New competitors, the high cost of social media ads, and acquisitions by big retailers are making the direct-to-consumer business harder for its pioneers.

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The first generation of direct-to-consumer (DTC) firms is exemplified by Warby Parker, a seller of eyewear founded in 2010. By now the firm has more than 70 physical stores, but one of the founding principles of its DTC model was to sell online only and avoid the costs of traditional retail. The idea caught on, and countless other DTC firms followed on a steady flow of venture capital funding.

Early on, Warby Parker and others in the DTC space were in a strong position, with few competitors, low operating costs, and no shortage of capital. Companies had easy access to user data, which they used to understand consumers and zero in on them with targeted ads on social media. Millennial-style branding and a socially conscious mission statement completed the formula. “It couldn’t have been easier to start a DTC brand,” says Len Schlesinger of Harvard Business School. “You didn’t even need a good idea.”

Warby Parker is now entering the next stage of maturity, having announced on August 24 that it plans to go public. The latest round of funding pushed its valuation to $3 billion. Another DTC firm, online shoe store Allbirds, also recently announced an upcoming IPO. But for both firms, profitability has been elusive. Between 2018 and 2020, Warby Parker’s net loss grew from $23 million to $56 million. In the past two years Allbirds lost $40 million.

Other DTC firms have been even less fortunate. The IPO of DTC mattress company Casper in 2020 fell flat, and its market value has tumbled. Others, including suitcase firm Away and clothing company Outdoor Voices, have also suffered losses of late. Some benefitted from the online shopping boom during COVID-19 lockdowns, but this success may not be sustainable.

Many DTC firms have not survived at all, and times are getting tougher. Competition in direct to consumer has swelled considerably. As The Economist notes, Casper alone now has more than 175 online competitors. Social media advertising has become much more costly, with ad prices on Facebook and Instagram more than doubling between 2018 and 2020. And giant retailers have dealt with the rise of small competitors by acquiring them or launching their own DTC brands. Unilever, for example, is believed to have acquired nearly 30 DTC firms between 2015 and 2019.

Venture capital funding is still coming in, but the number of deals is levelling off and venture capitalists are becoming more discerning. “It’s now less about innovation and more about execution,” notes Kirsten Green of VC firm Forerunner Ventures. Another VC firm, Lerer Hippeau, says that its priorities have shifted from growth to profitability. Overall VCs want substance more than style.

A new generation of DTC firms has taken shape accordingly, selling unglamorous products that favour functionality: Figs, for instance, has amassed a large following selling medical scrubs. Its gross operating margins are 27%, compared with Warby Parker’s 7%. Co-Founder Trina Spears says that many other products and services are also are ripe for “decommoditisation”. The emphasis is on basic things that are in what Lerer Hippeau calls “sleepy total addressable markets”, where competition is sedate.

The newer generation of DTC has also spawned an offshoot: Digital consumer goods firm Thrasio has built a business on buying these brands from the ranks of third-party sellers on Amazon, consolidating them, and turning them into “profit-doubling machines”. Last year it claimed to be the fastest American company ever to reach profitable unicorn status. According to TechCrunch, “The Amazon Marketplace roll-up play is well and truly underway.”

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