A Roadmap to DTC Turnaround, with Mehtab Bhogal, Cofounder, Karta Ventures

Transcript:

Peter Crosby:
Welcome to Unpacking the Digital Shelf, where we explore brand manufacturing in the digital age.

Peter Crosby:
Hey, everyone. Peter Crosby here from The Digital Shelf Institute. "We like the operational headache." This quote from the conversation with Mehtab Bhogal, co-founder of Karta Ventures, perfectly describes the grit and expertise it takes to make a living rescuing and reinvigorating distressed D2C businesses. Mehtab shared his turnaround process, how he evaluates opportunities, and his perspective on the current and future environment for D2C success as headwinds continue.

Peter Crosby:
Mehtab, thank you so much for coming on to discuss your work at Karta Ventures. You're focused on turning around distressed D2Cs. I know Rob and I both are really excited about talking about this path, because it just seems like a timely topic, given some of the headwinds and earnings reports we've been seeing in the sector. But thank you so much for coming on to share your roadmap with us. We really appreciate it.

Mehtab Bhogal:
Absolutely. Thank you for having me.

Peter Crosby:
Is it a timely topic based on some of the headwind reports you've been hearing? Tell us a bit about your current view of what's going on, and then how you even came to focus on this niche opportunity.

Mehtab Bhogal:
Macro, there's really three things going on specific to D2C. A, there's the supply chain dynamic, where container prices have shot up. That was an issue starting in 2020. It became really bad in 2021, and it's persisted into 2022, where delivery times are all over the place. But the core container prices jumping from $3,500 a pop to $20,000 plus dollars really hurt FCF for some of these companies.

Peter Crosby:
Wow.

Mehtab Bhogal:
Specifically, if you're selling something like furniture, where it's a large product fitting in a container, it really hurts your margin. It's less of an issue if you're selling jewelry or something like that. But if the product's larger, it can really hurt EBITDA and that cash flow coming out of the company.

Mehtab Bhogal:
The second big change was the iOS update, which hammered the efficacy of digital advertising. You saw that reflected in the Facebook stock. You can see it reflected in any sort of industry spend analysis that you look at, where spend is peeling away from Facebook, at least on the e-commerce and D2C side. Pouring into platforms like TikTok, going back into paid search, programmatic, et cetera. Those have been the main headwinds. Then, obviously, credit tightening now is going to turn off the faucet and cause more issues.

Peter Crosby:
And so, here you are, you're in this industry. Tell me. Those are sobering things to hear, but we all can recognize them. They're not a surprise to anyone who is listening, but you are in this market and you're really dedicated and focused on it. I'm wondering ... Your path to that. What draws you to it?

Mehtab Bhogal:
Absolutely. I started off in 2011, 2012. Started my first business. Then, I bootstrapped a few D2C brands. Both vary in niche. One was a guitar pedal for progressive metal guitarists. The other one was a men's hair product, which is pretty ironic, given I'm Sikh. I used to grab random guy's heads around the office and just apply the product. That's how I figured out the product market.

Peter Crosby:
I'm sure the FDA loved that.

Mehtab Bhogal:
It's great. Well, it's a Canadian company, so it was a little bit more okay.

Peter Crosby:
"What do you think?"

Mehtab Bhogal:
I'm really good at it, so it worked out.

Peter Crosby:
That's good.

Mehtab Bhogal:
Those two companies did well, but they were both fairly niche. There wasn't the scale that I wanted. At the same time, my partners there, they're great guys. They were just very lifestyle oriented, which is different from what I wanted to do. So I started investing in D2C brands and e-commerce.

Mehtab Bhogal:
Obviously, your deal flow is not going to be great. It's not a good sign if someone's coming to someone like me. At that point, for early stage equities, it's just bad. There's an inherent issue. You shouldn't go there. I started digging around Reddit to try and find deal flow. That's where I met my business partner. We invested a fair amount together before we ever met in person. This was around 2018.

Peter Crosby:
Wow.

Mehtab Bhogal:
He had a background doing turnaround work with CSC Generation, who was a large acquirer of distressed. Primarily, home-focused companies. Z Gallerie, Sur La Table, and ... What else did he acquire? DirectBuy. And then, a handful of others. They're rolling that all up, but that's where he learned the trade.

Mehtab Bhogal:
He dragged me into it. He said, "Hey. Why don't we just do a turnaround? We're both operators." That made sense and I got pulled into that. We started investing in really distressed opportunities, special situations, et cetera.

Rob Gonzalez:
When you are investing in distressed D2C ... Just for the listeners out there, D2C sometimes in our space is thrown around to include things like selling on Amazon Marketplace, or selling social media or whatever, in addition to selling on your own retailer dot com site.

Rob Gonzalez:
Are the places that you're investing really predominantly selling through a Shopify or another e-commerce site that they own? Or are they multi-channel, but doing all their own fulfillment? Where do you draw the line?

