Ecommerce Myths Part Deux
More on who survives, the viability of marketplaces, adding retail, getting beyond Facebook and the importance of influencers.
Welcome to People vs Algorithms #36.
I look for patterns in media, business and culture. My POV is informed by 30 years of leadership in media and advertising businesses, most recently as global President of Hearst Magazines, one of the largest publishers in the world.
On Tuesday Nasa revealed the first images from the James Webb Space Telescope giving the deranged inhabitants of planet Earth an opportunity to look beyond their worldly quagmire to an infrared view of galaxies wrapping galaxies, comprising trillions of planets, perhaps not unlike our own — leaving me to ponder our insignificance, or maybe our significance, and how the things that separate all of us here on planet Earth ought to feel trivial when we are collectively staring at the natural poetry that is the Southern Ring Nebula of Carina (see above). I wonder if they have Prime Day somewhere out there in Carina or if they use rice cookers or cricut machines, currently discounted on Amazon which is cool if you want to print nifty personalized mugs and cosmic tote bags in your home. I would def put one to good use.
Last week we dug into ecommerce on planet earth with our friend Haris Memon. People enjoyed it, so I decided to zoom in with him this week. (It also prompted Haris to launch his own newsletter on commerce. It’s called The Merchant and it’s coming soon. Subscribe here).
For context I also called a couple of investors, real experts in this stuff, particularly the intersection of content and commerce. Before we dig into part two of the Q&A with Haris, here are a few high level observations I pulled from these conversations:
Replicating the physical: Physical offers selling power of place and people. It adds serendipity and impulse. Digital is the opposite. Marketing strategies replace distribution. Intentionality reigns. Funnels replace sellers. Curation, merchandising and content nurture trust and desire. These things only increase the importance of brand. You have to learn to sell hard without anyone around.
A SKU on a webpage is worthless: A product on a webpage is worth absolutely nothing unless it is distinguished by brilliant merchandising, scarcity, price or superior fulfillment dynamics. This is strikingly obvious but important to remember. A physical store on a physical street has distribution value. A SKU on a page has zero distribution value. Either your product is unique or the things that surround it are. Retail is ruthless.
Content to commerce isn’t what you think: It’s not about writing a story and inserting a product links into it. It’s about compelling narratives intertwined with the commercial propositions. It’s just modern merchandising. Camp is a good example.
The value of niche: Content to commerce effectiveness depends on a high-quality trusted connection between buyer and seller. Curation and authority live in niches. Narrow, quality offerings work best. Think Epic Gardening.
We have to figure out how to sell with video and personalities: The connection between influential personalities, short video and social platforms has to become more and more important to product merchandising and sales (Haris will shortly challenge this, see below). The search-to-webpage continuum is slowly being challenged by new mobile, video-driven media experiences. Successful examples at bridging social authority and selling include Revolve, Meat Eater, Barstool.
Church and state collide: People don't really care about the separation of church and state, they care if you are selling a decent product. You can be completely explicit in the commercialization of your offering, as long as you add value to a transaction and stand behind what you are selling.
Back to Haris. We continued the conversation from last week. Enjoy.
Let’s take a step back and talk about sustainability. Will there be a successful and profitable segment of lifestyle retailers that are primarily ecommerce driven?
As much as my thoughts on commerce tend to sound fairly cynical, there's definitely a ton of room for brands to succeed as purely-ecommerce companies — it's just about understanding what level of scale that entails and what exit outcomes you're looking for. There are two types of lifestyle retailers from my POV — both are bootstrapped owners, but one is looking to exit as soon as the business is healthy enough to do so, while the other is looking to pocket the profits every year personally.
The latter is tough. Historically ecommerce is a pretty shitty category from a cash flow perspective. You might net $2MM but you end up re-investing a good chunk of that into inventory, so the actual FCF going into your pocket is pretty minimal every year. If you have the intelligence and hustle to build a business that nets $2MM, there are better businesses to build than ecommerce brands if your goal is personal cash flow. Commerce is very different from media companies — media sells eyeballs, and it doesn’t need to invest a million dollars to keep those eyeballs in a warehouse. When you operate a digital, no-physical-COGS business, your free cash flow can be quite healthy. When you operate an asset-heavy business, you’re often having to re-invest any profits into further inventory growth. There are obviously solutions to this i.e. leverage, but most inventory lenders will lend up to 50-60% of your total purchase orders, not 100%. You can go to more expensive lenders but then you’re cutting into your net income, which if your goal is personal profits, sort of defeats the purpose.
