In recent years, the consumer product goods (CPG) industry has struggled to sustain growth amid flat sales.1 The reasons are many: the strengthening of powerful retailers, the growth of e-commerce channels, and the change in consumers' needs and priorities. In response, large CPG manufacturers have focused on cost-cutting and trimming brands while seeking new avenues for growth.2 One avenue that holds promise for some CPG manufacturers is direct-to-consumer (DTC) strategies in which the manufacturers sell their products directly to consumers using e-commerce, without going through intermediaries like wholesalers or retailers, physical or online.
Indeed, new CPG players like Harry's, Dollar Shave Club, and The Honest Company have started to challenge the oligopoly of "legacy" CPG manufacturers. These new players differ from traditional manufacturers in that they are capable of developing the supply chain and creating a sustainable value for consumers with less time and money than established marketers by focusing intensely on specific categories—shaving products in the case of Harry's and Dollar Shave Club, and nontoxic household products in the case of The Honest Company. These new entrants are selling their products direct to consumer and using, in the majority of cases, only e-commerce.
Traditional CPG companies, however, have been more cautious about taking the plunge into the DTC market. A 2013 Deloitte survey found that although 92 percent of CPG executives agreed that e-commerce is a strategic channel for their companies, only 43 percent thought that their companies were well prepared for a digital strategy implementation.3 Moreover, a 2018 Boston Consulting Group report showed that only 34 percent of the most important CPG companies were "extra prepared" for DTC.4 Such companies have either a dedicated e-commerce supply chain management team or a cross-functional e-commerce team which includes supply chain representatives.
But some legacy companies are beginning to catch up. As new players continue to cut into and threaten CPG giants' income, these giants are engaging in new strategies to protect their position. One example is the US$1 billion acquisition of Dollar Shave Club by Unilever. In the future, we can expect an increasing number of DTC attempts by legacy and new CPG players. Before they dive in, however, CPG companies need to understand both the challenges and benefits of going direct to consumer and be thoughtful about what they offer online and how they develop their supply chain for this channel.
Do DTC benefits outweigh the risks?
In spite of the allure of going direct to consumer, large consumer goods producers are still reluctant to take that leap. According to Nielsen, the top 26 CPG food and beverage companies accounted for a mere 3 percent of overall category growth during 2012-2015, even though they held 45 percent of the total market share.5 Smaller companies are driving much of the growth in the CPG categories, as giants, such as Mondelez, Unilever, and Kraft Heinz, see risks in adopting an aggressive DTC approach. The e-commerce market is still relatively small, and going direct to consumer could damage a company's relationship with retailers, potentially reducing the manufacturer's primary income source, traditional retail sales. Companies are also worried about losing the highly prized premium shelf-space in which they have invested billions of dollars if retailers retaliate and promote more of their private-label offerings.
Cannibalization of CPG retail sales is another major issue when going DTC, as this channel will not just attract new customers but could also lure some retail customers from brick-and-mortar stores. Companies have to focus on gains in total revenues rather than on just DTC revenues. DTC margins, in the initial stages, are often lower than the traditional margins from selling to wholesale or retail, which further diminishes the interest a "legacy" manufacturer may have in going DTC.
Going DTC also requires a massive cultural shift and a significant investment. CPG companies will have to move away from having a distribution network designed for bulk shipments to stores, to one that also includes small-quantity shipments to individuals. In a world with free same-day or two-day shipping (thanks to Amazon), such a network redesign is not only challenging to implement but also costly. Additionally, customers' expectations when purchasing from the manufacturer's own website are higher than when consumers buy from retailers' websites with a variety of brands. Since the brand's website only offers its own products, consumers expect to find every variant (color, size, and style) at a cheaper price. They also expect manufacturers' websites to provide accurate and comprehensive information regarding the product, superior imagery, and excellent service.
In many cases, the benefits of a DTC channel may outweigh the risks. Consumers expectÂ to be able to purchase a company's products on its website. According to the "2017 Digital Consumer Preferences Survey" from BrandShop, 90 percent of consumers visit a brand's website to shop, 82 percent expect to be able to make a purchase directly from the brand, and 87 percent would buy products directly from a brand online if given the option.6 Consumers are also seeking easier ways to purchase CPG goods, such as through monthly deliveries to their homes.
Additionally, having a DTC channel through its website allows a CPG manufacturer to achieve a better understanding of consumer behaviors and preferences—something that can be hard to gain selling through a retailer. DTC forces a company to handle every step of a transaction, thus owning the complete customer experience and allowing it to collect unbiased insights while creating greater opportunities for customer engagement.