Mehtab Bhogal:
We really prefer anything that's predominantly direct-to-consumer by their own website. We've done marketplace heavy businesses before. Maybe the best example is a succulent company where we actually own the farm lands. We're completely vertical. We like the operational headache. It's a pain to ship plants online. It's just difficult.

Mehtab Bhogal:
When you're growing them, it introduces another layer of difficulty, which we love as well. Because it prevents you from becoming commoditized like most marketplace businesses really do. Anything with a strong focus on D2C selling is great. Or there needs to be a very strong barrier that keeps other people out.

Mehtab Bhogal:
In the case of the succulent business, that is literally farming the plants. We don't really mind if it's marketplace heavy. We've done a lot for traditional consumers, where retail makes up the bulk of sales, and there's a low hanging opportunity to come in and expand that D2C channel.

Rob Gonzalez:
Totally makes sense. And then, in this space of D2C in general, I'm not deeply familiar with the investor community around there. But I know a lot of dollars have been put into Dollar Shave Club or Casper or whatever over the years. It seems like in the last 10 years, capital has been so cheap that there's just infinity dollars to throw at everything.

Rob Gonzalez:
I was at a private equity conference a couple weeks ago, and one of the stats I heard was, "In 2021, there were 10 PE funds raised just in '21 that were each over $10 billion for a single fund." Four of those funds were over $20 billion. Just an astronomical ocean of money that's going around there.

Rob Gonzalez:
How do you differentiate in a world where there is just a ton of money? Or is that something you don't even have to worry about? Because, by definition, you're going after distressed businesses. Maybe there's not that much competition for them?

Mehtab Bhogal:
I'd say that VC, in the early stage on that side of things, funding slowed down quite a bit post-2018, 2019. A lot of the early stage VC investors, who were traditionally tech guys who were investing in the space, thought that margin was sustainable with growth. Or it would improve almost like a SaaS company. But everyone figured out, the more you scale, the worse tech becomes typically.

Mehtab Bhogal:
Because you're going further and further out from your core audience. And at the same time, your COGS can only drop so low. If you look at something like Warby Parker, Allbirds, et cetera, there really won't be any meaningful improvement in COGS. Just given they're already at-scale. You can only make a pair of glasses for so little or a pair of shoes for so little. Versus something like SaaS, where you have your core engineering team, obviously, but more revenue doesn't necessarily mean you need more heads.

Mehtab Bhogal:
I guess it depends on the quality of the product that was built, but hopefully there's not too much tape keeping things together. That's kind of where the VC thesis broke on that side. It turned out to be a lot more capital intensive than expected to scale, et cetera. And then, around 2019, 2020, we started seeing a lot of programmatic lenders entering the space, where they've been making quite a few ... The market for unsecured credit for D2C companies specifically went from being very rough to excellent.

Mehtab Bhogal:
A company hemorrhaging money, doing low weight figures, could be running with anywhere from 60% to 80% levered for every dollar in revenue they're producing. If you're doing $10 million in revenue, you could add eight million in unsecured debt sitting on your balance sheet, which is great. The risk associated with unsecured debt isn't very high. We saw a lot of that. A lot of leveraging during 2020, 2021. That's coming to the table now, where some of these companies are tightening up credit requirements and underwriting.

Rob Gonzalez:
Who are the players that are actually lending the unsecured debt? If you're talking about an eight-figure D2C company that's 60% to 80% levered, I don't even know where I would begin there. Is it a traditional commercial bank that's lending a business like that unsecured debt?

Peter Crosby:
There's an alley in New York where you would turn right, and there's some guys in the back.

Mehtab Bhogal:
ClearBank is probably the most notable and largest one that everyone's familiar with. I think they do a little bit of SaaS now too. Settle is another big player that emerged. And there's all these unsecured credit cards, which sounds nuts, but it literally creates flow. Say your payback window, you're not profitable on the first purchase. You have a payback window, et cetera. Then, you have a credit card with a 60-day float. Well, now you can float the cost of cap.

Rob Gonzalez:
That's incredible.

Mehtab Bhogal:
And then, floating back to your original point about competition. There really isn't much competition for businesses doing below $100 million and distressed. There's no bench of operators like there are in industrials or another space that you can pull from. If I'm a private equity firm and the company is upside down, I need to replace management.

Mehtab Bhogal:
If I'm in a manufacturing company, that's fairly simple to do. But it's much more complex in D2C, where there is no bench of operators. It's a relatively new space. That deep bench just doesn't exist in the same way. At the same time, there's not as much appetite, given there are not many funds that have spawned to do justice. There's maybe one or two upstream from us, but there's no one really our size doing what we do.

Rob Gonzalez:
That's so interesting. You don't see any of the Thrasios or whatnot in that space? We'd spoken with Carlos Cashman. One of their original founding theses was they were going to do a D2C roll-up, for exactly the bench strength reason that you were just talking about. There aren't that many operators that know how to do it.

Rob Gonzalez:
They felt like they could do it. They almost accidentally ended up doing an Amazon 3P seller roll-up instead. But then, I think they always meant to get back into the D2C space. Did you see any of those pools of capital playing around in distress? Or not at all?

