There’s a “really big shakeout” looming in the direct-to-consumer world — not unlike the dot-com bubble burst decades ago. Lindsay Drucker Mann feels it in her bones. But she’s sure her digitally native makeup brand Il Makiage will come out on top, asserting its dominance over other less tech-savvy merchants.
Given her investment banking pedigree — a nearly two-decade stint at Goldman Sachs, where she served as managing director and head of consumer and consumer-tech equity capital markets — she’s well-positioned to evaluate the retail industry and make predictions. And Q1 and Q2 earnings have been rough for a lot of Il Makiage’s peers, she says.
“A ton of direct-to-consumer companies are in a poor cash position, are burning cash, are not profitable — and they’ll need to find alternative sources of funding from outside capital. Or they’re significantly cutting a lot of costs, including their customer acquisition and marketing expenses. As a result, their top line significantly slows or contracts,” says Drucker Mann, who was brought on as the global chief financial officer for the fast-growing brand’s parent company, Oddity, in September 2021. “That’s not our issue.”
Lindsay Drucker Mann, global CFO at Oddity
While other companies are wondering “How on earth are we going to make rent this month?,” Il Makiage and Oddity leadership’s biggest challenge is figuring out what to do with all of their money, she adds. According to Drucker Mann, the brand is completely self-funding, and its cash position is growing. So now, it’s a matter of identifying the biggest opportunities and prioritizing the investments that will have the highest returns. That includes continued nurturing of Oddity’s recently launched wellness brand called SpoiledChild, building — or acquiring — additional new brands to plug into the company’s tech platform and more expansion into international markets, Drucker Mann says.
Il Makiage, a social media darling that bills itself as “makeup for maximalists,” must be doing something right. The company has found a way to achieve big — and steady — online growth since it burst onto the scene in 2018 and raked in $10.0 million in sales. By 2019, web revenue increased 400.0% to a Digital Commerce 360-estimated $50.0 million. It then tripled, reaching an estimated $150.0 million in 2020. That was despite consumers largely skipping the full makeup routine as the pandemic raged, employees worked from home in loungewear, and social events like parties and weddings were canceled. (Although the widespread lockdowns and subsequent quarantine lifestyle did lead to a surge in online makeup tutorial devotees as consumers tried to stave off boredom with new hobbies.)
Last year, Il Makiage nearly doubled the brand’s online sales to an estimated $293.4 million. (At one point, Oddity confirmed Il Makiage surpassed $260.0 million in ecommerce revenue for 2021, but the company declined to give more specifics since then.) And once again, it topped the list of the fastest-growing retailers in the health and beauty category within the 2022 Digital Commerce 360 Top 1000, a ranking of North America’s biggest online merchants. The brand has occupied a spot on the list of top 10 growers overall — most recently claiming the No. 8 slot behind three other brands — for years, too. It also came in second in 2021 growth among all Top 1000-ranked digital natives.
In January, Oddity announced it secured another $130.0 million in funding at a $1.5 billion valuation. And lately, rumors have been swirling that the company is considering an initial public offering. Drucker Mann declined to comment on the speculation.
But after a decade or more of web-first brands — like eyeglasses pioneer Warby Parker, millennial beauty favorite Glossier and eco-friendly shoe brand Rothy’s — generating a lot of buzz and commanding the attention of the retail industry, Oddity is coming of age at a challenging time for this group. Experts agree that growth is harder to come by, macroeconomic factors like inflation haven’t helped boost consumer spending, and supply chain snafus — a particularly thorny issue for brands looking to scale — have persisted. Additionally, profitability is elusive, funding is drying up, and the path to an IPO has largely disappeared.
