DTC Isn’t All It’s Cracked Up To Be | Simeon Siegel

Julia Raymond Hare:
Hello and welcome to the Retail Rundown podcast. I’m your host, Julia Raymond Hare. And happy NRF week to all of our listeners. If you’re going, be sure to say hi to us. A lot of our team is currently at the big show so we’d love to see you there. And joining the show today is Simeon Siegel. Simeon is the managing director and a senior retail and e-commerce analyst at BMO Capital Markets. I’m sure a lot of you know him or have heard of him who are listening in. He began his career at Goldman Sachs and has since been named a rising star of Wall Street by Institutional Investor, a rising star of equity research by Business Insider, and has been named of the Wall Street Journal’s top analysts. Welcome to the show, Simeon.

Simeon Siegel:
Wow. Julia, I’m waiting for the day where that just intro starts as my friend Simeon. So what to aspire to, but great to meet you.

Julia Raymond Hare:
My BFF, Simeon. Yes, absolutely. It’s great to have you on, we have so many mutual contacts. And so when we had our first call, I was really excited. You have quite the interesting view, sometimes more contrarian, so it makes for really interesting conversation. But before we hop into today’s topic, just curious, are you also attending NRF this week?

Simeon Siegel:
It’s kind of a personal question these days.

Julia Raymond Hare:
Honestly, it is.

Simeon Siegel:
I am ashamed and sad to say that I am not. We are dealing with the reality amongst our children right now. So I am sadly going to miss the in-person, which hurts, it hurts. But looking forward to being back in real life in a big way.

Julia Raymond Hare:
It does. And we’ll have a lot of opportunities at RETHINK to have some virtual sessions and some things that will recoup some of the lost time at NRF, because we’re seeing it here as well. But we will be there. And I hope everything gets better with the kids and everything with COVID because I know it’s just crazy right now.

Julia Raymond Hare:
But moving on to today’s topic, this topic is not new to our listeners. I think we’ve talked about it many times before. But today we have a little bit of a different viewpoint that Simeon is bringing and that is on the DTC. So DTC continues to be touted as the way to do modern retail. Not only does the model allow brands to cut out that middleman, DTC-ers are skilled at creating fans of their brands, through data-driven loyalty analytics. And you can think of the Warby Parkers, Glossiers Casper Mattresses, Dollar Shave Clubs of the world, they have all been so successful so much so that tech companies like Shoppable are helping legacy brands and CPGs develop their own DTC-like models as a means to compete. And it would appear then that the benefits of the DTC model are somewhat endless.

Julia Raymond Hare:
But Simeon is here to break down the news to us that DTC might not be all that it’s cracked up to be. In fact, that was the title of the report BMO published late last year. It’s really interesting. I took another read this morning. I’d like us to begin there. So Simeon, can you start by providing brief intro to the report and then sharing some of your key findings?

Simeon Siegel:
I was waiting for that sound effect, the dun dun dun, as the Grinch shows up.

Julia Raymond Hare:
There he comes.

Simeon Siegel:
So I love this topic. I think it’s so important, it’s so interesting. It creates many friends for me and many enemies for me, depending on which room I’m in. But I think the reality is we have to remember omnichannel was the word beforehand, and omnichannel pre-pandemic was used to remind us that e-commerce is a thing. Throughout the pandemic, we found that omnichannel just became synonymous with e-comm.

Simeon Siegel:
And so what we did, what my team did, we planned on doing a two-week research report that ended up turning into a six-month banging our head against the walls because of all the strings we kept pulling. But what we found was the conversation of stores versus e-comm got even larger to simply this notion of going direct versus wholesale.

Simeon Siegel:
And the surprising finding was that companies pivoting to direct did not see that expected lift in reds, did not see the expected lift in gross margin, did not see the expected lift in operating profit, and didn’t see the expected lift in operating profit dollars versus the others.

Simeon Siegel:
And so that just triggered, and again, this is this notion of we started pulling these strings that didn’t know existed. And it was just very interesting. And so we’ll get into the details. But the main takeaway that we had was the largest brands in the world, the ones that we know so well that are touting this push direct, I agree with everything you said, I’m not going to pretend like I don’t. You get to be closer to your consumer. You have the data, you control the brand image, et cetera. But somewhat by definition, those are the brands that made their own legacy by embracing wholesale. Those are the brands that got incredibly healthy and incredibly large by embracing wholesale.

