Why Did Direct-to-Consumer Retailers Stumble?

In this podcast, Motley Fool contributors Travis Hoium, Lou Whiteman, and Rachel Warren discuss:

• Why stocks of direct-to-consumer (DTC) companies have plunged.
• What omnichannel strategies have succeeded.
• The future of agentic shopping.

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A full transcript is below.

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Travis Hoium: What happened to the direct to consumer trend that was supposed to upend retail, Motley Fool Money starts now. Welcome to Molly Fool Money. I'm Travis Hoium joined today by Lou Whiteman and Rachel Warren. Today, we want to dig into what happened to this direct to consumer retail trend. This was supposed to be the big thing. I'm thinking about companies like Allbirds, Casper mattresses, Warby Parker, Peloton. Do you remember when Peloton was hot, guys?

Lou Whiteman: Barely.

Travis Hoium: A little bit, 5-10 years ago. This was the hottest thing in venture capital. A lot of these companies went public, and they did not work out well for investors. Some of that was the timing of coming public during 2020 or 2021, during the pandemic when valuations were really high, but at the end of the day, their business models did not turn out to be as profitable and as high growth as a lot of people thought they were going to be. What is the story here, Rachel, with directed consumers? Where did this business fail? We'll get to what survived in just a second. But I want to focus on the failures first, because I think oftentimes that's the best place to learn for investors.

Rachel Warren: There were a few key issues here, and I think it's very notable that that initial direct to consumer playbook really relied on cheap and effective advertising on platforms like Facebook, Meta Platforms, Alphabet's, Google, but that quickly changed. Then there was this dynamic where more and more brands were adopting the direct to consumer model. They were then all competing for that same very finite digital ad space. Ad costs went up for everyone. You had updates like Apple's that restricted third party data tracking. That also actually made it much more difficult for brands to just practically target specific consumers and measure the effectiveness of their ads. Importantly, that direct to consumer model, it promised higher margins, but many brands really underestimated the logistical burden that they would take on trying to replace all of these different elements the traditional retailers typically embodied. Then, of course, there was the pandemic, which I think really revealed a lot of the fragility of those supply chains. A lot of these brands were propped up by venture capital funding, as you noted, and that was a strategy that prioritized aggressive growth over profitability, and that became really untenable as the market changed. There's obviously some businesses that have been successful here. But that's a lot of the story behind it, and it's really changed over the years to now as we look at this model.

Travis Hoium: Lou, this almost seems like a case where the theory was, we'll take out this middleman. The wholesalers, the retailers, will just go directly to the consumer. What you ended up doing was sticking a different middleman, which was companies like Facebook and Google in, and they were much better at extracting the profits from this industry than the original middleman. They're still around. We'll get to where their role is in the future. But that almost seems like the death out of these businesses.

Lou Whiteman: I think that's fair, and I think we should take a step back because the first thing we should say here is retail is really hard. It is hard for new brands to break through, period. I don't think we should be surprised that most brands that attempt to break through, it doesn't go as planned. It's easier now just because of the Internet because back in the day, Apple needed to do a Super Bowl commercial or Nike had to really show itself with dramatic advertising. There are better ways to break through now. But at the end of the day, the failure rates always going to be high. Rachel mentioned venture capital. I think it's worth noting that a lot of this came in an era of zero rates, where it didn't really matter if you were profitable, that money was cheap enough that you could throw money at scale and not worry about profitability. I think a lot of what happened is, as rates went up, as just the funding situation changed, profits became more important, and profits in retail is hard.

Travis Hoium: This seems like one of those businesses where there was not a winner take all market. Uber, the criticism of Uber was they were burning money forever powered by venture capital. But when they won, they could turn up that profitability crank, and there wasn't a crank like that with Allbirds.

Lou Whiteman: Look, fashion is different and retail is different. I don't feel like a lemming if I'm taking Uber because of the network effects. Nobody wants to wear the same shoes or same pants or the same product as everybody else. You're never going to get a winner take all. Not to be that guy, Travis, but the other big thing, and Rachel hit it is, but look, logistics is really hard. In particular, retail logistics is really hard because you have to deal with returns and all of that. A lot of this is that, look small retailers are not supposed to be national. They're not supposed to because you need scale, you need all of these things to be direct to consumer. You can't just build that overnight, and for most of these companies, you can't build it on their own. You can lean into Amazon if you want, but then you're giving up all your data. It's a really hard model with really a fickle consumer base. I hate to say it, but I think it's more of a surprise when these succeed over time than it is when they fail.