Eric Roth, managing director, consumer at MidOcean Partners
Eric Roth, managing director, consumer at private equity firm MidOcean Partners, is one such voice sounding the alarm. This cohort of digitally native, vertically integrated brands, or DNVBs, has “lost its luster” a bit, he says. Many of them relied too heavily on marketing and not enough on product innovation to help them stand the test of time. So as the marketing dynamic has shifted, growth has stagnated, Roth adds. On top of that, with so many DNVBs expanding with wholesale partnerships and physical stores in today’s “omnichannel environment,” they’ve relinquished some of their biggest competitive edge over other retailers: the ability to mine the vast amount of data collected from the consumers shopping and buying directly from them.
So how have merchants like Oddity managed to buck the trend? And where do the other DNVBs go from here to avoid becoming a casualty of the bubble burst Drucker Mann anticipates?
How’d we get here?
As a whole, Top 1000 consumer brand manufacturers performed well online in 2021. The group collectively grew web sales 19.9% year over year — the highest rate of all merchant types in the Top 1000 and notably higher than the 15.7% overall jump. That marked a reversal from 2020, when retail chains’ digital revenue swelled 57.7% over 2019 thanks to their big store footprints that allowed consumers to skip crowded public spaces during the peak of the pandemic and still get their goods quickly through omnichannel offerings like buy online, pick up in store, or BOPIS, and curbside services.
In 2020, brands were the second biggest beneficiary of the COVID-19 ecommerce bump, collectively growing digital revenue 45.1%. The same is true when considering the two-year stacked growth, which compares 2021 web sales to a pre-pandemic 2019: Retail chains received the largest COVID-19 boost at 75.9% vs. consumer brand manufacturers’ 74.0%.
An analysis of median growth by merchant type reveals the same trends, meaning 2021 performance wasn’t overly skewed by the financials of some bigger retailers that were growth outliers. Consumer brand manufacturers had the highest median year-over-year jump in web sales last year at 24.8%. Meanwhile, retail chains took the top spot in 2020 with 31.9%.
Zeroing in on the 81 DNVBs in the Top 1000, which historically have increased digital revenue much faster than more traditional brands in the rankings, it’s apparent how much the gap has closed in recent years as the younger cohort has matured. In 2017, DNVBs collectively grew 54.0% — nearly three times as fast as other brands. They continued to outperform their peers by a wide margin until 2020. But during the peak of the pandemic, shoppers gravitated to the recognizable names of bigger brands. That was, in part, due to larger companies with more suppliers being better able to navigate supply chain disruptions than smaller startups like DNVBs. In 2020, consumers spent 46.7% more year over year online with established brands while DNVBs saw just a 29.4% collective increase.
By last year, those trends were less pronounced as the pandemic began to ease, and the digital natives once again outperformed their more established competitors. DNVBs grew online sales 24.6% to other brands’ 19.5% vs. 2020. But that’s still a far cry from the lowest roughly 15 percentage-point advantage DNVBs had in their pre-pandemic heyday.
And 2022 has been less kind. A dozen public DNVBs are ranked in the Top 1000 and break out ecommerce figures or guidance. (Some web-first brands, like Warby Parker, have a large number of stores, and others, like health and wellness brand Hims & Hers, have wholesale partnerships. So not all revenue is attributable to online channels.) Of those, nine do so on a quarterly basis. After this group collectively increased web sales by 21.2% in 2021, it has registered roughly a quarter of that growth — just 5.2% — in the first half of 2022.
Many brands are struggling to maintain growth as the online channel isn’t achieving the same year-over-year performance. And research is showing lower brand loyalty among consumers, according to Bernardine Wu, executive managing director at OSF Digital Strategy. The technology implementation and consulting firm was formerly known as FitForCommerce.
Funding dries up for DNVBs
One aggravating factor is there’s less funding to go around to help fuel brands’ growth.
“With endless amounts of capital, lots of people can grow, but we’re in this transitional period now where a lot of that easy capital is done,” Drucker Mann of Il Makiage says.
Up until this year’s secondary funding raise, private equity group L Catterton had been the only outside investor in the company, investing $44.0 million since 2017. And as far back as 2020, the brand mentioned it was profitable — a milestone that has become a big sticking point in retailers’ quest to raise money more recently.
