If you’ve been reading Loose Threads for a medium-to-long amount of time, you know that we care a lot about terminology. This is not purely an academic exercise, but a reflection of the consumer products space, where a number of terms are thrown around without much thought: “digitally-native,” “direct-to-consumer,” and “brand,” among others.

Andy Dunn coined the term DNVB—digitally-native vertical brand—in 2016. The clearest possible reading of the addition of the word “vertical” is that it means “control,” akin to the idea of vertical integration, in which a company controls various aspects of its supply chain to achieve better performance and economics. The phrase “cutting out the middleman” is as synonymous with this movement as any other string of four words.

From the piece (emphasis added):

….creating a DNVB gives you an opportunity to combine the growth of being an ecommerce company with the margins of being a brand, and with proprietary merchandise where you control distribution and your own destiny. When done right, when there is some differentiation in the core physical product itself made possible by the vertical commerce nature of the model, as the DNVB can provide a better overall bundle of product and service than the competition.

There are a few more important assumptions in the piece:

  • DNBVs by nature have better margins, unit economics and higher retention that non-DNVBs (65% versus 30% product margins and four to five-times higher contribution margins—the margin once all variable costs are accounted for).
  • DNVBs exist online first, but can also exist offline as long as they own the channel.
  • Big companies will largely be unable to capitalize on this shift.
  • There is a big focus on customer experience, which used to be an afterthought.

This piece largely catalogs Dunn’s experience leading Bonobos from 2008-2016, when the piece was written. But a number of things have since changed:

  • The most profound change is exponentially rising customer acquisition costs—since 2011, the average cost of a Facebook ad increased more than 17 times, as of Q1 2018. This hugely variable cost is not at all accounted for in Dunn’s piece, which focuses more on the result of channel ownership, rather than the cost of owning it and keeping it. Facebook, paradoxically, is the ultimate middleman, and many of these brands have only given it more power.
  • Another big shift comes with the number of brands that have recently moved into both retail and wholesale, a trend driven mostly by the point above, since both channels come with better unit economics for brands looking to scale than purely digital customer acquisition.
  • The points above challenge the theory that DNVBs have better contribution margins. When Facebook was cheap, they certainly did, but there are grave issues with building a business on a variable cost structure, which Facebook ads embody as a market-based system. It turns out the cost of building the distribution needed to own the channel is as expensive as it is unpredictable.
  • Additionally, these brands have turned to a range of third parties, from branding, marketing, ecommerce and PR agencies; distribution and customer service centers; and other companies that offer services that the brand does not own. This is not inherently a bad thing, but it runs counter to the idea of reducing middlemen on both the back end and front end.

With this in mind, the word “vertical” no longer seems that relevant or universally applicable to digitally-native brands.

The last point to challenge is what this landscape means for big companies. Direct-to-consumer is all about building the channel so you can own it, but with existing distribution power, big companies actually have a crucial asset they can leverage, both for themselves and for potential partner companies. If these companies can find a new model to let smaller brands thrive while tapping into their ecosystem, as Walmart is trying to do with its new brands and Amazon does with its private labels, big companies can actually rule this space. They just need to get out of their own way.

As the direct-to-consumer and digitally-native space becomes more about who can efficiently build and keep distribution at scale, it’s important that everyone involved challenges the existing terminology, which is too quickly accepted as the golden ticket to success. The reality is never that clear.