DTC Briefing: The DTC bottom is finally falling out

“In all categories, everyone is for sale,” said one DTC founder and investor who wished to not be named. “They’re not making money and they have never made money.

This founder, who operates in the home goods space, said they have been approached by several top DTC names — some of which have just opened a slew of new stores — that are “begging us [to buy them] because they’re going under.”

Those that are unable to raise to money or find some other lifeline are faced with difficult choices. The sleepwear brand Lunya, for example, filed for Chapter 11 late last month citing declining revenue and increasing customer acquisition costs.

This phenomenon isn’t relegated only to DTC businesses — although most are uniquely positioned to be impacted when capital becomes more difficult to access. “It’s not just DTC,” said Michael Duda, partner at Bullish, “businesses overall — especially tech businesses — have gotten punched in the face with rising interest rates and inflation.”

The issue boils down to business model. “There’s only so much stuff you can pass off to the consumer,” Duda said. “If you don’t have a viable business model and the music stops, there are no seats left.”

Much of this has to do with the age-old story of digital marketing. Early DTC darlings like Away and Warby Parker became consumer-facing unicorns by pioneering sleek millennially-loved branding and making it ubiquitous via then-cheap online advertising. But as the years went on, the costs of customer acquisition went up. This was best exemplified by Casper’s 2019 IPO, which gave numbers to the depleting fuel marketing represented: The bedding company spent $106 million on marketing in 2018 and brought in $357.9 million in revenue that same year.

At the time, this seemed like the bellwether for a bubble bursting, but that didn’t happen. Instead, the coronavirus pandemic changed everything — giving seemingly doomed brands another way to grow sales via cheaper advertising prices and an unprecedented rise in e-commerce sales.

But the merry-go-round is back to where it was before, this time thanks to the implementation of Apple’s iOS 14 — which made the precise targeting platforms like Facebook previously offered to brands nigh impossible. Even with these mobile ad changes a few years in, costs are still rising.

But online acquisition isn’t the only thing hampering these brands. Nearly every DTC has been trying to diversify away from its reliance on paid ads and e-commerce sales, seeking out wholesale deals as well as trying to open their own stores. But even these bets aren’t working out — Lunya, for example, cited the fact that it was losing $135,000 per month on its retail fleet as one of the reasons it had to declare bankruptcy.

And when brands can’t acquire customers cheaply, that means they don’t have amazing growth metrics to show investors. Thus, deal flow has slowed down precipitously this year, leaving founders with few options. They can raise debt or other types of alternative financing, but rates are higher than ever before. Services ClearCo require brands to submit business metrics to receive a line of credit. Indeed, in Lunya’s case, ClearCo was one of its major creditors.

As such, the industry is whispering about the number of last-ditch efforts founders are making to keep their businesses afloat. “We have got more inbound [inquiries] this year,” said Nicholas Ling, co-founder and CEO of the DTC holding company Pattern Brands. The problem for many of these brands is, however, is that if they stand a chance of piquing Pattern’s interest, they need to already be profitable.

“I think there are some brands that are too dependent on venture funding,” said Ling. “Coming off that isn’t easy for anyone.” And that’s becoming an especially stark reality in this current moment; “There are companies going through more challenging situations,” he said.

The one thing that every founder and VC believes is that merely not dying means success right now. Ling cited Fred Wilson’s recent letter that said “surviving is thriving.”

“I continue to think there a lot of founders and entrepreneurs holding their breath underwater,” said Duda.

There are a few glimmers of light, potentially. For one, the companies that are persisting have solid financials. According to data from the alternative financing platform Ampla, revenues from the companies it works with have stayed relatively flat quarter-over-quarter (up 2%), but are still up a fair amount compared to the year before — 17%. That being said, Mike Grillo, Ampla’s vp of marketing, noted that “the actual order volume is down year-over-year.”

The takeaway is clear: brands aren’t focused on acquiring new customers at all costs but instead trying to figure out a margin profile and business model that lets them stay afloat. “You see brands really focus on gross margins and profitability versus chasing order volume,” said Grillo.

These numbers, mind you, are from the companies that Ampla has agreed to work with — meaning they’ve shared their under-the-hood numbers and the company deemed them worthy of a line of credit. As such, they’re not indicative of the entire ecosystem. To give a sense of that, at least from Ampla’s point of view, the number of applications the platform received in the second quarter of this year is up 89% year-over-year — meaning more companies were scrambling to find cash than ever before.

As with any business cycle, this will likely end with a whimper. Already, we’re seeing some signs of life from the once-bear market. After an almost completely dead period of IPOs, the fast-casual restaurant Cava went public a few weeks ago and is still trading well above its opening price. Duda said that he’s seen an influx of executive recruiters looking to backfill positions over the last month after open executive positions were put on hold for nearly six months.

It points to a potential optimism in the wings after months of indecisiveness from the deal makers; “There seems to be more people looking to make plays right now,” Duda said. He added, however, that VC deal flow will likely take longer to rebound given the high interest rates making it difficult to raise funds. “There’s still access to capital in a non-traditional way,” he said.

Meanwhile, the damage of this past year likely won’t be known for a long time. “I think we’ll see more Lunyas, more soft landings, more roll-ups,” said Duda. “[There will be] slow deaths that you’ll never read about. They are not putting up a sign that says ‘going out of business.'”

According to the founder and investor, it points to a years-old DTC industry issue finally reaching a head: “We haven’t learned our lesson as a category with Casper and Allbirds.”

What I’m reading

• The Wall Street Journal has a deep dive into how Allbirds lost its way.
• Lululemon has laid off 100 people in its Lululemon Studio division, as the company further distances itself from hardware, a space it entered after the 2020 acquisition of Mirror.
• Fanatics, the sports merchandise juggernaut, is getting into the events business with a new division called Fanatics Events.

What we’ve covered

• As it has built out its retail business, Vuori has has settled on a “sweet spot” of opening 20 to 25 new stores a year.
• Mall stalwart Claire’s has rebranded its piercing studio, now called Pierced, as it seeks to fend off competition from startups like Studs and Rowan.
• Direct-to-consumer beverage brands Sanzo and Poppi are now sponsoring Pickleball leagues.