Get ready for the second order effects of the new DNVB economy

Our team at Wittington Ventures has decades of experience betting on the future of commerce. As we open up shop and launch our new venture capital fund, which is backed by iconic Canadian corporations in the retail and property sectors, we are asking ourselves how commerce will continue to evolve in the coming years.

Our predictions on the sector are largely informed by the fact that we’ve backed game-changing platforms such as Shopify in a past life. When investing in the company in 2013, it was evident to us that Shopify was leveraging and accelerating massive secular trends unfolding in commerce — namely:

1. the rise of e-commerce and goods increasingly being purchased online;
2. a high demand among Western consumers for a broader selection of cheaper, unbranded goods from other parts of the world (i.e. China);
3. the rise of the entrepreneur and the “side-hustle”;
4. an appetite among e-commerce entrepreneurs to create their own brands and own the relationship with their customers, as opposed to selling on major marketplaces such as Amazon and ebay; and,
5. a need in the market for bespoke tools that let users build an online storefront effortlessly to sell specialty, targeted goods.

One trend that wasn’t entirely clear at the time, but is arguably the most foundational to Shopify’s success, is the rise of digitally native vertical brands (DNVBs). These brands are born online, source from manufacturers directly, and control their own distribution and end-customer relationships. When doing the Shopify deal, there were clear first instances of DNVBs in the market such as Warby Parker and Frank & Oak, and specialty brands that were being sold under the “artisan” banner. But Shopify has since turned the trend into a go-to-market engine that now powers the next generation of consumer goods companies.

Regardless of whether brands are unique and digitally native, or simply white-labelled commodities that are easily drop-shipped, the entire DNVB category has reached critical mass over a short period of time. A new “DNVB wave” has created a replicable playbook for how to launch and scale any type of brand or product successfully.

The stats behind this wave are noteworthy and our team is paying close attention. According to eMarketer, 40% of U.S. internet users expect web-only brands to account for at least 40% of their purchases within the next five years. When looking at CPG as a category specifically, the growing influence of DNVBs becomes starkly apparent:

Beyond CPG, and looking at retail more broadly, Internet Retailer notes that DNVBs make up 31 of the 2019 Top 500 Internet retailers based on 2018 online sales. These brands continue to out-perform their competitors, growing collectively by 29.5% online in 2018 over 2017.

With such high growth and consumer adoption, it’s natural to anticipate “second order” effects from the pervasiveness of web-only brands. Unsurprisingly, the first generation of DNVBs were founded at a time when many of the functions related to operating them weren’t yet “eaten by software”. Brands had to worry about independently owning, and investing heavily in, each component of their value chain — from the supply chain to in-store experiences. The other option was to surrender to the capabilities of marketplaces such as Amazon, which could take them out of business.

But a lot has changed since the early days of DNVBs. We at Wittington Ventures are expecting to see a variety of new technology trends and startups that bring much needed meritocracy, productivity, and automation to the sector. These trends and companies will be poised to successfully monetize on the broad appeal of the modern digital native brand:

1. Managing the supply chain is becoming simpler.

Aside from the brand, a prominent source of intellectual property for DNVBs is their supply chain. These brands source from manufacturers directly and manage their distribution independently, thus forcing them to actively engage in supply chain management activities. Their supply chain work focuses on the following key areas:

• How do we find the best manufacturers?
• How can we monitor and optimize our direct procurement costs?
• What tools can we use internally to streamline workflows and increase efficiency?
• How can we move goods through the value chain more rapidly?

Supply chain management (SCM) has traditionally been a “large company” function that relies on outdated legacy systems. But a new class of startups are packaging these “large company” SCM sensibilities into cloud-based software that can be easily injected into the technology stack of a web-only brand. Take for example companies such as Anvyl and Backbone. The former helps digital brands deal with all the complications involved with manufacturing and managing inventory, and the latter helps brands manage complex design and product development processes. Both are taking traditionally manual / clunky workflows and streamlining them.

