Five traps to avoid: The long game of DTC and e-commerce

| Article

Key takeaways

  • The pandemic has only accelerated consumer demand for the ability to buy online.
  • Merely selling online is very different from building a sustainable e-commerce business.
  • Companies need to avoid five traps when launching direct-to-consumer operations.

It happened so quickly it almost felt miraculous: companies around the world pivoted to e-commerce in response to the COVID-19 pandemic. Seemingly overnight, online ordering and delivery was available from restaurants and grocery stores, coffee shops, and traditional retailers. It was a triumph of business ingenuity as companies sought to keep their doors open in the face of an unforeseen challenge.

For many, it worked. E-commerce sales penetration in the United States more than doubled to about 35 percent in 2020 from around 16 percent the previous year, the equivalent of roughly ten years of growth within a few months. Companies that successfully captured the business of consumers who were purchasing more online saw e-commerce climb to almost 50 percent of their overall revenue, a level expected to persist or increase as consumers continue to demand greater buying flexibility. This shift is expected to be durable: around 55 percent of Chinese consumers are likely to continue buying groceries online after the peak of the crisis.

The challenge? Even if it felt as though everyone was buying everything online, large retailers were the primary beneficiaries, as they had invested in e-commerce capabilities for years and could therefore adapt quickly to the changed consumer behavior. Small and medium-size retailers (those with less than $5 billion in annual revenue) and brand manufacturers, such as consumer packaged goods and apparel companies, still realize a much smaller portion of revenue from e-commerce. These companies have a long way to go to build successful e-commerce businesses, and as parts of the world move toward the next normal, cracks are appearing in e-commerce operations that companies rushed to launch.

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Getting e-commerce right

Investing in e-commerce can be costly, but those who do it well enjoy a significant return on investment. A recent survey of 800 executives revealed that companies got better revenue growth from launching a new business than they did from traditional growth efforts, such as new products and services. The tricky part is execution: 30 percent of consumers who have a bad experience with a brand don’t return, and that rises to more than 70 percent if consumers have three bad experiences.

At a time when brand loyalty remains shaky with 75 percent of consumers trying new digital behaviors, it’s critical from day one to think about how decisions will impact your ability to scale. Companies trying to move fast to launch an e-commerce business or a minimum viable product (MVP) often make short-term decisions that hamper their ability to scale six to 12 months later. That’s when it gets hard, and the right foundation becomes essential: only 24 percent of new businesses launched in the past ten years have become viable large-scale enterprises (see sidebar, “What great direct-to-consumer looks like”).

We’ve identified five short-term traps that often hamper companies’ ability to successfully grow over the long term.

1. Leading with tech focus

Companies often take a sequential approach to building their e-commerce business, focusing first on technology and development while deferring focus and investment in areas such as operations and channel management.

A $2 billion consumer-products company launching its direct-to-consumer (DTC) business was laser-focused on its website, heavily investing in development and design to keep pace with the desired launch timeline. Indeed, successful site launch was a key success metric for its IT and DTC leaders. The site went live on schedule, but the DTC business constantly lacked inventory: some key stock-keeping units (SKUs) driving more than 15 percent of revenue had out-of-stock rates of more than 40 percent. The problem? Sales and operations leaders didn’t have the same objectives and success metrics as the IT and DTC teams. Operations hadn’t built the proper stock-management and planning processes needed to support the new business, and the company’s sales teams allocated products to wholesale customers rather than DTC.

2. Building a directionless tech stack

Companies often architect and make technology, design, or ecosystem decisions for quick launch. But the wrong technology platform, architecture, or partners will create significant technical debt, hampering efforts to scale, and adding cost, complexity, and delays to unwind and rebuild.

A midsize European retailer with more than 500 retail stores selected a seemingly turnkey e-commerce partner to rapidly launch its online sales site. It worked—in the short term. But when the retailer sought to scale the business, it ran into significant challenges. One was high ongoing costs—since many turnkey e-commerce platforms are best designed and optimized for simpler businesses, the retailer’s technology costs doubled as it sought to expand to multiple geographies and brands. Another was slow feature updates. Developers copied and pasted code as a shortcut for speed, but this created challenges when making updates or adding new features. Rather than changing code once, a change in one place had to be individually changed everywhere.

3. Underinvesting funds and capabilities

Companies often seek to mitigate the risks of launching e-commerce businesses by spending as little as possible, borrowing resources and talent from other parts of the organization and expecting an immediate ROI for every dollar spent.

A consumer-services company launching an e-commerce business took only a six-month view of the expected ROI, barely dedicating enough funding for launch. The problem? First, although it had hired an e-commerce leader, it relied heavily on personnel borrowed from other functions, such as IT and operations, for all other roles. At one point, only three of its 15 e-commerce employees were dedicated to and hired for that business, and it hadn’t begun building a pipeline of candidates for other positions filled by borrowed resources. After launch, the company couldn’t scale beyond its first market. Using borrowed resources had stalled needed recruiting, and the opportunity to hire and train new talent was lost when the borrowed employees returned to their primary responsibilities. Second, the company expected a positive return on advertising spend for any marketing efforts, leading the marketing team to take a conservative approach to acquiring traffic: it spent around 3 percent of revenue on digital marketing, compared with up to five times that amount allocated by other companies in start-up growth mode. After two months, site traffic for the company’s e-commerce business had barely moved.

4. Learning the economics on the fly

Companies often don’t fully understand what unit economics look like, and they make short-term decisions that stifle growth, or they implement a business model that needs to be redesigned and slows down forward momentum.