DTC also allows brands to retain control of their brand image while selling online. Some brands have had trouble with copies of their products being sold on Amazon and other online retail sites. Birkenstock, a footwear maker, stopped selling its products on Amazon in 2016 because the presence of fakes on the site negatively affected its image.7
Interestingly some retail partners also want CPG companies to go DTC even though it might lead to a reduction of retail product sales. Fast delivery is a feature that consumers are increasingly demanding as they shift to e-commerce, and retailers are considering turning their stores into micro-warehouses from which they could ship a manufacturer's DTC orders. In this system, the retailer acts as a warehouse and delivery site rather than as a sales channel.8
Indeed, manufacturers do not have to decide between a DTC channel and the traditional wholesale channel. Focusing on both channels allows a firm to pursue the growth presented by e-commerce while fostering relationships with the main income source, retail stores. Additionally, an omnichannel approach offers synergies and access to potential clients loyal to one retailer only. Amazon, for example, has over 132 million active customers, and manufacturers could use such e-tailers to lift brand sales and return on investment. This cannot be ignored in blind pursuit of a DTC channel.
New brands for DTC?
Once manufacturers decide to go DTC, they need to figure out how they want to build their brand image in the DTC space. Do they extend existing brands, or do they create new ones? Offering an existing brand online could cause too much conflict with channel partners, and potential consumers might perceive a cheapening of the "brand" when it is available online. If the manufacturer decides to build a new brand, it needs to plan out how it wants its product to be perceived. Should it be price-based, convenience-based, or category-focused? As it develops the new product and its brand identity, a manufacturer should also be aware of the factors that encourage consumers to buy online and the factors that discourage online buying. Figures 1 and 2 show the most important enablers and obstacles that manufacturers must consider before creating a new offering that is sold online only. A product that offers a combination of enabling factors, while avoiding the obstacles, will be seen as providing value to the consumer.
Manufacturers can pursue several value-adding propositions to persuade consumers to buy their products DTC as shown in Figure 3. In addition to saving time or money, manufacturers can present a unique product with new characteristics or technology. They can also create an enjoyable and surprising experience so that their customers can get to know their products and help develop a strong brand image. Manufacturers can also offer products customized to a buyer's specific preferences which may be hard to do via a retailer's shelf.
Supply chainÂ challenges
When a manufacturer decides to sell DTC, it requires significant changes in the supply chain, extending from how a final product is designed and manufactured to how it is delivered to the end-consumer.
Product design and manufacturing:Â Designers encounter a great dilemma when it comes to thinking about the optimal solution for DTC products: They must balance variables such as physical handling, ease of transport, stability, and product digitization (how the product is represented online) with creating a product that appeals to the consumer.
Companies must acknowledge that there are some products in which the physical "touch and feel" experience is a significant element of the shopping process. When designing DTC products, designers have to compensate for the lack of that physical experience by developing, in collaboration with marketing, IT, and other functions, a product that is visually appealing and can also be experienced virtually. Virtual reality apps and videos of the product, for example, can help provide a virtual experience of physically handling the product.
While shipment costs are a significant part of e-commerce total costs, a transportation-efficient design and packaging will not work if consumers don't find it appealing. Companies need to find the optimal balance between cost and space-efficient packaging (that both protects the package while being handled and minimizes transportation costs) and package attractiveness. DTC product packaging needs to be lightweight, leak-proof, temperature-stable, damage-proof, and rectangular-fit. Ben & Jerry's has proved that even temperature-controlled products like ice cream can be sold online and shipped directly to the consumer. As consumers are becoming more environmentally conscious, they are demanding eco-friendlier packaging, which also needs to be taken into account.
When it comes to manufacturing direct-to-consumer products, there is a distinction between fast-moving and slow-moving stock-keeping units (SKUs). Slow-moving SKUs can benefit from production outsourcing, as the supply chain can be designed for efficiency. Third-party manufacturers can handle low demand more efficiently because they can lower material and manufacturing costs by spreading them over products from multiple customers. Outsourcing production allows CPG companies to focus their efforts on marketing and sales. As DTC sales build up, the supply chain needs to become more resilient and responsive, and companies can bring manufacturing in-house. Razor blade manufacturer Harry's first started outsourcing its blade production to a German factory, but once it had a big enough client base, it proceeded to purchase the factory so that it could control the production.9 One danger of outsourcing is that the third-party manufacturer might decide to enter the DTC market with its own product, as Dollar Shave Club found out when its contract manufacturer, Dorco, started selling a similar product.