Mehtab Bhogal:
No. They tend to prefer profitable companies that are relatively straightforward. They don't really like anything that's operationally complex either. They advertise a team across their portfolio of companies. But if I want to grow succulents, I need a team. They need to build that functionality out.

Mehtab Bhogal:
Or if I want deep manufacturing that's owned, completely vertical, I need to build that out. I need to build the competency around rolling things out like Lean or Six Sigma to improve manufacturing ops.

Peter Crosby:
Why do you run towards the fire then? What is it about the things you were talking about? Operational complexity, distressed, underwater. What is it that draws you to that? What is it that you think makes you successful at being able to do this?

Mehtab Bhogal:
We really compete on speed, flexibility, and value-add. We aren't going to beat out a room full of Wharton MBAs. It's just not going to happen. If we're bidding on a vanilla leveraged buyout. There's too many middle market, lower middle market players that can outbid us there. But where we can beat them is speed, when running diligence in a turnaround situation.

Mehtab Bhogal:
They might have to bring in third-party consultants to look at something. They might need someone to help them with maybe the attribution side. If they're not Rob, they don't just spit out perfect multi-touch attribution solutions. He has three of them. Spits them out all the time. But that kind of thing, we're comfortable jumping in. We can do all of that in-house ourselves.

Mehtab Bhogal:
I'm not great with ad accounts or anything like that, but I can pop in and get an idea if they're competent or not. We're able to compete on that side. Really every day that you wait in turnaround, the company is burning cash. The cost of entry goes up. Because you're the one who ultimately has to pay for the work in capital hit in some way or another. The value can only go so low.

Peter Crosby:
We've been talking about the ups and downs of D2C brands. Particularly, more recently ... You probably saw signs of this even earlier than those of us that aren't paying direct attention. But it seems like the seams of the business model are beginning to show. In large part, because of some of the headwinds you talked about, but just because it's also a really hard business. What do you think are the advantages and disadvantages of the D2C business model?

Mehtab Bhogal:
Absolutely. I think the biggest is being able to iterate on products very quickly. As you guys know, PMF, product-market fit is the biggest thing that can reduce CAC, improve scale. At the end of the day, it's always a product game. When you have a direct connection with your customers, you can reach out, you can solicit feedback.

Mehtab Bhogal:
To give you an idea of the response rate of post-purchase surveys, a poorly optimized post purchase survey ... I don't mean sent by email. I mean, right on the purchase screen after you buy. Response rates are about 35% if poorly optimized, but an optimized one can yield response rates of up to 70%.

Peter Crosby:
Wow.

Mehtab Bhogal:
That's a lot of data you're collecting.

Peter Crosby:
That is a lot of data.

Mehtab Bhogal:
That's data that you're not going to get if you're selling via retail channels. There's ways to get that data, but inaccurate, slow. There's a host of problems with it. The ability to iterate on product is unmatched really, when you're selling direct-to-consumer.

Rob Gonzalez:
I have this mental model of the way that the world is moving towards, due to the internet, which is just greater fragmentation and greater niche. In that world, there's this ability for ... Seth Godin calls it, "The smallest viable audience," where a D2C brand that's $10 or $20 million in top-line, might be the absolute perfect market for that type of product.

Mehtab Bhogal:
Yep.

Rob Gonzalez:
The internet allows you to have that size of market profitably. Whereas, in the world before the internet, it was really hard to be a manufacturer and just be a little $10 million manufacturer. Because of distribution and scale challenges. What's the disadvantage of this model that you've got?

Mehtab Bhogal:
A few things. This used to be a larger issue. And I think it's going to become an issue again, as these companies run into headwinds, and lenders get thrown off right after they just became comfortable with it. In the past, lenders were very uncomfortable with this type of business. They didn't understand it. They couldn't differentiate from a marketplace-driven business that's selling 90% via Amazon and other marketplaces, from something that's selling direct-to-consumer via their website, to something that's more omni-channel.

Mehtab Bhogal:
They just had a lot of difficulty really wrapping their heads around it. You'd get questions about, "Hey. Why don't you have any AR?" The reason you don't have any AR is because customers are purchasing right away. It just threw them off. It wasn't something they could account for cleanly. That's become less and less of an issue. There was a really good improvement through COVID, where lenders were more excited about e-commerce. They weren't as worried, et cetera, underwriting these deals.

Mehtab Bhogal:
I have a feeling that's going to become an issue again. The other one is just inherent instability around customer acquisition. For example, even a larger company pushing volume on a marketplace. Let's say you're doing $20, $30 million on Amazon alone. You can still run into issues with the account and not be able to get a hold of anyone. It's just a weird problem. There's no customer service to really reach out to. There's no one you can really call if something goes horribly wrong. Accounts get banned all the time for no real reason.

