The Direct-to-consumer (DTC) Lemmings

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Currently, there is a shake out in direct-to-consumer, also known as "DTC," startups. You may wonder what distinguishes the direct to consumer category from what is known simply as e-commerce, which is a venerable and long-ago consolidated category. Why has a lot of supposedly smart money spawned a large number of doomed startups?

While lemmings periodically have population explosions, they don't actually leap into the sea. So let's take a closer look at the breeding grounds of DTC startups to see why there are many more of them than the e-commerce ecology can support. Winter is coming.

A superficial reading of this wave of e-commerce startups can seem to find justification for their existence in the apparent opportunity to disrupt dominant consumer brands that have the power to deny competitors access to retail distribution and mass media marketing. This is why you see startups bringing mundane items like shaving razors, mattresses, bicycles, eyeglasses, and even penis-stiffening pills to the direct-to-consumer e-commerce channel, with hip makerketing on social media, podcasts, and other alternatives to broadcast media.

They keep breeding in part because the list of product categories that have potential for disruption is almost limitless. Consumer products are a much larger part of the US economy than technology. But they are also a brutal business. Barriers to entry are, in principle, low. Building barriers isn't a matter of technology.

In many consumer product categories, dominant brands have attained fat margins through near-monopoly power. They don't put a stranglehold on their retail channels just to be evil. Survival is at stake.

Through e-commerce efficiency, bypassing brick and mortar retail, and taking a little less margin, DTC brands look to be the next Gillette, or Sealy, etc. by being less evil. In addition to a price break, many DTC brands claim to provide better service, "sustainable" materials, or some other element of commercial wokeness.

They do this in a very hostile environment. "Winter" comes in the form of Amazon and Walmart. Both have house brands that perform much the same function as DTC brands: If their suppliers are too fat and happy, they will create a house brand product that takes price-sensitive customers away from brand-name products.

What's left for DTC, then? There is the wokeness factor, which you might already think is weak sauce. There is also the chance to become actual innovators: Once a DTC startup passes a certain size, they can justify a technology effort to "build a moat" around their business. If they can mine customer data, or innovate in their supply chain, or find some other justification for building a technological advantage specific to their product category, and if that advantage turns out to have significant value, they will attain at least three valuable goals:

  • Raising the cost of entry to their category
  • Increasing their competitive advantage over traditional consumer brands
  • Making themselves attractive as an acquisition target for Amazon, Walmart, or the traditional consumer brands they are disrupting

That's the story they tell their investors. Sometimes it works. Wayfair, an online furniture retailer, is racing to build a defensible advantage before Amazon turns their attention to a product category that hasn't been a focus for Amazon, and that poses some challenges for Amazon's physical and technological infrastructure.

Most DCT startups never cross that chasm.

But they keep coming toward that cliff. DCT startups are easy to start. They have also been bred into the supply of business graduates. Business schools run incubators and startup classes that are intended to give students a taste of the mechanics of creating a startup. These incubators and courses pump a lot of students through the startup experience in one semester. Time pressure discourages starting tech-based businesses because tech is hard, creating a liaison with a school's engineers is hard, and implementing tech can be slow. The result is a commonplace attitude in business: "Can't we do without all this engineering?" Nevermind actual science.

Will the DTC winter change the circumstances that flooded the startup world with DTC? As long as DTC remains fashionable, and as long as venture funds' limiteds demand to be in the fashionable thing, there is money for DTC, and eager young business grads willing to take that money and run right over the precipice.

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