Podcast: Five Harsh Truths To Scaling DTC Profitably in 2024 and Beyond

Episode Summary

In this episode of the Free to Grow CFO Podcast, Jon Blair is joined in the studio once again by his co-founder, Jeff Lowenstein to tackle the essential strategies for scaling a Direct-to-Consumer (D2C) brand profitably. The conversation delves into the challenges of managing in-house manufacturing, the critical move into physical retail, the importance of embedding repeat purchases into product design, and how high gross margins can drive growth through paid advertising. With their vast experience in helping D2C brands scale, Jon and Jeff provide invaluable insights and practical advice for entrepreneurs aiming to grow their brands sustainably.

• Explore how segmenting customer data and
  analyzing cohort behavior can provide
  valuable insights to refine your marketing
  strategies

• Understand the importance of designing repeat purchases into your product development to drive sustainable revenue growth.

Key Takeaways:

• Learn how integrating manufacturing and fulfillment processes can lower fixed overhead costs, positively impacting profit margins and cash flow

• Discover why scaling beyond $50 to $75 million in D2C often necessitates moving into physical retail to tap into a larger consumer base

• Grasp the critical balance between repeat purchase subsidies and first-order acquisition costs for profitable scaling

Episode Links

Jon Blair - https://www.linkedin.com/in/jonathon-albert-blair/

Jeff Lowenstein - https://www.linkedin.com/in/freetogrow-jeff/

Free to Grow CFO - https://freetogrowcfo.com/

Meet Jeff Lowenstein

Jeff was previously leading M&A efforts at ecommerce aggregator Boosted Commerce where he was the 5th employee. He built processes across M&A, finance and operations to support rapid growth from 0 to 30 brands under management in 2.5 years.

He previously co-founded and exited an app for Shopify merchants and spent time in the Strategic Finance departments of Etsy and Caesars Entertainment. Jeff holds a BA from the University of Pennsylvania and an MBA from Harvard Business School.

He’s worked with hundreds of brands over his career and founded Free To Grow because of his passion for supporting entrepreneurs and helping them succeed. The analytical and financial tools he has developed over the years are specifically crafted for the modern consumer brand.

