Tectonic shifts in the Direct-To-Consumer Landscape are surfacing

Originally posted on Medium.

The signs are everywhere. On a macro level, 2018 was a year where DTC brands continued to flourish and redefine the commerce landscape. Under the surface though, it was hard not to notice some of the cracks beginning to form in the foundation. As we find ourselves approaching the end of a full decade of disruption from DTC brands, 2019 will be a year of adaptation to the new realities of an evolving landscape, one in which the very idea of what constitutes a brand continues to shift and mutate.

The brands that excel in the next decade will have learned to navigate the following new realities:

Unrelenting competitive pressure from above and below

It’s never been easier to launch a DTC brand and it will keep getting easier to do so. While there is still real competitive advantage in making great product, the next decade will see this advantage erode significantly. In the apparel industry, the minimums required from manufacturers are on a race to one. At the same time, speed to market will increase to the point where just-in-time manufacturing becomes the new norm in apparel. Technology will do the same in the apparel manufacturing industry as it has for other industries: aggregating power to a few dominant players. These new giants will also be your new competitors. The brands that have managed to stay above the fast fashion fray by offering higher quality product will lose the protective moats surrounding their supply chains.

Thanks to Shopify and its growing marketplace of apps, developers and designers, a new entrant can spin up a best-in-breed online shopping experience in a snap. Existing competitive advantages like the out-of-box experience, rapid delivery and easy returns are on the path to commoditization. These aren’t core competencies any more, they are table stakes.

In the beginning of the DTC era, there was plenty of empty space to expand into. With the lower costs of entry, newer DTC entrants are increasingly looking to target smaller slices of the market with narrower, more customized product offerings. These niche players will not be VC-funded and will be quite content taking their time growing into upper seven to low eight figure businesses. Larger players in these spaces will be fending off these “gnats” with fly swatters made of mesh that isn’t fine enough for the job. Lawrence Lenihan, Co-Chairman of Resonance Companies, refers to this coming phenomenon as the “Economies of Small”.

As if that weren’t enough, the 800-lb gorilla in the room, Amazon, continues to eat up more and more space in the expanding online retail universe. FTI projects that its market share of online retail will expand to 50% by 2023. You can bet that after devouring the low margin, high volume end of the private label spectrum, it will turn its sights upmarket.

Consumer attention is aggregated among a few massive media players

The unrelenting onslaught of software eating the world has left marketers with fewer and fewer places to play. Too much power has been aggregated in the hands of too few and we now find ourselves feeling trapped and constrained in our options as growth marketers. The number of brands vying for impressions is exceeding the available attention span of Facebook and Instagram users, leading to declining ad engagement and soaring CPMs. Does an ad with little to no engagement influence users? News flash, it doesn’t, no matter how great the ad content.

Niche brands are at even more of a disadvantage on paid social. The more niche a brand is, the harder it is to scale spend on Facebook and Instagram. This is simply a matter of having less data for Facebook to work its machine learning magic with. As CPMs have risen, so too has the cost of traffic. At today’s elevated CPCs, these niche players lack the breadth of product to acquire enough customers to train Facebook’s machines adequately. With Facebook unable to learn where it can effectively expand the reach of these brand’s ads on its platform, scaling advertising spend efficiently is simply out of the question.

VCs initially overcapitalized DTC brands with the expressed purpose of acquiring as many customers as possible, economics be damned. But spending to go big (“Spending To Dominance”, as Bob Lefsetz puts it in his excellent piece on Netflix) hasn’t yet produced huge exits in the DTC space. The jury is still out, but the winner-take-all approach hasn’t worked yet. One can surmise that this is because network effects don’t apply to CPG brands (they have yet to behave as platforms…with one notable exception) and throwing dollars at advertising quickly reaches the threshold of diminishing returns as an investment. This overcapitalization, for however long it remains, is another factor leading to the increased customer acquisition costs seen in paid social today.

The lack of authority in brand content

When it comes to deciding content quality, it’s not the vote of a branding agency, nor the votes at Cannes that matter, but rather the vote of the customer. DTC brands today spend gobs of money on visual content only to have no real sense as to its effectiveness. Today’s consumers do not want to feel they are being sold to and regardless of its quality, so much of the content produced by brands today lacks the authenticity and authority the customer craves.

It’s not secret who has the authority these days. It’s the celebrity, the influencer and increasingly, the customer. They are the ones setting the trends and producing authentic content. Whether you agree with that or not, there is no question that the authority today lies with them. One need look no further than Glossier’s Instagram to see this dynamic in full effect. I would opine that Glossier’s visual content is not of the highest visual quality. However, one cannot deny that it is of exceptionally high authenticity and there’s no question of its effectiveness.

The dead cat bounce in physical retail

One could scarcely read anything in the DTC space last year without some mention about the re-emergence of physical retail. The problem with physical retail as a channel though remains foot traffic. There simply has not been a meaningful enough rebound in foot traffic for the recent buzz to be considered anything more that a brief counter to the long term downtrend. A glance at the US Retail REIT index shows the index at the very same level it was over 10 years ago, right before the great recession. More importantly, the index has fallen more than a third over the last 18 months. DTC brands may be bullish on physical retail, but it’s clear investors are not.

