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The new reality: Hims as an incubator, Bonobos as an M&A shop, and Harry’s as a VC. What’s driving this new DNVB trend?

NEW YORK — Over the last ten years, digitally native vertical brands (DNVBs) have sprouted up to an incredible degree. As a class, they all share several distinctive characteristics, but their main advantage over the old guard is that they’ve basically operated as tech-enabled, super efficient — and very much direct-to-consumer — retailers.

This technological differentiator has been their key advantage up to this point. Yet that now looks to be changing. Increasingly, well-funded DNVBs — think: Harry’s, Dirty Lemon, and Glossier, for instance — are pulling a page from big business. We’re now seeing them engaging in mergers and acquisitions, and in some cases even launching their own venture capital arms and incubators in an effort grab more market share or, when necessary, offset particular weaknesses in their businesses.

Why modern brands are stepping in this direction.

Frankly, this should come as no surprise. Starting a DNVB is simple in theory, much harder in practice. The steps usually look like this: You create a product. Then you develop a brand or personality that resonates with your target demographic. Next, you sell these products through your website. And then you watch as your revenues (hopefully) balloon.

Harry’s, Dirty Lemon, and Glossier are engaging in M&As, and in some cases even launching their own venture capital arms and incubators in an effort grab more market share or offset their weaknesses.

Sounds simple enough, sure. The silver bullet, of course, is in your own distribution channel, which is either your website, your pop-ups or permanent stores — or, for the lucky few, both. Your website in particular allows you to sell your products without massive overhead costs, and best of all, have a direct line to your customers. This very formula is what DNVBs all over the world have been using for the past few years.

But here’s the thing. As these young brands have grown, so too has the cost of running an online brand. The largest overhead costs have now moved from rent and physical infrastructure — to customer acquisition, your advertising and marketing costs (online and offline), in other words. This is because advertising rates on Facebook and Instagram, the bread and butter for a DNVB’s marketing budget, have continued to rise.

In response, young brands have had to stay nimble in their thinking. When growth through their website slows down — as it usually does at some point — most brands test wholesale (and sometimes fully transition over to it) in hopes of acquiring more customers. A few high level examples of this are both Allbirds and Reformation selling through Nordstrom and Bevel selling on Amazon. In each case, these brands used Nordstrom and Amazon as a marketing funnel, helping them get in front of a new set of consumers more efficiently.

For brands like these that have raised sizeable rounds of institutional money, business will be good for them just on the sales generated by these basic retail and social media marketing plays alone. But because they’ve taken on venture capital, massive growth is the absolute metric that trumps everything else.

So in order to hit the next stage of growth, they need to expand in new directions. Which explains much of this new M&A, in-house VC, and branded incubator/accelerator activity from them. DNVBs are taking stock of what they’ve learned and developed over the last decade and have begun to realize that they’ve built out complex competencies that can be replicated and scaled. And they’re going about leveraging that in the following ways below.

A. The M&A route.

M&A is a strategy that’s been used by private equity-backed companies for decades. Here’s how it works. Company A is sitting on cash. Company A buys Company B, which tends to have comparable (or smaller) revenues and sells products that are comparable or complementary to Company A’s. From there, the merged companies centralize things like fulfillment, supply chain, and customer support in order to reach economies of scale. This lowers overall costs and improves unit economics while increasing revenues.

Bonobos (now of course owned by Walmart) is a great example here. Enabled by the Walmart acquisition, the brand launched a digital consumer brands division, headed by Bonobos founder, Andy Dunn, with the express purpose of acquiring other e-commerce companies — and make no mistake, Walmart has been on tear here.

To that point, Dunn recently said on stage at Shoptalk: “My view is everyone fighting in their own corner for the same things. The concept [of these acquisitions] is actually let’s cross pollinate talent, let’s cross pollinate learnings and let’s have a common backbone and backend with the Walmart’s supply chain, operation infrastructure is going to be the backbone.”

In other words, Walmart, with the experience of Bonobos, will be acquiring more brands that address the markets that interest them. With the combination of Bonobos’ brand-building, online infrastructure, and Walmart’s supply chain and infrastructure, they’ll reach economies of scale to help these newly acquired companies grow revenue and save costs on the back-end. Everybody wins.

B. The Venture Capital route.

Most Lean Luxe readers understand this investment vehicle, but for clarity, venture capital is a form of private equity. It involves a cash infusion by a fund into an early-stage business in return for an equity stake. This capital is meant to fuel high-speed growth and gain quick market share.

Harry’s went from competing with Gillette in the razor industry, to taking on Proctor & Gamble through strategic venture capital investments.

In February 2018, popular shaving company Harry’s raised $112 million to move beyond shaving. As the NYT reported: “Now they want to take on Gillette’s parent company, Proct0r & Gamble.” Months later, in June 2018, Harry’s job board was actively hiring for their new Harry’s Ventures arm. Harry’s went from competing with Gillette in the razor industry, to taking on Proctor & Gamble through strategic venture capital investments.

Older brands investing in smaller, newer brands is not new. What is new, however, is a DNVB doing the investing. This allows brands to cozy up with one another and many in the industry look at as an unofficial right of first refusal to purchase in the future. Keep a look out for Harry’s on term sheets in the near future — and potentially acquiring companies outright down the road.

C. The Incubator/Accelerator route.

Business incubators have been around for decades and they primarily help smaller startups scale quickly by plugging them into their pre-existing network and infrastructure. Y Combinator, the world’s most prolific seed stage accelerator, takes a 7% stake in startups in return for seed capital, institutional advising, and, of course, connections.

Up until now, VCs, like Forerunner and Thrive, to take two examples, have brought their successful portfolio brands together to share information and connections. But they’ve never actually developed brands in-house and then launched them.

And then there’s Atomic, a venture capital firm that creates, funds, and builds start-ups, and is quietly upending the time-tested VC model. Their most well-known portfolio company, men’s wellness brand Hims, was created by Andrew Dudum, a partner at Atomic. With Dudum at the helm, the Hims team developed the brand and tested their marketing engine prior to launching. Roughly a year later, Hims is reportedly doing remarkably well, and continues to raise money (totalling $97M to date) to rapidly expand in what could turn out to be a zero sum category of men’s wellness.

Like the M&A strategy, incubators allow these companies to address markets that they’re unable to address with just their one brand alone. The two considerations with incubation, however, are first, you’ve got another brand on your hands to scale, and second, assembling the team to handle that. But the one outsized benefit of that is obvious: Creating another potentially large asset alongside the brand you already own.

As we all continue to keep a watchful eye on the still very young (and evolving) landscape of DNVBs and the modern consumer economy more broadly, it will certainly be interesting to observe their moves through the lens of these three business models to watch how things continue to unfold on this front. Without question, the future is an exciting one.

Lean Luxe subscriber Philip Soriano is a startup consultant and executive coach living in Brooklyn, NY. He is the co-founder of Hugh & Crye, a men’s apparel brand based in Washington, DC. The views reflected here are those of the author and do not necessarily reflect the views of  Lean Luxe.

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