The uniqueness of new technologies in SCM is their emphasis on the SaaS delivery model. As noted by Gartner, the move to SaaS delivery shifts costs from capital expenditure to operational expenditure, which makes investment in SCM technology more attractive to small and midsize businesses — including DNVBs.

SaaS deployments are forecast to account for more than 35% of total SCM spending by 2021, and this delivery model will expand the addressable market and increase overall spending on SCM to $19B, according to Gartner.

2. Logistics and fulfillment companies are moving goods faster.

Building on the supply chain theme, the physical shipment of goods is another continued area of disruption thanks to the rise of DNVBs. Amazon is the leader here with its 49% market share in e-commerce.

DNVBs have previously chosen to sell on Amazon because of the company’s scale and reach. Aside from providing access to millions of loyal customers that are eager to view and purchase products, Amazon has also built proprietary capabilities to fulfill orders quickly and efficiently (via Fulfilment by Amazon or Multi Channel Fulfillment). But digitally native brands are increasingly avoiding Amazon in order to build a community of customers that is independent of the platform. And also to avoid the risk of Amazon having access to key performance data which could help the marketplace compete against brands (via private labels).

The growing “anti-Amazon” narrative in the DNVB community serves as fuel for startups that are looking to democratize Amazon’s fulfilment capabilities and make them accessible to all brands. Most of the activity is centred around making transportation easier, distributing warehousing, and automating labour.

The startups in this sector are largely building products that connect into existing infrastructures, aggregate and optimize the supply side, and then go on to solicit demand. For example, pooled logistics and fulfillment companies such as Flexport connect customers to multiple ocean shipping, air freight, and ground transportation service providers. Much of Flexport’s intellectual property lies in its ability to allocate the supply optimally to the demand, and allow the demand to easily manage the services. Flexe, Stord, and Darkstore take a similar approach but for pooled warehousing. For example, Flexe doesn’t own any warehouses. It has built software that allows its customers to access fractional space in traditionally expensive warehouses at a reduced cost.

Whether democratizing “Amazon Prime” fulfillment and making it accessible for all brands, providing access to on-demand storage in warehouses, or reducing the need for human capital in the fulfillment process, the startups mentioned in the slide above are giving DNVBs greater control of their business operations. And by virtue of that, their fate.

Shopify is also poised to further elevate many of the startups in the logistics / fulfillment sector — by acting as an open platform that helps connect these technology providers to brands through its newly announced fulfillment network. As stated by Ben Thomson of Stratchery in Shopify and the Power of Platforms:

Aggregators tend to internalize their network effects and commoditize their suppliers, which is exactly what Amazon has done. Amazon benefits from more 3rd-party merchants being on its platform because it can offer more products to consumers and justify the buildout of that extensive fulfillment network; 3rd-party merchants are mostly reduced to competing on price.

That, though, suggests there is a platform alternative — that is, a company that succeeds by enabling its suppliers to differentiate and externalizing network effects to create a mutually beneficial ecosystem. That alternative is Shopify.

With a mutually beneficial ecosystem in place (i.e. Shopify Fulfillment Network) that is set to expand quickly, alongside the secular growth in e-commerce, it’s no surprise that 50% of all manufacturing supply chains will have the capability (either in-house or outsourced) to enable direct-to-consumption shipments and home delivery by 2020.

3. Physical retail is becoming experiential and fractional.

DNVBs are known for maniacally obsessing over their customers and how they interact with the brand. The best web-only brands are building physical and digital communities around their customers. For example, Glossier provides a space for women of all ages to inspire each other around beauty, while Peloton and Tonal are creating competitive communities of newly minted athletes.

Although the vast majority of sales by web-only brands are done online, it must be acknowledged that 90 cents of every retail dollar in the U.S. is still spent at a physical location, and industry watchers don’t expect it to fall below 75 cents until the middle of next decade. The customer experience is incomplete without a physical presence. DNVBs are realizing the importance of having a physical presence to drive sales and exposure — approximately 850 new stores from web-only brands are expected to open in the next five years.

