The conventional wisdom on brands is that they take a lot of time and money to build. And, even if they do reach scale, they can be quickly abandoned by fickle consumers. While this narrative held true for brick-and-mortar businesses, vertical integration between manufacturing and online distribution has fundamentally changed how quickly brands can be built and the ways that they can establish an ongoing relationship with customers.
While we have yet to see a vertically-integrated, online brand achieve an IPO, we have seen numerous brands emerge as leaders in their categories at a faster rate than ever before: shaving brand Harry’s, which reached a $350 million valuation in less than two years; women’s clothing company Stitch Fix, which has attracted an industry insider team since launching four years ago; mattress brand Casper, which has become a household name inside of a year; household products maker The Honest Company, which hit $150 million top-line in its third year of sales.
The main reason these brands have been successful is their ability to create a captive distribution channel online and a persistent, direct customer relationship through new marketing channels. But there are some deeper trends at play that have created the opportunity for brands to “go direct” now in a way that wasn’t possible before:
Brand loyalties are in flux. The brands of the last 50 years were all built on the same model of mass distribution through traditional retail channels. But today’s digital brands are interacting with hyper-connected customers in innovative and intimate ways. Online men’s clothing retailer Bonobos, for instance, has empowered its customer service agents, called Ninjas, to do whatever is necessary to take care of shoppers and turn them into brand promoters. This means startups don’t have to fight the dollar-for-dollar marketing battles they had to in the past.
Marketing is simultaneously broader and more targeted. With the rise of predictive marketing and personalization, direct-to-consumer companies can better understand who their customers are and target them more directly. This reduces the need for expensive, scattershot marketing efforts and shrinks customer acquisition costs. Additionally, the rise of social media allows brands with a disruptive value proposition to create awareness virtually overnight.
Lean supply chains allow for lower inventory investments. Rather than having to produce inventory in advance to sell to retailers, direct-to-consumer brands can embrace a “build to order” approach that enables them to meet customer demand more dynamically and with less working capital.
New business models create customer stickiness. In the past, brands had to rely on retail partners to promote and display their products, which made staying top of mind an ongoing challenge. But today’s digital brands are investing in new transaction models in the form of subscriptions, loyalty programs, and natural product line additions that allow them to speak directly to their customers and build stronger relationships. Rent the Runway, for instance, has perfected the rental model for designer dresses, which means customers keep coming back again and again, offsetting acquisition costs.
We’re still in the early innings of vertically-integrated, online brands. Clearly the quality of the product and the execution of the team are the main determinants of success. But industry dynamics, such as profit margins, are also a big indicator of where companies can and will be built. We think about the sectors that might be ripe for disruption by analyzing the total recapturable margin of a product. Effectively, that margin represents the percentage of existing retail price that goes to distribution intermediaries (both wholesale and retail). We did a high-level analysis based on industry classification that shows the retail, wholesale, and total recapturable margin:
It’s no surprise that successful direct-to-consumer companies have been built in categories with the largest margins. Think Warby Parker and Stitch Fix in apparel (62.9% margin), Casper in home furnishings (63.6% margin), and Fresh Direct in grocery (37.1% margin). Still, many attractive categories remain largely untouched by direct-to-consumer models where there are large recapturable margins.
Here are four categories we predict will spawn successful direct-to-consumer brands over the next few years:
1. Furniture and home furnishings. This is a $94 billion market that has been largely untouched by vertically-integrated models. While shipping may be prohibitive for some items, novel product innovations and delivery methods like Casper’s foldable mattress can alleviate that additional cost. In both furniture and home accessories, brand loyalty is very low.
2. Apparel. Sub-categories in apparel, especially in accessories where margins are highest, represent a large opportunity. Though brand loyalties are high, consumers are willing to try new brands that reflect their sense of identity. This leaves the door open for new entrants with a unique product or experience.
3. Building materials and supplies. This is a $300 billion-plus market with very few vertically-integrated models. Though consumers may not make all of the discretionary decisions when contractors or architects are involved, novel products and methods for reaching decision makers create room for new entrants.
4. Electronics and appliances. This is another $100 billion-plus industry, with reasonably high margins at 46% but incredibly low brand loyalty and a poor consumer experience. Home appliances in particular will be a target for vertically-integrated brands in the future (who really loves their toaster?).
That’s not to say that any industry with large margins will be a good fit (for example, vertically-integrated liquor is a regulatory no-no, at least in the U.S.). But entrepreneurs should take note: High margin product categories are attractive targets. For entrepreneurs thinking about building companies in these categories, it’s important to remember that branding matters early on, so it should be part of the DNA of the company from the start. For most companies, this means doing the hard work up front to invest in solid product and user experience design. Beyond the product and experience, it means that companies need to invest in the right messaging — distilling the core value proposition and how to explain it to customers.
Regardless of the category entrepreneurs are focused on, the shifts in consumer behavior and ability to reach customers directly have created the opportunity for the next generation of great consumer brands to be built.
Weston Gaddy is a Senior Principal at Bain Capital Ventures. He focuses on investments in media, marketing, and consumer technology companies such as Jet.com, Manicube, 4moms, Persado, Kenshoo, and TapCommerce.