Acquisitions Often Cause Direct-to-Consumer Brands to Shut Down Operations
Revamped Article:
A casual look at the bustling world of direct-to-consumer (DTC) brands reveals a captivating scene of young, hip companies aiming to disrupt the giants in their respective spaces. Their essence is often built on the notion of being fresh, vibrant brands that genuinely understand customers – a stark contrast to the older corporations.
So, why then do numerous DTC brands willingly succumb to being purchased, sometimes even by those identical corporations they initially sought to challenge?
Step back into 2002, when ModCloth emerged, its mission being to champion a vintage, feminine, and lively fashion aesthetic. From inception, this clothing brand aimed to set itself apart from the rest by offering inclusive sizing and enacting anti-photoshopping policies.
But the intriguing brand, fiercely loved by its customers, was snapped up by no other than Walmart in 2017. This acquisition appeared to buck the trend, aligning poorly with Walmart's stereotypical clientele and potentially driving away the DTC brand's devoted customers. Some ModCloth customers at the time expressed dissent or disappointment with the deal.
Deals like these, particularly within the Consumer Packaged Goods (CPG) sector, often safeguard brand reputation and open a plethora of opportunities for DTC brands – robust supply chains, new distribution channels, and additional capital to foster business growth.
From the highs in 2019 (131 acquisitions) to the relative lows in 2021 (114 acquisitions), DTC acquisitions have remained above the 100-per-year mark, with 66 already locked in for this year.
Acquisitions exceed 100 per year for the past five years
So what makes this exit option so alluring to both DTC brands and their potential acquirers, and what risks are involved?
What DTCs stand to gain from an acquisition
In the life of a DTC brand, there comes a point when it requires more capital to continue its expansion. Alternative methods for securing cash, such as seeking additional funds from venture capital firms or considering an Initial Public Offering (IPO), often take the backseat. Thus, acqusitions tend to be the preferred route.
A acquisition by a larger firm in the space may offer DTC brands the resources they need for sustained growth, such as marketing expertise, stronger supply chains, access to new customers, or a broader distribution network.
"Scale is an essential factor for success in business. That comes with negotiating leverage with suppliers and distributors," said Alex Song, CEO of DojoMojo. "Resources are a significant factor, and these larger businesses are generally geared towards profit, which means they have funds and resources to invest in different brands."
With that added capital, DTC brands gain more flexibility to branch out into adjacent categories, expand into new markets, or bolster their teams. Following Unilever's acquisition of Dollar Shave Club in 2016, the brand broadened its selection to offer things like deodorant and wipes, brought on executives from Target and Nike, and unveiled vending machines in mass transit stations offering trial-size versions of its products.
Simultaneously, an acquisition—versus alternative exit methods like an IPO— keeps several aspects of the business private, notably its financial reports.
While DTC brands have jumped aboard the favorable stock market, recently filing for IPOs, these filings have underscored the challenges that digital brands face when it comes to turning a profit. Casper's 2020 IPO, for example, revealed that its revenue was climbing, but so too were its losses. High marketing costs associated with acquiring new customers proved a major hurdle. Between 2016 and 2019, the company reportedly spent $423 million on marketing expenses.
Casper's stock took a beating just over a month after it went public, hitting a record low of $3.18 per share on March 20 last year.
"For Casper, hindsight is 2020, but it's unfortunate that they didn't manage to land a really killer strategic acquisition," Song said. "Sometimes it's better to take the win sooner."
Similar struggles with profitability are seen with Warby Parker and Allbirds, both of which recently filed for IPOs.
Brands are scrutinized under the public microscope; acquisitions offer relative stability
Once they've set their sights on a brand, acquirers tend to look more at the broader picture: Is the company credible? Will it fit well within their portfolio?
"When you're looking for a steward of the brand, or a partner to help you enter new markets and distribution channels, that's not typically an IPO. That's typically a strategic acquisition," said Matt Katz, a managing partner with SSA & Company.
What larger brands obtain from an acquisition
These benefits to DTC brands certainly entice their potential buyers, as acquisitions grant access to valuable assets like the brand's data, e-commerce expertise, and clientele. Many DTC brands have adopted aesthetics particularly attractive to younger consumers, so through acquisition, a larger company can target these consumers. Retailers like Nordstrom, Walmart, and Target have partnered with DTC brands for similar reasons: remaining relevant and appealing to a younger demographic.
Additionally, acquisitions expand a company's reach into new markets. When Lululemon acquired Mirror in 2020, the at-home fitness startup gained access to the retailer's customers by being integrated into its stores, but more importantly, "Lululemon also gained access to a new market it hadn't tapped into previously."
