DTC Briefing: Warby Parker’s direct listing highlights the profit challenges DTC brands face
This is the latest installment of the DTC Briefing, a weekly Modern Retail column about the biggest challenges and trends facing the volatile direct-to-consumer startup world. To receive it in your inbox every week, sign up here.
For the past few years, eyeglasses brand Warby Parker has been cited as an example of the rare direct-to-consumer startup capable of turning a profit — the company said 2017 was the first year it achieved profitability on an EBITDA basis.
But when the company filed to go public via a direct listing last week, it revealed that the path to profitability remains bumpy. While Warby Parker broke even in 2019, it recorded losses of $22.9 million during its 2018 fiscal year and $55.9 million in 2020. The company did generate $393.7 million in revenue in 2020, up 6.3% from the year before.
It’s long been cited (including by me) that the biggest factor keeping DTC brands from turning a profit is high customer acquisition costs, which rose in lockstep with rising ad costs on platforms like Facebook. In March, Facebook ad costs were up 30% compared to the same time a year prior, according to an analysis from digital agency Aisle Rocket.
But it’s not the only thing keeping brands from profitability. As Warby Parker’s S-1 shows, today’s DTC brands have to contend with new challenges. These include increased logistics costs during the pandemic, and the fact that some of the stabler customer acquisition tactics brands have turned to (such as opening more stores) don’t scale as quickly as acquiring customers through Facebook.
Below are my biggest takeaways from Warby Parker’s S-1 filing, and what it says about the biggest challenges DTC brands face in 2021.
High customer acquisition costs show no signs of subsiding
In its S-1 filing, Warby Parker stated that, on average, it spent $27 to acquire a customer in 2019 (that increased to $40 per customer in 2020).
On the face of it, that number is a lot better than the average customer acquisition costs many other e-commerce brands have reported — when Blue Apron went public in 2017, for example, it reported that it was spending more than $400 per new customer.
But Warby Parker reported customer acquisition costs much differently than most direct-to-consumer brands do. In its S-1, the company said it considered customer acquisition costs to be “acquisition costs [which include the costs spent to allow people to try on Warby Parker’s glasses at home, as well as total media spend] for a given period divided by number of active customers during that same period.” Active customer is a customer who has made a purchase in the last 12 months.
Daniel McCarthy, assistant professor at Emory University’s Business School, said that customer acquisition costs are typically calculated by “taking the amount of money that is spent to acquire customers, divided by and the amount of customers that were acquired.” By including active customers — not just newly acquired customers — it includes customers that are already familiar with the Warby Parker brand.
“That is the first time I have ever seen any company define CAC that way,” said McCarthy. “It is almost guaranteed that their CAC is likely substantially higher than $27, but just how much higher would require additional non-trivial analysis.
Clearly, high customer acquisition costs remains a challenge if Warby Parker still struggles to turn a profit. On the bright side, Warby Parker has a high retention rate — customers acquired between 2015 and 2019 had a 50% repeat purchase rate within 24 months, which can help offset some high customer acquisition costs if they can continue to buy from the brand.
Sucharita Kodali, retail industry analyst at Forrester said that the challenge Warby Parker and most other DTC brands still have to contend with is that they are not yet big enough to rely mostly on returning customers to drive revenue.
“When your business is not even a billion dollars, you are still very much in customer acquisition mode,” she said.
Stores present a path forward to acquiring customers more profitability, but they come with added challenges
In recent years, Warby Parker has relied more on stores, rather than digital advertising to acquire customers. So much so, that 65% of its sales in 2019 came from its more than 145 retail locations.
In recent years, DTC brands ranging from Casper to Untuckit — both of which now have dozens of stores — have turned to opening stores as a way to acquire more customers versus just spending more money on Facebook. For Warby Parker, acquiring more customers through its stores has the added benefit of lowering the amount of money the company spends to send glasses to customers to try on at home (which are baked into its customer acquisition costs).
