Is malinvestment in advertising killing D2C ecommerce?

Alex Taussig of Lightspeed writes that there is a typical playbook for vertical ecommerce brands: “(1) Launch a “hero” product that provides branded product innovation, (2) at high gross margins, (3) enabled by an owned & operated e-commerce experience, (4) with high marketing efficiency, usually driven by viral or word-of-mouth campaigns.” (Taussig 2019). The filings from Blue Apron and now CSPR Casper that item (4) on that list, marketing efficiency, can prove elusive as these brands attempt to scale to the level of the expectations they’ve set with investors.

When Blue Apron released their S-1, I was working on Stitch Fix’s own S-1, and so I immediately found their filing interesting. I looked into the numbers that I knew to be important for a subscription service: customer net present value and acquisition cost. From what I could glean, NPV on a customer basis actually looked fairly high; my guess was around $200 assuming a reasonable discount rate. But marketing costs were astounding: ~$144M in 2016, and with Q1 2017 marketing annualized to over $242M. We can’t say for sure how many new customers they paid for with that. If we use the difference in number of customers at the beginning of the period and the end (this is conservative due to the effect of churn), the implied blended CPAs are $320 in 2016 and $385 in Q1 2017. That already implies a money losing proposition, but it obscures how bad things really were. The marginal acquisition cost is typically much higher than the blended cost, because advertising does not scale up efficiently. It’s impossible to know exactly what the ratio is between blended and marginal. In my experience, 2x is a fairly conservative estimate. This means it is quite possible that at the margin, APRN was largely paying $700 or more to acquire a customer worth only around $200. When I saw that, I knew they were toast right away.

Now we have a new filing from Casper with a similar trend. Although Casper claims to establish deep customer relationships, they have a repeat rate of only ~14%, suggesting that we can safely treat marketing acquisitions as one-off. AOVs were $710 in the first nine months of 2019. Revenue plus discounts (which are included in AOV) were $392M, with COGS + refunds of ~$237M, for a profit margin of 39%, or $277 per order. Like APRN, this value per acquired customer is quite impressive, and may be slightly understated if customers are coming back unprompted to buy more big ticket items. Using the above numbers, we can assume 552k acquisitions on a sales cost of $114M, implying a blended CPA of $202. This may seem like a reasonable figure until, again, one considers that the marginal cost is likely to double the blended figure or more. In this case, again, this means that Casper may well be paying a $400 marginal CPA to acquire $277 of gross margin. This is not quite as dire as the Blue Apron situation, but far from comfortable. We can’t tell from this report how much value there is in those repeat orders, but they are absolutely relying on them to make their strategy work.

Direct to consumer brands succeed by providing good margin on product via vertical integration and efficiencies in customer acquisition via strong branding. Often marketing is easy in the early days, when word of mouth provides costless customer acquisition. But $APRN and $CSPR show that acquisition efficiency does not come for free for these brands, especially once they attempt to scale past the growth level supported by referrals. Once organic and word of mouth peter out, the temptation is strong to dump money into paid acquisition well past the point of efficiency. Casper has already had to reduce its offer price below its recent round; this week we’ll see the public market’s judgment.

Bibliography

Form S-1, Blue Apron, filing date 6/1/2017 [link].

Form S-1, Casper, filing date 1/10/2020 [link].

Taussig, Alex. “Drinking from the Firehose #154.” 1/13/2019.

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