Simeon Siegel:
So what I would say is let’s internalize that every decision needs to be made very carefully, rather than painting a broad brushstroke. And whether you’re the largest brand in the world, figure out the right wholesale partners to be a part of as opposed to walking away completely. But just as importantly, if you’re emerging, I think there’s a dangerous message hitting the newest brands being told wholesale is a bad word. And what I want to throw out is there’s a lot of very powerful wholesale partners. So I think this is going to be some interesting topics for us to dig into, but it works across the spectrum.

Julia Raymond Hare:
And it’s interesting because you said some of the largest brands in the world made their legacy by embracing wholesale. And so in a way, this is backtracking a little bit, but you said they wouldn’t be where they are without wholesale. And so is it part of the equation that you can’t just erase in many cases?

Simeon Siegel:
Exactly. I think you put it perfectly with the middle man. The notion of digitally native brands embrace this idea of there’s a middle man in a wholesale operation. Cut out the middle man and you make a lot more money. And what we found is that middle man actually isn’t that expensive, and that middle man is very effective.

Simeon Siegel:
So this idea of you think about universally, stores played a very important role in building the cache of all these brands. So yeah, I mean, you can’t delete it from their history, and I would argue they shouldn’t delete it from their future either. It doesn’t mean to that they shouldn’t hone in and target who the right partners are, but to simply argue that a partnership equals another fee, and another fee equals something bad, that’s, I think, too simplistic.

Julia Raymond Hare:
I could see that. And you made a great analogy in the report and I kind of summarized it in my own words, but you were saying e-commerce, as we know it today is broadly accepted as less profitable than your retail store. The store is king. And in a way that kind of mirrors what’s going on with DTC, because in many cases, DTC looks like it’s less profitable than wholesale channels.

Simeon Siegel:
Exactly. I think there’s this amazing parallel. We went through this 10, 15 years ago. When e-commerce came out, everyone knew, like we knew that e-commerce was going to be a profit enhancer. It was going to be great for the entire retail ecosystem. Why? Because there’s no rent and there’s no store labor. So it doesn’t take any complicated math to know that e-commerce is going to be better.

Simeon Siegel:
Fast forward and all of a sudden the reality was it didn’t happen. So why didn’t it happen? Well, there’s variable costs, there’s fixed costs, there’s the idea you pay your rent once and then you get to kind of enjoy the gravy whereas for e-commerce every incremental unit costs you another dollar. There was a whole conversation around there that people came around to. I think the same thing is happening right now with direct with DTC versus wholesale.

Simeon Siegel:
Obviously DTC is a better margin. Why? Well, if I’m selling the whole product and I’m not paying someone else to do it, I get the full markup. And at the end of the day, that flows through much more powerful than any incremental expense I’m going to have. The problem is that’s been story and the viewpoint for the last 10 years also, and it just hasn’t manifested.

Simeon Siegel:
And I think that’s why the same way that we had to internalize the nuance of e-comm versus stores, we also have to internalize the nuance of DTC versus wholesale. And that’s this really interesting thing. And I think, and Julia, you and I have talked about this, I think there’s this really interesting point that some people think is irrelevant and others really grab onto, but the digitally native brands that you and I know so well that have done such a nice job disrupting and grabbing a voice and telling their story, they pay someone else to tell that story. So this idea of not having a middle man… The worst thing a brand could do is to give up apparently their distribution. And yet no one challenges when companies give up or pay someone else to be their marketing agency. Why is that? Why are we okay with the notion that I’ll pay someone to control my brand’s storytelling, but I’m terrified of someone actually controlling my brand visualization.

Simeon Siegel:
I think the point is we should be okay with both as long as they’re vetted. We should be okay with both as long as there’s a partner. And it’s just that interesting cognitive dissonance, I think, speaks to this idea. There’s more than just saying DTC, good, wholesale, bad.

Julia Raymond Hare:
So if you’re actually drilling down into it, what your team found is that in a way DTC still does have a middleman because a lot of them are outsourcing their marketing because the efforts you have to put into marketing are enormous to get started if you’re going DTC first.