Mehtab Bhogal:
Outside of that, the digital advertising landscape changes quite quickly. IOS is probably the best example, where that privacy was pushed. As a result, CAC has just essentially climbed 30%, 40% for a lot of brands. Or it's just broken entirely. We looked at a skincare company that was bootstrapped to eight figures. Within two years, it really impressed the founder. IOS was rolled out and essentially broke the business, so they needed a runway to find a new acquisition channel.

Rob Gonzalez:
Wow. That's the first time I've heard the magnitude of the impact of the iOS changes and the ATT on a consumer business. I've seen some of the game acquisition numbers, because the mobile game companies track the CAC, customer acquisition costs, to some crazy decimal place.

Mehtab Bhogal:
That's true.

Rob Gonzalez:
But a 30%, 40% increase in CAC is brutal. People say that CAC is the new rent. Rent for retails, CAC for D2C.

Mehtab Bhogal:
Well, it's crazy too. To put things in perspective, you can send a catalog, I can mail you a catalog after paying Epsilon or someone else for the data. I can get it to your house for between 0.50 to 0.75 cents. Depending on the scale that I'm sending it at. That's not even a crazy scale. That's spending maybe $100,000 a quarter. It's not like you're spending a million dollars a quarter.

Mehtab Bhogal:
That's just a small test. To give you an idea of how much cheaper a catalog is. A click is probably anywhere from a dollar to two dollars. It really depends. That's paid social, by the way. I can send you a catalog that's targeted with excellent data for less than I have to pay to get you to click.

Rob Gonzalez:
That's unbelievable.

Mehtab Bhogal:
Worst thing. Rent, pop ups, et cetera. It's a lot more viable now. I think before the gist was, "Hey. CAC is so cheap. Digital is so cheap. I could buy all those impressions for next to nothing." There's a bit of an arbitrage opportunity. That's really dissipated. Pushing into retail makes more sense now. You're seeing a lot of traditional D2C-only brands push into retail channels much harder. I'm sure you guys see it. Given your product.

Rob Gonzalez:
Well, in our world, because we're selling ... At Salsify, we sell to enterprises. If you look at the marketing mix on getting a new buyer meeting, historically, it was in the $2,000, $2,500 bucks per meeting. All-in kind of cost. The last few years, it's gone up about 30% or so.

Mehtab Bhogal:
Wow.

Rob Gonzalez:
And that's true for a ton of a ton of companies that are using this traditional outreach. What you see is you see folks experimenting with old channels that are all of a sudden looking profitable again. The last couple of years, there's been a crazy rise in direct mail.

Mehtab Bhogal:
Actually, we just invested in a direct mail company. It integrates directly with Shopify and a few other platforms. It's almost like Klaviyo or a similar email marketing platform, with all the triggers and stuff built-out, but it sends direct mail.

Peter Crosby:
We may need to hire you. I feel like we should do some sort of awesome catalog out to Salsify's prospects and customers, showing ideal product pages and things like that, and send them in the mail.

Mehtab Bhogal:
Just put a giant picture of Rob up-front.

Rob Gonzalez:
God. No.

Peter Crosby:
No.

Rob Gonzalez:
Do you know what we could do, Peter? Remember back in the day, every magazine you bought had 20 hours of AOL that came with the magazine on a floppy disc?

Peter Crosby:
Yes.

Mehtab Bhogal:
Or the CD.

Rob Gonzalez:
The catalog of our podcast with a little floppy disc, which no one's going to be able to read, but with a podcast episode on it for free.

Peter Crosby:
That sounds perfect. We'll start with this one.

Mehtab Bhogal:
Probably, still less than a click.

Rob Gonzalez:
That's unbelievable to me. Printing and sending a catalog is cheaper than getting a single click. That's amazing.

Mehtab Bhogal:
And if you can crack pop-ups or similar temporary retail spaces for some of these brands, where they're able to experiment across a few different geographies, a few different retail concepts, it really is quite viable. Your CAC ends up being significantly lower than what it would be via digital only. It really is quite interesting.

Peter Crosby:
If I can jump in. I'm imagining that first day when the deal is through, and then you walk up to the front door. Presuming it's not just remote. Just before you open that door, you take a big deep breath like, "Here we go." I don't know whether that's true or not. You could tell me how it feels.

Peter Crosby:
When you go in there, day one ... And I know you're done analysis before. What are the core issues there holding them back? Often, what are the things you know you need to tackle day one and those first 90 days? Or whatever your timetables are.

Mehtab Bhogal:
I'd say the first one is definitely ... I'd break it out across a few different areas. But the first one, the most critical one is always people. In a turnaround situation, there's obviously something wrong. The company is not failing ... Well, sometimes it is. But most of the time, the company is not failing because the people are great. There's something critically wrong. It's almost always traceable back to management or a few bad apples.

Mehtab Bhogal:
A good example. We had a team for customer service operating state-side. Walked in, quickly looked at the numbers. Found out two or three of the people were only answering one or two tickets a day, which doesn't really make sense when everyone else is answering 100. That kind of thing tends to be fairly obvious. The first thing we do is, we want to make all of our cuts the first week. We don't want anyone worried about their job after that. It's just a bad environment to be operating in.