Transcript

~~~

00:00:00 - Welcome to the Free to Grow CFO Podcast

00:00:30 - Introducing Jeff Lowenstein

00:02:50 - D2C and Vertical Integration: Challenges and Considerations

00:18:36 - The Role of Physical Retail in Scaling a D2C Brand

00:29:11 - Strategic Approaches to Physical Retain and Pricing Strategies

00:32:55 - In-House Manufacturing and Fulfillment

00:35:25 - Expanding into Retail with Consultants

00:37:08 - Repeat Purchase Strategy: Designing into Product Development

00:45:09 - Segmentation and Analysis for Repeat Purchase Behavior

00:47:45 - Importance of High Gross Margins for Profitable Scaling

01:01:00 - Final Thoughts

Jon Blair: All right, what is happening, everyone? Welcome back to another episode of the Free to Grow CFO Podcast, where we're diving deep on conversations about scaling a D2C brand, and it's all about doing so with a profit-focused mindset. I'm your host, Jon Blair, one of the founders of Free to Grow CFO. We are the go-to outsource finance and accounting firm for eight and nine figure D2C brands. And who do I have with me today? The infamous partner in crime, co-founder of Free To Grow CFO, Jeff Lowenstein. Jeff, it's weird to see you on a computer screen because I was just with you in person in New York yesterday, but great to see you. What's happening, man?

Jeff Lowenstein: Jon, you feel so close I could reach out and touch you through the screen. You're literally just here in this small office with me in New York City for the last 48 hours. So it feels weird, but also natural to be back in the little box on our computer where we spend so much of our time doing our work. Good to see you on the pod, and I'm happy to join and talk shop again.

Jon Blair: Yeah, man, it's gonna be good. We're gonna do something a little bit different on today's episode. There's a recent LinkedIn post I posted a few weeks ago that really kind of ruffled a lot of feathers and just got a lot of people talking about, I think, real issues and challenges with scaling D2C. And honestly, there was some really cool comments that I think even brought to the discussion some things that I wasn't thinking about. And it left such an impression on me. I was like, hey, Jeff and I should riff on what I talked about in this post because it wasn't just a post to just like get people all riled up. They're real true, they're beliefs of mine about scaling a D2C brand profitably. So, you know, the post was called five harsh truths about profitably scaling a D2C brand in 2024 and beyond. And the reason why I said 2024 and beyond is because some of these things weren't necessarily true in the early days of e-com. Back in 2017, 2018, when I was scaling Guardian bikes, not all these things were true. And so I just wanted to put something together where we could have a conversation about these things and just like elaborate on some of those points that, you know, you can't really be elaborate in short form content. And I think you have a lot of very interesting examples and additional perspectives on these topics from where you sit in the marketplace and your set of clients that you oversee versus the ones that I oversee. So, I mean, dude, let's dive in. Here's the first one. And this one, I did another post on this like a couple months ago and it actually upset a lot of people. That wasn't my That wasn't my aim, but it's about D2C and vertical integration. And so in layman terms, bringing manufacturing and fulfillment in-house. And what my statement was, was D2C and in-house manufacturing slash fulfillment don't mix. It drives too much fixed overhead, and unless you can reach a nine-figure annual revenue, it's gonna wipe out your profit and cash flow. Let's just riff on that, man. What are some of your thoughts when you hear that statement?

Jeff Lowenstein: Well, I don't think it's quite as hot a take as you think. I mean, I completely agree. It's really hard to run an econ business between getting your storefront in tip-top shape, getting fulfillment to the customer, customer service. There's so many things you have to get right and are hard to get right, and getting production in your own facility right on top of all those other things is really freaking hard. So I think there's that side of it, too. The great thing about a traditional econ business is that you have mostly variable cost P&L, right? And so Really, what you're getting at is switching from a variable cost COGS to a fixed cost, moving more of it to fixed cost. It's not entirely fixed cost. You still have your raw materials, right? But that can be great if you're able to scale into that and create operating leverage. But for most people, getting from zero to eight figures takes time and effort. Starting out of the gate producing your own product is a really big swing that's going to be hard to do without raising significant capital.

Jon Blair: Yeah, and you know what's interesting? Your comment about like the hot take. I didn't expect this to be a hot take, right? Like this was just an observation that we've had in working with several dozen brands at the same time, right? And seeing most of them outsourcing fulfillment and manufacturing and a small subset of them. Insourcing it and it does work for some brands, but generally we see it not work for brands, right? there are always exceptions, but Most brands have to deal with the rule not the exception and so like I was actually surprised when I wrote this post that so many people got fired up about it and what what I actually realized in the comments was that like there are a lot of people who either had figured out an exception to the rule and so they were like hey this is possible right or they were in the middle of trying this and they had a firm belief that it was possible and so like a couple things i want to say like one there are exceptions to the rule and the reality is in short form content you can't like write this long thing that caveats everything right you have to say what's mostly the universal truth right but another thing that i want to mention is that there's two And again, this is generally speaking, there's always nuance, but there's two ways that I have seen brands be successful on bringing manufacturing and fulfillment in-house. One is the obvious, or I think the obvious one, sales volume, right? They're able to scale enough to actually realize the economies of scale of, and of operating leverage of like converting more variable costs to fix costs, right? That's one. But the second one is there is a second one that is closely tied to DTC and this is why Guardian bikes decided to vertically integrate. because they needed control over the quality and the experience, but they were able to charge for that. in the D2C channel. And I want to like all caps charge for that, right? Because there are some brands that I have seen try to insource this stuff to control the experience, but they're not able to charge for that really amazing unboxing experience that they do by doing their own packaging and fulfillment, right? And so if you have a strategic sales advantage, sales and marketing advantage, that needs to be enabled by vertical integration, and you can charge for that, that is another way that I see DTC brands actually successful, but most brands don't figure that out.