Now, if your goal is to be a $10m/year business with healthy margins and end up exiting for $15-20m, it’s totally doable. Recently a lot of brands in the mid seven figure revenue range have been asking for my advice around what to do next. These brands have spent years growing carefully, have raised little-to-no money and have healthy customer bases who are fairly loyal to the business. My advice is the best thing they could do for themselves is not take on any new money, continue growing profitably, try to hit $10m revenue with 15%+ margins and a loyal customer base, and flip the biz for $10-20m while owning 80%+. That's an amazing outcome and to be honest is not that difficult once you're already at a few million in revenue with strong metrics.
It's similar to the challenge that publishers faced a few years back, where the reality is most weren't going to get venture-scale outcomes and should not have had serious growth capital poured in. That doesn't mean they are bad businesses. They are just not good venture outcomes.
I know businesses who've been offered $20-30m for brands that were doing between $8-12m in revenue with $500k-3m funding, because they had strong metrics in desirable categories. The problem is most brands end up raising $5-10m once they've proven $5-10m in revenue, and now you can't really sell for $15m. You've priced yourself out. It's similar to the challenge that publishers faced a few years back, where the reality is most weren't going to get venture-scale outcomes and should not have had serious growth capital poured in. That doesn't mean they are bad businesses. They are just not good venture outcomes.
Now if your goal is to exit for a $100m+ outcome, it's extremely difficult to do so without any retail distribution. So my point is, there are a ton of great $25m businesses to be built in commerce - whether there are a ton of great $100m businesses, with little-to-no-retail, I'm not convinced. It's not that it's impossible - it will just require an extremely strong level of product market fit (super high retention, great word of mouth and organic growth, etc.) in a great category with a ton of strategic acquirers.
Should DTC brands open stores or is there a better way to think about it?
Definitely not. Opening stores comes way later — and is very difficult — and it also depends on your category. Better to focus on distribution through existing retail chains.
To dive deeper on opening stores — it's a big undertaking and if you're a new brand, it'll be tough to get real, non-organic foot traffic. If you're a niche apparel store you might be fine, because it's pretty obvious what you offer and people may browse and find something they like. I had a friend that built this high end menswear brand and he ended up opening four physical stores on top of his DTC offering, and each store was pretty profitable. But it was clear you walked into the store for suits, and suit stores aren't really the type of place where you walk in to casually check out the store.
But most categories are not necessarily retail friendly. Especially since most newcomers are really building a brand off the back of just one core hero product, which is super tough to build a store around.
Do you see a new aggregator on the horizon, analogous to the department store of the past?
I don't think so. Department stores were really just for fashion and accessories if you think about it. Do people ever really go to Macy's, Bloomingdales, or Nordstrom for anything other than clothes, perfume/cologne, and maybe a bit of cookware?
Let's break down aggregator-retailers into 3 categories — the generalists (Walmart/Target), the grocers (Kroger, Whole Foods, etc.), and the department stores (Macy's, Nordstrom, etc.).
I don't think there's a play for a generalist digital retailer.
The digital equivalent of Walmart and Target is Amazon and I don't think anyone will take that throne away from them, at least not for many decades. So the generalist category is taken care of. The grocers have had their fair share of digital equivalents, and the reality is they have to be fairly niche — Hungryroot, Thrive Market, etc.. Most are focused on health, and in general I am fairly bullish on those platforms and I like those businesses. I also think they need to remain very focused on a specific customer profile to keep working.
Lastly, the digital equivalent of fashion department stores is a little bit trickier - there are definitely a ton that exist, but also a lot of fashion brands these days have ridiculously large catalogs and are just retail powerhouses in their own right, like Revolve, Fashion Nova, Shein etc. Winners have gotten extremely sophisticated at supply chain connected to social media signal.
So really I don't think there's a play for a super-generalist digital retailer that encompasses everything and has all types of brands. Verishop is trying to do it but I don't like their model. So really you're just looking for a model like Amazon, and Amazon is already Amazon.
Related, can you build a business selling others people’s products?
Are you referring to a marketplace? If so, my belief is that it only works if the curation and audience is hyper specific. If you're a generalist marketplace like Verishop, I'm super bearish. If you're focused very specifically on a target audience and offering, like Umamicart (basically the ecommerce version of an Asian food market) and Milk Street (content around making cooking easier and better, and offering the ingredients & tools to do so in their storefront), then I'm bullish.