Mehtab Bhogal:
We'll bring everyone in, and interview everyone in the company. That might take a while. That might take us four days. We'll take notes. We'll ask questions, "Hey. Who do you think is performing well? Who isn't? What numbers do you look at?" Et cetera. "What does the reporting cadence look like?" After that, what I found odd is a lot of the same people will pop up in a good way and a bad way.

Mehtab Bhogal:
People will always point to the same bad apples, et cetera. From there, we'll just make the cuts. It's fairly straightforward. Especially, in D2C, where everything tends to be quite quantifiable and quite measurable. You get a fairly good idea just speaking to these people if they're operationally competent or not.

Mehtab Bhogal:
For example, if you speak to someone running a company doing $50 million a year, spending heavily on digital, and they're using last click attribution. There's something really wrong with that. It's a bad sign. Similarly, on the manufacturing side, if they're not running a system like Lean, Six Sigma, et cetera, that tends to be another area of low hanging fruit.

Rob Gonzalez:
You get in there. You review the people first and foremost. You're mostly looking at who you're going to keep. And so, then you've got the team that's in there and the business is not a great business. That's the whole point. The whole reason that you're in there. I'm distressed. It's not doing as well as it can.

Rob Gonzalez:
Once you get in there, what's the battle plan look like? Is it different for every single company just based on what their weaknesses are? Or do you tend to invest in a particular weakness? Or a particular small set of weaknesses that you know you can almost programmatically turn around?

Mehtab Bhogal:
Right. It tends to be the same set of problems. That might be what the first week looks like. We'll also turn off the bank account. There's just too much being incorrectly pulled from it. We don't really care which lenders, et cetera, are plugged into it. No lender wants to run your company. It's just the way it is. Unless you're a chunky company.

Mehtab Bhogal:
If you're Salsify, everyone wants to run it. But if you're a small company doing under $100 million a year and you're a D2C brand, no one really wants to jump in and run it. They might blow it up. It's too small to really be worth it. The equity will probably be worthless if they can't get someone in the seat fast enough. We'll turn off the bank account first thing, first week.

Mehtab Bhogal:
We'll kick off creditor negotiations, vendor negotiations, et cetera. We'll come to them with a plan. We'll say, "Hey. Look, this is our turnaround plan. We understand that management made a lot of mistakes previously. Here's how we're going to correct them. Here's what we've already done this week. We've reduced the workforce from X to Y." That cuts ongoing variable labor by whatever the percentage is.

Mehtab Bhogal:
"We've removed the following executives. We know you didn't have a good experience with them. The finance team is gone. We're implementing a 13-week cash flow model. Here's what the 13-week projection looks like. Here's what it'll look like when we're done." That tends to buy us anywhere from three to 10 months, right off the bat. We've had landlords tell us, "Don't pay rent for the next six months. You guys seem like you know what you're doing," and we'll make them whole.

Mehtab Bhogal:
The landlord is probably one of the hardest things to negotiate, because they know they have you by the neck. Especially for the manufacturing facilities there. Again, you have to understand the market dynamics, et cetera. It's different. If someone had something like real estate, where it's easy to seize, you can't do much there. Anyone can run a building.

Mehtab Bhogal:
If I have an apartment building and I'm upside down with my lenders, they'll gladly kick me out and sell the building. It's not rocket science. But if it's something like a D2C brand, where it's a manufacturing ops, there's the marketing component, et cetera. It's just too easy to make a mistake and blow the company up.

Rob Gonzalez:
Are there some of these things that you have to review before doing the acquisitions? You've got a company. They're manufacturing succulents. First of all, for me, I would be a distressed asset trying to manufacture succulents. Because I can't keep those things alive. You're trying to manufacture succulents, and you've got a facility that the business is renting to manufacture succulents.

Rob Gonzalez:
I know your diligence process is really fast. But before you sign the check, are you trying to pre-negotiate with the landlord? To see if they're even somebody that you can deal with? Or is that something like you're just going to buy the business and assume that you can do that negotiation? Because nobody wants to repo a succulent business.

Mehtab Bhogal:
That's a great example. Who's going to show up and run a farm for succulents? I actually don't know who you'd bring in to run the farm.

Rob Gonzalez:
Me either.

Mehtab Bhogal:
Luckily, it's actually a weirdly simple product to farm, but it just sounds really bad. Essentially, if we feel the deal is fairly close and we know we'll get there more or less ... If we're buying in through credit as opposed to equity, for example, you have a more solid idea that the deal is going to go through. If the bank lender is upside down, they're seeing that they're secured, and we're entering the deal that way.

Mehtab Bhogal:
I feel better about making some of those moves before we necessarily get in. Worse comes to worst, we help the company out, we win good will on the deal flow end of any future upside down deals, et cetera. We'll usually kick that off ahead of time. We'll have our own 13-week model that we've built out to see how the unit dynamics need to change.

