Brands are leaning into their direct-to-consumer businesses. But a new report suggests that doing so might limit profitability in the long run.
According a new report from BMO Capital Markets analysts, DTC channels can offer retailers lower profit margins than wholesale channels before taxes and interest. The report points out a possible downside to the current retail industry trend of brands like Nike, Adidas and Crocs nixing partnerships with different wholesalers to focus on key accounts and direct-to-consumer channels.
Analysts observed an inverse relationship between DTC penetration and reported revenues in the retail companies surveyed in the report over the last five years. In other words, companies that had a decline in DTC penetration also saw meaningful sales growth. The opposite was true as well.
“This appears to suggest that although revenue per item grows at DTC, the units lost by abandoning wholesale generally overwhelm the unit price lifts at DTC,” analysts said in the report.
Overall, the market experts estimated that DTC gross margins are about 1,000 basis points lower on average than wholesale gross margins.
For many major footwear companies, DTC has been the North Star guiding their brand and merchandising strategies. In the last year, Nike has terminated wholesale accounts with major retailers including Dillard’s, DSW, Urban Outfitters and Shoe Show, plus many others, as it forges ahead with a plan to lean into its direct-to-consumer capabilities. Adidas, Under Armour and Crocs have made similar moves.
As for the reason behind their surprising conclusions, BMO’s analysts suggested that direct-to-consumer sales, which often occur online, can incur a variety of additional expenses related to fulfillment, logistics, heavy marketing and technology, which account for smaller profit margins overall.
Nevertheless, the report highlighted other reasons why DTC channels are still important. For instance, they offer companies a higher level of control over brand image, distribution and pricing. And according to analysts in the report, these benefits are “perhaps reason enough to pivot from wholesale to DTC,” margins aside.
“Brand perception remains key to brand equity; where and how a product is sold can be as important as the quality of the product itself,” analysts wrote in the report.