Simeon Siegel:
Exactly.

Julia Raymond Hare:
Interesting.

Simeon Siegel:
There is no brand that I know that’s 100% vertically integrated. If we think about Lululemon, phenomenal brand, known for being vertically integrated the whole way up and a very large brand. Do they own their factories? The answer is no. So at the end of the day, it’s a question of what you’re willing to outsource, who you view as being a good partner. And I think that’s very important. And I think that that’s a point that wholesale… It begs the question of are brands that are walking away from wholesale actually signaling that they believe their wholesale channel has matured rather than is their wholesale channel bad. And I think it’s an interesting signal about levels and company sizes and maturity and life cycles. And I think it raises a lot of interesting questions along those lines. But yes, 100%, you are absolutely correct, every company has middle people.

Julia Raymond Hare:
And it’s more of a question like you said, you should be asking, and for our listeners who are in retail, what are you willing to outsource? That’s probably the more important question than am I keeping up, am I doing what my competitors are doing? Because maybe it’s not the right decision for some brands.

Simeon Siegel:
A hundred percent. I think you said that perfectly. I think that… And across the board, because it’s not just channel, it’s not just marketing, it’s every part. Do you own the fabric or are you a great storyteller? Know your strengths, but recognize that there’s some partners that are very, very powerful. And I think what’s interesting, I think there’s this notion that department stores are bad because we constantly hear about them being knocked down in the news and the results, and what’s their reason for being. And listen, that’s another whole conversation you and I can have.

Simeon Siegel:
But what we do know, without deciding are department stores good or bad, or for themselves, we know that their gross margins are among the lowest in the business. What does that mean? That means they actually are not that expensive of a middle person. If their gross margins are bad or low, then the companies that are selling to them are seeing that benefit.

Simeon Siegel:
And so the question you have to ask is, well, you have an internal sales force if you’re a brand, so here’s an external sales force. And here’s one that’s doing it for you in real life, on their floor, with traffic. So it’s this thought process of actually digging into the numbers. And by no means am I saying every brand should embrace every department store partner. But I think to your point of ask what you are good at, what someone else is better at, where can you create a symbiotic relationship, that’s what retail has… Retail has always been an ecosystem. The notion of going direct makes it a singular party. And that’s where you get dangerous. That’s where you start drinking your own Kool-Aid. And that’s where I think sometimes the numbers can tell you a story that the stories maybe don’t.

Julia Raymond Hare:
Absolutely. And I want to just take a step back and ask you, you’re a really smart guy, and this is what you look at all day long. And if you look at something like Warby Parker compared to Nike, and how they started and where they are today, what are some things you would point out? And no hate at all to Warby Parker. I’ve interviewed Dave Gilboa, I think it’s a great brand. They have amazing AR in app, by the way. It’s incredible. But they’re not profitable, they’re not profitable yet.

Simeon Siegel:
Yes, yes.

Simeon Siegel:
So I say what I’m about to say prefacing with the fact that I’m wearing a pair, and without exaggerating, staring at four different Warby Parker cases on my desk. So I’ve been there for a while. I am exactly watching the process as both a user and as an analyst.

Simeon Siegel:
I think it’s very important, and to use your terminology, no disrespect or no knock on Warby to the comment I’m going to make, Nike generates, whether it’s Warby’s or any of the other digitally native brands, revenues. Their annual revenues, Nike generates them in moments. The scale of comparison on a number basis is meaningful. And that doesn’t mean these brands can’t grow in. I mean, there’s no brand that has grown into the size of Nike. So I think that that’s a pretty high hurdle.

Simeon Siegel:
But what I like to remind myself, because I do have four Warbys on my desk, I like to remind myself and create guardrails for myself that we live in certain bubbles, we live in certain insulated categories. TAMs and audience sizes are very specific to specific companies. And at the end of the day, what we know is that revenues are a measure of customer buy-in, gross margin is a measure of external brand perception. So at the end of the day, the revenue that a company puts out is the best indication of where they are right now. Doesn’t mean they can’t grow, but to your point, tracking where they’ve been historically is helpful.

