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Here’s Why VCs Are Injecting $703 Million Into Direct-to-Consumer Brands

This article appears in the Fall 2018 issue of Silicon Slopes Magazine.

Written by Curt Roberts, Partner at Kickstart Seed Fund

When you think of venture capital investment, usually tech products like software and mobile apps come to mind. However, over the last 3-5 years, shifts in consumer spending, investments from the private sector, and the bankruptcies of traditionally large brands have shown VCs that the entire direct-to-consumer (D2C) economy (e.g. socks, cosmetics, apparel) is growing. In fact, digitally native vertical brands (DNVBs), or brands that are native to the online universe and focus heavily on customer experience, are growing nearly three times as fast as the average e-commerce retailer.

Whereas in the past it was difficult to find capital for consumer products, the industry’s staggering growth in recent years has encouraged many VCs to expand their portfolios to include D2C companies alongside their traditional tech investments. The development of popular brands like Birchbox, Casper and ThirdLove, who were among the top 25 DNVBs in 2017, are great examples of just how quickly that growth is taking place. But what’s really behind this sudden rise in consumer goods?

Consumer acquisition costs have plunged

When I ran strategy at Nike almost 20 years ago, I was consistently impressed with the emergence of new athletic brands that would eat away at pieces of Nike’s business. When discussing this with a member of my team, he commented that “all it takes to compete with Nike is a designer and a fax machine.” There was certainly some truth to that statement, but it was missing something very material: the cost to capture the consumer’s attention and move the needle on purchases was huge; distribution, sports marketing, advertising and other marketing expenses were massive.

Today, a lot has changed. The cost of getting a consumer’s attention is lower than it’s ever been. Social media gives brands instant and ubiquitous access to their target audiences for a fraction of the cost of more traditional media advertising. In fact, two-thirds of all U.S. consumers expect direct access to the companies from which they buy goods and services.

Take Glossier, for example. The beauty brand launched its product line on Instagram as part of its core promotion strategy and now estimates that it owes 90 percent of its revenue to its fans on Instagram. Today, 74 percent of consumers identify word-of-mouth (via social) as a key influencer in their purchasing decision, and it’s this level of access allows brands to market products more effectively, thus keeping costs low and subsequently increasing profit.

Traditional venture economics are possible

Historically, economic variables such as high working capital needs, no recurring revenue and modest margins (at best) have discouraged VCs from investing more in consumer companies. However, today those economics have changed. Many manufacturers have had enough success with DNVBs that they now offer favorable sourcing terms including, in some cases, no required deposits and extended payment terms. This allows business owners to keep overhead costs low and buy time to bring in revenue to pay the purchase order from the factory. When paired with a progressive revenue model, DNVBs find they can also fund high rates of growth with little to no outside capital.

For example, some DNVBs are designed from the ground up for recurring revenue (think Chatbooks and Dollar Shave Club) while others are showing repeat purchase rates that are substantially higher than the e-commerce average. Even margins have improved to the point that DNVBs can run gross margins of 65 to 75 percent and still save consumers money relative to the cost they would pay in a retail store. The final result is less overhead and more opportunity for growth and profit.

Consumer behavior is changing

The new generation of consumers (namely millennials) demand that brands are social media-literate and express the same values as they do — namely personalization, uniqueness, simplicity, quality and lifestyle over materialism. Consumers today don’t want to be just a walking billboard for a brand. Instead, younger consumers prefer distinct brands that help set them apart from their peers.

A major factor in the popularity of consumer goods today is that niche lifestyle brands can find a wider, younger, larger, and more devoted audience than ever before. If you truly offer something different that stands out from the clutter, you can more easily capture the critical mass of consumers that are looking for something that represents them.

A great example is the Utah-based children’s clothing company, Rags. Founder Rachel Nilsson started by taking what would otherwise be considered a very pedestrian baby product — a onesie — and turning it into a luxury consumer lifestyle product by electing to run her business on the basis of exclusives only. Twice a week, she posts high quality, unique, and exclusive products to her website in limited quantities, selling out every time. Why? Her audience has learned that if you don’t get an item when it’s available, you may never get it at all. This creates a fear of missing out (FOMO) effect on the part of consumers, increasing demand, and allowing Rags to charge more for a now premium product. It’s a brilliant strategy and one that has ultimately transformed her small business into a a sales machine that is only barely scratching the surface of a very poorly served market.

It’s all about returns

At the end of the day, VCs are finding that there are major returns to be had in the consumer product realm. Changes to traditional economics, consumer acquisition costs and overall consumer behavior are making it easier than ever for consumer brands to thrive without the need for substantial capital upfront. But smart investors and founders know that augmenting these now-viable models with additional capital brings a great opportunity to accelerate these companies in what are ultimately super competitive markets. Large, established brands have not often effectively countered the success of the DNVBs. But it would be foolish to assume that they won’t spend a lot of money and time figuring out how to do so.