Travis Hoium: Would you say that this is part of the tension between something like venture capital funding and a business that isn't necessarily built to be a $100 billion or trillion dollar business? I'm picking on Allbirds here, but they're the most stark example. If they would have just said, hey, we're going to have this really great niche business, and I think those still exist in the DVC space. That may have been a really great place to be, but their venture capital investors are going, Hey, wait a second. We gave you $1 billion valuation. We're expecting you to be a $10 billion company or a $50 billion company, not just $1 billion company. That's not what we do.

Lou Whiteman: Venture capital and into the markets, too. Because I mean, Wall Street does not pay for steady, stable, no growth. You need to generate growth either via margins as a total return story. If you could be a low growth company with strong margins, who can return that cash to shareholders, or you can be a growth company. But one way or the other, venture and public markets, you just don't get the benefit if you are treading water and a lot of these at best, we're going to trade a lot.

Travis Hoium: Isn't as if direct to consumer is going away. There are still very powerful businesses. I still buy a lot of my clothes online, bombas socks, public rec pants, for example, but it seems like, Rachel, the opportunity for investors may have actually been in more picks and shovels play. Amazon, which plays a huge role, depending on what a retailer wants. But you have Shopify, which was arming the Rebels. These would be the Rebels. Meta and Google are going to be the advertising platforms. There are logistics companies that Lou is alluding to. Is that trend going to continue, and maybe these brands are going to take a little bit different strategy, but as investors, we're just going to ride this wave of these markets are growing, and those big companies are going to be the beneficiaries. Is that the right way to think about?

Rachel Warren: I think so. I think if you're an investor like myself and I wanting to capitalize on DTC brands, I do think you're doing it through these major platform companies like you were talking about the Amazons and Shopifys or even the advertising side through Meta or Google. There is still very much the reality that these DTC brands, they face intense competition rising customer acquisition costs. They really do need to rely on the infrastructure that's provided by these larger players. I do think that's we as investors can tap into the changing tide of the DTC space in the places that brands and third party sellers go to. When you think about it, consumers prioritize, for example, the convenience and speed of Amazon. For many consumers, that's simply where they prefer to shop. You were talking about some of these smaller direct to consumer brands that are successful. They're not publicly traded. A lot of them are built on the infrastructure of platforms like Shopify. Shopify's value has really evolved from simply providing a single store front to being this very sophisticated platform that manages a brand's entire ecosystem. I think what we're seeing right now in the direct to consumer space, the most successful brands are adapting their strategy rather than abandon it, and a lot of these brands are also integrating online and offline channels to really meet customers where they are. I think that's something that's really important to note, as well.

Travis Hoium: We're going to talk about those omni channels, as they're known in just a second. You're listening to Motley Fool Money.

Welcome back to Motley Fool Money. Before the break, Rachel alluded to the next topic that we're going to talk about here, which is brands that have multiple channels. If you want to buy a pair of on shoes, for example, you can buy them online. You can buy them at Dick's. You can buy at a bunch of different retailers. Rachel, I think the question here is, what have the companies that have succeeded? I mentioned on, but there's HOKA, there's Vari. There's a whole bunch of other brands that have not gone through this failure mode that some of the companies that went public were then bought out again. I think Casper was an example of that. What have they done differently to leverage wholesale? The other name that we should bring in here is the company that tried to go the opposite direction, which is Nike. They were the dominant company in wholesale for 30 years. Then they said during the pandemic, hey, you know what? Let's do this DTC thing and then they've come backwards. What has been the strategy that has worked for these companies? Because it seems like some mix of DTC, some mix of wholesale has been the magic there, but it's not always easy to find the right spot.