Simeon Siegel:
And so when I think about that, and this makes me think about the fact that at the beginning of the pandemic, Elle Brands own owned Victoria Secret and Bath & Body Works. Now it’s split off, but at the time, Elle Brands was the best performing stock in the S&P or one of in 2020. Let’s assume it’s somewhere around there. I’ll fact check this later. But they were phenomenally productive stock.

Simeon Siegel:
And at the beginning of the pandemic, every single article read Victoria’s Secret is a dead brand. That was very interesting to me because Victoria’s Secret at the time was still selling over $3 billion of lingerie, was selling over $2 billion of Pink, had another billion dollars of beauty. So we’re talking about a business that was selling $5 billion worth of effectively cloth, that was being called dead. That doesn’t make sense. Now, the gross margin, they weren’t making any money on that. So you had this customer buy-in, but brand perception was effectively in the gutter.

Simeon Siegel:
So the answer there, the reason the stock ended up being such a strong performer was that they internalized. Before we started talking about supply chain issues, they internalized that they had to sell less and charge more. They bought inventory down 50%, five zero, well before anyone heard about supply chain constraints, because they realized that people like me and Wall Street and stakeholders and everywhere and the media, said grow for growth sake for so long. So you had this internal flip to say, you know what, let’s focus on profits. Let’s actually grow healthy business, even if it means selling to fewer people.

Simeon Siegel:
And so I think, and that’s where I come to this, Nike is the only business… My team’s done a lot of work around where brands peak and ceilings and revenues. And we have found that there are brand ceilings. We know in fashion, ubiquity is not cool, uniformity is not a good thing. You have a certain level of unit versus price velocity saturation, where you no longer sell something else unless you promote it, and that just brings your price down, which ultimately is a negative flywheel.

Julia Raymond Hare:
Supreme.

Simeon Siegel:
So Nike… Yeah, right. And the ability to sell logoed Oreos is a very powerful thing. How many can you sell is the other question?

Simeon Siegel:
So Nike doesn’t fit on this scale. Nike is the only company that can have a $400 LeBron drop and sell half a billion pairs of $50 Roshes. They’re the only one that has figured that out sustainably. Ralph did it for a very long time and then it caught up.

Simeon Siegel:
That question, I think goes back to your point earlier, to a different question, which I think was spot on. You have to know who you are. You have to know who your audience is. You have to know what you want to be when you grow up. And if your audience is appealing to bi-coastal, whatever the income demographic you’re targeting is, and more fashion-edgy, then that’s who you’re going to be and you’re going to have a constrained TAM. If you’re going to be selling into the department stores and off-price, it’s just different TAM. It’s not right or wrong, it’s just knowing who you are and who you should be and not ultimately drinking that Kool-Aid.

Julia Raymond Hare:
Yeah. And that’s a great way to put it, and it’s an important factor to look at as more and more brands begin opening these DTC channels. I mean, I’ll just mention, there was one story we covered, I think in 2020, where Pepsi had a direct to consumer website and it looked like it was from 1995.

Julia Raymond Hare:
We questioned why it was up there. I mean, it looked like it was frozen in time and they were like, yeah, let’s make the page live. And I doubt they got sales.

Simeon Siegel:
That’s the problem with the internet, is it buffers.

Julia Raymond Hare:
Yeah. It’s just incredible. So really interesting comments there. But in your opinion, Simeon, is there a way to do DTC that’s sustainable when it comes to growth?

Simeon Siegel:
So it’s a really interesting question, it’s a really important question. The interesting outlier that we found while putting together this report was that the more profitable you are as a business, the higher your margin on a rate basis. Objectively the higher your margin, if it’s above 20, 30%, the more beneficial direct is. So I don’t know that whether that’s prescriptive or whether that’s just simply a fact that I can point out. I don’t know if I can tell some of my advice is be more profitable, because what do you do with that?

Simeon Siegel:
But if you’re inherently, if you’re lucky enough to be an incredibly high margin business, if you’re a luxury business, the simple math of it works out that direct actually is either less bad or actually beneficial. There were a few companies that we saw that had that.

Simeon Siegel:
So if your margin, if your gross margin or your product margin is so high that all the OPEX that flows down below it is less impactful, then you will benefit by being a direct business. So that was the first outlier, and I’m saying-

Julia Raymond Hare:
Then yeah, Simeon, luxury goods and luxury as a subcategory of retail was probably the slowest to adopt e-commerce except for grocery. I mean, it doesn’t operate like that. Luxury is all about in-person, touching, feeling, having that shopper experience that’s really catered to you.

