Category Killers: Direct to Consumer E-Commerce

NOVEMBER 3, 2015

Category Killers: E-Commerce Startups Disrupting Brick-And-Mortar Brands

categorykillers

Cosmetics, baby gear, caskets, and socks are among the physical goods categories ripe for e-commerce led disruption.

Over the past five years, companies like Warby Parker, Casper, and Harry’s have grown from unknown startups to leading brands in their respective categories. It’s hard to take a subway ride in New York without seeing Casper’s “One Perfect Mattress” campaign or walk a few blocks without spotting a pair of Warby Parker frames.

During my MBA internship with Gotham Ventures this past summer, I studied these “category killers” to identify common traits, potential early indicators of success, and categories poised for future disruption. I am happy to share the thinking that emerged from my research. Below, I have outlined common trends for market conditions, team composition, product development, and branding taken from interviews with employees at many of these companies, their investors, and outside research.

Category Killer (n): A startup that disrupts an established consumer physical goods segment through direct-to-consumer e-commerce distribution of branded products. 

Ex. Warby Parker, Harry’s, Dollar Shave Club.

Despite Amazon’s position as the dominant online distributor of third-party brands, opportunity remains for e-commerce companies that pursue proprietary merchandising and branding strategies (as detailed by Andy Dunn, founder and CEO of Bonobos). Fueled by the proliferation of e-commerce and advances in marketing and logistics infrastructure, dozens of would-be category killers have sprung up over the past five years to take advantage of this opportunity and several have emerged as meaningful businesses.

This research focused on seven leading category killers — Bonobos, Casper, Dollar Shave Club, Frank & Oak, Harry’s, Mack Weldon, and Warby Parker — most of which rank amongst CB Insights’ list of most promising e-commerce startups [1]. There are surely lessons learned from earlier e-commerce startups, but these are beyond the scope of my research.

Favorable Market Conditions

 The typical profile of the industries in which these category killers have emerged includes:

  • Total Addressable Market > $2B in US: offers opportunity for new entrant to gain share and build brand prior to incumbent retaliation;
  • High Concentration: > 50% of the market is controlled by ≤4 incumbents;
  • Limited Brand Allegiance: existing companies focus on selling product rather than lifestyle;
  • 3rd-Party B&M channels: incumbents typically distribute their offerings primarily via brick-and-mortar locations of other brands; little focus on e-commerce distribution;
  • High Headcount: > 60,000 employees each for the incumbents; and
  • High Price Point: the incumbents generally enjoy high margins and distribution involves several middlemen — a structural mitigator to lower prices.

Founding Teams

 Amongst the founding teams of the top seven category killers, the most common professional backgrounds included:

  • Strategy consulting or business development: 5;
  • Previous founder: 4;
  • Relevant category experience: 4; and
  • Private equity: 3.

The high number of founding teams that include former consultants is arguably due to the nature of the consulting skillset, which lends itself well to the analysis and improvement of long-standing industries, such as retail, that are data-rich and have major logistics and supply-chain considerations. Notably, the first hire at Casper, which did not have former consultants on its founding team, had previously spent years leading strategy and marketing efforts for major corporations.

Best Practices: Company Culture

Many companies described an iterative culture as a key enabler of successful tactics and strategies. Warby Parker’s foray into brick-and-mortar (B&M) sales began as an experiment, offering glasses to consumers in person at its corporate headquarters.  As demand grew they eventually opened a standalone B&M. They now operate 20 stores nation-wide. This was not the result of a corporate strategy that laid out B&M opening goals and timelines for the year. Similarly, Casper’s New York showroom helped the company iteratively understand what customers value in an in-store experience to position itself as a sleep company. Now, upon scaling markets, one of the first tasks is to establish a local showroom.

Best Practices: Product

Product best practices can be broken into three chronological phases: laying the foundation (generally pre-Seed), building customer experience (Seed and Series A), and establishing retail presence (Series B and C).

Phase I: Lay the foundation 

  • Initial product selection: Companies offered a product that is a necessity. Think about Warby’s glasses or Harry’s razors — both are products that consumers don’t need to be sold on. This allows the company to focus on selling an experience rather than generate demand for the product;
  • Price point: Prices for challenger products were typically 30-40% lower than incumbents’;
  • Brand Potential: Companies established brands broad enough to accommodate future product expansion, enabling the startups to create additional product lines as they matured. Casper is branding itself as a sleep company, allotting itself room to expand beyond mattresses; and
  • Minimize middlemen: Companies established multi-source supplier contracts or own the supply chain like Harry’s (which owns its German factory) to minimize middlemen margin.