Mehtab Bhogal:
What happens if the AOV goes up by five dollars the first week? Does that completely change the first purchase profitability? What happens if we can juice the LTV by X? Et cetera. And then, we do have our go-to systems that we like to plug and play.

Rob Gonzalez:
When you're doing your diligence, getting back to the financial process, you've got your system that you go in there. There's a certain set of regular issues that you know that you're going to deal with. What's the difference between a good problem to have and a bad problem to have?

Rob Gonzalez:
I'm getting the impression somewhat ... The reason I'm asking this is there's a bunch of D2C businesses that are distressed. A lot of them just go out of business. One of the big themes that we have on the podcast is that a lot of traditionally large markets are being broken up a little bit by D2C brands.

Mehtab Bhogal:
Right.

Rob Gonzalez:
They might not ever become billion dollar brands, but enough $20 million brands makes a dent in a billion dollar market.

Mehtab Bhogal:
Absolutely.

Rob Gonzalez:
Is what you're saying that virtually any of these businesses can be profitable and successful? Or is there a subset of them that really cannot be profitable and successful?

Mehtab Bhogal:
I think it can be really difficult sometimes. We used to do a lot of both. Turnarounds tend to be split into either an income statement turnaround or a balance sheet turnaround. A balance sheet turnaround might occur because there's a big hiccup that was caused by maybe some debt they took on a while ago from a leveraged buyout. That's pretty easy to get over. It's just pushing creditors arounds. It's controlling cash flow. It's reducing certain expenses, et cetera.

Mehtab Bhogal:
On the income statement side, that's a little bit harder. Because you really have to juice cash flow very aggressively. When you're doing both at once, that's the hard mode of turnarounds. We've done a few of those before. I think I'm getting too old for those now. I'm 29 this month. At over 30, I'm good. That's a no-go for me. Once I get there, that'll be a no-go.

Mehtab Bhogal:
But in that type of situation, you probably want to avoid the company. If it's something that requires massive scale, that's a bad sign too. It's much easier to cut than it is to build. We've done both. But if you can take a company that's doing $100 million, bring it down to $75 million, and significantly reduce CAC because you're getting closer to that core customer base ... Get rid of all the fun experimental projects that went nowhere. That's something we're okay with.

Mehtab Bhogal:
But if the company has to be doing $100 million in order to breakeven, because of certain locked in ... Maybe they bought a bunch of equipment, et cetera, that you can't get rid of or there's no real creative solution to. In that case, we prefer to stay away. Or some businesses are just permanently impaired. If it's something that was paid social heavy, and it doesn't look like paid social is bouncing back, you probably want to stay away from that.

Rob Gonzalez:
Right now [crosstalk 00:29:54]...

Peter Crosby:
Go ahead, Rob.

Rob Gonzalez:
If you look at the D2C landscape, you said there was a tailwind in the ability of creditors to lend significant leverage to unsecured credit on small businesses, which is amazing to me. My dad, by the way, was a career risk manager for GE Capital. I hear, "Unsecured lending to small business," I'm like, "Oh my god."

Mehtab Bhogal:
It doesn't make sense.

Rob Gonzalez:
It doesn't make any sense. But if you go to 2020, all of a sudden credit is opening up for these types of businesses. They're going long on e-commerce and all that. Does that mean that right now in '22, where e-commerce growth is way lower than it was a couple years ago, where interest rates are rising like crazy ... Are you seeing a ton of deal flow where there's distressed businesses of the first type that you're talking about?

Rob Gonzalez:
When they took off a lot of credit on their balance sheet a couple years ago, they did it to run an experiment, and the experiment has failed. Therefore, they need some type of major restructure, but they're fundamentally a sound business. Is there just a ton of deal flow like that right now?

Mehtab Bhogal:
Yeah. We started to see deal flow pickup in Q4 of 2021 and really accelerated in Q1. I suspect it's going to accelerate even more. We're thinking it'll peak around Q4, Q1 going into next year, which is where the credit side really hits people pretty hard.

Rob Gonzalez:
Wow.

Mehtab Bhogal:
Getting squeezed margin-wise on the supply chain side and on the customer acquisition side. Really, that's when you start to feel it. Just given there's a little bit of a tail on the financial end of all of this.

Peter Crosby:
Mehtab, I'd love to focus on. Because you were talking about cost of acquisition, et cetera. With your battle plan, you've walked in the door. You've taken that deep breath. You've done your initial work. Where do you focus in marketing to get the biggest bang for your buck? What do you change?

Mehtab Bhogal:
Absolutely. Obviously, acquiring the last 10%, 20% of your customers is always the most expensive bit in D2C. At least, in e-commerce. It's always the least efficient. If we can scale that back, that's great. We'll do that. We'll lean harder into channels like email, SNS, et cetera, to try and juice more out of the existing customer base.