Jeff Lowenstein: Do you agree? I agree. What I think you said, you said a couple of things that are interesting, which Again, there's always exceptions to the rule. So when does this work? It works when you're selling a product, you've designed a product that is truly differentiated and cannot be produced in a contract manufacturer setting, or it's so proprietary that you don't feel comfortable allowing someone else to produce it, or you're not confident in the ability of someone else to produce it. The other thing you need to think about is if you're going to start this way from scratch, is how large is that initial fixed investment? And so for those that do make this work, they're able to start with smaller production capacity, and then eventually you do have to turn that into larger and scale that, right? Totally. you don't want to go too big too fast, but you also don't want to be locked into the smaller one, right? Because you're, you're going to have to grow beyond that eventually too. I did recently actually invest in a brand. I do try to do a little bit of angel investing that is making their own product and it's going very well and they have a different methodology for production than the competition. And that's been a huge value add. It's been their competitive advantage. And so they're very happy with being constrained on the production side for the time being because of their in-house production. They can't produce quite as much as they would like to be able, or as they could sell. They are constrained for the time being, but they're okay with that because they're going to keep control of that process and they're going to be able to invest in a larger facility soon. And their whole business model really does revolve around that. I say that with the caveat that that is more of an exception than the rule. And so it does work for some people. But I think for most people, your time is better spent working closely with your manufacturer to design your product in a proprietary way that is still differentiated and using existing infrastructure that's already out there in the marketplace.

Jon Blair: Totally agree. Totally agree. To draw out an important theme here and what we're both saying, I don't want to sound like a consultant. The word strategy is overused in the consulting world. Is it strategic to insource these things? Is there true strategic value? Because if you think about it, like you said, there's fixed costs and there's upfront investment to getting this stuff up and running. So you do need to analyze if it's going to take X dollars to get this thing up and running. what is the strategic value that's being created either in being able to charge more and or lower costs over time or some other competitive advantage in the product and how long will it take for that set of advantages strategic advantages to pay back that investment. We did this analysis at Guardian Bikes and we actually distilled it down into like, hey, it's gonna cost X hundreds of thousands of dollars to get this facility up and running. We're gonna save this many dollars per unit on effectively outbound shipping. We're gonna save this much on containerized shipping because we could ship components instead of full bikes so we could fit a lot more in a container. And then additionally, we had a strategy for how we were going to reduce inventory levels and we're able to distill that down into like, Hey, it's going to take this many units sold to pay back this investment. Right. And we, we felt pretty confident in certain sales volumes we were going to hit. So when we went to go raise the money for it, we could say, Hey, we just need to sell this many units for this to pay for itself. And let us show you why we're going to be able to sell that many units in two years and this is gonna pay for itself in two years. It's about being intentional about the true incremental impact of making these investments and just doing a little bit of homework.

Jeff Lowenstein: Yeah, it's interesting. What you just said made me think of another consideration that I've seen with some of my clients that do make their own products. is the sourcing component is much more complicated when you're buying your own components, right, and raw materials. And especially if you're in a category where it's, you know, natural products or agricultural products, those components and raw materials might only be available at certain times of the year. And by the way, those MOQs might be way, way, way higher than what you would actually need to buy if you were just buying finished products from an outsource manufacturer. And so there's a whole different supply function, team, cash flow consideration that you need to consider. You might need to be storing products that are, you know, you might need to buy like two years of a certain component. two years of cover because the MOQs are so high when you're sourcing direct. So that type of stuff you don't always think about when you make these types of decisions. Totally. But it can really make everything a lot more complex.

Jon Blair: Well, and to distill, like to kind of like distill that down into a summary, there's fixed car, there's upfront investments to consider. There's the changes in variable costs, right? And margins over time post the changes. There's the changes in ongoing fixed costs after the, after this, but then what you're talking about, there's a change in working capital, right? Your inventory, uh, your, your inventory days, equation changes. This is a perfect example of where a CFO can help with a three statement financial model, right? Where the three statement financial model is not just projecting out the P&L impact, which is like the fixed cost changes and the variable cost and contribution margin changes, but it's also, you're also able to forecast What if inventory days change like this or like that because of, so like that three-dimensional view of projecting out the P&L, the balance sheet, and then ultimately the cash flow impact is really important. You can't, you shouldn't make one of these decisions just by looking at the P&L impact because like you said, there's very clearly a working capital impact but if not other reasons like definitely impacting inventory days but probably impacting AP days as well because you're now buying different types of materials and components from different vendors and you may be able to take advantage of better payment terms. I've seen it happen where you can get better payment terms with a component supplier versus the finished goods supplier. But I've also seen it work out in the wrong direction, which is all of a sudden you had really good payment terms or decent ones with your assembly factory. You're now the assembler and you go to these component factories and you're starting from scratch. And so this is where a CFO is really, really important to help you get that three-dimensional, three financial statement projection view of making a decision like this?

Jeff Lowenstein: Yeah. I mean, I'm just thinking about how the balance sheet changes, right? You have fixed assets all of a sudden with your machinery and what's going on on the floor. And then you have the inventory and finished goods, but you also now have all these components and raws you need to keep track of, uh, as well. So it gets, it gets quite, uh, it's quite a different balance sheet to take care of and make sure you're managing. And then even on the P&L, another thing is you're actually moving away from gross profit. You're moving costs out of gross profit in terms of COGS when you're buying finished products at a higher per unit cost. And if you make it in-house, now actually some of that cost is actually going to hit your payroll line, which people don't think about either. Again, that goes into the operating leverage conversation, but people aren't really fully thinking through what that means, right? You have people on the floor making the product, you might have managers, you might have other sourcing people running around doing things, right? So the payroll line actually goes up quite substantially as well.

Jon Blair: Yeah, and one thing, I mean, I've talked about this with several of our clients and our prospects is that like operating leverage It's called leverage for a reason, right? Leverage means it is something that you can leverage to your advantage, right? But it comes with a risk. And the risk is it takes more revenue to break even, right? When you have less operating leverage, it can take less revenue to break even. So that's the general disadvantage. But the advantage is when you cross the break-even point, the number of dollars that drop to the bottom line for every dollar of revenue after that is massive. Whereas if you have a mostly variable cost, like cost of goods sold, you keep paying the same variable cost no matter how much you scale up. And so it's a question of where the risk lies. Like for a company with a lot of operating leverage, the risk lies more heavily before your break-even point, right? And I would say again, it lies again when you scale past the break-even point, you have to make the decision of increasing capacity. Because then you have this new step you have to take up in operating leverage and get to break-even again. And so it's not a good or a bad thing. It's just a different game. And you have to be able to recognize it's a different game. And you have to have the tools from a financial planning standpoint to be able to make sound decisions as you're dealing with scaling with a lot of operating leverage.

