Disruptive innovation in Direct-to-Consumer.
January has never been my favorite month, but this one was DISASTROUS! 1+ billion animals dead in Australia, US-Iranian tension escalation, the loss of Kobe and Gianna, and of course, the deadly coronavirus. All were extremely painful and anxiety-inducing, but none moved me as much Professor Clay Christensen, whom I had the privilege of taking a couple of classes with, passing away.
Professor Christensen is the father of the disruption theory, which challenged the notion that innovation is the result of big R&D budgets and gradual improvement in product performance. He instead argued that disruption takes place when smaller, more agile players introduce a lower performing, cheaper product with a structurally different business model. Initially targeting a niche set of customers, they are ignored by incumbents, who instead focus on defending their legacy business model (historically a source of competitive advantage).
As new entrants gradually improve their product, they move up the food chain targeting more attractive customers and stealing market share from incumbents, who unable to disrupt themselves, see their business models become obsolete, and gradually die. Blockbuster vs. Netflix, Nokia vs. Apple, Kodak vs. Canon, and Department stores vs. Amazon, many others are examples of disruptive innovation.
Disruption in Direct-to-Consumer
Prof. Christensen’s theory is particularly applicable in the D2C space, as almost all successful brands start with a more targeted, lower-performing product and innovative business models. Armed with a clear value proposition (see chart below for some examples), these brands disrupt their categories by innovation on one or more of the following elements: product, distribution, brand, and price.
1) Product innovation = Lower overall performance, but a few better features
Bonobos Inc. was founded in 2007 by two Stanford graduates who couldn’t find pants that fit them well: available options lacked a contoured waistline and had too large or too small rises.
Their first product solved just for that (fit) and underperformed on almost every other area: limited fabric choices, limited colors, boot-cut, and can only be bought online. Yet, they did manage to attract a small group of customers, who hated how their current pants fit them and despised the traditional shopping experience. That’s where the brand started (point 1 on the graph below).
Over time, the company improved its pants quality, expanded its product selection, and adopted an omnichannel approach (partnership with Nordstrom + own Guideshops). By doing so, it gradually appealed to more demanding/ affluent customers and started converting them (point 2 on the graph). In the meantime, incumbent players maintained the same-old strategy, slightly improving their product offering over time. Although they arguably continued to outperform on quality (more options, better shopping experience), they still lost market share to Bonobos, which offered customers exactly what they were looking for, at better prices and better convenience.
Implication for founders: You don’t need a better performing product to gain market share. Focus on improving a few features and start catering to an early niche. Iterate and improve as you grow.
2) Distribution innovation = Better access/ convenience/ experience
Thanks to Deliveroo, Netflix, and Uber, we now expect to order food, watch a movie, and hail a cab almost immediately and do so with minimal hassle.
Dollar Shave Club, Casper, Hubble, and many others took advantage of this shift in consumer expectations (and incumbents’ inaction) to reinvent the shopping experience for their products. Their products were not better, just more convenient to get. They are distribution innovators
Dollar Shave Club founders were frustrated that they had to find a store employee and ask them to open a locked display cabinet, whenever they needed to buy razor blades, only to pay an unreasonably high price for them! So, in 2011, they started shipping blades to customers monthly for much less. Gilette didn’t react fast enough and saw its market share drop from 70% and 50% in a few years.
The bar is much higher today, and simply shipping a product to your customer or offering a subscription model is no longer innovative. Today’s distribution innovators create a seamless, excellent experience across the entire funnel, including purchase (mCommerce), shipping, post-sale service, and returns.
Implication for founders: Convenience is important, but at a certain point, more convenience does not mean better experience. So, don’t chase real-time delivery or 24×7 customer service, focus instead on solving the customer’s most urgent pain points across the purchase journey.
3) Brand innovation = Better reach/ followership
All successful DTCs build great brands and strong followership. However, some of them take branding to the next level, nurturing a ‘cult’ of die-hard fans and turning them into enthusiastic brand ambassadors. These companies are brand innovators.
Most companis build a product and then look for customers to buy this product. Brand innovators build a customer base and then develop products to sell it to them.
Starting from nothing and in a few years, Huda Kattan built a global beauty brand, valued at $1.2+ billion, and challenged the hegemony of big beauty brands. How did she do that? Brand innovation.
Huda made her debut as a beauty blogger, writing and posting videos on her website and Instagram in the early 2010s. Big beauty brands did not take notice: Their massive budgets granted them a much larger share of voice as they controlled more effective marketing channels at the time (out-of-home and TV).
In the meantime, Huda’s personality, authentic storytelling, and exciting content attracted more inspired followers, exceeding 41 million today. When Huda launched her first product (faux lashes which sold out within a day), those followers turned into devoted customers and brand ambassadors (responsible for a large share of the brand’s earned media). When big brands realized that the centers of influence moved from traditional advertising to social media, it was already too late.
Brand innovation is the hardest to achieve, but the most defensible as it forms high emotional switching costs within customers. Most brand innovators start with a group of followers (Huda with her blog, Glossier with Into The Gloss, The Honest Company with Jessica Alba) and turn them into customers.
Implication for founders: Brand innovation doesn’t happen overnight and just like ‘going viral’ is not a strategy. Focus instead on creating a useful product for your target customers and continuously talk to/ engage them. As Paul Graham (of Y Combinator) says: it’s better to have 10 customers who love you, than a 1,000 customers who kind of like you. So look for those 10 customers!
4) Price innovation = Better value to customers
Brands like Everlane, Away Travel, and MVMT disrupted their categories by offering high-quality products at a fraction of the incumbents’ prices. They are price innovators.
Price innovation does not mean underpricing your competitors or losing money in your quest to build market share and attain higher economies of scale. Price innovators are brands that sustainably reduce costs across the supply chain, by eliminating high distributor/ retailer markups and non-essential product features, and pass on savings to their consumers.
Beyond capturing market share, price innovation helps disruptors expand the addressable market by targeting previously unserved customers. MVMT is a clear example of that, as the brand tapped into the previously unserved millennials, offering them fashionable watches at a fraction of the price.
A value proposition built around price innovation alone is not enough and needs to be coupled with other forms of innovation to mitigate the risk of your product getting Amazonified. ‘Better & Cheaper’ or ‘More convenient & Cheaper’ are way more attractive than just ‘cheaper.’
Implications for founders: When it comes to pricing, your product should be cheaper than high-quality alternatives (people love telling their friends about a new, cheaper, product they discovered). However, your unit economics need to make sense: Don’t sell them a 1$ product for 50 cents!
It’s the right time to build a D2C in the MENA region, and at HBI, we’re always on the lookout for new founders because we understand how disruptive this new model is. If you’re one, I would love to talk.