Rachel Warren: I think that's right. I think what we've seen the last few years is omnichannel is the more sustainable path. That's what consumers seem to want. We had this conversation right a few years ago where there was this idea that maybe consumers are going to entirely stop shopping in person, for example, and are going to only shop online. That's not the reality. Whether it's shopping online in store, through third party, DTC brands and otherwise have really had to contend with this. I think it's worth noting, these businesses, especially the direct to consumer side, they aren't dead. You look at Warby Parker, for example, Glacier, which is a private company. Both of these have expanded beyond a purely online model. Warby Parker, they've expanded their physical store presence. They have their in store sales that now comprise a really significant portion of their revenue, Glacier, which is private, but they've partnered with major retailers like Sephora to broaden their reach. Lululemon is, I think, a really great example of a company that has been very effective at the DTC strategy, but also just more broadly, that omnichannel approach. They built their community brand through their stores offering classes and events. That was before the e-commerce business grew significantly. I think you're right. Nike is an excellent example of an idea where DTC alone doesn't work. I think it also proves that just having that infrastructure in place for a really solid business also isn't enough to make that DTC strategy work. They wrongly assumed that customers would switch from some of their preferred retail partners to Nike's own websites or stores, and that turned out not to be an effective approach. I think it shows there's a lot of holes in that model, whether you are a start-up or a really established brand, like Nike.

Travis Hoium: Do you think that the way that some of these companies are thinking about their own retail strategy, I remember writing about this probably a decade ago. I'm not far from the Mall of America, and you go through the Mall of America, and it's just a showroom. That is the way that I look at it. You don't even need to buy anything there, and I don't think brands like Puma are really selling a whole lot there. It's more, hey, let's get this brand out there. Let's get somebody to figure out what size shoe am I? What size shirt? Do I like the way that this product feels and then maybe I'll go buy it online. Is that part of that retail strategy, too because then they also end up in other retail?

Rachel Warren: I think that's a huge part of it. I think, again, it goes back to that omnichannel approach. Look, not every retailer is going to win. We have seen some of the most established of companies struggle in a changing retail environment the last few years, and there's a lot of reasons for that. But I think what we have seen is that DTC model hasn't proven to be effective over the long run. It just doesn't resonate with consumers in the same way. I think that's the key takeaway here.

Travis Hoium: Lou, I'll give you the last word here. What are you looking for in some of these retail companies, whether it's a brand or whether it's a retailer themselves, that can be a sustainable differentiator?

Lou Whiteman: As an investor, you got to get distribution right, but the model I think matters is the economic one, not the distribution one. I think if you get the economics right, distribution, you can do what you want.

Travis Hoium: What do you mean by that? Are you looking for high margins?

Lou Whiteman: I'll tell you exactly what I'm looking. Right now, the trend is it's a barbell consumer. We will pay through the nose for certain items, but we want rock bottom for everything else. The things we pay for tend to be fleeting. It tends to be trendy. It tends to be what's real. If you want a sustainable business, you hope to get that high end, but you better be able to survive. You better have a business that works on the low end because inevitably, I think Lululemon is a great example of this, and maybe they can get it back. But for now, Lululemon, what they're fighting through is is that their business is getting commoditized and they either need to figure out how to get people to want to pay more for their version of this product again, or how do we make money in a market where we have to bring prices down to compete? The best businesses are the ones that, yes, they can exploit when their products are premium, but they can survive when they're not. Again, if you figure that out, distribution is part of that. But distribution, I think distribution you can have almost any distribution model if the economics are right and you have a business that it can at least survive when you're simply just out of favor.

Travis Hoium: How these companies survive may change in the future. We're going to bring artificial intelligence and AI agents shopping for us into the conversation in a moment you're listening to Motley Fool Money.

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Travis Hoium: Welcome back to Motley Fool Money. We have to bring artificial intelligence into this. Last week, Alphabet announced or Google, I guess, announced that they are going to be working with PayPal to bring AI shopping agents to the market. Part of that has to be done within the Chrome browser. In theory, you could just go to Gemini and say, hey, I really like this pair of pants. Tell me when it's $50. maybe they're $75 right now. Tell me when that price comes down a little bit. That was actually the example that they gave made me think that these retailers or these brand companies are going to be under even more pressure from Big Tech. But, Lou, how does AI shopping agents change this market if it does at all?

Lou Whiteman: I think you're right that retailers should be worried. I'm just going to reject the idea that AI does my shopping for me.

Travis Hoium: Maybe it should, Lou.

Lou Whiteman: It probably should, in my case, definitely. But look, I am the target for Stitch Fix because my fashion sense is terrible yet I haven't, because I do like to buy my own clothes. I think, looking at the problems they've had, part of taste and part of style is wanting to express yourself. I doubt that we surrender that to AI. The part I can see doing is, a race to the bottom for prices because you let me know when this is cheaper, and I will buy it then. As a retailer, you have to either give in to that and accept lower margins or hold your ground, and hopefully your competitors don't. I think this makes the retail environment even tougher for the companies involved. I really don't see a Jetsons like world where AI is just picking out clothes, and I'm just pleasantly surprised when it shows up anytime soon, at least for.