Finally, the customization and personalization that is enabled by the DTC channel creates additional challenges for manufacturers. The DTC channel allows for a large number of product variations, but this adds complexity and cost from a manufacturing point of view. There is a big difference between profitable diversity and money-burning complexity. One way to mitigate the negative effects of SKU proliferation is through standardization of the costliest components. Another approach involves product postponement, or shipping almost-ready products in bulk to a mini-warehouse or a retailer store and customizing them closer to the demand, just before last-mile deliveries. Postponement is particularly effective if the customization is related to quantities or product mix; that is, if the DTC order can include customer-specified quantities (rather than manufacturer-determined) and a customer-specifiedmix of products (specific quantities and mix of toothpaste, toothbrushes, and dental floss, for example).
Logistics:Â Delivering the ordered product into the hands of the consumer is an expensive, tricky part of DTC that CPG companies are still struggling to master. As retailers such as Amazon and Walmart offer free one- or two-day delivery for premium members or for qualifying purchases, the need for speed and flexibility in the DTC channel has increased, adding complexity to the logistics network. CPG companies will need to consider transportation partners and delivery points that they have not worked with before. Delivery options increase every day as new transportation players (such as Uber and Lyft) and options (click-and-collect, time-slot delivery, lockers, and others) proliferate. As technology improves, even seemingly bizarre delivery ideas can become feasible, like drone-based deliveries. CPG players will need to carefully review and pilot the various options before choosing the one(s) that minimizes costs while also fulfilling customers' requirements. Additionally, CPG companies going DTC have to worry not only about product deliveries but how to handle returns and reverse logistics.
First, manufacturers must establish the minimum price point that makes home delivery of individual SKUs economically feasible. Amazon and Walmart, for example, offer free delivery for orders over US$35 or when a certain number of products are subscribed. As companies set a price point, they will need to consider factors such as product weight, temperature control, fuel price, delivery options, and demand. Given the unpredictable nature of some variables (such as fuel, distributor availability, and regulations), companies should recognize that there are certain products that might not qualify for free shipping by themselves but can be shipped free as part of a larger DTC subscription.
In many cases, a DTC channel may require CPG companies to completely redesign their distribution network. As companies try to make pickup and home delivery more affordable, they are desperately seeking economies of scale, which would help lower costs. One option is to have smaller distribution and fulfillment centers in many large metropolitan areas. Based on the 2017 Census data from the U.S. Census Bureau, if CPG DTC players had distribution and fulfillment centers in the top 36 most populated metropolitan areas, they would be able to reach and offer feasible pickup and home delivery options to over half of the U.S. population. But this would require a major network redesign, as many CPG distribution networks currently rely on a few, large, centralized or regional DCs to deliver to retailer DCs. Having a large number of distribution nodes also implies that CPG manufacturers would need to have more transportation routes and logistics partners. Partnering with their biggest retailers or with third-party logistics companies that can provide warehousing and distribution capabilities in metro areas is one viableoption. By having more decentralized distribution capabilities, DTC companies can test pilot programs locally, as a delivery or return solution which works in one area might not be economically feasible in another area.
Once the "mile before the last mile" is covered (getting the products to the last distribution stop), the "last mile" must be addressed. Either the company delivers the product to the consumer's doorstep, or the consumer covers the last mile and picks up the order. If the order volume is big enough, delivering to the customer's home as the final shipping destination should not be a logistical problem. However, the majority of DTC CPG sellers do not have such economies of scale or predictable enough demand to accommodate this option. Efficient deliveries would also depend on powerful analytical capabilities that would create optimal routes and prevent delivery vehicle capacity from being underutilized. Hence DTC CPG manufacturers might find it best to partner with the right third-party logistics partner for home delivery services.
To lower the complexity of the last-mile deliveries, the click-and-collect model is becoming an increasingly popular option, as deliveries can be grouped together, significantly reducing the number of drop-off spots.10 In this model, customers can collect their DTC orders from a neighborhood store or from lockers placed in public access spaces like train stations. DTC companies have to enter into arrangements with retail store owners or with building managers to enable this service. According to Ecommerce News,Â in 2017 more than 40 percent of consumers from France, Germany, the United Kingdom, and Sweden used click and collect in the past 12 months.11 Now U.S. consumers are beginning to use the click-and-collect model. An additional benefit for the retailer is that consumers coming to pick up their orders in the store might make additional store purchases while they are there. Big retailers are already investing in facilities to allow for this category's growth. Amazon's recent US$13.7 billion purchase of Whole Foods was driven, in part, by its desire to access storefronts for its click-and-collect network. Walmart has been expanding its click-and-collect infrastructure taking advantage of the fact that over 90 percent of Americans live within ten miles of a Walmart store. However, the click-and-collect model has to overcome certain challenges. First of all, companies have to partner with facility owners like retail stores, office building managers, and others. For the consumer-facing front-end model, DTC players can choose one or a combination of the following options:
In-store pickup from a retail partner:Â Typically used by DTC clothing companies, customers come inside a partner's retail store to ask the staff for their order. To improve workflow and customer service, the retail store should dedicate an exclusive online pickup zone. This option is the preferred one for stores in urban areas with enough space to dedicate to DTC sales.
