June 6, 2022
Based on our study of 107 tech startups in our 2022 Tech Startup Financial Projection Report, we found that when compared to B2B Software, B2C Software, and Marketplace business models, D2C product startups:
- Expect to raise less capital from investors
- Expect to generate approximately 1/10th the projected revenue in year 5
- Check on breakeven by business category to see if they take longer to breakeven
The difference between D2C startups and other startups really jumped out at us once we looked at the following graphs:
The striking visual differences made us want to dig in a bit deeper and speculate as to why D2C Product startups might have a tougher time scaling when compared to their counterparts, and we wanted to help D2C entrepreneurs know what they are getting themselves into before they start.
Why is it Hard for D2C Product Companies to Scale?
D2C Product companies are hard to scale, but before we get into why, I want to make sure we are all on the same page.
What is a D2C Company?
A D2C Company stands for Direct to Consumer. D2C companies sell physical products directly to consumers, and if you are a D2C company trying to raise investment, that probably means you are selling your product online - an ecommerce business.
Typically a D2C brand like design, manufacture, market, sell and deliver their product directly to consumers. Manufacturers on the other hand typically like to sell in bulk, instead of individual sales to the end consumer.
Examples of Successful D2C Companies
Even though it is really tough to scale a D2C product company, there are plenty of examples of success. A few of the best examples include:
- Warby Parker - Publicly traded with a $3 billion valuation (source)
- Dollar Shave Club - Sold to Unilever for $1 billion (source)
- BarkBox - well over $500 million in annual revenue with a $2.5 billion valuation (source)
These are 3 of the most successful D2C product companies and yet their combined valuation is less than $10 billion which is less than some of the new high flying Marketplace, B2C and B2B software companies like:
- OpenSea - Marketplace - $13+ billion valuation (source)
- Airtable - B2B SaaS - $5.7 billion valuation (source)
- TikTok - B2C Software - estimated $50 billion valuation (source)
Again I think this just goes to show that the most successful companies in the D2C market are just more difficult to scale to massive valuations when compared to marketplace and B2B and B2B software companies. I think there are a few key reasons why this is the case.
3 Reasons Why D2C Product Startups are Hard to Scale
1. D2C Startups have Lower Gross Profit Margins - When you are selling software or digital products, you build the product once and then have no incremental cost to sell the same product again and again. You can sell your software to everyone in the world for effectively no incremental cost. When you are selling a physical product, even with great margins, it isn’t free to manufacture more units, so you are going to have worse gross profit margins by default. That extra margin that software companies have can be reinvested into sales and marketing to grow faster.
2. D2C Companies are Cash Intensive Businesses - The more you grow a D2C business the more cash you will need to shovel into the business. You will need cash for manufacturing, cash to hold inventory, cash to store inventory in warehouses, cash to place larger and larger minimum orders of your raw materials or finished goods. You might get a solid return on investment on that cash, BUT the cash that is going towards inventory will not produce venture capital expected returns. So as fast as you can, you need to start funding inventory, warehousing, manufacturing capacity with debt. There are some options for D2C companies, for example:
- ClearBanc - Provided D2C companies $1 billion in inventory financing (source
- Kickfurther - Financed over $100 million in inventory for D2C companies (source)
- Shopify - Provides capital to Shopify merchants for growth (source)
We speculate that part of the reason that D2C companies expect to raise less capital in seed rounds than other types of startups is because they aim to raise some debt capital from lenders to fund inventory, and some equity capital from investors.
3. D2C Products have Real World Manufacturing and Logistics Constraints - Lastly, when you are manufacturing a product in the real world, you have real world constraints. A software company’s primary real world constraint is scaling servers to be able to handle the traffic, but Amazon Web Services has made this so easy that few software startups need to worry about this constraint. A D2C company on the other hand could have the following real world constraints:
- Do you have enough equipment to produce your product?
- Do you have enough workers to produce your product?
- Do you have enough physical space to produce your product? (Remember when Elon Musk was in “production hell” and even set up tents to manufacture Tesla vehicles?)
- Do you have all of the raw materials to produce your product?
- Do you have enough space to store all of your raw materials and finished goods?
- Do you have truck drivers and other delivery workers to deliver your finished product?
The list could go on and on, but designing, marketing, selling, manufacturing and delivering a physical product to a customer is clearly really tough!
So between the lower gross profit margins, the cash intensity of the business and the real world constraints that run rampant in D2C companies, it is clear that scaling a D2C brand is difficult. Our goal with this article is not to dissuade you from starting your business, we think you should start! But we want you to go in with eyes wide open and understand the challenges you face.
Ultra Successful D2C Companies
Because we don’t want to end this on a bad note and discourage you from ever starting a D2C Product company, we want to end with this:
Here you see that 2 of the top 6 companies in the world by market capitalization are arguably D2C Product Companies. Apple and Tesla both design, market, sell, build, and deliver extraordinary physical products to consumers around the world each day. To be fair, some of their valuation is related to the software (app store and self driving / driving safety features) that both companies have developed, but nevertheless these are primarily D2C product companies that have built 2 of the most valuable companies in the world.
So go for it! Start your D2C brand today and let us know how we can help!