How Unicorns Disappear
They were never real in the first place…
Are Direct To Consumer “DTC” bands joining the “VC fund my life” crowd and in danger of being the needle that pops the bubble?
WebVan — a cautionary tale from the VC crypt
We were really excited for Andy Katz-Mayfield and Jeff Raider, the founders of Harry’s Shave. After 9 years of truly impressive hard work, they had their exit — a $1.3B acquisition by Edgewell Personal Care, the owners of Schick. The valuation (12x LTM revenue) was eye-popping to us, especially for a distant #2 market share when most direct-to-consumer (DTC) acquisitions have seen the acquired companies’ growth come to a screeching halt post-purchase.
We had also had a small investment with Michael Dubin’s Dollar Shave Club when it was acquired by Unilever for $1B in cash three years earlier. At first, we wondered if Dollar Shave Club had sold the #1 brand in DTC men’s grooming too soon. But on closer reflection, it became clear that the DTC space is a dangerous place for attackers or incumbents. Harry’s eye-popping valuation may have been the high-water mark before a painful retrenchment that is just beginning.
Michael J. de la Merced looked at the impacts of this acquisition on market share,, writing that in “the men’s shaving market, the combined Edgewell and Harry’s will remain a distant second to Procter & Gamble’s Gillette brand, which commanded 47.3 percent of the American market last year, according to data from Euromonitor. Edgewell’s top brands held about 13.6 percent of the market, while Harry’s had about 2.6 percent.”
Arye Zucker also wrote an interesting post after Black Friday last year, starting with an interesting question: “Does anyone buy that stuff splashed on Instagram and Facebook feeds?” They looked at eight brands for the post: Adore Me, Allbirds, Away, Everlane, Glossier, ModCloth, quip, and Thirdlove, and according to Rakuten Intelligence, buyer growth across these eight merchants is 44.5 percent.
The question that we had was a little different: Are there real businesses to be built by great founders attacking with the Dollar Shave Club playbook?
We could be in the early innings of a DTC attacker wave that will crush stumbling giants like Gillette and Victoria’s Secret. Consumers are starting to want both different and better products delivered in a way that works for them and the large incumbents seem to have a classic innovator’s dilemma, leaving them unable to move fast enough to beat back the VC attackers.
Or, are these unicorns that disappear because they never had a business in the first place? Is the game almost over, with money being invested by VCs now ultimately subsidizing the delivery of products to consumers? Many of this next wave of companies appear to be just subsidies financed by VCs, AKA “VC fund my life”. This not the first DTC wave of this kind of company, nor the 2nd (Zappos, founded 1999), or even 3rd (ShoeDazzle, founded 2009). We may be getting close to this point in the 4th wave, and what you can say with certainty is that it does not end well for founders and VCs who do not build real businesses and wait too long to get out.
The most classic example of what not to do was Webvan, founded in 1996, aka a dot.com company.
As posted on Wikipedia, Webvan’s investors pressured it to grow very fast to obtain a first-mover advantage. This rapid growth was cited as one of the reasons for the downfall of the company. Webvan placed a $1 billion order with Bechtel to build its warehouses and bought a fleet of delivery trucks. At its peak in 2000, Webvan had $178.5 million in sales — but it also had $525.4 million in expenses. In total, venture capitalists invested more than $396 million in Webvan.
Do some of the behaviors sound familiar? They should, some of the same players are running the same playbook again.
Webvan raised an additional $375 million in an initial public offering in November 1999, during the dot-com bubble that valued the company at more than $4.8 billion. Up to that time, the company had reported a cumulative revenue of $395,000 and net losses of more than $50 million. Webvan lost over $800 million and shut down on June 2001, filing bankruptcy and laying off 2,000 employees.
Webvan is one of many examples of a “non-business”, who can happily subsidize consumer experiences with products/delivery for a period of time, but ultimately kneecaps everything around them. As an operator in 2001, our company Digital Island was kneecapped by Webvan and other dot.com customers that disappeared overnight. We lost 50% of our revenue in a month when all the “you don’t get it” dot.com customers stopped paying their bills. Good businesses, public investors and hard-working innocent people were wrecked by the carnage that followed, not just the “non-businesses”. This ultimately led to the first dot.com bust.