Travis Hoium: The other thing, Rachel, I thought was interesting in some of these discussions is that one of the companies fighting AI agent shopping is Amazon, and that's because it doesn't behoove their business. They don't get that sweet advertising revenue that they get from retailers paying to be at the top of your search results when you search for something. It seems like there's a lot of tension here. But what are your thoughts on AI coming into this?

Rachel Warren: I think it's interesting. I do think there is a real tension there that we're seeing, obviously, from the big brands you mentioned, like Amazon, but also smaller retailers, mom and pop brands that are working to survive on these platforms. I think that the reality of AI agents as it pertains to retail, I don't think it's going to be so extreme as there's an AI that's doing my shopping for me. I agree with Lou on that. I think that we are a long way off from that, and I don't even know exactly what the on ramps to customer adoption are there. But I do think that it is notable that you do have everyone from the Shopify of the world to Warby Parker, for example, they are using AI agents agentic AI to personalize the customer experience. You've got Warby Parker. They have an AI shopping assistant they launched called Advisor that uses AI to replicate in store experience at home. Then there's very practical use cases for companies. You could have autonomous agents that could predict demand spikes and automate replenishment of orders, optimize logistics for businesses.

Travis Hoium: Inventory is really the huge challenge in retail.

Rachel Warren: Huge.

Travis Hoium: Maybe that does make this a little bit better.

Rachel Warren: I think actually the real value here is on the back end for these businesses, for the Amazons of the world and others. But that super futuristic version of this, I still think that's a really long way off if that happens at all.

Travis Hoium: I want to get your thoughts on this quickly. Does this bring in new business models? I'm thinking of Nike used to do those drops. I remember the Jordan drops. Something would come for sale at 6:00 AM and it'd be sold out by 6:05. Does that become more common if there is something like AI agents, and then does the world of shopping just become like eBay where the person who's willing to pay the most for the limited drop is going to be the winner? What do you think, Lou?

Lou Whiteman: I think that's the exception, not the rule. I think maybe it works, but again, I don't think most products, most brands are going to be able to do that. For my dish soap, I don't think I'll get in on the limited edition. You know what I mean, though. For most things, I don't think it works. But, yes, it could be a possibility for in demand items.

Travis Hoium: Rachel, are new business models in the work?

Rachel Warren: I'm sure there's someone thinking about it. There's this idea where, for example, brands could set up this AI agent store for a new exclusive drop, and you could have a customer's personal AI agent interact with the brand's AI agent to negotiate the best price. I think that's where we go the way of the meta verse when we're estimating what AI agents are going to be doing in a way that resonates with consumers. But I do think there's a lot of value to the tech, and I think companies like Amazon are seeing that.

Travis Hoium: As somebody who doesn't like to do his own shopping and don't have a lot of fashion sense, I'll take the bullish side here for AI shopping agents. I'd be happy to have an AI that has a little bit better fashion sense. Pick out my clothes for me, and I'll just happily pay for them and let them come to my door. But we'll see how this plays out, definitely a topic. We will be covering more here. Speaking of topics, tomorrow, they are talking about the home building industry. They're going to do a deep dive there, so be sure to tune in tomorrow. Always, people on the program may have interest in the stocks they talk about and the Motley Fool may have formal recommendations for or against. Don't buy or sell stocks based solely on what you hear. All personal finance content follows the Motley Fools editorial standards and is not approved by advertisers. Advertisements are sponsored content and provided for informational purposes only. To see our full advertising disclosure, please check out our show notes. For Lou Whiteman, Rachel Warren, Bart Shannon behind the glass, and the entire Motley Fool team, I'm Travis Hoium. Thanks for listening to Motley Fool Money. We'll see you here tomorrow.

Lou Whiteman has positions in Nike and Shopify. Rachel Warren has positions in Alphabet, Amazon, Apple, and Shopify. Travis Hoium has positions in Alphabet and Shopify. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Lululemon Athletica Inc., Meta Platforms, Nike, Peloton Interactive, Shopify, and eBay. The Motley Fool recommends Stitch Fix and Warby Parker. The Motley Fool has a disclosure policy.