Has the DTC model peaked? | Mobile Dev Memo

Has the DTC model peaked?

One of the most visible opportunities created by the Duopoly’s shift into algorithmic, event-driven campaign management has been the growth of the Direct To Consumer (DTC) category, in which non-digital consumer goods are marketed to relevant audiences via targeted Facebook and Google ads, sold via the retailer’s own website, and fulfilled via post, dis-intermediating the retail sales process. Targeted marketing has always been possible, of course, but Facebook and Google have streamlined the process to such an extent that this entire new commercial model was conceived.

The reason this model is an obvious artifact of event-driven campaign management is that the ads are pervasive: independent brands marketing shoes, shirts, every variety of sweatpant and jogger pant, watches, mattresses, pillows, weighted blankets, etc. in the Facebook and Instagram feeds. These specialized brands, for the most part, didn’t exist before the Duopoly made it possible for marketers to easily and programmatically target (and re-target) audiences on the basis of online purchase completions.

The DTC model is a bi-product of event-driven algorithmic marketing; programmatic, conversion-optimized hyper-targeting made the DTC model viable. So it logically follows that not only is Facebook the best and most efficient channel through which to market DTC products, but that the limitations of Facebook’s advertising mechanisms likewise limit the distribution potential of products from DTC companies.

Given that these limitations — audience overlap conflicts, upward pressure on CPMs for the most prized audience segments, the diminished power of over-used conversion events, etc. — are becoming ever more common grievances for DTC companies, it seems likely that growth for the DTC model may have peaked.

Proof of this slowdown is evident in numerous market developments. Many DTC companies, having experienced inverted unit economics, have stopped spending money on marketing; others have seen their categories invaded by competitors to the point that their margins have collapsed; and still others, having reached saturation on Facebook and Google as advertising channels, are reverting to traditional retail tactics by partnering with big box stores.

The reality of the DTC model is that, as its popularity swelled, newer entrants mistook the success of performance marketing campaigns for brand building; every DTC company, regardless of size or popularity, billed itself as a “brand” and baked flawed assumptions into their growth models. Fatuous brand marketing consultants, convinced in the DTC era that they could launch brands at will, hoodwinked companies into hiring them to run marketing that was really the worst possible combination of sensibilities: the square peg of high-conviction, brand-first ad creative into the round hole of event-driven, algorithmic performance marketing inventory on Facebook and, to a lesser extent, Google.

As a result of this perceived gold rush and blossoming of the DTC consultant industry, a flood of companies began operating under the DTC model, many of which are now facing the harsh realities of performance marketing: it is complex, it requires sophisticated data infrastructure to scale, and total addressable markets always seem larger at the outset of marketing than they actually are. The brute effectiveness of Facebook’s targeting algorithm actually exacerbates that last point: it is so efficient at finding relevant users quickly that it fools companies into thinking they have more traction than they do (for more on this, see The Power and peril of Facebook’s advertising algorithm).

When DTC companies see impressive early results with Facebook advertising, they sometimes assume that 1) they have already built a brand that is contributing to low CAC and will continue to put downward pressure on acquisition costs, and 2) the marginal cost of acquiring a user will only rise slightly as marketing spend scales. This is the deceptive power of Facebook. Not only does CAC generally rise once this Honeymoon phase ends, but it often skyrockets.

An example of this is illustrated below: two products both experience the same favorable acquisition costs in the Honeymoon phase, but Product A (green line) is able to continue to scale spend with only minimal CAC increases whereas Product B’s CAC increases are substantial. Both products ultimately reach a level of customer scale that unlocks brand benefits (which manifest in the non-linear increase of scale relative to marketing spend above the purple line), but Product A reaches that scale at a much lower level of overall marketing spend.

This lack of viability — the inability to grow profitably beyond the Honeymoon stage — is often the result of a DTC growth model that is predicated on a number of faulty assumptions. A few of those:

  • The product’s LTV is very high because, after being acquired, customers will make repeat purchases without needing to see subsequent ads. Reality: customers may only make purchases in reaction to seeing ads, so either the Average Order Volume (AOV) of the first purchase is high enough to compensate for the cost of acquisition, or future re-engagement campaigns provide enough increased margin to compensate for an unprofitable initial purchase / CAC ratio;
  • The company is building a brand that will decrease CAC and / or increase AOV over time. Reality: the best way to build a brand is to achieve ubiquity, and most DTC companies get nowhere near brand status. It is almost impossible to build a brand on the back of a sequence of transactions — only the best products can ultimately become brands, and assuming that any company can do so solely via Facebook advertising is facile;
  • The company will be able to utilize non-Facebook / Google channels for efficient growth to diversify its traffic mix and facilitate profitable scaling once Facebook and Google showcase creeping CAC increases. Reality: For most DTC companies, there is no viable acquisition channel outside of Facebook and Google; the reason that Facebook and Google have captured all digital marketing spend growth is that almost all other channels are less effective, have much smaller reach, and require much more manual effort to manage. Short of programmatic digital advertising, which is beyond what most DTC companies are capable of doing, there really is nothing that can match the effectiveness of Facebook and Google. I often hear advertising channels like Podcast placements, Reddit, Pinterest, TV, etc. recommended as alternatives to Facebook and Google, which is telling: these are poorly-targetable, un-scaleable sources of traffic that might really only be seen as supplemental. In other words, if these channels are a Plan B, the necessity of the Plan A is evident;
  • The company will be able to decrease CAC / CPAs over time through qualitatively better, artisanal creative. Reality: This doesn’t scale. Performance advertising on Facebook and Google requires large volumes of ad creative. Manually curated ad creative cannot propel a company to continued growth on digital channels; Facebook and Google require very large numbers of ad creative variants in order to optimize ad serving for large, diverse groups of potential customers.

As DTC companies have proliferated, the strategy delta between brand-first and growth-first mentalities has become more discernible through casual scrolls of the Facebook feed. As the scale challenges of well-known DTC companies are increasingly laid bare, it does feel as if growth for the DTC model is slowing and that the allure around the model — the provenance of which lies in systematic, efficient advertising on Facebook — is slowly dissipating.

Photo by Mike Petrucci on Unsplash