Drive-through or curbside pickup at a retail partner:Â This is the most time-efficient option as customers, in a first-in, first-out service, can come and pick up their orders from a DTC's retail partner store without getting out of the car. The main challenge is the costly effort to create a physical drive-throughor curbside pickup area and to move inventory locations within the facility. Increasingly, a number of retailers like Kroger are redesigning stores to offer this service.
Lockers:Â The previous two options needed personnel to be present to deliver product to the customer. Lockers provide the benefit of occupying little space while being "autonomous" since an employee can load orders inside empty lockers and customers can pick them up without physical interaction with an employee. Lockers have been widely used in other countries and are often the primary method for picking up product in some European countries.
For the back-end model for preparing orders for pickup, a DTC company can choose between the following options:
Use retailer stores: Similar to the in-store pickup front-end model, the retail partner's employees are going to deal with handling and packing orders in an area designated for DTC sales. This can be helped by more efficient use of existing store personnel.
"Dark" stores: These facilities are closedto the public and dedicated exclusively to preparing DTC orders. They are designed for DTC sales and can be located in the outskirts of big cities to take advantage of lower real estate costs and better logistics network connections. After orders are prepared in these stores,the front-end delivery model takes over.
CPG manufacturers' existing warehouses: This solution may be economically feasible depending on the location of the existing warehouses.
What happens when customers don't like going to a store to pick up their packages, but they aren't home during delivery hours and don't trust leaving a package unattended all day long on their doorstep? DTC players need to be ready, by themselves or through partners, to deliver in a precise time slot if the consumer desires (with a premium delivery fee, of course). Otherwise they might lose a customer to another player already capable of offering such services. In certain residential structures like apartments or condominiums, this problem can be addressed by having building management install lockers that can be accessed by the DTC delivery provider.12
Delivering on DTC
Creating a DTC channel is not easy. Pricing and delivering products in a channel-agnostic way that balances both offline and online strategies is challenging as different sales channels often have different cost structures, resulting in different prices or margins for the same product. There's the risk that consumers will demand to pay the lowest possible price irrespective of the manufacturer's channel economics. The coexistence of brick-and-mortar sales, digital commerce through e-tailers, and DTC channels makes the coordination of in-store and online promotions more challenging. Marketing will have to make sure that brand messaging and content are consistent across channels to minimize consumer confusion. Assigning budgets to different channels will become more complex.
While DTC is challenging, the CPG companies that can pull it off not only will see growth in their current products but also will gain invaluable insights that will power future growth. The alternative might be "direct to the CPG graveyard."
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2.S. Veldhoen and R. Soundararajan, "2017 Consumer Packaged Goods Trends," PwC Report, 2017.
3.P. Conroy, R. Nanda, and A. Narula, "Digital commerce in the supermarket aisle-Strategies for CPG brands," Deloitte University Press, December 2013.
4.E. Koeller, P. Dawe, and A. Pittman, "How CPG Supply Chains Are Preparing for Seismic Change," Boston Consulting Group Report, January 2018.
5.K. Alldredge, B. Brown, and M. Magni, "Playing catch-up: How to partner with the retailer of the future," McKinsey & Company, June 2016.
6."Brands need a DTC strategy," WARC, June 15, 2017: https://www.warc.com/newsandopinion/news/brands_need_a_dtc_strategy/38828
7."'Amazon is an accomplice': Birkenstock CEO accuses Amazon of profiting off fake goods," Business Insider, Dec. 22, 2017.
8."Zebra study: 40 percent of parcels delivered within 2 hours by 2028," Zebra Technologies, April 2018.
9.B. Warne, "Why This Shaving Startup Made a $100 Million Gamble on a 100-Year-Old Factory," Inc. Magazine, May 2016.
10.G. Gopal and A. de Miguel, "Tackling the difficult last mile," ISE Magazine, December 2017.
11."24% of Europeans buy more in-store with click and collect,"Â Ecommerce News,Â November 8, 2017.
12.Gopal and de Miguel, 2017.
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