Talent and innovation merge in a harmonious dance of business
Oftentimes, DTC brand founders or existing leadership are brought onboard as part of the acquisition deal. These executives' expert knowledge is a massive draw for many acquirers. Edgewell, the company behind shaving brands Schick, Wilkinson Sword, Edge, Personna, and Skintimate, was ready to acquire Harry's—and was thrilled about the opportunity to bring Jeff Raider and his team aboard.
"They're acquiring value from now having those founders in-house," Song said. "I think the Harry's deal—they were really excited for Jeff Raider and his team because they were going to bring a new level of innovation."
Similarly, when Walmart took on Jet and Bonobos, it also welcomed Marc Lore and Andy Dunn to its team to help transform its digital operations. Acquisitions provide a great way to get the talent you need, helping to drive innovation and encourage growth within your business.
This isn't always the case, and sometimes a DTC brand founder steps down from their CEO role shortly after the brand is acquired. Just over a year after Lululemon purchased Mirror, Brynn Putnam, the brand's founder, announced she would step down from the CEO role.
Part of the reason may be due to a shift in power dynamics.
"If you've been the king or queen of your business for five or ten years, and suddenly someone wants you to be a knight in someone else's kingdom, it's simply not a sustainable arrangement for very long," said Song. "You may comply, but I don't think you'll stick around for the long haul. You'll do it to collect your payday, but I don't think you'll stick to it for the long run."
Other founders have been replaced by veteran retail executives as CEO. For example, in January 2021, Dollar Shave Club founder Michael Dubin was replaced as CEO by Jason Goldberger, who had previously worked for Sur La Table, Target, and Amazon.
In some cases, founders just move on to the next thing.
"I believe that most founders, once they reach the point where they intend to sell their business and someone else will control it, already have a roadmap in mind for moving on," said Song. "You're effectively planning a new path to realize your dreams and satisfy your investors' expectations. While there's the potential for harm to the brand itself, ultimately, the decision is made behind closed doors by investors and CEOs."
Through an acquisition, a larger company may also be seeking expertise and resources it currently lacks, such as real estate or specialized capabilities—choosing to acquire a brand that already has these attributes rather than building them in-house is often the quicker choice.
"You're acquiring a capability that your existing team may or may not have," said Katz. "They're after a new distribution channel from a brand house they didn't have previously. They made the decision that it would be easier and they'd receive faster value from the acquisition than from building it themselves."
As it becomes increasingly clear how tough it is for DTC brands to operate profitably, some larger companies begin to question whether an acquisition may be more work than anticipated. If a brand isn't demonstrating a clear path to profitability, some companies may choose to cultivate a brand in-house rather than buying one.
"They don't want to take on a company that's burning through cash," said Andrea Hippeau, a partner at Lerer Hippeau.
In recent years, Walmart has bought a number of DTC brands, such as ModCloth, Elloquii, Bonobos, and Bare Necessities, in an effort to bolster its e-commerce operations.
In 2019, Walmart's e-commerce division was projected to lose $1 billion on revenue of $22 billion, and was even considering selling off some of its recent acquisitions, including Bonobos and ModCloth, according to a Recode report. Walmart eventually sold ModCloth to financial services firm Go Global Retail for an undisclosed amount.
"It used to be that larger brands would purchase unprofitable, high-growth brands just to get growth velocity," said Hippeau. "Now, bigger companies are looking for businesses that can function independently within their larger business."
The allure of fitting seamlessly into an established ecosystem
When Lululemon purchased the consumer-facing technology company Mirror, it unlocked access to a burgeoning market with plenty of room to grow. But many brands operate in the CPG space, where their products are already well-established on a large scale. True, the brands may adopt a sans-serif font and a color scheme preferred by younger consumers, but their products and manufacturing process aren't revolutionary.
"We're not building a brand that's never existed, like a totally new data platform. There are plenty of alignments that make it attractive for strategics to be the ones to acquire these brands because they'll fit snugly within the existing physical world, complete with infrastructure and capabilities," said Song. "You'll get synergies from being able to strip out costs, or speed up revenue growth due to new distribution channels that an incumbent strategic, larger business has already established."
By being acquired, brands gain access to advanced supply chains, enabling their founders to focus more on growing the business and less on fundraising and investing.
"After being acquired within a larger entity, I no longer have to worry about finding funds, nor deal with investors demanding an exit timeline," said Song. "I think sometimes people forget how distracting fundraising and investor relations can be for a founding team."
What's at stake?
While an acquisition presents ample opportunities for growth, it comes with risks.
In some cases, a larger company may acquire a smaller brand but fail to provide it with the attention it needs, creating a gradual obsolescence. There's also the risk of alienating the brand's current customer base by integrating it into a larger company. At the time Walmart purchased ModCloth, some questioned the retail giant's motives and how the quirky brand—and its devoted customers—would fit under Walmart's umbrella.