Mehtab Bhogal:
I'd say probably the most consistent, low hanging piece of fruit that's around is implementing a true multi-touch attribution solution. Rockerbox is great for that. The guys at Northbeam are solid too. That's something that's custom tailored and built out just for the company. Last-touch attribution. I guess I can clarify too. The last-touch side doesn't paint a full picture for what is driving customer acquisition.

Mehtab Bhogal:
Multi-touch effectively does. And it's an imperfect science. We'll implement something like that. Then, we'll use holdout tests, lift analysis, et cetera, to verify that what we're seeing is correct. We'll start to move around that way. The other really big win is just deploying new channels very fast. We've actually used Salsify in a turnaround situation before. I'm not getting paid for that or anything like that. Rob didn't send me anything cool.

Rob Gonzalez:
No. I won't ask you if you liked it. I just appreciate you saying you used it.

Mehtab Bhogal:
We just plugged the company in and we deployed it across a ton of channels very quickly. I feel, in a turnaround situation, it's probably not the best time to worry about a brand. You see a lot of people being concerned about their brand and what marketplaces it's on, et cetera. But if you're hemorrhaging money, I feel like brand is the last thing you should be really concerned about.

Mehtab Bhogal:
It's good to maintain it. But I don't think it's a big deal if you pop up on a few marketplaces or discount sites, et cetera, so you can move some bad inventory very quickly. The velocity around testing is what we find needs to increase the fastest and systematization around that. What goes into designing a test? How do we deploy it? How do we get the assets we need very quickly and find something that's scalable cost-effectively?

Peter Crosby:
I would imagine that one of ... I've known some D2C businesses where they try to solve their issues by having as many SKUs as possible to see which one is going to hit, which is part of your test and learning strategy. But I was wondering, when you walk in, what do you think about that? What should your SKU strategy be?

Mehtab Bhogal:
Rationalizing SKUs is really important. Especially, if you have a manufacturing component. What you'll sometimes see is that the bill of materials that they have, or the raw components, it's a very wide base of components for no real reason to create some of these SKUs. 20% of the bill of materials might be used to create 80% of the SKUs. The other 80% of my bill of materials is only used to create 20% of the SKUs. There's a huge opportunity to cut and improve working capital.

Mehtab Bhogal:
A lot of the time, I feel entrepreneurs get very obsessed with offering width, when there's no proven correlation to offering width with revenue. Fastest way to test this is to change the collection levels, the collection pages, and the products displayed in each collection. Very rarely do we find that there's a strong correlation with offering more width and revenue.

Mehtab Bhogal:
Obviously, it's different when you're a long-tail retailer. Say I'm selling auto parts or something similar. In that case, you definitely want width, but they tend to get there differently. They're almost always drop shippers. Even the ones pushing $200, $300 million. They almost always drop shipping. They're not carrying the inventory in-house most of the time, so it's not a big deal there.

Mehtab Bhogal:
But for the manufacturers, the bill of materials dynamic is a really big problem, because it creates so much operational complexity. Managing inventory at the warehouse and everything that goes along with that. The working capital side. Managing vendors. What happens when one out of 5,000 of my bill of materials goes out of stock? How many SKUs does that break?

Rob Gonzalez:
It's funny. I remember reading a case study years ago on Taco Bell. One of the brilliant things that Taco Bell did, and I forget the exact timeline on this, was they reduced the number of ingredients in each individual Taco Bell to some tiny number like seven. And so, literally everything on the Taco Bell menu can be made from seven distinct things.

Mehtab Bhogal:
That's great.

Rob Gonzalez:
It's just recombining them in different ways. It's amazing to think of the Taco Bell strategy as key to D2C.

Mehtab Bhogal:
Chipotle is another really good example. They're famous for it. I forget what it is. Their ingredient count is very small. That's why you'll see them ... I forget what they introduced recently. Not recently. Maybe two years ago. And then, they cut it very quickly, because it just wasn't worth the headache. That's the marketing side.

Mehtab Bhogal:
Then, on the operation side, it's generally managing cadence. We have four core systems. The first is Lean slash Six Sigma, which is the Toyota manufacturing method more or less. It's fairly well-established, but a lot of lower middle market companies for the manufacturing component don't utilize it for whatever reason. It's very common above $100 million. You'll see it pop up there, but below that, they don't use it. I don't know why.

Mehtab Bhogal:
The really cool thing? It's all state-subsidized. For example, the Utah MEP Program, which subsidizes Lean training. They gave us Purple the mattress company, their ex-VP of manufacturing, who also had a SaaS company on the side. Really cool, brilliant guy. They're giving you these high quality people at state-subsidized rates to help implement Lean. It's a total no-brainer. That's the big one that we always find wins on with variable costs, reducing work, and capital required, et cetera. Sorry, Rob. Do you have a question?

Rob Gonzalez:
No, I'm just thinking through how fun this job is that you're describing. It's got so many interesting things that you get to go deep on. My question is not a question. It's just, "Wow. This sounds fun."