A large national food distributor building an e-commerce and DTC business believed it could deliver and manage its supply chain for e-commerce by leveraging the scale of its existing operations. Yet after launching and delivering to customers, it discovered that the existing operations model was inadequate to profitably scale the business. The company’s warehouse network was optimized for B2B, not for fulfillment and shipping, and the cost of adding those services for e-commerce and DTC was equal to 20 percent of revenue, making it the primary driver of their unprofitability.

5. Building the new business too close to the core

Corporate business-building activities are often hampered by certain challenges associated with working in a legacy organization. In a survey of executives involved with corporate venture capital (CVC) incubators and accelerators, almost half of the respondents said internal policies had slowed the development of new businesses. Fewer than 10 percent said their companies had given start-ups full freedom to operate.

A leading consumer-products company struggled to launch its new digital business without the right digital talent. As a well-known consumer company, they had no problem finding candidates, but technical talent, such as developer and product managers, found the new business lacking in the advantages they perceived in start-ups. For example, they would be required to work at corporate locations, such as Austin, San Francisco, or New York, which were far away from where they lived. Additionally, the recruiting process took months due to chains of approval required for headcount and aligning schedules. This gave candidates used to fast-paced start-ups the impression that this was a company where they couldn’t move fast.

DTC e-commerce: How consumer brands can get it right

DTC e-commerce: How consumer brands can get it right

What you can do to avoid these traps

If any of these traps sound like something your company might be doing today or could fall into, the good news is there are some key actions that can be taken to avoid them. Critical to each is keeping the customer experience at the forefront. Taking these actions without having the customer in mind is likely to have little or no impact.

Growth trap 1: Leading with tech focus

Make e-commerce a priority and tie performance goals to outcomes for all cross-functional leaders. If you’re thinking about launching a DTC or e-commerce channel, prioritize that aspiration for all functional leaders, then design and build all elements of the business in parallel.

For example, before 2020, Nike set a goal of deriving 30 percent of total revenue from e-commerce sales by 2023. Nike hit that goal three years early but had set itself up for success years before. In 2017, Nike aligned objectives across the business to prioritize its DTC business setting a goal of three milestones, “2X Innovation, 2X Speed, 2X Direct.”1 Now, the company is on track to break 50 percent of total revenue from e-commerce.2

Growth trap 2: Building a directionless tech stack

Define the longer-term architecture and build your minimum viable product (MVP) as a steppingstone toward the target state. An MVP is critical to prove business value and validate design decisions. Therefore, the MVP design and ultimate state should be based on target-state considerations such as desired customer journey, geographic and brand footprint, flexibility to add new features, and ROI.

For example, Williams-Sonoma’s e-commerce revenue penetration rose to 70 percent in 2020 from 58 percent a year earlier, attributable in part to its investment in building a scalable, modern e-commerce platform. Williams-Sonoma comprises multiple brands beyond its namesake, such as a Pottery Barn, Pottery Barn Kids, and West Elm. Its single platform allows it to create a different look and feel across all properties while at the same time testing new capabilities that can quickly and readily scale across all.3

Growth trap 3: Underinvesting dollars and capabilities

Create a “learning buffer” in your budget. As a promising business starts to scale, it’s important to acknowledge that there will be setbacks. They are a reality of building a business and necessary, in fact, to learning and progress. That reality needs to be reflected in budgets. A learning buffer doesn’t mean providing the new business with infinite funding. The best enterprises release funding as the new business hits set targets. That money, however, needs to be ready to go to avoid endless rounds of approvals, which blunt the new business’s momentum.

A US consumer-products company continuously invested in online marketing as long as the investment broke even. The DTC business aligned this with finance to continually allocate marketing dollars in six-month increments so long as it achieved this metric. This allowed it to learn and refine its campaigns and algorithms to the point that by the end of six months, the DTC business could predictably achieve a fivefold return on marketing spend.

Growth trap 4: Learning the economics on the fly

Understand the key drivers of growth and profitability through the lens of profit and loss. A deep understanding of unit economics can help identify where you need to invest, further determine where to build or partner, or define the right revenue model for a scalable, profitable business.

A leading consumer electronics company with more than $10 billion in revenue increased its e-commerce earnings before interest and tax (EBIT) by 50 percent through two strategic decisions: first, it outsourced its warehouses, and second, the company reinvested the savings into its technology platform to focus on customer experience and personalization. It realized it could not operate a supply-chain network as efficiently as much larger players, and outsourcing reduced its supply-chain costs by half. On the other hand, the company realized its DTC conversion rate lagged competitors, and focusing investments on personalization and marketing drove EBIT growth by increasing conversion rates even as traffic increased.

Growth trap 5: Building the new business too close to the core

Create physical virtual distance between the new e-commerce and core businesses. Physical separation allows companies to establish new centers to attract expertise and entrepreneurial talent who collaborate with more agile ways of working. Companies can also create virtual separation by minimizing obligations to the legacy features of the parent company such as giving freedom for financial pressure, from red tape, and to source talent.

In the United States, Walmart opened Silicon Valley offices to attract top tech and entrepreneurial talent to accelerate its technology and e-commerce ambitions. In 2014, Walmart employed approximately 1,000 tech employees, and today is one of the largest tech employers in Silicon Valley with over 10,000 software engineers, data scientists, and machine learning engineers. Walmart has taken these learnings to grow a tech community at its headquarters in Bentonville, Arkansas, and even influence its core DNA.

The desire to launch e-commerce capabilities rapidly is understandable—and important, given the changes in consumer behavior. But ensuring that decisions are considered carefully from day one is critical to building a foundation for long-term success.