Jeff Lowenstein: It looks like a staircase function. Your fixed costs are flat for a while while you're in your current facility when you make it in-house, and then when you move to a bigger one, it's a big jump up, and then you're flat for a while as you increase sales to the maximum in that facility. I actually have a client that I just helped with a fundraising deck and analysis for. They make their product in-house. The math that we did was we calculated at certain unit volume levels exactly how much operating leverage they would realize and how the margin expands. as they scale. And it's very clear. There's going to be a lot of margin points opened up as they continue along that path. And it's going to be a very profitable, successful business in the future. But the reason they need to raise money and the reason we're doing this exercise is they're still below that break-even level. And so there needs to be a cash injection to help get through and help invest in some of that growth. So it's exactly what we're talking about. We just put that together in the last couple weeks.

Jon Blair: So then let's talk about this, the next point from this LinkedIn post, which is related because in some way, because it talks about where is the volume out there for the brands, right? Like what channels are like high eight figures and nine figure revenue volume. And so what I said was the D2C brand with nine-figure aspirations must expand into physical retail. Sorry, that's just where the nine-figure addressable market lives. Getting to 50 to 75 million D2C can be doable, but if you want to scale beyond that, get ready for retail. Now, let me contextualize this a little bit. Back in 2017, when we started Guardian Bikes, there were D2C darlings that got to nine figures on their website. And crazy enough, we know some, we know them personally, like in the mattress industry, who got there without top of funnel spend, who got there all from spending on Google, like basically bottom of funnel, like PPC. Those opportunities generally don't really exist anymore because those were like the first movers in these D2C spaces, right? So that's dried up. We work with plenty of brands. I've worked with plenty of brands and we have several clients who have gotten to very healthy eight figures, right? But the ones that wanna push into nine, we do have a unicorn that is e-comm only that we won't name. That's pretty cool. But they're the exception. That's one out of 25 clients that we work with, right? If you wanna break through 50 to 75 million, you gotta get into retail. And it's just because That's where the high eight figure, nine figure addressable market is. That's where the consumer is. I didn't come up with this. Candidly, I talked about this on our podcast many months ago with Ryan Rouse and Ryan Rouse who's one of my mentors, was just like, dude, it's just the way it is. I'm not trying to say, I'm not trying to ruin your dreams. And he's like, by the way, if you wanna run a mid-eight figure brand, D2C only, and not expand to retail, he's like, that's okay. If you can sustain a competitive advantage and sustain your margins, you got strong repeat purchase. You should do that if that's what you want to do, but if your aspirations are to get to nine figures or high eight figures, physical retail is most likely a reality and it's just the truth of where the TAM is. What are your thoughts about that, man?

Jeff Lowenstein: There's a couple of things I want to respond to. You have my brain going in a few different directions. I think the last point is like really interesting. I think that there is a natural ceiling for some brands within direct to consumer and you can have a really profitable, stable business at that level. And so some brands actually that ceiling might be lower, uh, depends on the channels you're going to be in in terms of your marketing channels and all that depends, depends on your category there. I think I have this idea in my head and I actually, um, I respect, I, put a comment on Preston Rutherford's LinkedIn post about this the other day. That natural ceiling that Ryan is alluding to and that I'm talking about is really important to understand because every incremental sale you get beyond that is going to be super expensive for you to acquire, and it completely changes your margin profile. And more brands die by trying to scale too fast than the other way around. And so those extra incremental sales are going to be so expensive. And you'll get more sales. They will come, but they're so expensive incrementally that they can change your whole business. And you're going to invest in people. You're going to invest in spend. And it's not worth it a lot of the time. But I know it's hard, right? You're a founder. You've worked super hard at this. It's been multiple years, blood, sweat, and tears. You see the rich wallets and the true classic tees that have successfully done this. The truth is not every brand is meant to be a nine-figure brand DTC only. that mentality of I'm going to be the next simple modern or whatever is actually very harmful. And I'm not saying don't be ambitious. I'm just saying there is such a thing as going too hard and too fast. So yeah, that was one of the things that I wanted to respond to. And I think that's a little bit of a hot take. It's hard for people to respond to that when I say that, because it feels like I'm shooting down their hopes and their dreams when I bring up something like that. And like, oh, you're the CFO. of course, you're more conservative. And so I also struggle with like, you know, not not being too negative and like trying to, you know, rain on someone's hopes and dreams. But, you know, that is something I do feel very strongly about.

Jon Blair: Yeah, so do I. But but here's the thing, like, if you dig in, like, I've I've listened to a lot of interviews with the true classic guys over the years, like if you dig into their story, Dude, they struggled to get to where they got and when they got there, they really started getting squeezed on their margins. It was not like You know all sunshine and rainbows like it was like a constant fight to like what do we do with email? What's the next offer? Like what like it was it's I think the point that i'm making because i've worked with a couple brands that have gotten They were on their way to that and they were crushing it and seemed like everything just worked right on the way up to 50 million and that 50 million and beyond They still figured out how to continue growing, but it got really challenging. And not just the economics, it's like, what is the next thing that we try? Is it the offer? Do we need to think about product development? Do we need to think about channel mix? And in reality, what it is is that The next incremental dollar that you go to acquire, it just takes more strategy to get that next dollar of revenue. When you see a brand that gets to 100 million, I can guarantee you that it was a dogfight to make it happen. We knew a lot of people that were early on at Tuft& Needle. that worked for us at Guardian Bikes. And like, sure, at the beginning it was like crazy growth, but they really had to figure out, like once they started saturating certain marketing channels, they had to get really, really creative. And they had to do it on a budget because they were bootstrapped. from day one. They didn't take on any outside equity capital. And so like the ideas that they came up with to in a very bootstrapped way, try to do more top of funnel advertising was really, really interesting. They had this one billboard campaign, like funny enough, out of home billboards, like actually really, really crush it for them at a certain stage of their growth. And they had this one campaign that just like, I believe it was a black billboard