Phase II: Build customer experience

  • Brand consistency: Brand values tend to be consistent at every customer touch point, including but not limited to, messaging on the website, the product aesthetic, and packaging;
  • Magical unboxing: The unboxing experience is a critical component of the customer experience that can create a “magic” moment. It is not an accident that YouTube is filled with thousands of Casper unboxing videos;
  • Brand experience: Focusing on experience to a much greater degree than incumbents enables customers to recommend the company as a whole. One telling Casper reviewer on YouTube who did not like the mattress still recommended the company to others because their customer experience was so positive;
  • Exclusivity: Making the purchasing experience “cool” helps customers feel like they are getting exclusive exposure to a scarce product. Referral programs that foster word-of-mouth are one way of achieving this. Harry’s invited customers to sign up for a site that did not identify what products would be sold, and its messaging was about revolutionizing shaving. The company invited these early adopters to earn referral discounts, resulting in 100K new emails in one week; and
  • Trial period: For products with a > $100 price point, free trials help alleviate consumers’ trepidation about purchasing a relatively unknown product.

Phase III: Establish a retail presence

  • If?: Based on interviews with investors, there is some consensus that expansion into brick-and-mortar these days is a question of “when” not “if” – all e-commerce startups eventually have to establish physical locations if they desire to achieve scale.
  • When?: The first location tends to follow a Series B/C raise due to capital requirements of physical locations.
  • How?: One common growth hack is to use existing working space as initial retail presence – Casper’s first showroom was in the back room of their corporate HQ in Manhattan. This can help companies test variations on customer experience before committing to a full showroom or store.
  • Really?: Companies in lower-price point categories could elect to distribute through brand-aligned third-party channels in addition to establishing their own retail locations. For instance, Harry’s has an interesting approach in distributing their products through Birchbox and Nordstrom since those distribution channels tend to appeal to Harry’s target demographic.

Best Practices: Brand

  • Millennial mindset: Being digital natives, Millennials typically make a good initial target demographic. Their mental barriers to buying online are low and they are receptive to brands that appeal to experience, engagement, and social benefit.
  • Excel on NPS: Net Promoter Score (NPS)—the percentage of customers who would recommend your product minus the percentage who wouldn’t—is an important metric used to evaluate brand health. Established online retail companies like Amazon and Zappos have NPS of ~60. For a would-be category killer, an NPS of around or above that range appears to be helpful for attracting investor attention (Warby Parker had a score above 90 prior to its Series B).
  • Content marketing: Can be a great way to “soft-sell” the product and raise awareness of a certain space. Casper hired five independent journalists to write articles about sleep; Harry’s has a “Five O’clock” magazine.
  • Altruistic message: Embedding a social good component in the value proposition (e.g. Warby Parker’s “Buy a Pair, Give a Pair”) can bolster brand affinity.

Potential New Markets

During the course of this research, I identified several markets that share many of the favorable conditions described earlier, and which consequently may be prime for disruption. In no particular order, these markets include:

  • Baby/children products (e.g. baby strollers, car seats): $2B US market with product price points of $500-$5,000;
  • End-of-life market (e.g. caskets/coffins): 75% of $750M market owned by four players. Larger funeral market is $15B;
  • Cosmetics: close to 50% of the $12B U.S. market owned by two players; and
  • Others: diamond rings, socks, flowers, pet products, and bras/lingerie.

Closing Thoughts

Across today’s e-commerce landscape, startups are leveraging internet economics to build high-potential companies to disrupt staid retail categories. These category killers share several traits in market structure, team composition, product, and brand that may help future entrepreneurs with early-stage growth. At the same time, investors may be able to extrapolate certain criteria to assist with capital allocation. There are likely further insights and conclusions beyond those outlined above, but hopefully this can be a start. Your opinions and thoughts are welcome and would be greatly appreciated.

Click here for the full Category Killers presentation. 
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[1] Determined by CB Insights’ proprietary Mosaic score (combination of momentum, fundraising, and industry health).

 

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