However, ModCloth might be the exception rather than the rule. In many cases, CPG brands have less emotional connections to consumers.
"Harry's is edgy for a razor brand, but I'm sorry, we're essentially talking about razors," said Song.
There's also the risk that a brand grows too large to be attractive as an acquisition target, making it difficult to achieve a return on investment that investors desire. A company like Warby Parker, which has secured significant funding over the years, would need an enormous acquisition offer to make sense for investors, as it would have to distribute a large portion of the sale proceeds to investors to generate a reasonable return.
"You essentially force yourself down a path where you must IPO because you've become too large for an acquisition," said Song.
Even when deals seem mutually beneficial and appear to be moving forward, they don't always make it to the finish line. That's because the Federal Trade Commission (FTC) and the U.S. Department of Justice work to enforce federal antitrust laws to preserve a competitive landscape and protect consumers.
The Clayton Antitrust Act of 1914, enforced today by the FTC, addresses unethical business practices, such as monopolies or price fixing. Section 7 of the Clayton Act blocks mergers, acquisitions, and some joint ventures where "the effect of such acquisition may be substantially to lessen competition, or to tend to create a monopoly."
In recent years, two separate shaving brands were set to be acquired by larger CPG giants. Harry's would have been picked up by Edgewell for nearly $1.4 billion, while Billie was eyeing a deal with Procter & Gamble. Both transactions ultimately fell apart following preliminary injunctions from the FTC.
The argument was that because these DTC shaving brands had disrupted their sectors, merging the brands into the larger CPGs already dominating the space threatened competition.
"If you examine that market, there's a long-standing duopoly—two companies that dominate the industry. This has been happening for decades," said Sally Hubbard, director of enforcement strategy at Open Markets Institute. "What happens when companies don't face competition is they can start manipulating consumers."
Razor manufacturers for years artificially inflated prices and even designed products that limited consumer choice (e.g., compatibility with specific razor replacement heads).
"Now, we have a company that can break into the market, and we're starting to see prices drop and innovation pick up," said Hubbard. "By the FTC stepping in, they're hoping to preserve that competition and prevent the dominating CPG companies from eliminating the DTC competitors."
These deals fell apart just four years after Unilever successfully acquired Dollar Shave Club.
"I'm not certain you could have predicted that," said Hemant Kalbag, a managing director at Alvarez & Marsal.
While the FTC and DOJ use the Clayton Act as a standard for identifying anticompetitive mergers, it's quite broad. Over time, it has been "narrowed" by antitrust laws developed by judges, leading to some anticompetitive mergers being approved. "What we've actually seen is a real weakening of antitrust law in recent decades," said Hubbard. "But the recent upswing in enforcement reflects a need for a correction."
In the case of the shaving company investigations, the FTC's motive was to protect consumers by preserving competition within the DTC sector, potentially precluding the development of monopolies in the future.
Even after witnessing two major deals fall apart in the DTC space, there is a lingering concern that, "I've put in all this work to court these larger brands, only to have my efforts result in nothing," said Kondrat. "I'll be forced to either go it alone with an IPO or remain private but continue moving forward."
While some brands begin considering an exit from day one, the best approach may be to focus on sustainable growth rather than building a brand for an acquisition or another exit route, according to Hubbard.
"Often, direct-to-consumer companies see the most success with monopolized markets," she said. "Rather than looking to be acquired by a monopolist or a duopolist, these companies should aim to build the next great company. Rather than being fixated on the notion that every business must exit through acquisition, this mentality will lead to a monopolized economy and stifle innovation."
[1] Boston Consulting Group (BCG)
[2] Civic Science
[3] Digital Commerce 360
[4] Digital Commerce 360
[5] Salesforce
- DTC brands, in search of sustained growth, often turn to acquisitions, offering resources like marketing expertise, stronger supply chains, access to new customers, or a broader distribution network.
- With an acquisition, DTC brands gain more flexibility to branch out into adjacent categories, expand into new markets, or bolster their teams.
- Larger acquiring firms are typically geared towards profit, which means they have funds and resources to invest in different brands.
- Unilever's acquisition of Dollar Shave Club in 2016 was a significant example of a DTC brand broadening its selection, bringing on executives from Target and Nike, and unveiling vending machines in mass transit stations.
- An acquisition, versus an IPO, keeps the brand's financial reports private.
- Casper's 2020 IPO reveled the challenges digital brands face when it comes to turning a profit, with Casper's stock taking a beating just over a month after it went public.
- For DTC brands, the broader picture for potential acquirers includes assessing the brand's credibility and whether it will fit well within their portfolio.
- Talent and innovation often merge in a harmonious dance of business in acquisition deals, with DTC brand founders or existing leadership often being brought onboard.
- Through an acquisition, a larger company may gain expertise and resources it currently lacks, such as real estate or specialized capabilities.
