‘VCs are more comfortable with a lack of profitability’: Why private equity firms are investing in DTC brands

As direct-to-consumer brands mature, the players in the ecosystem are changing as well.

Venture capitalists, who put money on brands’ balance sheets and have pumped more than $3 billion into consumer brands since 2012, have played key roles in the rise of the DTC darlings.

Private equity investors are now sniffing around the direct-to-consumer category, particularly as more hit $50 million in revenue, and the complexities and logistics of a business start to change. Private equity firms like L Catterton, Diversified Trust and Great Hill Partners have taken notice. 

“There are tectonic plates moving in retail. Amazon is at one end of the spectrum, and DTC brands are on the other,” said Michael Kumin, the managing partner at Great Hill Partners. That shift opens up new opportunities for the firm, which has largely focused on categories like software, payments and healthcare with investments in companies like Paytronix and Recruiting.com. More recently, it’s invested in Bombas, Wayfair and The RealReal on the consumer side.

Digiday caught up with Kumin to see what comes next for PE companies going into the DTC category.


What opportunities do you see for private equity firms in the DTC category?
The private equity community is trying to figure out how to play the DTC trend. VCs have traditionally focused on seeding companies and investing before the business models are fully formed or locked in – when companies are still getting their footing.  Once they get to a certain point – for these e-commerce businesses it’s typically over $50 million in revenues – private equity would begin to be a viable pathway. At Great Hill, we will invest when the business model and unit economics are clearly established because we focus on businesses that are either making money or have a clear path to be profitable.

Private equity firms have been influenced by their own history with the retail businesses it has invested in, which were traditionally lower-growth companies. Now many of these investors are transitioning their focus to e-commerce and DTC, but the business models and the pattern recognition are somewhat different. These are direct marketing businesses which have different characteristics, opportunities and risks than a typical wholesale distribution model or brick-and-mortar roll out.  They are much more dependent on management skill sets involving technology and rarely have the bottom-line profit profile private equity investors typically invest behind. You have to be willing to look at a business differently than many traditional investors have been comfortable doing.

What are some issues you’ve seen DTC brands face?
We have seen most often that earlier stage DTC businesses are frequently single-product or single-marketing channel dependent. Scaling their businesses from $25 million in revenue to $500 million in revenue creates a set of new challenges. Many of these companies have grown with social or search marketing but don’t have experience in TV, radio or out-of-home advertising. Strategizing around issues like third-party logistics vs. in-house and when to expand internationally can also be critical business decisions. We have developed some pattern recognition as investors based on our experience with other companies who have lived through similar challenges.

What is the next milestone for these brands? Going public?
IPOs are on the horizon for some of these businesses but there have yet to be many, if any, DTC brands that have achieved adequate scale to go public, at least at the target market caps you’d want to see as an investor. Companies would need to be at $300-$500 million in revenue and showing profitability, or at least demonstrating a pretty clear path to near-term profitability, before it would make sense to tap the public markets. Also, I think many companies need to show that their truly addressable markets are large enough to get public markets investors excited.

What do you look for in companies you plan to invest in?
We look for companies that have developed meaningful moats to defend market position. In the case of an e-commerce company like Wayfair, in which we were a large investor, it has developed meaningful proprietary technology and complex logistics infrastructure – there’s a real complexity to their business model that is difficult to replicate. For digitally native brands, it is much harder to build what you’d classically define as a moat.

Bombas started out selling socks online. At first glance, it sounds like the most basic of businesses, without much differentiation. But Bombas is more of a traditional consumer brand, and as an investor, you have to believe in the product design and quality, and the positioning and branding. A brand can definitely be a moat, but you have to be really careful what you define as a “brand.” Is it just a name with advertising support or does it truly stand for something meaningful to the consumer?

In the case of Bombas, as with other DTC brands in which we’ve invested, we’re betting on what we believe is a 10 to 20 year trend – that the brands many of us grew up with are not guaranteed to be the brands of the future. There is going to be a shift in market share to emerging brands that directly connect with customers and have something to say. That’s the value transfer we’re currently looking for as investors in the e-commerce and consumer space.

