More and more brand companies are choosing to use the DTC model to interact with consumers instead of just selling products. By establishing a close connection with consumers, the DTC model not only provides a more cost-effective way to scale, but also controls the brand experience, obtains valuable first-party data, and improves profitability. However, the economic model of the DTC model is much more complex than many companies expected. The transaction-centric approach taken by many businesses has often resulted in rising costs and increased operational complexity. In contrast, by focusing on consumer engagement, more of the benefits of the DTC model can be realized more quickly. This article provides some examples of successful brand DTC engagement strategies and highlights the key factors for achieving success through this approach.
As the pandemic in 2020 completely changed consumption habits, more consumer goods companies accelerated their attempts at the direct-to-consumer (DTC) model. With a clear private domain strategy, bypass distributors and build relationships with individual consumers, allowing brands to directly control the brand experience, capture valuable first-party data and improve product profitability.
But for many brand companies, the economic value of the DTC model is more complicated than expected. Many companies did not gain a large proportion of direct sales by reducing their reliance on distribution. Instead, they were surprised to find that brand business profits were weakened by the soaring cost of DTC infrastructure and the complexity of DTC operations.
A key reason for these difficulties is the transaction-focused approach to DTC adopted by many brands. These strategies of focusing solely on self-operated e-commerce may be effective, but achieving profitable growth will take longer. Our client experience shows that the faster way to realize DTC benefits is to effectively adopt a DTC strategy centered on user interaction.
1. Why is it difficult for DTC to make money?
While the transaction-centric DTC approach is winning over a growing number of consumer goods industries (including fashion, toys, automotive and electronics), it is still a fairly new business model, and some experimenters have experienced growing pains since 2022 : An audio product maker was forced to halt its DTC efforts because its directly-operated stores failed to generate enough sales; a beverage maker hoping to establish a home delivery service has struggled to expand the scope of its initial pilot. One cosmetics company closed all of its DTC stores in less than three years. Even new consumer brands that are purely DTC and have digital advantages because they were born on the Internet are in trouble, with some companies' market values having fallen by 80% since their IPOs.
Many participants were surprised by how difficult it was to achieve financial goals. On the face of it, using a transaction-centric approach to DTC should allow companies to achieve higher profits because direct sales reduce channel costs. However, gross margin improvements are typically amortized by higher DTC fixed costs and operational complexity.
BCG's analysis of several footwear and apparel players adopting transaction-focused DTC strategies found that marketing costs typically rise by 1 to 3 percentage points (pp). Selling and general administrative expenses increased 2 to 5 percentage points, with most of the increase coming from transportation and logistics expenses (up 1 to 2 percentage points) and physical costs (up 2 to 4 percentage points). (See Exhibit 1) There are many reasons. For example, the rise of cookies and ad-blocking software and related privacy technologies has made it harder and more expensive for brands to build private awareness, driving up customer acquisition costs. The pressure to offer free or heavily discounted shipping is another challenge, especially for businesses that produce large, heavy-duty or easily returned products.
BCG also found that for brands adopting transaction-focused DTC models, earnings before interest, taxes, depreciation, and amortization (EBITDA) are often much lower than many expect, ranging as high as 9% to 9% in the sample we studied. 14%.
Another unpleasant surprise is that the investment timeline for profitable growth using a transaction-focused DTC model may be longer than the company anticipated. While some brands have built profitable businesses using DTC, they are being patient about it. Our research shows that it may take five or more years of sustained DTC investment for a company to enter the growth phase and start enjoying the profitable growth that comes with scale. (See Exhibit 2.)
But DTC models don’t have to be transaction-focused, and brands can often realize much of the value of DTC more quickly in different ways.
2. DTC Growth Formula - Analyze the key factors driving growth
A mental model called "DTC Growth Formula" is introduced here, which scientifically reveals the key variables and their interactions that affect the growth of DTC companies. This simple yet elegant formula consists of funding, cash conversion cycle, traffic cost, conversion rate, customer lifetime value and customer acquisition cost. The model also emphasizes the importance of differentiation, noting that even small improvements in differentiation can have a huge impact on outcomes.
Fund utilization efficiency
DTC business requires a lot of capital, and the efficiency of capital use is also crucial. The length of the cash conversion cycle (CCC) determines the rate of return of funds and plays a key role in the effective use of funds.