Simeon Siegel:
Absolutely. And sorry, just to be clear, that point was DTC as a whole, as a channel. So that was both online and store. So it’s the idea of rather than versus wholesale. Because you’re absolutely right, the idea of maintain… And that’s part of this, it’s maintaining control. As you go online, you’re involving another partner.

Simeon Siegel:
So I think that this idea of D2C as a channel versus wholesale as a channel, the higher your margin is the less this math holds, that it has to be a high margin, that bar is high, it’s above to 25%. That’s generally what we saw.

Simeon Siegel:
The second half though, like in terms of thinking through, for those that don’t have the luxury of just saying, okay, I want to be more profitable, therefore I shall, the answer is to look at DTC as part of your proposition. It’s not to be, this is good and wholesales bad. It’s to look at what the benefits are. The benefits are exactly what you started with. With direct, I can be closer to my customer, I can be closer to the data. I’m not going to control the data. I don’t think we should fool ourselves into believing that the customer isn’t going to own their data. The question is what they’re willing to share with us. But being direct allows you to be closer to that and it allows you to elevate your brand image.

Simeon Siegel:
I think the key though, is recognizing that all the brands that are very openly discussing the push to direct because of those reasons, have to internalize that if you give up the unit volume that you got at wholesale, that becomes a profit inhibitor.

Simeon Siegel:
And what was very interesting to me is the pushback we’ve got…. And listen, it’s not a good report if there’s not pushback. There should be. This should be a debate. And so the biggest pushback I get is exactly the point. Like you’re just not getting it Simeon. We want the data, the data is valuable. And I don’t disagree with that, but the problem is everything… I can be very opinionated, which means I can be very wrong. I know that there’s plenty of people that are a lot smarter than I am. This report actually has very few opinions. It’s empirical, it’s data-based. And the math argues that whatever the value of owning your customer’s data is isn’t flowing through to your profit line as a company.

Simeon Siegel:
And so this idea of forests and trees and nuance and expectations, obviously my DTC is going to be higher margin than wholesale because I’m selling it at a higher markup, the same way that obviously my e-comm is going to be better for the business because there’s no store labor and store rent.

Simeon Siegel:
What I try to remind myself is anytime the word obviously shows up in a conversation about retail, chances are you should dig deeper and it’s probably the opposite. And I say that a little bit facetiously, but it’s an important lesson. The obvious answer is normally our consumer hat answer rather than our operational or analytical hat answer.

Julia Raymond Hare:
Yeah, and defaulting.

Simeon Siegel:
And so, what to do with DTC? Include it as part of your business. But include it as part of your business, not the entirety. You still need the unit velocity that you get from hiring a low cost distributor, which we know as wholesale.

Julia Raymond Hare:
And we’ve seen that with a lot of the really successful DTC first brands that now have stores and are in wholesale channels.

Simeon Siegel:
Exactly, exactly, that’s a great point.

Julia Raymond Hare:
And it’s really interesting. If any of you are listening, this report actually talks about you guys have a working template for this model. And it says let us know if you’d like it. So is that something people can get ahold of?

Simeon Siegel:
Yeah, absolutely. Feel free. Listen, like I said, I like healthy debate. So whether it’s something that you think makes a ton of sense and want to talk about it, or whether it’s something that you want to lambast me for, by all means. I’m fairly easily accessible, so please feel free to reach out.

Julia Raymond Hare:
Absolutely. And I love that, that you guys are offering that. And where can someone listening download a copy of the BMO report?

Simeon Siegel:
So that you’ll have to come to me for, but I would say LinkedIn is probably the easiest way to find me. I assume my name is on this, but easy enough to find. There aren’t that many Simeon Siegel, for better or worse.

Julia Raymond Hare:
I love that, better, worse. Awesome. Well, thank you, Simeon Siegel, it was amazing to have you on the show today. As I said, super smart analysis and love hearing your perspective. It’s a fresh one, and that’s what we want on the podcast for sure.

Simeon Siegel:
It is great to be here, always great to chat. And like I said, next time I’m looking forward to coming on as my friend Simeon.