industry. When Greats Brand was reportedly acquired by Steve Madden after their most recent year that saw $13 million in earnings, it was a shock to many in the industry. Revenues seemed lower than what many expected but inline with the realties of buildng an omnichannel brand with an often-costly means of customer acquisition. It’s likely that profitability was an issue. This begs the question, how would things have been different if Greats’ customer acquisition model was one built on profitability and value? The venture-dependent, high growth model may elevate a select few brands in the ecosystem but it seems to be depressing the exit optionality of the majority of them.

Percentage of ad spend is a fine tool for aligning incentives. The problem is not with tested and vetted agencies. It’s with bad ones using it to pad income before providing value.

Marco Marandiz

Founded by Ryan Babenzien, Greats was considered a well-respected, independent shoe company with great propects to become a brand as promising as Allbirds. Babenzien’s marketing team had command over several types of outreach. Greats employed several methods to include performance marketing, direct mail, strategic partnerships, and even text-based promotion. But in the end, the brand never achieved profitability. It was a stark reminder that we may be turning a corner in the DTC space; there seems to be an added weight to the importance of earning profits. A rebuke of the SaaS multiple model that many tech companies can adopt to grow in value. At the intersection of growth and profitability, its the street named ‘Profitability’ that DTC brands should run along.

Greats, which still sells most of its shoes through its eCommerce site, opened a 500-square-foot location on Crosby Street last year. The brand also inked a wholesale partnership with Nordstrom and unveiled a buzzy collaboration with men’s fashion authority Nick Wooster.[1]

The company seems to have done everything right and yet, Greats reportedly sold for no more than two times the previous year’s revenues (June 30, 2018 – June 30, 2019). Greats raised $13 million in funding and sold for around a reported $26 million. It became abundantly clear that an absent path to profitability became the issue that drove the wedge. Steve Madden’s supply chain and organization will be a great fit for this reason, the company drove north of $410 million in the previous year. And they did so while maintaining profitability.

We want to build a profitable business and we’re one of the few digitally-native brands that hasn’t raised an ungodly amount of money that makes it challenging to build a profitable business and exit where everybody wins. We weren’t trying to build the company that had the biggest valuation in round one. We’re trying to build the company that had the biggest valuation at the end. [2]

The news of this acquisition served as a wakeup call for many in the direct to consumer space. What else can be done to improve the viability of DTC brands? Is an early-stage path profitability that crucial? If there is one thing that’s clear, the days of optimizing for ‘at any cost’ growth may be over. As customer acquisition costs continue to skyrocket, retail media has begun reporting on several marketing alternatives. Of them is Mavely, a relatively new platform that launched with a unique approach to reducing CAC for these brands. Mavely’s big idea: turn these DTC brands into multi-level marketing companies.

Mavely is trying to put a new spin on the multilevel-marketing model, in which companies recruit people to sell for them but which has gotten a bad rap for leading a lot of people to actually lose money. Wray said Mavely has no cost to join, no inventory requirements that consumers must maintain, and no minimum follower count that users need to recommend products. [3]

Founded by Evan Wray, Peggy O’Flaherty, and Sean O’Brien, the Chicago-based company has raised $1 million and is reportedly profitable “on a per user basis.” The app-based service has 10,000 users and currently operates as a glorified, peer-to-peer affiliate model. But while it may eventually and significantly supplement organic and paid growth for brands, that timeline is likely to be longer than Mavely would care to admit. Critical mass for this type of service means that Mavely will have to earn tens of millions of users. It will be interesting to observe whether or not Wray’s company can remain committed to growing the way that they’re preaching to their DTC partners: cost-effectively, perhaps a bit slowly, and by one customer (down-line) at a time. In the meantime, the performance marketing industry may be due for an evolution of its own.

Web Smith on Twitter

I’m not sure that a lot of DTC brand owners realize that they’re building companies valued at 1 – 1.5x revenues.

In a recent conversation on the merits of percentage of ad spend as a profit center for media buying agencies, agency owner David Hermann provided his perspective on how business should be pursued between DTC brands and agency partners.

This is why we do percentage of revenue tied to ROAS that’s based on their margins and what the break even point is after costs associated with our fees and expenses. Trust is key, we lay everything out before we get started so they never are in dark on anything. [4]

It presented a worthwhile question. As institutional investors continue to pour more and more venture capital into the DTC space, the approach to marketing should evolve with the volume. CAC has risen as a result of an influx of capital spent on performance marketing. This cycle has led to an unintended result; larger but largely unprofitable businesses. Perhaps the math of success or failure should be reconsidered by investors and founders, alike. What Hermann suggests is correct, agencies should consider a new model for compensation – one that emphasizes healthy contribution margins for these retailers.

Hermann went on:

[My firm is] dealing with one client’s margins right now. [We’re] helping them find a better supply chain. They needed a 2.15x margin just to break even after fees and expenses, so I am now helping on their margin-side. As I always say, media buying is just one side of the job now.

There is an opportunity for a new style of performance marketing agency. Agencies equipped with brand-side, practical expertise could build acquisition strategies around healthy margins, paving the way for percentage of profits as the key performance indicator shared between DTC brands and their agency partners. This solves several problems. Of those concerns, this model accounts for: (1) sustainability, (2) efficient paths to profitability, (3) longer-term relationships between agencies and brands, and (4) decreased dependence on institutional capital. Rather than media buyers being compensated for what they spend, agencies should consider compensation on the profits that they earn for brands.

It’s acquisition vehicles like Mavely, BrandBox, DTX Company’s Unbox, and Showfields that may influence this shift in the agency business model by providing meaningful opportunities for CAC diversification. And if so, the DTC era may finally begin to solve its profitability problem. This could be the first step towards improving valuation multiples and exit optionality for an industry in need of another feather in its cap.

Report by Web Smith | About 2PM