Is the Direct-to-Consumer E-Commerce Business Model Broken?

It's been a tough time for most e-commerce businesses... Three factors have been recently weighing on profitability at direct-to-consumer ("DTC") e-commerce players. One factor relates to logistics, and the other two relate to marketing. First, there are the soaring supply chain costs... The cost to get foreign-made products into the country, whether by container ship […] Not rendering correctly? View this e-mail as a web page [here](. [Empire Financial Daily] Is the Direct-to-Consumer E-Commerce Business Model Broken? By Berna Barshay --------------------------------------------------------------- [Forensic Accountant: Big asset shift is coming]( Man who briefed U.S. Pentagon officials five times in past year says big money shift coming into an asset you've probably never heard of before. [Click here to learn more](. --------------------------------------------------------------- It's been a tough time for most e-commerce businesses... Three factors have been recently weighing on profitability at direct-to-consumer ("DTC") e-commerce players. One factor relates to logistics, and the other two relate to marketing. First, there are the [soaring supply chain costs](... The cost to get foreign-made products into the country, whether by container ship or air freight, has surged over the last year. Most foreign-manufactured products come by boat, and the cost to ship a container from China to the U.S. has gone from a couple of thousand dollars to $15,000 or more. Once the product gets here, it still must travel from its port of entry to a distribution center or store. Then once you click to buy, your order makes its journey to your home. All this domestic moving around happens in trucks and by rail, which also have seen rates surge. This is a problem for all players selling goods online, although the impact is worse the smaller the company is. Large companies tend to have direct relationships with shippers and are more likely to contract for some capacity ahead of time. In the case of e-commerce giant Amazon (AMZN), it even has significant internal logistics capabilities. That doesn't leave Amazon immune to rising fuel and labor costs – but it insulates it from paying a markup to a third party on those increases. But e-commerce players less ubiquitous than Amazon are at an even bigger disadvantage when it comes to marketing costs... Companies have a few levers to increase sales. One is price increases – but if companies raise prices indiscriminately, they will eventually lose market share. The more sustainable way to grow is to increase the number of active customers and/or grow the share of wallet with existing customers. If we're talking about a broad e-commerce retailer like Amazon... or Walmart.com (WMT)... or even eBay (EBAY), growing share of wallet may be a very achievable goal. Who isn't buying more on Amazon than they did five years ago? I am sure there are a few people who fit that description, but not many. But if you sell a narrower range of goods – or goods purchased with lower frequency – growth relies on recruiting new customers. Think about online glasses retailer Warby Parker (WRBY). It's one of the biggest brands born on the Internet – or digital-native – in industry speak. It did more than half a billion in revenue in 2021, but it's still not profitable. To achieve profitability, it needs to grow the topline to get operating leverage. But glasses aren't something consumers buy many times per year. Plenty of people will go a few years before they replace eyeglasses. So to grow into profitability, Warby Parker must grow its active customer count. What makes this tricky for Warby Parker is that awareness of its brand is still quite low. Despite being one of the most famous digital-native brands, when Warby Parker had its initial public offering ("IPO") last year, it had only 13% brand awareness... While almost everyone knows that Amazon, eBay and Walmart.com are options if you want to order a toy or phone charger online, plenty of people don't even know that Warby Parker exists. To reach those unaware consumers, Warby Parker has a marketing budget. It can spend that budget in several ways... on digital ads that pop up on Meta Platforms' Facebook (FB), Alphabet's Google (GOOGL), and other places... on traditional media ads, like through television, radio, and newspapers... throwing events that get covered by the press... on social media influencers who will post glamour shots wearing their cute new glasses. But like most digital-native brands, Warby Parker relies most heavily on digital ads – the ones you see on your Facebook and Instagram feeds or the ones that pop up at the top of your search when you use Google. But the cost of these ads is soaring. At the same time, they may be getting less effective. --------------------------------------------------------------- Recommended Link: [Hedge fund legend calls 'The End of Real Estate']( Few people see what's coming. But Whitney Tilson is predicting the end of real estate. And it's already starting. [Tilson reveals everything right here](. --------------------------------------------------------------- Companies like Warby Parker were built on the back of inexpensive Facebook ads... But according to a recent piece on the website The Hustle (colorfully titled "Are D2C companies f*cked?"), ad prices on Facebook have tripled in the last two years. Adding insult to injury, these ads no longer perform as well as they used to when reeling in new customers. Thanks to Apple's (AAPL) iOS 14.5 update and [Ad Tracking Transparency ("ATT")]( – the dreaded opt-in for tracking users' browsing activity on iPhones – most ads are packing less of a punch. Most iPhone users, now given a choice, opt out of tracking. Without the rich data offered through this tracking, prospective customers are targeted with ads far less precisely than they used to be. As The Hustle explains... One expert claims Meta's attribution metrics – user actions that can be attributed to an ad – are now off by 30% to 50%. This has led companies to spend more, often with worse results. Simply put, companies hawking goods in digital ads are paying much more now than a couple of years ago for ads that are nowhere near as good as they used to be when it comes to getting a consumer to click and visit a site. The problem here is the cost of customer acquisition, commonly referred to as "CAC"... This isn't just a problem for Warby Parker – it's a problem for nearly every DTC e-commerce company that isn't already a household name. CAC has always been a closely watched metric by investors. Even in the days before rising ad costs, rising CAC could be a red flag... In the case of fashion subscription site Stitch Fix (SFIX), [a company I have long been bearish on]( rising CAC was a clue that the company was working through its total addressable market ("TAM") much faster than the bulls wanted to believe. Stitch Fix painted a picture of an enormous market – pretty much anyone who buys clothes online! But interest in their curation service was far lower. The low-hanging fruit had been mostly picked by the time of Stitch Fix's IPO. To keep the topline growing and attract ever more new customers, Stitch Fix had to press the pedal to the metal on marketing. It needed to spend to convince the wary and naturally uninterested in giving the service a try. When the easy customers have already been picked off, and ad rates start to soar – it's a lethal combo, as is clearly reflected in Stitch Fix's stock price over the last year (don't say I didn't warn you!)