Mehtab Bhogal:
That's the manufacturing side. That's really the go-to. Easy way to find wins. I love it because it empowers everyone on the team. You might have a team that's never had a good idea in two years, but you can empower everyone. It really does turn an employee making $15, $18 an hour and it doubles that productivity. Now, they're almost a $30 employee.

Mehtab Bhogal:
People can't believe it and the retention differences are massive. We had one portfolio company that had about 120, 130 people there. It was turning through that workforce essentially every two, three months, which is crazy. With Lean implemented, that was significantly reduced.

Mehtab Bhogal:
I forget what the numbers worked out to, but almost nobody left the company. The best thing is there was no increase in costs. Your costs went down. You ended up with a higher quality workforce that was more happy. It was just a win-win all around. It's a really cool thing to implement.

Peter Crosby:
Wow.

Mehtab Bhogal:
A lot of the same process-building techniques that carry over to digital. You see some of the same methodology used in something like Agile, which is interesting. It's fairly widespread.

Peter Crosby:
Listening to Mehtab, just to close out ... You were talking about the retention of employees. I would imagine in this environment, at least in our space, it's a very active hiring environment. A lot of job changes are going on out there.

Peter Crosby:
You're probably walking into an environment that has been very stressful for a while and has a lot of complications. How is it that you inspire retention? Particularly, I'm thinking of the digital teams that are required to run the kind of acquisition programs you're talking about and retention programs.

Mehtab Bhogal:
On the digital side, stepping away from the brand, you end up with two groups of people in a turnaround situation. One is the people who really love the brand. They'll stay there until the end. You could probably not pay them. You could probably pay them apples or potatoes or something. They'd be stoked. They'd be there every day. They absolutely love it. They love the company. Those are your hardcore loyalists, who just genuinely love the company.

Mehtab Bhogal:
Then, the other group are the people that need to go. They're underperformers, et cetera. They've been there for a while. Management hasn't cut them. Management hasn't been managing adequately, et cetera. They're typically very thrilled when we cut that problematic group of people. And then, you end up with real fanatics. Maybe they're not the best at what they do. They can certainly be trained. They can certainly be molded, et cetera.

Mehtab Bhogal:
They tend to have a great appetite for learning. Sometimes that ratio ... Maybe you only have 20% of the team. That's great. 80%, that's horrible. Or it can be inverted. It tends to be a 30/70 type of split. 30% are great people. But there's almost no drop-off in productivity. We've come in and we've cut teams of 50 down to 10, 15 people. Productivity goes down maybe 10%, 15%.

Peter Crosby:
Wow.

Rob Gonzalez:
Holy cow.

Mehtab Bhogal:
The tail is what's crazy. You see that on maybe the dev side with your 10X engineers, et cetera, where there really are guys who just crank output. That can take you really far.

Peter Crosby:
Again, before we let you go, I'd love to know as you look ahead ... We're asking everybody these annoying prognostication questions. But as you look into the environment the next couple years, it sounds like at least, you're pretty bullish on your sector. That there will be lots of inventory for you to evaluate and things like that. What are you seeing out there that is on your mind for the future?

Mehtab Bhogal:
We're really excited to tackle some of these larger retailers that aren't necessarily digitally native and transform them. The only blocker is personnel. More or less. We have a team that we advertise across the portfolio and throw in. If we acquire something new, they're stepping in there. Maybe a new CMO, et cetera.

Mehtab Bhogal:
But we need more of those people. Beefing up the team. It's not really a capital thing. You can acquire a company doing $100 million in revenue for as little as three to $10 million in cash, which is next to nothing. All things considered. If you were looking at vanilla LBO, that'd be a much larger transaction.

Mehtab Bhogal:
For us, going up market, tackling some of these brands that aren't necessarily digitally native and making them more digitally native or accelerating that process. And at the same time, taking advantage of their omni channel infrastructure is really exciting to us. Especially the older, more established brands.

Peter Crosby:
Well, you can't have Rob, so stay away. Right, Rob?

Rob Gonzalez:
Well, it depends on the brand. I'm just imagining you grabbing whatever the next Lord & Taylor is before they go out. It changed hands for really not that much cash, not that long ago, before going down. That sounds like it would be really outstandingly fun. To take a classic brick brand that's been around 100 years and just have carte blanche to reboot it. That sounds awesome.

Mehtab Bhogal:
Absolutely. It really is exciting.

Peter Crosby:
Well, Mehtab, we're definitely going to be keeping an eye on that moving forward. Really, thank you so much for talking us through your process and what drives you and how you make this work. Because it's just fascinating. As somebody who comes more from a words, marketing, branding kind of side, to hear the rigor and the operational excellence that you need to apply to do something like this, it's just really impressive. Thank you for sharing it with us.

Mehtab Bhogal:
Thanks for having me on.

Peter Crosby:
Thanks again to Mehtab for sharing his turnaround roadmap with us. For more from the Digital Shelf Institute, rock it over to digitalshelfinstitute.org and click to become a member in the upper right-hand corner. Thanks as always for being part of our community.