Will this time be different? There are reasons to hope, but the math is looking eerily similar..
On the positive side, digital newcomers still represent only a fraction of the overall market share in most segments, according to the report, which analyzed sales data from IRI market research firm for 90 categories of goods. Startup brands accounted for only 2 percent of market share across the 45 product types they disrupted from 2012 to 2016, the report said. Venture-backed DTC attackers captured a quarter of the growth in that time.
Being small works well when going after a very large market share player that is “fat, dumb, and happy”. Especially if they have very high gross margins, undifferentiated products, and legacy distribution. This was the opportunity that Michael Dubin, founder of Dollar Shave Club, saw going after Gillette. Rick Rasmussen did a great job of breaking down this market thesis.
However, it is clear from the subsequent market behavior, that the door is closing very quickly for VC-backed DTC companies. The market targets with high gross margins and with high market share incumbents are thinning quickly. The cost to attack is going up exponentially, driving the marginal profitability of a customer into the negative. “VC fund my life”.
The data is still not totally clear, but what is clear is the clock is running out. Founders going after this strategy will need to be exceptional, be the #1 attacker, and will need a lot of money to even have a shot.
The data we were able to pull together from public sources, is not perfect or exact. However, it does seem to be clear enough for the purpose. We looked at a couple of the prominent investments in the DTC space. We looked at the amount of money raised, the amount & quality of the revenue, and the returns (actual or projected). We then contrasted the basket to both Dollar Shave Club & the Webvan case studies.
We looked at a couple of the recent transactions, and even for those of us with some worn tread, it seemed jaw-dropping similar to the Webvan cautionary example.
Just including four of the better-known names in DTC, the total spent to create $1B in revenue has been over $1B, with massively negative cashflows and zero profits. It seems unlikely that capital markets will continue to fund companies that have no profits and no prospects of profits. Every $1 of investment gets you $1 of revenue, losing money on every shipment to a customer — it seems crazy to us.
We are staunch adherents to the art and craft of capital-efficient growth at BreakawayGrowth. There is both art and craft to it, and it is extremely hard to execute. Only 0.3% of companies funded by VCs get to both $1B in revenue & profitability. The median time to get there is 12 years — a lot of hard work.
We have been privileged to work both as operators and investors with great founders and the teams at Newbridge, SuperCell, Juniper, DSC, VMware, and more recently, Pinterest and DocuSign, who built real businesses creating value for consumers and shareholders.
Ending this one summer reflection “from the lake”, we are very glad Michael Dubin exited Dollar Shave Club when he did. More importantly, we are very glad that he had the discipline to build a real business that created value for consumers and shareholders. This seems to be a quality that is harder to find these days. We are fortunate to have the opportunity to invest in a couple of these founders in our new fund.
For those still in the late innings of “the DTC game”, be careful — it is starting to look like a Ponzi scheme. Public and small investors should not be victimized that same way they were in 1999 & 2000. Companies that never make money are not a business. Certainly, not one we understand. Amazon is often the counterexample, but it is the counterexample of one that is now profitable with very high positive operating cashflow.
When this bubble bursts, just like in 2001, everyone will lose badly, and the individual retail investor will be hurt worst of all. This is a moral hazard that those of us who have seen a cycle or two have a duty to be prudent about and speak out about. There can still be good exits — often to the incumbents that are facing the DTC attackers. There can be good logic in this for the buyers and the sellers with a good balance of information and knowledge. However, it is our belief these exits for wave 4 will increasingly look like Bonobos and less like Harry’s.
If we are right, the impacts on the entire innovation community will take a big hit — worse than in 1999. Minimizing the collateral damage on good founders, companies, and investors are worth an open conversation. If we are wrong, and the “new math” from the “you don’t get it” crowd works, then great for them!
However, we tend to see math as math. As the saying goes, history does not exactly repeat itself, but it does rhyme.
