This is a guest post from our friend Alex from No Best Practices. Her newsletter is worth your time. Subscribe over here.

We’re all familiar with the original promise of the direct to consumer business model: cut out the middleman, sell via the internet and access infinite scale and reach with low overhead costs. The reality hasn’t quite worked out that way for most DTC brands. Facebook and Google became the new middle man, and the eCommerce fulfillment model’s variable costs replaced the fixed costs of bricks and mortar retail.

Three brands born at the start of the DTC era recently went public: Casper, Allbirds and Warby Parker. And S-1 filings revealed that none of these brands were profitable, although all three have been in business for close to a decade.

Two questions are now on every retail observer’s mind: 

1. Do these brands have the potential to become profitable businesses? 
2. Is the direct to consumer model a viable one? 

Supporters say that these brands are still in growth mode and will soon reach a profitable scale. Naysayers think that the DTC model is all hype and that there is little hope of a sustainable outcome. So which side is right? 

To answer that question, we first need to ask ourselves “under what conditions would Casper, Allbirds and Warby Parker become profitable”? 

All three brands are making the same assumption: they will eventually reach a scale that will result in lower customer acquisition costs and stronger retention rates. In other words, the customer mix, retail footprint and P&L statements of these brands will more closely resemble their legacy competitors.

But this begs another question: can these brands–or any brands for that matter–pull that off in today’s retail environment? To answer that question we need to understand how today’s category-dominating consumer mega brands achieved that status.

Note: Casper recently announced that they are agreeing to go private via a PE firm buy-out. This will be addressed at the end of this piece.

Defining A Mega-Brand

There are a few reasons that legacy brands enjoy lower customer acquisition costs. A major reason: these brands own consumer mindshare in their category. When you suddenly realize you need something specific—a bathing suit, a barbecue grill, a ski helmet, whatever—a mega-brand will be the first option that pops into most people’s heads.

There are two ways that brands achieve this mindshare dominance. The first is physical availability. If your stores are one of a few options to buy the product, and those stores are everywhere, you’ll automatically become the default option. The second is good old fashioned marketing. If a brand invests in brand marketing for decades and does it really well they will eventually drown out the competition.

Most product categories contain two or three brands that perpetually duke it out for the top spot. Think Coke vs Pepsi or McDonald’s vs Burger King. But there are certain categories where one clear winner has come out on top. Those are the categories we should study because Casper, Warby Parker, and Allbirds must achieve category dominance (or at least come close) if they want to lower their marketing costs.  

Role Models: Victoria’s Secret and Lululemon

Victoria’s Secret and Lululemon have both achieved category dominance. These brands have massive revenues ($5.4 Billion and $4.4 Billion respectively), a balanced mix of new and loyal customers, and the kind of brand awareness that drives down average acquisition costs. While Victoria’s Secret is facing declining revenue and profitability, it is still a profitable multi-billion dollar brand and the lingerie category leader. 

Both brands employed a similar playbook:

1. Rethinking A Category With Differentiated Product:

When Victoria’s Secret was acquired by Lex Wexner in 1982, the concept of lingerie was alien to the American consumer. Most women’s underwear was purely utilitarian, and there were few standalone retailers dedicated to the category. 

VS brought a fashion sensibility to the category, developing products that women were excited to purchase. The brand transformed an often-overlooked category into a retail destination.

When Lululemon was founded in 1998, yoga was still a niche pursuit and no one had yet uttered the term “athleisure”. Most women’s activewear on the market wasn’t well suited to yoga; it wasn’t stretchy enough. Many women used dance tights as a solution.

Founder Chip Wilson observed this gap in the market and designed a yoga pant that combined the stretch of a dance legging with additional structure to hold in the wearer. This new product became incredibly popular with the yoga community as the practice went mainstream, resulting in exponential growth.

2. Distribution That Enables Profitable Scale:

Victoria’s Secret had a major distribution advantage: the brand was scaling its retail footprint at the same time that mall foot traffic was on the rise. Because the brand’s core proposition was a hit with consumers, and because they had little competition, each new store quickly became profitable. VS also had the advantage of sitting within the L Brands family, where it could leverage capital from the already-profitable Limited stores.