But these types of marketplaces are super difficult to execute - the challenge is that a $100 order on a marketplace is much lower margin than a $100 order as a brand. You're either making money off of a take rate, or you're buying the inventory like a retailer and taking your margin. Either way you're probably not getting more than $15-30 of gross margin out of that order. So the amount you can spend on customer acquisition is substantially lower and your payback window before you break even on a customer can be several months. But you have to make the math work, because given you're the marketplace and your value to merchants is that you are providing the customers.
So really the only way those businesses work is if customers become super high value, driven by high retention. Think $400-500+ per year to offset an unprofitable first-time customer, and/or the value proposition is targeted enough where you can build a very strong brand in the space and get a lot of organic growth through customers referring their friends.
Do we foresee the growth of memberships or retail clubs that trade value for some type of customer commitment? To solve the paid acquisition problem for brands.
This is a really good question and one I've spent a lot of time thinking about.
First, I want to highlight a very important nuance about the industry. It's not that it's bad to be reliant upon endless paid acquisition. It's totally fine to rely on paid to acquire customers, so long as your retention is so great and LTV is so strong that even a $25 bump in CPA barely does anything to the overall business long-term, and the integrity of your product generates organic referrals from your existing customer base. If your customers are worth $500, then whether you acquire for $40 versus $65 does not do much to harm the business long term. Clubs are great if they drive meaningful LTV value.
The way I like to see this industry is, cheap acquisition made it easier to be shitty at a lot of things. As time passed, you had to be less-shitty because the acquisition arbitrage got tighter. Now, we've officially crossed the threshold to you-cant-be-shitty-at-all. So really, the truly great brands will thrive and be okay, and the ones that are pretty good but not great, will have a tough time.
It's totally fine to rely on paid to acquire customers, so long as your retention is so great and LTV is so strong that even a $25 bump in CPA barely does anything to the overall business long-term.
But to bring it back to your original question of a permanent construct that brings efficient customer acquisition like club retail concepts. This is definitely viable as marketplace businesses and we will see more of these in various categories and niche markets — these businesses might be great on their own but I also want to highlight that they are not going to solve the distribution/retail problem for DTC brands themselves, as it’s unlikely to drive substantial scale to any individual SKU. It’s just simple math. A marketplace has to have insane numbers for it to matter for a individual DTC seller and single SKU.
I think it's super important to remember how much revenue Walmart, Home Depot, and Target bring in. Walmart generates $570B+ of annual revenue….Target generates $106B+....Home Depot generates $150B+. These retailers can bring 8-figure revenue opportunities for your brand if you can crush sell-through and get strong nationwide distribution — but remember that these are $100B+ giants.
Now to bring it back to digital retailers…the big ones like Thrive Market do a few hundred million in GMV…we're talking 0.1% of the volume of these mass-retailers. So if Thrive does for example $300M in revenue (random number) across thousands of SKU's, is there really an opportunity for individual brands to generate millions or 10's of millions through them? Not really. But is this a great business model for Thrive? Most definitely.
Again, the challenges in ecommerce almost always come back to scale. Most things work on a very tiny scale, and while those are great for your business, they won't make or break your business or get you to mass-scale in an efficient way. So club-like ecommerce retailers are definitely great businesses for the actual marketplaces themselves (like Amazon Prime), but for the individual brands, they provide a little bit of revenue and margin boost. Not a bad thing but not the answer to all your problems.
Is a Facebook alternative emerging for DTC sellers?
I'm not sure we'll have a distribution outlet that hits that level of scale and efficiency. My belief is that the key to success is to really crack your conversion metrics via high-performing funnels and customer journeys, and then layer in a number of different acquisition channels that together amount to the total distribution that FB used to provide for folks — and drive them all to those high-performing landers, advertorials, etc.. So it shifts the team focus away from hyper-execution on one media channel and instead on optimizing your funnels, and then being able to spread distribution across a number of channels because of those high performing pages.
At Miracle, we used to derive almost all of our revenue from Facebook, at a 8 figure scale. These days it's more like 25-33% from FB and we're an even larger business than before — the rest of acquisition is split across various distribution channels like affiliate, Google, TikTok, native, direct mail, etc.. Facebook is still a great pillar for us — 25-33% is no joke. But if we try to double that percentage, we're going to start losing money.