The problem lies in the current day physical retail experience. There hasn’t been enough innovation yet to drive incremental foot traffic. Certainly, there is nothing wrong with taking advantage of very selective and strategic retail opportunities. Getting direct tactile feedback from consumers is invaluable, as is offering a high density slice of a brand’s core demographic the opportunity to touch and feel. Physical retail should only be a small part of the overall channel mix for most DTC brands though. Brands that are banking on physical retail as the gateway to profitable growth are relying on an old playbook.

Well, all of that probably sounds quite foreboding. You might mistake me for being bearish on future of DTC brands, but I’m actually quite bullish. The brands that will be successful going forward will have adapted and, in the process, will have disrupted the disruptors.

Here’s how I see brands evolving in the DTC space:

A shift from acquiring customers to acquiring attention

With the cost of customer acquisition continuing to increase, the focus will shift from acquiring customers at unfavorable economics to acquiring more of a brand’s existing customers’ attention. The more attention a brand has from its customers, the better it can understand their wants, needs and desires. These additional data and insights will allow brands to develop product extensions to their increasingly niche core offerings. Selling these new products to an existing customer is significantly more profitable than the economics involved in acquiring a brand new one. The metric that captures this profitable symbiotic relationship with customers is lifetime value, which will quickly become the new vanity metric for DTCs going forward. This sentiment is perfectly articulated in David Perrel and Nik Sharma’s excellent article, The Customer Acquisition Pricing Parade.

Brands are already feeling the need to expand their presence in the lives of customers. If they don’t, they risk being forgotten and replaced by more engaging brands or simply cannibalized by Amazon, the bottom-of-the-funnel brand crushing black hole of online retail. If the presence of a brand in your customer’s digital life is simply to capture the occasional transaction, consider that brand at risk. If a brand’s email program functions as a way to refresh its customers recollection of its very existence, the next decade is not going to be very kind. The digital presence of every brand needs to shift from transaction to attention.

So how does a brand acquire more attention from its customers? By widening the aperture of its storytelling lens. Brands need to reciprocate the trust they’ve earned from customers and entrust them to help tell the story. The days of push storytelling are numbered and pull storytelling is taking its place. Brands need to pull customers into their storytelling and explore their journey with these customers on board as equal partners. With product quality becoming less of a differentiator in the future, word of mouth effects will begin to shift towards the brands whose stories are increasingly intertwined with those of its customers. This audience will seek to increase the utility they receive from sharing in these brands’ stories by bringing their friends along for the ride. Just like a ….. platform. A perfect example of this phenomenon today is Glossier, which will continue to shine in the next decade as it becomes a huge beauty platform with network effects. The growth of all brands going forward will be more a function of the role played in the lives of its consumers than of the product produced.

The rise of influencers-in-residence

Brands today lack the authority to set trends. As this realization becomes more and more readily apparent, I believe we will begin to see brands seek to gain back authority through association with influencers. That in and of itself isn’t newsworthy. But in this case, these won’t be with just any influencers; but instead a brand’s very own homegrown talent. In 2019, we will begin to see the rise of influencers-in-residence.

If you’re looking to launch your influencer career today, it’s going to be very difficult to break through. Just as there has been an explosion of brands in the DTC space, so too has the number of influencers expanded exponentially. The reason why is essentially the same in both cases: low barriers to entry. Nascent influencers lack trust and credibility, but existing brands have that in spades. These brands in turn lack compelling content, an issue that influencers can certainly alleviate. Brands routinely need to boost their posts through paid advertising (if ever there was an indication that advertising is the cost of being boring, this would be it). Influencers never have to pay to ensure their posts are seen.

Once brands realize the benefits of nurturing their own nascent influencer talent, they will gladly foot the bill to gain this increased organic engagement with their owned media. As soon as the influencer has proven s/he can support a presence of their own, they will move on to posting in their own channel and the next influencer-in-residence will assume the mantle for the brand’s social properties. A virtuous cycle thus forms where the brand’s audience will continue to associate the influencer’s rise with the brand, which in turn, lends the brand on-going authority. Rinse and repeat.

Of course, such an arrangement will require brands to give up a degree of control over the content posted in their social channels, including and not limited to, content about another brand’s products. GASP!

Which leads to the next trend..

Lifestyle ecosystems built by like-minded brands

Brands of the future will have no delusion of owning the entire customer and will focus obsessively on a single product category to improve their customers’ lives. These brands will cater to a particular lifestyle and ethos shared by other brands focusing obsessively on complementary product categories. Together, these brands will form self-sustaining ecosystems built around specific lifestyles.

Brands today put up artificial walls, but the days of brands as dead ends are over. The need for brands to be authentic stalwarts of a lifestyle requires discovery of and reciprocity to other complementary brands. The brands that share freely will form galaxies in a universe of otherwise disparate planets. The solo path will feel increasingly lonely. Larger DTC brands who came to fruition during the current decade will likely eschew this trend during the coming decade. Their prior VC-funded growth will offer connective brands the opportunity to chip away at the these larger brand’s market share . For a present day example of this ecosystem trend, look no further than the collaboration between Rowing Blazers and Tracksmith. When I saw this collaboration between these two like-minded brands, I had to stand up and cheer. Bravo!

From the aforementioned Perrel and Sharma article:

There’s the current state of customer acquisition — a parade of brands looking to acquire every single customer individually.

I predict we’ll see a lot of innovation in these lifestyle ecosystems very shortly. Sharing, open borders and collaborations are the future for the vast majority of brands.