Lululemon also pursued a retail store network for growth, although it was operating in a more challenging retail environment after the 2008 recession. The brand was selective about its store locations, focusing on areas with high household income and high foot traffic. It also leveraged grassroots community marketing focused on local yoga studios to drive awareness.

Many DTC brands consider physical stores a marketing exercise, but Victoria’s Secret and Lululemon operated profitable stores from the start. As the rest of the market caught on to each brand’s product innovation, the physical footprint made it harder for competitors to catch up.

3. Cultural Relevance (Good Timing):

Both Victoria’s Secret and Lululemon became part of the larger cultural dialogue, to the point that both brands are still synonymous with their respective categories. When you think of lingerie brands, most Americans still think of Victoria’s Secret, even if they don’t shop there. Ditto for Lululemon’s association with athleisure, yoga pants and high-end fitness.

Part of this cultural relevance is savvy marketing and part of it is good timing. VS promoted their glamorous “Angel” persona in the late 1990’s and early 2000’s, when in-your-face sexyness became a cultural trend and celebrity obsession reached an all time high. Lululemon embedded itself in the Yoga community just as the practice was becoming mainstream in America. The brand further benefited from a cultural obsession with wellness–including high-end fitness studios–that took shape in the 2010’s.

The Result? Winning Sales & Winning Mindshare:

These three factors allowed Victoria’s Secret and Lululemon to achieve the holy grail of marketing: the brands became household names and lower customer acquisition costs did follow. Both brands achieved category dominance and profitably drove multiple billions in revenue.

What enabled these brands to “sneak up” on the market? Their decision to rethink or reinvent their given product category. When Victoria’s Secret started to expand, most lingerie was still sold in department stores and viewed as a niche business. And when Lululemon started selling the yoga pant, most athletic apparel retailers viewed the women’s market as a secondary focus. Operating in a niche gave VS and Lululemon breathing room to profitably build their reputation before pursuing massive scale.

Casper, Warby Parker, and Allbirds are all aiming to achieve this level of profitable scale. Let’s see if they have what it takes to make it work.

Publicly Traded DTCs & The Mega-Brand Framework

Rethinking A Category With Differentiated Product:

• Casper: Casper’s product differentiation was not the product itself, but the means of delivery. Most mattresses had been sold in stores, but Casper’s was vacuum sealed and rolled up in a box for easy delivery. The mattress itself was produced by several third party suppliers. 
• Allbirds: Allbirds sneakers are produced from sustainable, renewable materials, some of which were developed and patented in-house. The original sneaker design was unique when it launched, but was quickly knocked off.
• Warby Parker: Warby produced its own product as a means of getting around the Luxottica eyewear cartel and offering lower prices. They also offered a home try-on service where customers would only keep and pay for the frames they liked. 
  

All three brands attempted to solve a problem with their category’s shopping experience, but did not change much about the product offering or target a specific consumer segment. In fact, the target market was “everyone who buys X product”–this is what justified venture capital investment.

Distribution That Enables Profitable Scale:

• Casper: The brand’s “mattress in a box” concept was differentiated but it was also a key contributor to profitability challenges. Product that was used and returned couldn’t be repackaged and sold to other customers for sanitary reasons. 
• Allbirds: Allbirds followed the standard DTC distribution model: launch online and then open owned stores as the brand gained momentum. This approach neither accelerated nor detracted from profitability.‍
• Warby Parker: The brand’s stores are some of the most productive in retail, generating slightly more than half the sales per square foot of Apple stores. This enables profitable expansion, but Warby has a long way to go before it becomes the most convenient place for most Americans to buy prescription glasses.

When it comes to distribution, Casper, Allbirds and Warby Parker offer a mixed bag, with Warby coming out on top. All three brands positioned themselves in opposition to existing category leaders, locking themselves into a one-on-one battle in the best case scenario.

Cultural Relevance (Good Timing):

• Casper: The brand’s launch roughly coincided with the Wellness trend in the US. But a lot of Casper’s initial marketing focused on the “bed in a box” narrative and the shortcomings of mattress shopping in-store, so they did not form a strong association with the wellness movement.
• Allbirds: Allbirds likely benefited from recent increased interest in sustainable products. But consumers’ willingness to pay higher prices for sustainable products is debatable, [link] and Warby hasn’t done much to align itself with environmental movements in the mind of the public.
• Warby Parker: The brand doesn’t have a strong association with any major cultural trends from the past decade, other than the DTC “cutting out the middleman” narrative.
  