I just don't see it (TikTok) being $50k+ per day for thousands of brands, the way Facebook was for so many years.
Everyone's talking about how TikTok is the 2012 Facebook. I don't really buy that. I'm definitely bullish on Tiktok as a media buying channel, but not at old Facebook levels. I think it can get close to your current-day-Facebook scale, with a bit more efficiency, and that's only if you do it really well. Just be weary of everyone who keeps raving about TikTok ads. Almost everyone that is pushing that agenda is an agency owner and wants clients. Again, I'm not saying TikTok can't scale — it really can be a great channel to spend $3-10k a day on if you get it to work. And I know of a few brands that have found insane scale on TikTok. I just don't see it being $50k+ per day for thousands of brands, the way Facebook was for so many years. But I do think it can be 20-25% of a brand's acquisition budget and be fairly efficient, for a low 8 figure brand.
What role do you think influencers and social media play in this equation?
Not much. It is incredibly difficult to really find scale through influencers. A lot of people like to push the agenda that you now have to focus on influencers in order to diversify from FB/paid but that's kind of bullshit. Most influencers don't drive revenue, and most of the people pushing that agenda are influencer agency owners.
A lot of people like to push an agenda that you now have to focus on influencers in order to diversify from FB/paid but that's kind of bullshit.
I'm not saying you can't find revenue through influencers. Brands in certain categories like fashion and beauty can probably still get a 10-20% boost through influencers. But extremely few will super-scale their brand off of it. It's just that you have to get through so much inefficiency to find the diamonds in the rough that provide revenue. And finding a repeatable playbook for that is tough. There were definitely times where people could go all-in on influencers and it worked, I'm not so sure that's still possible. I know of a few that still did it at scale even while entering the game late, like Glamnetic and Parade around 2019 or so, but the founders of both of those brands were extremely good at that and executed very well.
Lots of people have tried to create value aggregating brands on Amazon. What’s your take on the roll up?
I've got a lot of thoughts on this space. I am very deeply involved with an Amazon aggregator in the ~$100m revenue range. So I've had a ton of discussions with them about the challenges in the space, and I looked at a lot of these deals.
My hot take is that the actual business model can be good. Many were structured in a poor way. Management teams with zero ecommerce experience, tons of equity raised at 20-30x EBITDA multiples, and very expensive debt. They all realized 3 things — 1) executing well on Amazon requires extremely disciplined operations and experimentation, and almost every aggregator failed at proving post-acquisition growth, 2) it's not just about buying "good deals" its about buying good businesses, 3) these businesses are really worth 8-12x EBITDA to a buyer rather than 20-25x, and so now you're screwed because your business is worth $100m in a sale but you've raised $30m of equity and have $100m of debt on the balance sheet, so effectively the lenders get their money back and everyone else is screwed.
Fundamentally though, if done right I believe in the model. The one I backed is doing fairly well and is not burning money (in fact they will be FCF positive and at 8 figures of EBITDA by end of year). Amazon businesses require extremely similar execution across categories regardless of what product you sell — whereas in DTC it's a whole different ball game for each brand. Amazon is a game of deeply understanding growth tactics on the platform — which is the same across your categories — and operational excellence around the supply chain. Whereas in DTC, each brand needs its own video production shoots, full-time growth team, relentless focus on managing the P&L with efficiency, and incredible product-market fit. There really isn't much synergy with other brands if you rolled 5 brands into one, because each brand needs its own dedicated team in order to really win.
So with Amazon - the fundamental business lends itself well to an operating platform. Cash flows are strong and consistent (I think something like 86% of Amazon sellers are profitable), execution is uniform across categories and brands, and the arbitrage of acquiring brands at 3-5x EBITDA into a portfolio that's worth 8-12x EBITDA is still a good business so long as you can continue maintaining or improving the growth of the brands you acquire.
That's a big if. The one I backed is doing well because the founder is a deep Amazon expert and spent 7 years launching hundreds of Amazon products as a bootstrapped operator generating millions a year in cash flow before he turned into an aggregator. Half his staff is overseas and he runs a super lean ship across 23 brands and nearly $100m in revenue.
How about DTC roll ups? Where are the real synergies? Are platform synergies different here than in publishing?
I'm super bearish on DTC roll ups. I was offered a ton of capital in the past to build one out, and so I've dug pretty deep into the model and thought through the infrastructure here.