with white writing and it just said, mattress stores are greedy, tn.com, right? And they bought the tn.com was the landing page for that to try to figure out attribution. But they were going around and they were buying up billboards that were sitting there unsold. And so the advertising companies were selling them at a discount for whatever period of time it took for someone. You could do month to month or like a short term contract for super cheap until someone would come in and buy a long term contract. So they're finding all these obscure billboard locations that had nothing on it. striking a deal with the companies that own them and coming up with these really provocative one-liners that would get people to their site. And I'm just mentioning that because you gotta get more and more creative, right? But at the same time, figuring out channel mix is really important. And one thing I wanna say about physical retail that I don't wanna sound like a broken record, but this is something that I've learned since we've been growing free to grow together and have worked with dozens of brands. Don't try to go into physical retail just because you feel like you're hitting a ceiling in other channels. Again, I hate to sound like a broken record. What is the strategy for going to retail? And I'm gonna be more specific instead of just say the word strategy. Why is that channel strategic for you? Because physical retail actually isn't strategic for every channel. Guardian bikes may never, ever, ever, go physical retail because that is not a strategic channel for guardian we have to tell the story of the safest kids bike that costs more in physical retail unless it's a single brand store and that is a guardian bike store We're not going to be able to tell that story. We tested it. It's very hard to do that on a Walmart bike aisle or independent bike shops. If there is any physical retail, strategically, Guardian probably has to do a single brand store like a Tesla store or an Apple store. The point that I'm making is Don't just say physical retail because I want to get to a certain amount of revenue. What is the channel? How can you use physical retail strategically? If you're a consumables brand and you're doing cosmetics, it's likely that Target's a no-brainer and there's something very strategic about going to Target. For Guardian Bikes, Target was not strategic for us and there's no way we would end up doing that. I think that's very important to just not, just try to expand into channels to get revenue, but to ask yourself, what is the next most strategic channel for me to actually have a competitive advantage or some unfair advantage in because of either my product or my marketing or something like that? What are your thoughts on that?

Jeff Lowenstein: No, I completely agree. I mean, it's, you know, we like to think that direct-to-consumer e-com is like the whole world because we're in the industry. we could, we all talk to partners and brands all day, but like there's, you know, I can't remember off the top of my head, but I mean, it's only what, like 15% of sales are online in the U S right. The rest is physical retail, some, something around there. So, I mean, that's where the consumer is. That's where they're shopping. You, you do need to go there if, if you're going to grow beyond a certain point, it doesn't mean it's right for every brand either. That's it may not be. a good option for everyone. Another thing to be strategic about and just to remember is you need to maintain and stay on top of your retail sales and your actual retailers in the same way that you are on top of your site, making sure nothing's broken, right? Just because you get a few POs to a few different stores and you send out some product doesn't mean it's all going to go well. Is your packaging and the way that you're shipping it out to those stores working well? Does it appear nicely on the shelf? Are you in the right aisle and category? All that type of stuff is important. And so I actually recommend working with a consultant that knows what they're doing. Totally. In terms of getting brands into stores and scaling up the number of doors that you're in. Going deeper in one geography first is another strategy or tactic really that I think does well for people because you get better feedback. If you show up in a few stores in the same geography and people see you more and more, I think there's a positive feedback loop there. And then you can also understand, you know, you're getting like your, your product velocity metrics within like a certain, within a set of stores, uh, and understanding those versus like overall sales, right. Is, is, is something that people need to, you know, unpack and not just look at the aggregate numbers.

Jon Blair: For sure. For sure. Yeah. I mean, and another big pain point, I talked about this with, um, Renee Hartmann on one of our previous episodes is like the, the, Multi-channel pricing strategy right becomes a really big challenge and something you definitely have to police and work with retailers on because like You do lose control over your pricing. You have to know that that's going to happen. Yes, there's an intentionality and a strategy to trying to work with your retailer on it, but there are just going to be times when that lost control is going to result in them doing something to your pricing. Going back to your comment or your suggestion about using a consultant, Use a consultant because they can help you go in eyes wide open. I was actually talking with Amazon Growth Consultant right before this on the other episode that I was recording today. We were talking about how if you find the right consultant, whether that's a fractional CFO like Free to Grow or it's Tana who I was just talking to who's an Amazon and Marketplace Growth Consultant or Renee Hartmann who's retail consultant, they can help you go further faster. Yeah, you gotta pay them a fee, but they've made all the mistakes, right? They've made all the mistakes that you are going to make if you don't have someone to help you go in eyes wide open and say, no, no, no, no, don't do it that way. I've made this mistake. I've seen many brands make this mistake. I know this may be counterintuitive, but you wanna go at it this way, and here's why. I think the challenge is, finding the right consultant because there are plenty out there who will cost you money and you don't get that value, you don't go further faster for the fee. It's just a comment that I want to make that especially Eventually, as you scale in retail and it becomes a significant portion of your revenue mix, you're going to want an in-house retail team. But you don't need to step out and hire a full-time in-house retail team when you're just getting launched. You're testing the waters and you're seeing how much volume you can get. That's the perfect time to use freelancers and consultants. to help navigate the various aspects of expanding into retail. And then if it sticks, because you can turn that consultant off whenever you want, and they're probably cheaper than a full-time person. But if retail sticks and you start scaling, then you can bring the most valuable roles in-house to support that. So anyway, it's just another thing to consider as you're expanding into retail.

Jeff Lowenstein: Yeah, absolutely. And I mean, they can help you avoid a lot of unforced errors, right? So Walmart, for example, is notorious. If you don't ship exactly the right quantities in the right way, you know, like with the right inbound logistics, you're going to get charged out the ass for all these fees that you don't see coming and they're going to hit you. Only, you know, much later you're thinking you're, you're getting paid for your product, but between certain types of trade spend and all these fees and logistics fees, you know, your margins are. Everyone knows your margins are lower to begin with on wholesale, but you know, there's all these hidden fees that you may not know about, uh, going into it for the first time. So using a consultant can really help you avoid some of those or even like just understand what they are so that you can say. Maybe I'm not ready for Walmart. Maybe I need to get my own operations in order first. That type of decision is quite important as well.