“You’ve seen investors rotate away from some names. They’re just focused now on profitable businesses as opposed to businesses that have great dreams of being profitable in the future but are (blowing through) cash in the near term,” Drucker Mann says. “The funding environment for that is gone. Maybe it comes back some day, but for now, it’s gone.”
Polly Wong, president of direct-to-consumer marketing agency Belardi Wong, agrees. She says investors have been burned by many digitally native brands that have not managed to scale profitability. And that poor track record — combined with economic instability — is impacting the funding available today. Most of the private equity firms Belardi Wong currently work with want to see $8 million to $12 million dollars in profit before investing.
“This puts smaller, emerging (direct-to-consumer, or DTC) brands at risk of running out of money before getting the funding they need,” Wong says. “This could negatively impact the landscape for DTC in the next three years. It’s very possible consumer demand will outpace investor demand.”
Of the 23 Top 1000 retailers that raised funds (excluding debt-related rounds) in 2021, nine are DNVBs, according to a Digital Commerce 360 analysis of data from funding tracker Crunchbase. Digitally native brands accounted for 39.1% of the group that year. That’s compared to 2019, when of 30 retailers that raised funds, 14, or 46.7%, were DNVBs. And analysts and consultants say there’s bound to be an even bigger drop-off in 2022.
MidOcean Partners’ Roth says tech investors will have a much higher bar in the next six to 12 months. When interest rates are very low, high-growth companies that need a lot of cash to grow have a better profile because the cost of capital goes down and the value of the business is in the future. With interest rates expected to continue to climb, high future growth companies will be less attractive to investors than more mature businesses whose value lies more in the five- to six-year range, he adds.
The omnichannel tradeoff
A number of well-funded DNVBs have embraced more traditional sales channels as part of their growth strategy, straying from their digital roots. Eco-friendly shoe brand Rothy’s, which raised the largest non-debt funding round of all Top 1000 retailers in 2021 with $475.0 million, according to Crunchbase, opened eight stores and has previously partnered with Nordstrom Inc. And after launching its lines in Target Corp. stores in late March 2020, Hims & Hers went public in January 2021 via a merger with a special purpose acquisition company, or SPAC, and raised $75.0 million that year. In the first half of 2022, the brand’s wholesale revenue more than tripled year over year, bringing in $13.3 million.
Glamnetic, a digitally native cosmetics brand known for its magnetic false eyelashes that launched in mid-2019, found similar success in placing its products in stores. And founder and CEO Ann McFerran says DNVBs must become omnichannel to survive in 2022 and beyond.
“To continue to grow past a certain point, you want to cross over into brick-and-mortar stores,” she says. “We were a DTC brand first, and that’s where we were able to build our first customer base and get momentum. When we were able to land space on store shelves, though, is when we knew we had real staying power.”
Without any outside capital, Glamnetic pulled in $50 million in online sales in its first year. By 2021, the brand also secured a partnership with Ulta Beauty, entering into 1,000 stores, and started selling on Sephora.com and Nordstrom.com.
“Even major stores like Target, Ulta and Walmart are embracing newer and smaller companies,” McFerran says. “There are great opportunities for brands to land valuable in-store placement while maintaining the thriving DTC aspect of their business.”
McFerran declined to comment on the specifics of her brand’s growth through different channels.
It’s worth noting that although wholesale has been a popular pivot for DNVBs in the last handful of years, the move doesn’t necessarily translate into higher growth. Digital natives selling their products through third-party retailers had a median web sales growth in 2021 of 19.3% vs. 28.2% for DNVBs without a wholesale segment. It is true that DNVBs that have scored wholesale partnerships are likelier to be bigger brands — their median Top 1000 rank is 363 vs. 454 for their purely digital counterparts — and revenue growth is harder to achieve as the base dollar figure gets larger. But that’s still a sizable disparity.
