Is DTC More Profitable For Brands Than Wholesale?
A new study from BMO Capital Markets has found that while many brands are aggressively turning to direct-to-consumer selling (DTC), underlying profitability may be better by selling through wholesale channels.
“Over a decade ago, when e-commerce began its significant rise, the world expected the channel to be a boon to retail margins,” wrote Simeon Siegel, senior author and analyst at BMO, in the report. “After all, there was no rent. That was until it became clear that the costs of e-commerce were variable and ended up putting a big drag on company-level profits.
Siegel added: “We are concerned that a similar problem could reoccur with a widespread push from the biggest wholesale-dependent brands to DTC (both through company-owned stores and e-commerce), far away. wholesale channels on which they are soundly built. their retail empires.
While BMO agreed that a company could better control and elevate its brand to DTC, collect more data from customers, and achieve higher revenue per item sold and possibly a substantial increase in gross margin, the analysis of The investment firm shows that almost every time a company has reported margins by channel, its DTC EBIT (profit before interest and tax) margin has been “significantly lower” than wholesale EBIT.
Overall, BMO’s analysis showed that DTC expansion did not increase company-level revenue, gross margins, commodity margins, EBIT margins, and EBIT dollars. .
BMO’s findings are based on a working model it created that explores the dollar and margin implications of a brand choosing to sell units through wholesale or DTC. Suppliers analyzed in the report include Vera Bradley, Tempur Sealy, Ralph Lauren, Nike, Skechers, Columbia Sportswear, Canada Goose, Carter’s, Under Armor, Puma, Urban Outfitters, Deckers Outdoor, Tapestry, Canada Goose and Levi’s as well as several third-party retailers. .
On the revenue side, BMO’s analysis found that when companies transfer revenue to DTC, more of the selling price per item is captured. However, when measurable over the past five years, companies have in most cases shown slower growth as they have increased penetration of DTCs. The report notes, for example, that Skechers has shown an expansion of “significant sales” even as its DTC penetration has declined. Conversely, Vera Bradley and Michael Kors, with a major expansion in DTC penetration, recorded stagnant revenues.
Siegel wrote: “As such, and potentially plagued by our overgeneralization, it seems to suggest that while revenue per item increases at DTC, the units lost by dropping out wholesale generally outweigh the unit price increases at DTC. DTC. In other words, revenue per unit may increase, but not the company’s total revenue. However, the main objective of the report was to explore the widespread belief that DTC is more profitable than wholesale for brands.
Among the findings regarding profitability is the fact that almost all companies that report (or have ever reported) EBIT margins per channel showed significantly higher EBIT rates at wholesale compared to DTC. BMO’s analysis shows that the operating costs of DTC operations, in most cases, outweigh the gross margin gains that come from DTC, “a fact that we believe is generally overlooked,” has writes Siegel.
In an analysis of nine sales companies that have broken their wholesale margins against DTC in the past, only Canada Goose and Deckers Outdoor, the parent company of Ugg and Hoka One One, posted higher DTC margins.
The report further found that only four of the seven companies reporting growth in DTC penetration saw their gross margins increase in the past five years. Michael Kors and Nike, two companies that have accelerated the growth of DTC, saw their gross margins erode while several companies with slower passage or reduced penetration of DTC saw strong improvements, including Ralph Lauren, Skechers and PVH.
A major surprise was that despite the overall finding that DTC’s gross margins are on average 2,350 basis points above wholesaling, many DTC-only companies had merchandise margins well below those companies that derive up to 50% of their revenues from the much lower gross margin wholesale segment. . For example, American Eagle and Gap’s merchandise margins were lower than those of Ralph Lauren and PVH, which rely heavily on wholesale.
BMO has offered several hypotheses as to why DTC’s merchandise-only margins are lower despite the gross margin advantage. These include international gross margins typically exceeding national margins for many of the larger wholesale brands, the benefits of high margins from outlets that feature many of the larger wholesale brands, and some derived scale. from a larger wholesale company. However, BMO admitted that the discovery “remains puzzling for us” and has scheduled further studies on the phenomenon.
BMO has also explored the profitability of online operations given the digital switchover that has been accelerated by the pandemic. BMO has found that while the profitability of e-commerce benefits from reduced rental and labor costs compared to physical selling, e-commerce “comes with its own set of expenses that are missing from selling.” wholesale ‘including execution, logistics, heavier marketing, technology, and increased returns. These expenses can “quickly erode” any of the benefits of not having to operate physical stores. BMO said that as the online shift continued long before the pandemic, the overall erosion of DTC margins could reflect the oversized growth of the Internet for many businesses.
Siegel wrote: “Additionally, it now appears to be common knowledge that e-commerce has put pressure on industry margins, not a boost. A fact well demonstrated by the recent deposits of native digital disruptors. “
Nonetheless, the report highlighted other reasons why DTC channels are beneficial. For example, companies can better control branding, distribution and pricing. According to Siegel, these advantages are “perhaps reason enough to switch from wholesale to DTC” despite the margin risks. Siegel wrote: “Brand perception remains the key to brand equity; where and how a product is sold can be as important as the quality of the product itself.
Photo courtesy of Nike / Business Of Fashion