Jon Blair: One other note I want to make. When I was talking to Tana on this episode earlier today, she was talking about the sequencing of expanding into marketplaces. In her opinion, you go Amazon, then Amazon Canada and UK, and then Walmart And then depending on your product category, like Target, Wayfair, and what I'm pointing out is what? A sequencing, right? And like I'm realizing the older I get and the more that I help, like we run our own business and work on our own strategy, but then also work on the strategy of the numerous brands that we serve. I think it's very common when you're talking about developing a strategy to talk about what we're going to do. I think generally people are really good at coming up with the what strategy, but I think that more attention needs to be paid to the sequencing. When you do something, I'm actually finding, as I get more gray hairs on my head, I'm finding that when you do something is actually oftentimes more important than what you do, and can lead to either success faster or setbacks. Now, that's where, again, where consultants have been really helpful to me in my life, like on the brand side, is they have some experience of doing things in the wrong sequence. Right? And say like, no, no, this is the right sequence to do it. And that will, that will add years back to your life that will add dollars back in your bank account and it will take a lot of stress. And so just wanted to make a call out about sequencing. Sequencing is really, really important. Physical retail maybe isn't the right second channel. Maybe you should go to Amazon seller central first, right? To squeeze out that next bit. of revenue, and then maybe you spend some time on the marketplaces, and then maybe you go to physical retail, right? And so, just some things to consider if you've got those big high eight figure, nine figure aspirations. Really think hard about the sequencing, right? And again, not to sound like a broken record, but why does that sequencing matter strategically? Like, ask yourself that question. Why would I want to go here first? as opposed to here first. And I think that if you bring the right people around the table to chat with and you challenge yourself with those questions, you'll probably make a better quality decision. Absolutely. What else do we have on the list? So, repeat purchase is designed into your product catalog during product development. It can't be fixed through advertising efforts. So, this one actually upset a lot of people too. And again, I wasn't This is not trying to make this a hot take, right? It's just I'm realizing, I mean, I have to look back to see how many total brands we've served. Maybe 35 in the last two, two and a half years, probably approaching 40. Right now we have 25 brands we actively serve. That sample, I've run single brands before this, but being able to see 35 plus brands over the last couple of years, it just really hit me hard that repeat purchase is mostly a product problem. Are there things that you can do with advertising to incrementally improve it? Of course, there are things. But all the advertising in the world can't fix a product problem. And if you didn't intentionally think about repeat purchase when you designed individual products and product lines and product roadmaps, you're doing yourself a big disservice and you're leaving it up to chance that repeat purchase actually happens. And so I'm actually starting to believe this really wholeheartedly the more brands that I work with that you've got to fix and design. You've got to design in repeat purchase up front, not on the back end. What do you think about that?

Jeff Lowenstein: Well, I totally agree. I don't even know I don't even see the other side of that argument. It's a behavior related to how you use the product that you're going for. If it's going to be used over and over again, that's fantastic, and it lends itself well to subscription, which is obviously great as well. But also, if you're a single-use Or single purchase product, right? That's also okay. You need to know that expecting repeat purchase in a place that it's not realistic can get you into trouble. There's another angle to this, which is if you have other products and other products that you can sell. that might be complimentary or cross sell. Once you have that, that person's information, um, that's not necessarily a typical repeat purchase because they've consumed the product, right? So in particular, home goods is a category where it's not as easy to get that repeat purchase like skincare or supplements or something like that. But home goods, I mean, If you have a great product, a great aesthetic, people like it, they're going to need a different product next month or next quarter. There is still an LTV there even though it may not be built into your exact first product or that product may not be consumable per se. That type of stuff is actually important to think about as well.

Jon Blair: Yeah, that's a really good point. That's a super good point. And I think, I think the other thing to keep in mind too, that to riff off of that repeat purchase velocity or frequency, you've got to, you just really need to consider that. And here's why. So I actually, I've known this, but I think I heard it articulated really well in a conversation that I had with Liam, one of the co-founders of Aplo G roup. a marketing agency that we have some shared client base with. So there's the way that I've termed it is that when there's a repeat purchase, one way to think about it is it's a marketing subsidy, right? That like when you have people coming back and buying stuff and you're spending no money on reacquiring them, that revenue with no acquisition costs is a subsidy or can be thought about as a subsidy to subsidize acquiring new customers. And you're on the seesaw, right? We're on one side of the seesaw. You've got repeat purchase subsidy. And on the other side, you have first order acquisition at potentially a very low margin, depending on how fast you're trying to scale. Because if you're scaling spend fast, your MER is going to take a dip fast. That's just how it works. It's going to take a dip fast. If you have the repeat purchase side of the seesaw rising, because there's a lot of frequency, like things are being repeat purchased with a high level of frequency, you're getting a bunch of subsidy that you can then push back down on the seesaw to acquire a bunch of people at a crappy margin on your first order, right? But as soon as that side of the seesaw starts to tick up too high and come out of balance, your profitability at the company level really starts to suffer. And you do need to either figure out how to increase the velocity of repeat purchase to rebalance it, or you need to pull back on that first order acquisition spend, right? And it's about scaling fast. So what I've actually come to learn is that scaling fast profitably is in large part determined by your repeat purchase velocity and how fast that side of the seesaw is rising to then take that money and push it back down into that first order acquisition. And if you're getting slow frequency, You cannot scale as fast. You can't scale as fast at a profitable level. It's just how it works. And so that's why I've started to realize supplements businesses can be just so fantastic because there's such a there's such a high frequency of repeat purchase. It's a noisy space, right? So you better be damn good at marketing and product. But if you can figure that out, it's an amazing business that can grow super fast, super profitably, because you have so much of this repeat purchase subsidy to push back into new customer acquisition.