In order for a roll up to work, you have to believe that the following exist: 1) cost synergies through a shared operating platform, 2) growth synergies across the brands in the platform.
I don't believe either of those to be true in DTC. Sure, you will be able to find cost synergies — but your execution will suffer. The problem with DTC is that in order to do it well, there are a million things you need to do on a weekly basis. You need to be relentlessly testing your funnels, creatives, paid channels, etc.. In order to really do it well, you need dedicated focus on each brand. If you end up doing it through a shared pool of talent, you're unlikely to succeed in today's era of ecommerce. It's just too hard to do it in a half-assed way.
Now in terms of growth synergies, there really are none. There are a handful of things you can do to get one brand to improve the growth of another, like email partnerships and the like, but to be honest it will drive very little scale. And cross-sell potential is fairly limited. I know of a brand at $500m+ scale that really tried to crack this, and they have one of the best teams in all of ecommerce, and they were never really able to make that strategy work. They succeeded in the end as a business but that's just because each individual brand just executed well on its own. They didn't succeed because of any real alignment across brands and there really wasn't much of a reason for those brands to all be housed under one roof in the end.
I'm not convinced 10 DTC brands under one roof will spit out cash. It's super difficult to operate these profitably, especially since there are few cost synergies like I mentioned, and few growth synergies.
Which then brings me to my next point - what is the value of a roll-up aggregator in the end? Who will buy it? A CPG strategic will not buy it, because you're likely looking at a string of brands that are very different from each other and across multiple categories. And even if they're all in one category it's not so valuable for a strategic, because they don't want a string of $10m brands — they want individual products that are category leaders and can become billion dollar brands.
So then a PE buyer? Well they want cash flow. I'm not convinced 10 DTC brands under one roof will spit out cash. It's super difficult to operate these profitably, especially since there are few cost synergies like I mentioned, and few growth synergies. Where you can start to spit out profits is if retention is really solid and/or retail distribution is very strong. But then the problem here is, if retention is great and retail distribution is great, then why have this brand under a roll up when it's probably worth way more as an individual brand to a strategic buyer? If you can actually crack retention and retail at scale then you can likely get a great multiple from a strategic, which means it would be a waste for that brand to be part of a roll up where it'll be valued off of a fairly reasonable EBITDA multiple.
So it isn't valuable to a strategic….and it isn't valuable to a PE firm unless it's spitting out cash…and it can't spit out cash if it doesn't have great retention or retail….and if the brands do have great retention or retail, they are worth more on their own. So why the roll up?
Affiliate has become such an important revenue diversification opportunity. But it’s crowded and the choke point is, once again, Google. Is the game up?
Yeah publishers are definitely facing a lot of platform dependence here. Google is a choke point and Amazon is always going to be decreasing their commission rates.
I still think there's plenty of opportunity for publishers. They will just have to get pretty smart with it though. In last week's Q&A, I wrote out my thoughts on publishers amplifying the paid opportunities for brands, and so to bring it back to that, one thing I've really been thinking about is how publishers can be the middle layer between a paid media channel and an acquired customer on a landing page. If publishers can figure out a way to be the middleman, with 10-30% greater acquisition efficiency (and can find scale) there's a ton of money to be made. The publisher-hosted, direct-response UX-driven advertorials were a great example, because if those can drive CPA's at $20 lower than what brands are paying on their own funnels, there's a $5 spread that a publisher can demand right there that a brand would be more than happy to pay.
If publishers can figure out a way to be the middleman, with 10-30% greater acquisition efficiency (and can find scale) there's a ton of money to be made.
And these opportunities can scale, because like I mentioned, advertorials have the ability to generate millions in revenue as an evergreen pre-sale page on a funnel, in the same way that one landing page can generate millions over a long time frame. So if publishers start to think like this, I think they can make a lot of money in commerce, especially since all merchants are actively thinking about how to find hacks to get greater efficiencies in ad spend.
To sum that up - if publishers focused on figuring out strategies like this, they're really just figuring out a game of distribution and acquisition, which is something they are inherently good at. Whereas what they've done to date — trying to figure out how to really operate ecommerce in a deeper way — is just something they're not inherently good at. So I'd bet publishers have a greater chance at cracking this than other things they've tried to do in commerce.
Once again, thank you Haris. You have given readers terrific perspective. Don’t forget to sign up for Haris’s new commerce newsletter, The Merchant.
Have a great weekend.../ Troy