Given the importance of physical retail’s impact on brand longevity, it should come as no surprise that marketplaces such as Appear Here have gained traction because of their ability to connect brands directly to physical spaces (as per slide above).

It’s worth noting, however, that physical retail isn’t cheap. For brands that can’t afford a stand-alone location that can be serviced independently, new store concepts such as Neighbourhood Goods, B8ta, Bulletin, and Re:store are emerging to give brands access to fractional shelf-space. Stores are becoming the new media and each square foot represents an ad unit that can be strategically purchased by a brand to access exposure.

4. Data and capital have converged, with the former informing the latter.

According to Vogue, the average cost to launch a beauty brand is $1.5M. Using this amount as a proxy for other vertical brands, and given the typically high margins of DNVBs (due to sourcing products directly and owning their distribution), the likelihood of attaining breakeven status and profitability without direct venture funding is high. Successful startups such as MVMT opted to steer clear of venture capital and still managed to attain a lucrative exit.

The success of DNVBs that have taken little to no capital from external investors has spawned a new class of capital providers that lend to these brands against their expected performance. A prominent example is Clearbanc, which has developed proprietary methods to identify promising companies to enter into non-dilutive revenue sharing agreements with before the capital is paid back.

Another prominent company relying on data to inform investment decision-making regarding DNVBs is CircleUp. CircleUp has both debt and equity funds, and its proprietary technology Helio uses machine learning to help its investment team identify the next breakout brand, such as Halo Top Ice Cream. Both Clearbanc and CircleUp have announced massive rounds of funding to issue more debt to startups. And to the extent that DNVBs intersect with big platforms such as Square, Amazon, Paypal, and of course Shopify, these tech companies have also moved into the lending business since their data gives them an edge over banks.

The statistics for this convergence of data and capital suggest that debt is slowly falling into favour. When looking at the data for CPG companies and non-food DNVBs, we see that the amount of debt raised has increased at a CAGR of 12.4% between 2015 and 2019:

The broader questions posed by the convergence of data and capital is the future role of venture financing in seeding DNVBs. And how the low barriers to entry and abundance of equity-free growth capital will continue to fuel a greater number of brands entering the market. With all else being equal, if founders can guarantee themselves successful outcomes without needing to raise large equity rounds, then in theory we should see an acceleration in this sector.

Another potential trend worth monitoring is what happens with the data being captured by these capital providers? Do these investors continue to use it purely for investment diligence purposes, or is there a broader opportunity to commercialize it in other ways?

5. Social commerce is becoming more important for brands.

Facebook has played a pivotal role in helping DNVBs gain exposure among the masses, and has been touted as the storefront for web-only brands. According to eMarketer, approximately 87% of U.S. marketers will use Facebook for social media marketing in 2019, and 73% will use Instagram. Pinterest and Snapchat are gaining market share as well, particularly for brands interested in targeting women and Gen Z. Glossier represents an example of a DNVB that has harnessed the full power of these platforms successfully. Founder Emily Weiss at one point attributed 90% of her revenue to the engagement of fans on social platforms such as Instagram.

Because social platforms have become the main storefront for web-only brands, they have been investing heavily in their commerce capabilities. From “Buy” buttons to group orders, these platforms are streamlining the steps that consumers must follow in order to make purchases directly on these sites. For example, “Checkout with Instagram” was announced back in March of this year. According to TechCrunch, the new feature allows 130 million people who tap Instagram’s product tags on shopping posts to buy those items without leaving the app, thanks to stored payment information. The major brands that participated in the launch — such as Adidas and Kylie Cosmetics — no longer have to direct their Instagram fans to their websites to make purchases.