Jeff Lowenstein: You said it very eloquently. I had not thought about the Seesaw analogy before, but I mean, those things being in balance or out of balance determines your growth rate, your profitability on the P&L, right, and how fast you're scaling. So the thing that I like to look at when I'm thinking about repeat rate and all this is not just looking at the cohorts. The cohorts are important and understanding how quick you're getting pay back on that acquisition cost. Or even better if you're first order profitable, right? Like you're increasing that contribution pretty quickly. But what I like to look at is actually segmenting. What I find in a lot of businesses, they look at the cohort in aggregate and they say on average I get you know, three more purchases in the next six months, right? Or like I have a $250 six month LTV. But if you segment that further and say, uh, you know, do I actually have some people that are buying five times, uh, in the, in the first three months and some people that are never coming back, obviously there are people that some people that never come back and some power users, but understanding those segments of your, customer base is super important and not something that's always so easy to find in the data, but you can actually see patterns like which, which product are they buying first and which product are they buying second, third, fourth, and fifth? Is it the same? Is it different? Where, where in the product category are people going? What's the easiest thing for them to buy the first time asking yourselves, yourself, all those questions, right? Allows you to understand the buyer behavior better. which can then feed back into better acquisition strategies as well. And so that analysis is something a CFO can help you with. A good marketer can do it as well. But when I think about retention and repeat purchase rate, I'm always thinking about segmenting it out rather than just looking at overall averages.

Jon Blair: Yeah, no, I mean, it's interesting you mentioned that because like, even going from like every level of segmentation you can do. I'm a big fan of like starting high level and then segmenting one layer at a time. Because if you try to like go all the way down to the most granular level, you can get lost. And there's a number of things that can cause issues. But like if you even just start like thinking about Okay, first you just see revenue across the business and spend, that's like blended. And then you go, okay, hold on, now let's go revenue and spend, MER by sales channel. And then let's go, okay, but what's the first order economics versus the repeat purchase revenue in each channel? And then you start going, like, when you start kind of cutting one layer deeper, one at a time, each time you get your, your intelligence quality goes up and you can make a decision on another lever or maybe a couple more levers. Averages are definitely something you still have to track to just see how everything is funneling or bubbling up to the top. It's really dangerous to draw too many conclusions off of highly aggregated blended averages. They are useful in their own right, but you have to be honest with yourself about what conclusions you can draw and cannot draw from using aggregated blended metrics versus segmenting them out.

Jeff Lowenstein: Yeah, absolutely. And I mean, I don't mean to get into like the attribution wars here. Like that's not where I'm trying to go and get.

Jon Blair: That's a good, that's a good webinar. Um, attribution wars. We can get will from prescient. We'll get someone from triple whale. Um, we'll get someone from, uh, North beam and let's like, here we go, baby attribution wars.

Jeff Lowenstein: Let's go. Cause the thing that gets complicated, right. It has you drill down to those lower levels is you can see data from a certain platform or from a certain attribution tool. And then, you know, maybe they don't make sense when you look at them, compare them side by side. Right. And so it is important to, like, actually have a really good feel and understanding of the highest level, you know, so you can for sure now and really, you know. understand how it all fits together because it is true that it's all interconnected as well, right? So that's a whole podcast and deep dive for another day. Totally agree.

Jon Blair: Well, let's go on. Let's go on to the next point here. This has turned out to be a meaty conversation. I love it. I had a feeling. All right. The profitable D2C brand that reaches 20 million plus in annual sales through paid advertising has high gross margins. plus or minus 80% and can turn a profit at a two MER. And so to contextualize this a little bit, what I'm getting at is that like, this actually goes back to that seesaw example in some ways, that like how fast you can grow, right, is highly determined on what your blended margin is, right? And without even bringing repeat purchase into the equation, from a blended margin perspective, the brands who can get to eight figures, like healthy eight figures in revenue fast, they're able to scale up, spend fast, and they're able to withstand quickly diminishing MER returns, but the reason they're able to withstand it is because their gross margin is so high. When they have really good unit economics, what we call contribution margin before marketing, which is net sales minus landed cost of goods sold minus shipping and fulfillment and credit card fees. When that number is really high, You can take a two MER, like 50% marketing spend, and still turn a profit. Here's what you have, the advantage you have at your disposal. And I've seen a brand that I worked with at Free to Grow do this. They literally went from scaling like, spending like tens of thousands on meta, to millions a month on meta. Really fast, and they were still profitable. And even though their marketing spend was 50% of revenue, their margin before marketing was so high, that they could withstand it and still turn a profit. And volume went up so high that even though their contribution margin was like less than 20% after marketing, they still turned a massive profit in dollars. And so I'm just, now hear me out here. I'm not saying if this is not your economics to quit and throw in the towel. I'm not saying that. But I'm saying you probably have to grow slower. That's what I just tend to see out there. What are your thoughts?

Jeff Lowenstein: Yeah, I totally agree. There's different ways to get there. I mean, look, this is not meant to be a math test, but let's just walk through that P&L that you kind of alluded to. And that's, I think, actually a really interesting one for certain categories for people to focus on, right? And so if your net sales is 100%, your landed cost of your product might be 20%, which gives you an 80% gross margin, right, which is Very solid then you might have another 20% between Shipping and fulfillment could be 15 credit card fees could be four or five. Let's call that bucket what we call variable order costs. Let's call that 20%. So now you have 60% left in contribution before marketing. That's what Jon was saying. 2x MER is the same as 50% of your net sales is spent on marketing. That's the same thing, right? So now our 60% contribution minus that 50% spent on marketing leaves you with 10%. And if you're below 10% on your overhead, if you're running lean, you can be above break even, right?

Jon Blair: Which the brand I'm referring to was at that time, right? Because they scaled from basically 1 to 35 million in one year, which is crazy. And their overhead was like 2 to 3% of revenue. So they turned a 7% profit and it's dollars. In dollars, it was a huge number of dollars. The founder was making money hand over fist in dollars, you know?

Jeff Lowenstein: That's amazing, right? Because what some people think about, right, is let's say I have really strong gross margins because I designed the product a different way or just because I have a really great manufacturer that no one else knows about. And so I have savings in my product costs and therefore high gross margins. A lot of people will just say, great, more profit. And that's a totally fine way to think about it. That is great. More profit in your pocket per unit sold. However, another way to think about it and sounds like this brand you're talking about did this. They took those savings and they said, I'm going to invest that back in marketing so I can scale further. Yep. And that that extra marketing spend might allow you to capture share from the competition. Right. If you're willing to spend a little bit more. because your economics are better, and you might be able to reach a lot more customers, and you make more profit by selling more units and scaling faster, rather than making more profit per unit on an ongoing basis. So hopefully I didn't confuse anyone with that example, but I think that's a really interesting strategy, is investing your gross margin savings back into marketing.