Traffic cost and conversion rate
The ratio of CPV (cost per visit) / CVR (conversion rate) reveals how much it costs to acquire a customer.
There are many different ways to express customer acquisition cost. We recommend this logic the most because it highlights the inverse relationship between traffic cost and conversion rate.
CLV (Customer Lifetime Value)
How much profit does a DTC business generate from each customer?
Since most marketing in DTC is about customer acquisition, this should be based on contribution margin 2 (CM2). So, your net revenue minus your cost of goods sold, logistics and transaction costs.
CAC (Customer Acquisition Cost)
Average cost to acquire a new customer. Since CLV is based on CM2 (and therefore before marketing), CAC is deducted from CLV to derive the profit per customer.
For brands pursuing high customer retention rates, they typically invest more in marketing in the initial phase, and therefore need to realize returns through sustained marketing over a longer period of time. Understanding the relationship between CLV and CAC is critical to determining your return on investment point.
brand differentiation
We still feel this formula is somewhat incomplete, missing a factor that differentiates the speed of expansion of DTC brands. This is differentiation.
Small differentiation improvements can have an exponential impact on a DTC brand’s growth. Therefore, brands need to find unique selling points to stand out in a highly competitive market.
As a brand, you can refer to the DTC Growth Formula to develop the following key DTC growth strategies to achieve profitable growth:
- Capital management and capital utilization : Make sure you have enough capital to support business growth and optimize capital utilization efficiency. This means allocating your budget carefully and putting money into areas that will generate the highest returns, such as marketing, product development, and customer experience.
- Increase conversion rates and reduce customer acquisition costs : Improve conversion rates by optimizing your website and shopping experience. Also, look for ways to reduce customer acquisition costs, such as attracting high-quality leads through precise ad targeting, partner marketing, and referral programs.
- Increase customer lifetime value : Focus on increasing customer lifetime value, not just the first purchase. By providing high-quality products and services, establishing good customer relationships, and taking regular customer retention measures, such as personalized recommendations, loyalty programs and after-sales support, to encourage customers to repurchase and increase their purchase frequency.
- Differentiation and brand building: Find selling points that are different from competitors and establish a unique brand image and DTC model value proposition. By emphasizing the uniqueness of the brand, attract target customer groups and build customer loyalty to the brand.
- Data-driven decision-making and continuous optimization: Use data analysis and business insights to understand key indicators and trends to guide decision-making and optimization strategies. Continuously monitor and evaluate business performance, and timely adjust and improve strategies to adapt to market changes and changes in customer needs.
By following the key strategies above, combined with the principles of the DTC Growth Formula, your brand will be able to achieve profitable growth and build a strong DTC business model.
3. Interaction-centric DTC can reduce cost pressure
Although the DTC model is often seen as synonymous with direct e-commerce, leaders have broader goals in mind. They use DTC to increase user engagement. While jump-starting DTC transactions can be part of the model, user engagement-focused DTC models typically do not have sales conversion as their north star metric. Instead, the focus is on driving consumer interest, improving engagement, and gaining loyalty—recognizing that enhanced consumer engagement generates conversion momentum wherever it occurs (including omnichannel).
Brands can adopt different user engagement-focused DTC models. (See Exhibit 3.) The following four interaction modes can be considered:
- Physical brand experience and real participation: such as novel brand flagship stores and in-store services, providing unique consumer experience.
- Brand add-on services: Provide consumers with free experiences or entertainment that are not necessarily related to product purchase but can increase brand awareness.
- Brand Platform: A platform created by a brand that connects customers to the nearest dealer who offers additional services such as advice or delivery.
- Brand Gamification : Use game-like interactions and virtual experiences like Web 3.0 to build brand value and retain customers.
For example, Colgate is engaging with parents and other consumers through Colgate Magik, a new smart toothbrush with a gamified app that keeps kids entertained and ensures they brush for the recommended number of minutes. Estée Lauder offers free skin care diagnostics to consumers, while Porsche has set up pop-up boutiques in high-traffic locations to create new touchpoints with the brand.
As some of these examples show, the DTC model may not all be online. In fact, as some successful DTC players realize, opening physical stores such as flagship showrooms can be an excellent way to interact with consumers, and DTC leaders are constantly raising their ambitions. For example, Lego and Apple have integrated DTC experiences into their physical stores. This includes one-on-one coaching for consumers to ask questions and receive advice. They also include unique offerings such as a mosaic-making experience that allows customers to create a LEGO self-portrait.