Casper, Allbirds and Warby Parker have failed to gain the cultural traction of Victoria’s Secret or Lululemon at their peak. Each brand has a strong association with its category, but only among those who have been marketed to directly or who keep up with the DTC space.

Lessons Learned And Likely Outcomes

It doesn’t seem likely that Casper, Allbirds or Warby Parker will reach the level of category and mindshare dominance required to profitably drive billions in revenue–at least not without an additional decade of expansion or a major strategic pivot. A few reasons why:

Reframing The Game Vs Coming For The Crown

Victoria’s Secret, Lululemon and most of the other consumer brands we now consider global household names all seemed to come from nowhere. Instead of taking on the market leaders directly, they reimagined the value proposition in their category. This enabled VS and Lululemon to operate under the radar until they gained a sizable and loyal following.

Casper, Allbirds and Warby Parker took a different approach. They announced their ambitions to unseat the category leader from the start and directly attacked the worst parts of the leader’s existing business model. This did win some initial interest and enthusiasm for consumers. 

But starting with a target market of “everyone who buys X” makes it hard for a product to embed itself organically within any kind of community and develop reputation by word of mouth. It also makes marketing less efficient and more expensive. When the category leaders catch on to these challengers, they fight back hard.

Where Have All Our Movie Stars (And Household Names) Gone?

There are fewer actors or actresses who can fill a movie theater based on star power alone,  and those who remain often started their careers in the 1980’s or 90’s. Brands are facing the same challenge–most of today’s household names were founded decades ago in the age of mass media and thriving malls. 

Today’s media environment simply makes it harder to create brand awareness that penetrates all the niches of American society. The internet makes it easier for individuals to cloister themselves within their own interests and communities. There are fewer cultural narratives that transcend age, location and household income. And the delay in family formation and declining birth rate makes it less likely for brands or trends to cross generational lines.

The net result is that it takes a lot more money and a lot more work to become the first brand that pops into someone’s head when they’re looking to shop in a particular category. Legacy brands have an incredible advantage here–they built awareness at a lower cost, when the infrastructure for doing so was more stable.

“Going Mass” Is More Complex Than Ever

Middle-income Americans are declining as a share of the total population and the rising cost of basic necessities is eating into the “fun budgets” of all but the wealthiest Americans. This makes it increasingly challenging to develop a brand with a broad enough appeal to generate billions of dollars in revenue. 

Victoria’s Secret scaled during the 90’s, when the middle class was larger and had more spending power. In later years it used marketing to maintain an elevated reputation but provided steep discounts (the semi-annual sale) to serve the lower household income audience. Lululemon bypassed lower and middle income audiences entirely, opting to grow by increasing share of wallet with the high income crowd.

Casper, Allbirds and Warby Parker all chose to take on competitors that served a broad spectrum of incomes but focused their initial marketing efforts on high household income urban audiences. This puts them in a tricky situation–they can either double down on wealthy urbanites or go after lower income consumers, which will require a different pricing and distribution strategy.

Likely Outcomes

After slightly more than a year as a publicly traded company, Casper recently announced that it had agreed to be taken private by a Private Equity firm. The standard PE playbook for unprofitable firms? Major restructuring (aka layoffs and reorganization) that would result in too much share price volatility for a public company.

This is a likely outcome for any publicly traded DTC brand that can’t pivot to profitability within one to two years of its IPO. And that isn’t due to any lack of vision or competence on the part of the brand. The public markets are less patient than private investors, and these companies become prime PE targets: good deals at a low share price with lots of fat to trim and efficiencies to create. 

In an effort to achieve profitability, I expect that an increasing number of DTC brands align with partners who have nailed a profitable physical retail model for a mass audience–multicategory big box retailers like Target and Walmart.

This doesn’t mean that the DTC model is invalid. There are plenty of DTC brands that have reached massive scale while maintaining profitability–Duluth Trading Company and Gymshark are both great examples. 

What does it mean (Miley voice here)? The fundamentals of brand building and brand strategy are just as critical to success today as they were in the days before the internet.