— Hilary Milnes

Kohl’s makes it Amazon official
Kohl’s announced Tuesday that it would begin accepting Amazon returns at all 1,150 store locations in July, after nearly two years of testing the service that brought the pilot to 100 stores.

It’s a foot traffic play. Customers can bring any Amazon purchase, unpackaged and without a return label, to Kohl’s, which will then take care of the return for free. Hopefully, they’ll stay and shop. Maybe they’ll stay and shop Amazon products, like the Echo, which Kohl’s stocks in stores as part of the deal. By adding convenience to customers’ lives, Kohl’s is betting that incremental sales will follow.

Kohl’s Amazon playbook speaks to the larger identity crisis riddling physical retail, which has seen more stores close this year than 2018 as debt-saddled stores cave to pressures. Retailers now have to strike the right balance between convenience — offering customers the right options at the right times — and experience, and making sure that one isn’t being sacrificed over the other.

“The idea of a retail apocalypse is overblown, but retail is changing fundamentally. That has different implications. All of the growth in retail is online, either through online retailers like Amazon or omnichannel retailers, who see their online business growing. Physical store business is flat or down,” said Ed Fox, a retail research professor at the Cox School of Business.

For Kohl’s, cozying up to Amazon underpins other efforts it’s made to make the in-store shopping experience more efficient, and not just in service of catering to Amazon’s returns. In the past few months, it’s rolled out BOPIS lockers, and pushes customers shopping online to pick up items in stores by offers Kohl’s Cash incentives at checkout. It consolidated its rewards program to function more easily. It’s also enabled RFID product tracking to get accurate inventory reads, ensuring that items can be easily found and delivered most efficiently. Kohl’s has also been experimenting with an in-store analytics tool to help store managers respond to customer data insights in real time. The strategy is to make convenience the experience.

“Stores are our special sauce,” said Sona Chawla, Kohl’s president and COO. “We have to win there, so we have to be constantly innovating there.” — Hilary Milnes

The state of CPG
CPG stalwarts Kimberly-Clark and Procter & Gamble both reported earnings this week. Kimberly-Clark reported net sales of $4.6 billion during the first quarter of 2019, with organic sales up 3% year-over-year, while P&G reported net sales of $16.5 billion, with organic sales up 5%. Here’s what else their earnings say about the state of the CPG industry.

Price increases: Both Kimberly-Clark and P&G looked to price increases this quarter to grow revenue. Kimberly-Clark said it upped the price on Pull-Ups and premium Huggies diapers in the first quarter, while P&G said that it raised prices on products in grooming, personal health care, feminine care, and organic baby care products.

The threat of private label: On Kimberly-Clark’s earnings call, one analyst asked CEO Michael Hsu what he made of mass retailers like Target encroaching upon Kimberly-Clark’s territory, particularly in baby products. Hsu’s response: “They’re still very receptive to big brands and big innovation. They are pursuing some other opportunities. But I think we’ll work with them as partners kind of leading these categories.”

Adult care is booming: As Digiday previously reported, new direct-to-consumer brands are targeting baby boomers, and so are legacy brands. Hsu said that Kimberly-Clark would be putting more advertising dollars behind some of its adult care brands, spending predominantly on digital.

Grooming is challenging: P&G saw the biggest sales drop in grooming — net sales decreased 8% year-over-year. But the company sought to reassure analysts that all is not lost in that category. “We have the potential to increase usage, bring men back into the category who have left, or increase shave frequency,” chief financial officer Jon Moeller said on the call. And the company’s recent acquisition of Walker & Co, may provide a much-needed boost in this category. — Anna Hensel

What else we’ve covered

Walmart in ChinaWalmart is holding strong in China, where it’s building a grocery business.

Loyalty rebootedRetailers are switching up their loyalty strategies to focus less on discounts. Blame Amazon Prime.

Gyms are now acting like publishersIn the name of diversified revenue streams.

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