A smaller — but present — disparity exists for DNVBs that opened stores. One-third of the 81 DNVBs in the Top 1000 operate at least one physical location, with the median being eight. The median increase in 2021 web sales for digital natives with a brick-and-mortar presence was a little lower than that for DNVBs without a store footprint — 22.6% vs. 25.9%.
Oddity has no plans to take Il Makiage down the wholesale or physical store path, Drucker Mann says.
“It would be so easy for us to open up retail distribution and just — poof — massively increase our revenue and profit, but in the long term, we see a consumer who is at least 50% digital,” she adds. “And if you want to win at 50% digital, you can’t chase easy money in a physical wholesale format. You’ll miss the prize.”
Drucker Mann acknowledges that Il Makiage’s predecessors — the “incumbent” cosmetic brands like Estee Lauder and L’Oreal — created so much value in a brick-and-mortar wholesale model that it’s hard to opt out. But a brand looking to grow via a third party — whether that’s through department stores or a Sephora or Ulta — is missing the opportunity to really understand what shoppers want, she says.
“They don’t have control of the data, they don’t have the ability to create those tools that really work to drive acquisition, repeat retention, etc. — all of those things that we’re maniacally focused on,” Drucker Mann says. “They give up control, and the retailers become more powerful as they cede those capabilities over.”
Roth is of the same opinion. The ability of DNVBs to mine data is “a wild advantage” — one they surrender by wholesaling, when any visibility into the consumer gets lost, he says. Data analytics allow direct-to-consumer brands to go beyond oversimplified demographics and dig into psychographics to figure out how to serve shoppers better.
“Knowing who’s buying and why they’re buying as best as you can or better than the competitors — that’s hugely challenging when you have other channels,” Roth says. “Bucketing someone as a millennial is using a pretty broad brush. There’re all kinds of overlays. You gotta look at are they men or women? Are they affluent? Educated? Are they rural or urban?
“Understanding that better is going to enable those folks — over this probably more rocky period in the market — to have higher confidence of where those pockets of customers are,” he adds. “When DTC businesses sell through wholesale channels, they have no idea who’s buying or what to do for them.”
Data and product innovation
Oddity co-founder and CEO Oran Holtzman has long said technology is the main driver of Il Makiage’s success, pointing to the size of their tech team — data scientists and engineers make up more than 40% of the total employee head count. And that group spent more than two years developing its machine learning and color-match quiz, called PowerMatch, in house. The algorithm can pair an online shopper’s foundation shade to one of 50 hues without seeing her face with more than 90% accuracy, according to Il Makiage. Formulas are fueled by data from more than 30 million shoppers who have used interactive features on the brand’s site.
Drucker Mann says that’s exactly why Oddity conceives of itself as a consumer technology platform rather than just a cosmetics brand. IlMakiage.com users give the company a constant stream of information on their beauty routines, how they use products, ingredients they care about, what’s missing from the brand’s offerings and more. This data infrastructure is Oddity’s competitive moat, Drucker Mann says.
The company’s new brand SpoiledChild, a beauty line with rapid recovery haircare and anti-aging skincare products as well as supplements, was developed based on data collected on IlMakiage.com. After launching in February 2022, SpoiledChild had “an extraordinary first six months — really just an incredible early performance,” Drucker Mann says, declining to share more specifics. And Oddity will continue to either develop additional complementary brands or “look opportunistically” for acquisition targets to add to its portfolio and address unmet needs, she adds.
Glamnetic’s early digital insights are the “golden ticket” that allowed for better product evolution, according to McFerran. She expanded her line, too, branching out beyond magnetic lashes with magnetic eyeliner and press-on nails, which have sold out more than 10 times.
Roth thinks that’s a good move. In his estimation, too many DNVBs operated more like marketing vehicles, with their products being a secondary side of the business. And when more popular marketing channels got crowded, that’s left them in a lurch.
“(DNVBs) didn’t necessarily innovate in their core areas as much as they should have,” he says. “Product innovation and potentially product adjacency — I think that’s gonna be the key going forward.”
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