Warby Parker went to great pains in its S-1 to highlight the productivity of its stores — the company says its stores have an average sales per square foot of $2,900 — the reality is that opening more stores is a slow-going process. The company is on track to open 35 more this year.
Opening more stores still require DTC brands to spend tens of thousands of dollars outfitting the stores and forking over rent each month — something that proved to be a damaging cost last year when retail stores in some states were ordered shut for a few months due to the coronavirus pandemic.
Increased costs during the pandemic show no signs of subsiding
Warby Parker blamed the pandemic last year as the main reason why its losses increased last year — and some of the increased costs it incurred last year show no sign of slowing down. “[Warby Parker] had a pretty bad 2020, but everybody had a pretty bad 2020,” said Kodali.
“Increases in component costs, shipping costs, long lead times, supply shortages, and supply changes could disrupt our supply chain and factors such as wage rate increases and inflation can have a material adverse effect on our business, financial condition, and operating results,” the company stated in the risk factors section of its S-1.
As I have previously reported (and every retail executive has experienced) everything from the cost of shipping containers to lumber to aluminum cans has increased during the pandemic, as factories have to contend with churning out more products in the face of heightened e-commerce sales.
More people doing their shopping online has been a welcome occurrence for DTC brands, leading to many of them to beat their sales goals this year and last. But it also has ushered in a significant amount of increased costs. And until the costs of things like shipping and packaging get back down to normal — DTC brands, including Warby Parker, are going to have a hard time turning a consistent profit.
High-tech mattress brand Eight Sleep announces a new round of funding
Eight Sleep, a self-described “sleep fitness company” has quickly become the mattress brand of choice for a number of high-profile executives and athletes — the company claims more than 100 professional athletes use its products, and Alex Rodriguez, Kevin Hart and Boston Red Sox outfielder J.D. Martinez are all investors in the company. Yesterday, the company announced a new $86 million round of funding led by Valor Equity Partners, and disclosed that revenue is on track to more than triple this year compared to 2020 — roughly the same amount that revenue grew last year.
Eight Sleep’s marquee product, the Pod Pro mattress, comes out to a hefty $3,095 for a queen bed. Compared to other smart mattress brands, Eight Sleep claims to offer dynamic temperature cooling, and more detailed statistics about a user’s sleep cycle and health through its app.
But last year, the company released a — still expensive, but slightly more manageable — $1,795 cover that people can zip over existing mattresses, a product launch that Eight Sleep co-founder Alexandra Zatarian said contributed significantly to revenue growth last year.
With the new round of funding, Zatarian said the company plans to hire more employees, especially engineers, expand its international distribution (right now the company only ships to the U.S. and Canada) and new partnerships with health companies and athletes are on the horizon.
“We have very good penetration amongst a certain consumer that knows us, that sees us on social media, sees a lot of the word of mouth, sees our advertising, but how do we start going beyond that?” she said.
What I’m reading
- Business Insider has a feature looking at how Shopify has a built a loyal following of app developers, and how developers play into Shopify’s quest to fend off competition from other e-commerce platforms.
- Thingtesting looks at how some furniture startups are trying to capitalize on supply chain issues right now by encouraging customers to give rental or resale a try.
- Gap is the latest retailer to buy a virtual fitting room startup, announcing its acquisition of Drapr yesterday.
What we’ve covered
- Cupshe has quietly become one of the biggest swimwear startups in the U.S., having done $150 million in revenue last year after former Alibaba CEO David Wei launched the brand in 2015. Now, it has its sights set on new categories.
- Executives at home goods startups said that an increased focus on self-care has driven interest in luxury bath goods specifically, with sales of high-end bathrobes and towels continuing to rise this year.
- Manesh Joneja, CEO of newly-public dog toys and accessories brand Bark, stopped by the Modern Retail podcast to talk about how the company plans to capitalize on the boom in dog ownership over the past year.