... To sum it up, even in a more stable environment for ad rates, many companies would be having trouble with CAC. Once you have recruited the natural buyers for a relatively niche offering, further growth relies on converting skeptics. Growing an e-commerce company is hard, and the companies that were around 20 years ago, like Amazon and eBay, managed to stake out a piece of mental real estate in consumers' minds. The same goes for well-known brick-and-mortar retailers who have pivoted into e-commerce, like Walmart, Home Depot (HD), and Williams-Sonoma (WSM), just to name a few. Consumers know these brands, and they don't have to build awareness from scratch. I don't think that the DTC e-commerce business model is dead. It's just a lot harder than some people made it out to be... There have always been many e-commerce businesses out there where the TAM struck me as potentially too small versus the valuation the market was assigning to the company. Stitch Fix is the perfect example of this – it was profitable when it came public, and if it had stayed a niche business with a billion or two in revenues, it might have stayed profitable... But venture capitalists ("VCs") set much higher expectations for the company, ones that now look unrealistic. The VCs sold that dream to public market investors, who bid the company's stock up even more. Another company I would put in this camp is [scrubs maker Figs (FIGS)](. Then there are the business models that never seemed to make a ton of sense in the first place, no matter what your CAC is. If your product margin is barely positive after delivery costs, you can't make it up on volume. Companies [like fashion rental business Rent the Runway (RENT),]( and online low-end consignment shop ThredUp (TDUP) fall into this bucket for me. The collision of increasing supply chain and customer acquisition costs with more sobriety about TAM and valuation has led to a complete rout in DTC e-commerce companies so far this year. Here is just a sample of them... E-commerce was always hard... To meet the challenge of rising CAC, companies need to grow the amount of money a newly acquired customer will spend with them. So the companies best positioned to weather this environment would be e-tailers with a high average order value ("AOV") because that CAC can be spread over more sales dollars in that first order. All hope isn't lost for companies that sell more modestly priced items, however, because they can make up their marketing investment by driving spending through order frequency... Lots of small orders are almost (but not quite) as good as one big one because of shipping costs. Online pet supply store Chewy (CHWY) would argue that their business model still works despite 2021 CAC nearly tripling versus 2019 CAC because so many customers subscribe to monthly deliveries of dog food. The jury is still out on that one for me. Other DTC companies are better positioned to weather surging CAC costs because they used the pandemic to really ratchet up general awareness and customer recruitment, so their CAC, while still up a lot, remains at a lower nominal level. A good example would be [peer-to-peer marketplace Etsy (ETSY),]( which saw CAC halve in 2020, only to more than quadruple in 2021. But even with the giant 2021 jump, Etsy's CAC is still well under $100, while CAC at Warby Parker sits over $200... and at Chewy, it's over $400. In conclusion, it's a miserable time to be a chief revenue officer or chief marketing officer at a DTC e-commerce company. The playbook that worked for so long – buy cheap Facebook and Instagram ads to find new customers – is dead, at least for now. That doesn't mean growth prospects at these companies are dead – but it does mean they will have to get a lot more creative about how they find growth. In the mailbag, another reader begs for transparency instead of shrinkflation... Have you noticed your digital ads getting less relevant in the last several months since the restrictions on app tracking? What are your favorite e-commerce sites, and do you feel loyalty to any of these digital-native players? Share your thoughts in an e-mail by clicking [here](mailto:feedback@empirefinancialresearch.com?subject=Feedback%20for%20Berna). "Shrinkflation is just another deception for short-term gain. If a retailer raises the price of the same product, customers may not buy – an informed rejection. "If a retailer keeps [the] price the same but shrinks the product instead, the deception fuse is lit, just waiting for customer perception. The bomb may go off right in the store when the shallowness of the cereal box is perceived by customer's grasp. Or in the home, when the chip bag is finally opened. "Either way, the customer then has a triple-negative experience: deceived, insulted [intelligence], recognizing the price hike anyway. The result can be as bad as [a] rejection of product, brand, manufacturer, and retailer! "Deceiving customers to kick the can [of higher input costs] down the road is risky business that will inevitably bite the deceiver. "The Fed-engineered inflation of our current everything bubble is just a higher fractal of similar deception, but much riskier. Not long from now, many will open the bag of their portfolio and realize there are only a few chips of any value in there and have the same triple-negative experience. "Fortunately, we readers have you at Empire Financial, Stansberry, and the whole MarketWise group, weeding the garden and bringing us gems! Keep up the great work!" – Micah H. Berna comment: Thank you, Micah! Regards, Berna Barshay April 13, 2022 If someone forwarded you this e-mail and you would like to be added to my e-mail list to receive e-mails like this every weekday, simply [sign up here](. © 2022 Empire Financial Research. All rights reserved. Any reproduction, copying, or redistribution, in whole or in part, is prohibited without written permission from Empire Financial Research, 601 Lexington Ave., 20th Floor, New York, NY 10022 [www.empirefinancialresearch.com.]( You received this e-mail because you are subscribed to Empire Financial Daily. [Unsubscribe from all future e-mails](