Jon Blair: Yeah, I mean, you and I, I can think of a few clients we have who just have these really killer margins before marketing, and they do have a decently low MER, like 2.25, 2.5, nothing stellar, but they've scaled up to 10 plus million, and they're turning a profit, and their overhead's super lean, right? Which actually, funny enough, segues into the last point from that from this post, which is to continue turning your profit at scale, see number four, which is what we just talked about with the margin and the two MER. See number four above and keep your overhead lean, like less than 10% of revenue. Achieve this through outsourcing instead of taking on massive headcount. This is part of why number one is a harsh truth. And if you remember, number one was in-house manufacturing and fulfillment. Don't mix with D2C, because it's hard to have less than 10% fixed overhead and have all that operating leverage. But so like, as Jeff actually, your example was really great because it outlined the interplay between contribution margin before marketing, ad spend scale, right, and volume scale, and then really lean overhead. Again, if you don't have this structure, I'm not saying throw in the towel, because there are brands that We have seen grow successfully who don't have this exact structure but the structure we're laying out here actually I have seen in my experience allows you to be much more aggressive and really lean into ad spend and not have to worry about your MER being higher than three which a lot of brands need to and just needing a three MER Again, without the nuance of repeat purchase and the strategy on product and whatnot, just needing that, relying on that, automatically slows down scale because there's only so fast you can scale at that MER. So mind you, what we're talking about here is the formula that we've seen several brands put into play that has allowed them to scale up really fast and turn a meaningful profit in dollars.

Jeff Lowenstein: Yeah, it's interesting to think about and by the way, it's not for everyone. Just because you can scale fast doesn't mean you should. Scaling a little slower and more steadily while making a healthy profit along the way is a good strategy for many people, too. And then I'll also make a comment. I think on all four or five of the topics, there's one common thread, and that's keeping your overhead lean. As CFOs, that's something we are super passionate about. It just gives you so much more optionality. It gives you so much more. flexibility. You don't need a full-time CFO. You could hire a fractional CFO, for example, right? Using great consultants on the retail side, like we were talking about, rather than hiring the head of retail, for example, that's super expensive. Those types of things. Using offshore talent. you know, always important as well. So, you know, that's always a common thread. You don't pigeonhole yourself into needing a certain amount of sales to break even. If you're, if you're lean on the overhead, right, that break even point is going to be much lower. So, so you really have so much more flexibility.

Jon Blair: Yeah. I mean, we work with this one brand that is doing like several hundred million in revenue. Uh, well, I guess they, they might do close to 200 on, on, on. e-com only. Again, one of our, that is the exception, not the rule, right? But their margins before marketing are not fantastic, but their overhead is crazy lean for the revenue size that they're at. And they make all their profit. They make all their profit, in my opinion, because of how lean their overhead is. And you know, it's only You know, generally speaking, 10%, this is a general 10% tends to be like, kind of like a, a mark, like a, a good goal to have, like, that's a healthy profit. Anything above that is like above normal or above market and is really healthy. These guys are at seven to eight, but dude, with their revenue volume, they're making like 19 to $20 million a year in profits. So like, yeah, seven or 8% bottom line. But you're going to tell me you don't, you wouldn't want to have a business that makes $20 million a year, even if the margin is 8%. I think, I think you might be okay with that. And so the point, I think the major takeaway is in all of this. It's not just that there's a single winning formula, right? It's about how to understand the dynamics of variable costs, fixed costs, and acquisition costs, and understand how, depending on how those are structured for your brand, it does dictate to some degree how fast and profitably you can grow. And so when you think about When you think about setting your brand up for success, you don't just set random goals and see if you get there. You actually build out some intelligence of understanding how your variable costs, or how your acquisition costs, or how your fixed costs are drivers of said goals that you want to achieve and you start messing with the drivers so that you are you're messing with the thing that is causing the effect that you want right as opposed to just setting goals and hoping that you get there and this is a big thing This is where, amongst other things, this is a big source of real value from a CFO, especially a CFO that understands D2C like our team does, is that we really understand the drivers of the growth and profitability equation for a D2C brand specifically, because we're D2C specialists. And furthermore, how they impact your balance sheet, so how they impact your cash flow. And so we're actually able to help you manipulate or leverage the drivers, right? And that is how you run a great business, no matter what, no matter what your makeup is of margin, no matter what your makeup is of repeat purchase or fixed overhead, is that you understand what truly drives it, and you understand how, like, if you move a driver in this direction, it should impact the business in this direction. And a CFO can really help you connect those dots. It's what we do every day. Um, I mean, that's it. We got through it. I mean, that was an hour, man. That was a pretty legit conversation. I, that was actually, that was actually a lot of fun. I hope that it was helpful for everyone that's listening. Um, I mean, just to be 100% honest, this is just, uh, this is just us taking a little sliver out of, uh, what it looks like for Jeff and I to wake up every day and just. And just work together at free to grow. And it's usually on a screen cause our team is all, all remote. Right. And so, uh, these kinds of the con conversations are, are what we're having every single day with the 25 brands that, that we serve as, as DTC CFO. So, um, I hope it was super helpful. Um, Jeff, we're getting you back on here many more times this year. I want to see more and more of your face and your thoughts on these ideas because it's just fun to share what we're learning from our clients because working with all these brands, it's really like drinking out of a fire hose and it's a really unique perspective that I've never really had before on the D2C market. It's really kind of cool.

Jeff Lowenstein: Oh yeah. Let's do it. I'm excited to come back on. And there's some people that are going to hear this and say, damn, that's what you talk about every day. That sounds terrible. You guys are a bunch of nerds. I'm not into that. But then there's some DTC people out there, too, that are going to be like, OK, this is my jam. These are my people, right? Exactly. Exactly. It's truly what we love to nerd out about all the time. So I hope you guys enjoyed.

Jon Blair: Yeah, before we shut down here, don't forget, if you want more helpful tips on scaling a profit-focused D2C brand, consider following me, Jon Blair, or Jeff Lowenstein on LinkedIn. And if you're interested in learning more about how Free-to-Grow's D2C accountants and fractional CFOs can help your brand increase profit and cashflow as you scale, definitely check us out at freetogrowcfo.com. Until next time, scale on.