How to drive profitable growth via D2C

Changing consumer requirements prompt new D2C models

In brief

• Although D2C business models are popular, increased competition and high product development, fulfillment and marketing costs have made profitability elusive.
• Companies should establish a proper role for D2C products in a brand portfolio and determine the right price point aligned with scale requirements.
• Companies can increase D2C profitability and brand success by taking five key steps.

Direct-to-consumer (D2C) business models have gained popularity with consumer goods companies, but profitability has remained a major challenge. Companies are grappling with increased competition and high product, fulfillment and marketing costs. Driving meaningful profitable growth requires clarity on D2C’s role and an understanding of price and scale requirements in the near term, as well as the ability to build or source unique D2C capabilities in the long term.

Direct-to-consumer market explodes with new D2C models to address changing consumer needs

The recent pandemic has contributed to a rise in e-commerce sales and rapid growth of the D2C market. US e-commerce retail sales grew a whopping 44% in 2020.[i]  COVID-19 has accelerated profound consumer behavior changes across all demographics, with many consumers getting comfortable shopping online for the first time. This acceleration has many parallels to the exponential e-commerce growth China experienced following SARS in 2003, giving birth to the Chinese digital retail economy. Although the gains largely benefited a few market leaders, analysis of the numbers indicate that competitors are making serious inroads in the market.[ii]

Changing consumer requirements, including a need for richer, direct engagement, are prompting brand owners to adopt and experiment with various types of D2C models. The D2C model has evolved rapidly from an online-only to an omnichannel presence, enabled by a renewed focus on consumer experience. For example, many D2C players are shifting their strategy by opening physical retail locations and investing in traditional advertising channels like video streaming. Still other traditional consumer packaged goods companies are establishing their own D2C channels to better understand consumer needs and behaviors by directly engaging with them.

Three main D2C models emerge

Three distinct D2C go-to-market models have emerged: (i) electronic and mobile e-commerce — focused on the front end only or integrated with production operations; (ii) brick and mortar (B&M) establishments (brand-owned or pop-up experience stores); and (iii) intermediaries, such as retail partnership stores or “stores within a store.” These models vary based on the ownership of different aspects of the end-to-end experience. While D2C assortment, pricing and inventory are largely owned by the brand in all models, order management and customer support could be managed by the partner in an intermediary-based model. In B&M-based models, they can be owned by either the brand or the partner.

A brand can now consider multiple go-to-market models based on consumer needs and its D2C value proposition. Each approach has clear implications for the revenue model and challenges for cost of operations. Therefore, it is critical to understand D2C profitability drivers and levers for each go-to-market approach.

The profitability question — tackling D2C economics

Despite astounding growth, D2C unit economics remains challenging due to high last mile and storage and packaging costs compared to traditional brick and mortar channels (Figure 1). As a result, EBITDA is highly sensitive at lower price and volume levels.

A recent EY study analyzed a D2C snack box product priced at $35 a box and with an EBITDA of -7.1% (Figure 2). The analysis showed that moving to a $55 per box offering could recover unit costs and become margin accretive at +4.3%, even with a lower volume requirement. This detailed understanding of unit economics and EBITDA sensitivity could inform an optimal D2C offering, price-pack architecture, marketing or acquisition approach, and operational investments.

The EY benchmarking assessment of D2C go-to-market approaches indicates that the path to profitability lies in applying five improvement levers:

1. Improve average order value: Adopt strategies related to consumer experience, pricing, products and marketing that lead to an increased basket size.
2. Configure fit-for-purpose products: “Rethink” all product solution components (packaging, formulation, delivery, manufacturing) stripping out non-value-add components
3. Reduce fulfillment cost: Automate the repetitive processes, optimize the delivery route and enhance last mile delivery.
4. Improve cost of consumer acquisition: Find new ways to reach new customers and increase repeat purchase from existing customers.
5. Move toward an asset-light model: Improve and enhance value chain partners to enable the lowest possible landed cost.

With the application of these levers, brand owners can potentially improve EBITDA 25%–30%.

Driving sustainable long-term growth by investing in the right capabilities

Driving growth via D2C starts with clarity on the role of D2C within a consumer goods company’s portfolio. D2C products in the market have been positioned as a sales driver, a new channel driver, an innovation platform or a shopper engagement mechanism. While a “sales driver” role will require supply chains that can service brick-and-mortar businesses as well as online businesses, a “channel expansion” role will focus on defining the D2C offering and relying on supply chain partners.

This D2C role definition will enable brand owners to define the right go-to-market approach and plan for requisite near- and long-term capabilities, including:

• Commercial capabilities (e.g., price pack, assortment, consumer experience, direct marketing)
• Operational requirements (e.g., retrofit or expand, launch new D2C last mile partnerships)
• Enabling capabilities (e.g., customer relationship management software, enterprise resources planning software, analytics, data privacy and security)

To effectively scale D2C operations, brand and business owners need to prioritize investments in consumer experience, multi-channel marketing, fulfillment, value-added services and analytics capabilities, among others. Establishing a long-term, targeted D2C capability model is important; approaches may vary with respect to sourcing and transitioning partners and vendors and centralizing capabilities across regions.

Technology integration considerations

A successful D2C go-to-market approach includes technology integration considerations. After determining the appropriate business strategy and operating model, companies must align their technology strategy to support the new D2C vision. Technology integration and scalability are key factors for success. With the right technology and more data, companies can gain new and deeper consumer insights to enable a successful transition to the D2C market. Getting it wrong can hurt a company’s ability to capitalize on this market.

Phani Bhamidipati and Harsh Khanna of Ernst & Young LLP contributed to this article. The authors also wish to thank Joy Peters for his contributions to this article.