The Unbundling of Retail

The State of the Commerce

2022 saw perhaps the most emphatic rejection of the DTC-only narrative. As we beleaguered in our Death to DTC and Point of No Returns blogs, sky-high CACs and return rates, combined with a shift away from ecommerce back to brick & mortar, have undeniably exposed the weakness of the DTC-only strategy. The market pullback didn’t help — across the board, public and private investors are now firmly rejecting unsustainable growth stories. Allbirds and Rent the Runway have both yet to turn a profit and are down 90% and 80% (as of 1/9/2023) respectively since their IPOs — both with shocking ratios of current market cap to dollars raised. Capital is no longer dirt cheap and consumer wallets are no longer wide open.

For many brands used to the unsustainable growth of the past few years, this refocus back to the fundamentals will be a drastic, and perhaps painful shift. Omnichannel, especially in retail, is back — per the U.S. Department of Commerce, ecommerce as a percent of total retail sales has declined every single quarter since Q2 2020. Margins, not top line growth, are king once again. Going forward, there is no doubt that brands and retailers will be taking a hard look at their existing operations to improve the economics across the value chain.

The Vertical Hypothesis

One of the prevailing theses for startup success over the last decade has been to vertically integrate to unlock a meaningfully better consumer product. While we believe this method demonstrates a lot of promise in other industries, its application in retail has destroyed a tremendous amount of shareholder value.

A core tenet of the original DTC narrative was that verticalizing the value chain to fully own the customer experience would lead to a better economic outcome for a brand. As brands realized that ecommerce unit economics were structurally flawed for most product categories, they started exploring other channels, notably brick & mortar. Naturally, staying inline with the verticalization thesis, many DTC darlings eschewed working with traditional retailers and attempted to build out their own brick & mortar infrastructure themselves to fully own the consumer. Given the capital intensity of physical retail, the results have not been pretty. Full verticalization in retail requires significantly more paid-in capital to achieve profitability and the DTC OGs — Warby Parker, Allbirds, Casper, Rent the Runway — have all yet to turn a single dollar of net profits despite billions of venture dollars raised and more than 200 stores opened.

Go Big and Go Home

Economies of scale have long proven to be one of the most powerful moats one can build in retail. From sourcing to manufacturing to fulfillment to returns, and even disposition, the giants — Amazon, Walmart, Nike to name a few — all have stellar grasps on their fundamentals, tight ground games, and more importantly, massively different cost profiles than emerging brands. Most things get easier with scale. For example, a larger brand has more leverage over suppliers, broader name recognition across consumers and better access to capital to invest in building out its brick & mortar footprint. Subsequently, once a brand has the physical network, they can leverage B&M locations to lower fulfillment and return costs by bringing products closer to their customers.

Many brands pursued this same logic to verticalize in the hopes of achieving these economies of scale. The problem, however, is achieving scale benefits is counter to many of the principles of operating like a startup. Achieving scale parity to legacy players with billions of dollars of sales is extremely capital-intensive. In an age where platforms like Amazon offered unprecedented flexibility and efficiency, these brands robbed themselves of that agility in pursuit of a capital intensive road to nowhere. In reality, the incumbent retail value chain is highly sophisticated and developed — beating the legacy value chain proved far more difficult than most thought!

At Equal, we believe that emerging brands should focus on the core competencies that startups excel at — understanding their consumer, developing amazing products, and building inspiring brands. This is how startups in other spaces operate — they focus on their core product and channels to the customers, outsourcing non-core functions to “as a service” platforms that enable them to mimic the infrastructure of much larger companies while they pursue product-market fit. Why should retail be any different?

The Great Unbundling

“The Great Unbundling” has been a major theme of Equal’s Retail thesis since the inception of the fund. We’ve long held that brands should focus on what they do best and outsource everything else. We love businesses that enable brands and retailers to take activities off their balance sheet that are not core competencies, particularly around operations and logistics. Not only does this free up a brand’s energy to focus on what matters the most, but it also enables the opportunity for emerging brands to band together to reach greater economies of scale together.

We first unveiled this thesis with our investment in Leap, a retail-as-a-service platform and our first core investment. As Rick wrote in 2018 in “The Rebirth of Retail,” we saw a massive market opportunity to help mid-market and long tail brands enter and manage the retail channel. With Leap, brands can focus on what matters the most — the product and consumer experience — and outsource retail operations, similar to how startups rent their services, not own them. More importantly, because economies of scale are so critical to retail operations, the brand is actually tapping into a much more powerful network than attempting to execute by themselves. In scenarios where a brand already had existing stores, Leap delivers significantly better performance because Leap enables brands to access best-in-class operations that they would not be able to implement by themselves.

We expanded upon this thesis with Ghost, a managed marketplace for excess inventory. Instead of an internal operations team attempting to tackle the headache of dealing with various brokers and suppliers, a brand can go onto the Ghost platform and optimize ROA through tapping into a vast network of excess inventory buyers. Brands can achieve a significantly higher return on their excess inventory through Ghost with fewer headaches and without having to worry about heavy discounting diluting their brand.

Along the way, we partnered with various other providers in the value chain (we’ve seen logistics providers like Outerspace do incredible work with brands they share with Leap and Ghost). In all these cases, the brand is significantly better off “unbundling” parts of the value chain that rely on economies of scale, such as retail operations and excess inventory disposition. These are not the only examples out there in the market today. We’ve seen the growth of outsourced infrastructure and distribution channels with wholesale marketplaces like Faire and even ecommerce-as-a-service solutions like Pattern.Com. As we see the “Great Unbundling” fold, a new infrastructure stack is emerging to give brands the scale benefits of the incumbents.

The New Commerce Stack

As we look at the retail value chain, we see a stack of supporting platforms and solutions that can better enable brands to be more nimble and profitable without significant capital investments. While brands can’t achieve scale parity independently, these platforms can aggregate these individual brands to unlock economics that rival that of those like Amazon. With the exception of Shopify, the companies we’ve highlighted are responsible for atoms, not just bits and all monetize through a percent of GMV pricing model. We’ve already made bets in brick & mortar retail and excess inventory and are very interested in areas like returns / reverse logistics (see our Point of No Returns blog), re-commerce, and ecommerce management. That said, we’re excited to see any and all solutions that can better enable brands to unleash better economics in the commerce value chain.

We look forward to meeting passionate founders working on the New Commerce Stack to arm emerging brands with the capability to achieve operational excellence on par with the giants of the industry. If anyone’s building in this space, please reach out to Rick (zullo@equal.vc) or Chelsea (chelsea@equal.vc)!

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