But while interaction-focused DTC models can vary widely, effective models do three things well:
- Ability to engage in ongoing conversations with consumers to gain better, richer consumer insights.
- Leverage first-party data to deliver unique experiences, products and services.
- Convert audience excitement into long-term user relationships, increasing lifetime value.
Together, these elements can trigger a virtuous cycle. Providing rich and unique interactions can attract more interest. When consumers enjoy their experience, they are likely to come back again. Increased frequency increases loyalty, ultimately supporting stronger revenue growth.
Crucially, adopting an engagement-centric approach to DTC alleviates cost pressures because there is no need to build a complex e-commerce platform. Instead, spending is focused on variable costs such as advertising, influencer marketing and other marketing investments that can be scaled up or down as needed. (See Exhibit 4)
4. Promote a winning DTC private domain strategy
By approaching the DTC model with an engagement-centric lens, brands can capture data, shape differentiated experiences for consumers, and drive profitable growth. But realizing these benefits requires execution in the right way. Here are the key steps.
1) Create a differentiated value proposition
To avoid getting lost in the crowded consumer goods market, brands must provide their target audiences with a clear rationale for a participatory DTC model. Dyson, for example, offers unique colors and accessories for certain products, in addition to offering the opportunity to purchase products before they hit store shelves. Nespresso offers loyalty and subscription programs that offer lower prices to customers. Porsche's boutiques are designed to appeal to younger enthusiasts.
However, while it is crucial for brands to think big and take risks outside of their comfort zones in order to be different, they need to be clear-eyed about where they are starting from. Brands just starting out on their DTC journey need to allow time to build consumer awareness and grow their audience. That's the case with smart oven brand Tovala; it's been working on this endeavor for five years.
2) Put data at the core
Given the importance of capturing consumer data across touchpoints, companies need to create feedback loops that support two-way conversations. For example, to aggregate all reviews shared on its brand websites and distributor platforms, L’Oréal has developed a semantic and quantitative analytics platform powered by artificial intelligence (AI) to evaluate consumer reviews. Its consumer feedback loop is a digital dashboard updated in real time by marketing and research teams and powered by custom artificial intelligence algorithms. During the pilot phase, the platform analyzed more than 30,000 reviews per month in the US cosmetics category.
SHEIN, the world's leading fast fashion platform, also invests in two-way interaction with consumers. On the front end, collect first-party data from social media engagement. When traffic is directed to the SHEIN website, the company uses gamification to incentivize consumers to provide feedback, and then mines that feedback to create personalized recommendations. On the back end, SHEIN uses real-time data analysis to verify purchasing trends, aggregate consumption insights into a predictive model, and then use the predictive model to automatically adjust inventory.
In addition to building strong data and analytics capabilities, most businesses will need to break down internal silos within the organization so that the data collected can be used across functions, including product development, promotions and customer service. Starting an agile team organized around a business use case or a clear value stream is often a good starting point.
3) Organized as an entrepreneurial team
To quickly launch an innovative DTC business, some brands find it helpful to set it up as a separate unit within a larger enterprise. Nespresso takes this approach. With the unwavering support of Nestlé's CEO, Nespresso started as a stand-alone unit and grew into a $6.5 billion DTC business with an EBIT margin of 20%. Operating Nespresso as a self-sufficient DTC business unit simplifies execution. The team gained control of the DTC channel, allowing for rapid website and app updates, as well as the creation and execution of in-house marketing campaigns. Like startups, companies should learn how to attract consumers by doing so. Companies can start small, test the DTC value proposition to ensure the DTC engagement offered is compelling enough, and then grow from there.
4) Keep improving your ambitions
Adopting an interaction-focused DTC model could be the first step in a long-term DTC journey. Once the foundation of the DTC model is laid, moving to a transaction-centric approach should become easier. Brand leaders can then begin to expand their horizons and explore new ways to facilitate direct engagement with consumers, protect valuable distributor relationships, and raise barriers to competition.
Adopting a DTC model that leverages user interactions rather than simply using DTC as a transactional tool can rewrite the economics of this dynamic new model—enabling richer, more meaningful user interactions that deliver ongoing customer value. and profitability.
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