Many of these social commerce features aren’t just “nice to haves” for DNVBs. With the ballooning cost to acquire customers through ads on these platforms, brands need a good reason to keep investing precious marketing budgets. If social commerce features can help turn expensive ad impressions into purchases more easily, then DNVBs have a continued incentive to remain on these social platforms and build their communities within them.

Moreover, the growth in purchasing activity informed by social media fundamentally points to the need for brands to quickly respond to new forms of storytelling to drive purchases. As such, another trend worth monitoring is “headless commerce”, defined as separating the frontend and backend layers of any application and having them speak with each other via an API.

The building blocks of storytelling (content management systems, or CMS) and e-commerce platforms have traditionally done a poor job of extending into the other’s territory. But with headless commerce and companies such as Contentful, Mobify, and Elastic Path, brands can operate and spin up new front-end shopping experiences quickly without needing to re-factor their e-commerce back-end every single time. Re-factoring would significantly drive up costs and increase time-to-market.

Given the speed at which commerce is evolving and the ongoing impact of new channels of engagement, we can expect to see incumbents such as Shopify, BigCommerce, and Volusion embrace headless commerce to give brands the utmost flexibility and speed when it comes to creating new digital shopping experiences for their customers.

6. Retail buying will become more sophisticated.

With so many DNVBs being launched that own the relationship with their customers directly (digitally and physically), traditional retailers are being forced to uncover new ways of identifying “it” brands per category and luring them into their stores.

Companies such as Faire represent a new category of startups that are providing retail buyers with the ability to spot new bestsellers. Faire’s technology uses artificial intelligence to help identify emerging products and brands, and suggests to retailers which products to feature on their shelves. This is fitting, as the most popular application of AI technology today is in the form of recommender systems. The diversity in Faire’s business model allows for the retailers to test inventory risk-free for a certain period of time — in the event a product doesn’t resonate with customers, the retailer can simply send it back to Faire. Although geared towards independent retailers, the premise behind Faire’s technology can easily be applied to how mass retailers purchase inventory.

Faire’s approach seems to be working, according to TechCrunch: In December 2018, the company said it has 15,000 retailers actively purchasing from its platform — a 3,140% year-over-year increase. It had also garnered $100 million in run rate sales and expanded its community of artists 445 percent year-over-year to 2,000. Although companies such as Hubba pre-date Faire, and are also focused on connecting brands to retailers, Faire has differentiated itself as a transactional platform and its proprietary use of data to inform the transactions.

Other startups such as Daisy Intelligence are using AI to help retailers augment various aspects of the traditional buying process, wherein the retailer assumes the risk of inventory. These solutions assist with such tasks as demand forecasting and promotional product optimization. For example, Daisy’s AI uses reinforcement learning that can help retailers better understand merchandising effectiveness and its impact on driving revenue. As the capability of AI evolves, there will eventually be fewer steps attached to the traditional buying methodologies. And if the challenge is with informing better manufacturing decisions as opposed to simply buying inventory, platforms such as MakerSights can use crowd-sourced insights on consumer preferences to help with that too.

There is still an important place for the traditional wholesale model in a conversation about the future of commerce. Wholesale isn’t dead and won’t go away anytime soon. As long as traditional retailers reflect the core values of DTCs and update their offerings for the experience and speed-obsessed consumer, then wholesale will remain an important source of revenue for both retailers and DNVBs. Platforms such as Faire and Daisy can help to streamline the wholesale process for both parties in a mutually beneficial way.

Are you building the future of commerce?

Wittington Ventures is a new venture capital fund that invests in the future of commerce. We are backed by iconic Canadian corporations in the retail and property sectors. Some of the operating companies we work with include household names such as Loblaw, Holt Renfrew, Selfridges, and Shoppers Drug Mart.

Our team is excited to partner with entrepreneurs who are building the future of commerce. If you’d like to get in touch and tell us about your company, feel free to send me a note at qmohammad@wittingtonventures.com

A special thanks to Jim Orlando for collaborating with me on this piece.

Note: All currencies in USD unless noted otherwise.