TRANSCRIPT
Peter: Welcome to Unpacking the Digital Shelf where we explore brand manufacturing in the digital age. Hey everyone, Peter Crosby coming to you from the digital shelf Institute studios in Boston. We've got our weekly episode of quick takes on the industry news that you might just want to pay attention to. Rob's in the copilot seat here in the studio. Hey Rob.
Rob: Hello.
Peter: So these past couple of weeks, Rob, we have new lessons that, gosh, retail is hard.
Rob: It turns out it turns out not everyone can do it super easily.
Peter: Like they say on project runway, “one day or in the next day you’re out”. That's my Heidi Klum impersonation, who I know doesn't host anymore. Do not tweet at me, but the point remains. So let's talk a little bit about who might appear to be up right now, which is the, the investment from a Warren Buffet and his team at Berkshire Hathaway, $550 million into Kroger. What is going on there?
Rob: So Buffet's investment strategy, which is famous and, and, and I'm going to probably mess up some aspect of this, but at a high level, the way that most people understand it is that he goes deep into a specific market and he goes deep into specific companies and he doesn't invest in lots of companies. He invests only in specific picks that he believes have long term upside. So his investment in Kroger is not an investment that, Oh, Kroger looks like it's going to do well in 2020 or 2021. His investment in Kroger is a bet that Kroger over five or 10 years is in a unique position in that particular market compared to its competition to succeed. So if Warren Buffett were looking at all of grocery and he looked at Kroger and he looked at Ahold, then you look at Albertsons and you looked at Publix and he looked at all the other majors and he picks Kroger.
Rob: He's got reasons for doing that. Now he's, he hasn't been right every single time. And you might wonder whether at this point he's making a bet that, maybe it's just a bet, you know what I mean? And people have said that people have wondered whether the the, the, the Oracle of Omaha's charm has, has fallen off a little bit or whether just the fact that he invests through to his reputation is enough to make the investments worthwhile because then there are other people pile on the bandwagon and think, Oh, Warren Buffett invested, therefore it must be good. I, I'm, I'm of the opinion that actually I think he's probably making a pretty good bet. I, I look, I look around the grocery space. I think Kroger's as well positioned as anybody to continue to grow and succeed here. It's not at all clear to me that in the United States we're going to see the type of grocery penetration that the UK does, just the way that our country's spread out and things like that.
Rob: It's not at all clear to me that the big delivery investments that people are making are going to pay off. Even Kroger, I mean, Kroger's got that big Ocado investment. It's just, it's unclear whether that's going to pay off. And the fact that they've got a ton of grocery stores and they've got a great supply chain and they've got a great management structure and they've got a whole division 84.51° that focused on analytics. I think there's a lot to like there.
Peter: People need to eat.
Rob: Yeah, there's, the margins are already so tight in grocery that, you know, Amazon keeps trying to get into it and finding that it's hard. Yeah. And Kroger, Kroger's in a position where they've been successful competing so far and I think there's, there's a lot of reasons that you could come up with that to believe that there's still gonna be around in 10 years and they're still gonna be big and they're still going to be doing well.
Peter: Yeah. And there are signs of Kroger that they are, they are working that innovation. You were talking about the investment in the supply chain. And there's, there's those observers in a financial world who feel like that's not the way to do it, that they've over centralized it and all that stuff. But you know, they're clearly working on the issues that they have. They launched Kroger precision marketing, which is allowing brands that sell goods through the stores to see how their certain campaigns or promotions are impacting sales. Like they're starting to open up the visibility for the, for the brands that work for them and also try and get more of the, you know, buy online, pickup in store, all of that kind of stuff that, that is headed in the right direction. And they have the scale and the, and the coverage to compete.
Rob: Yeah. I think if you look at one of my favorite articles that I've read in the last, last couple of years on cursory is titled it's on long reads.com and it's the man who's going to save the grocery store. And the story talks about grocery stores evolving in this next phase. A grocery store, 10 years from now is not going to look like a grocery store today. You can go to extremes here. You can basically say the whole center aisle is going to go away. But anything that's shelf stable and packaged, you would just order that online. So why would you go to the grocery store? You know, so the, the bare argument against the grocery store as supermarket as a thing is a lot of these things are easily deliverable and they remove incentive to go to the store. The bull argument is the places that are doing something that's experiential or discovery oriented, you know, the Aldi's and the Trader Joe's and the Whole Foods and so forth are, are doing well and, and there's more of these types of stores popping up.
Rob: So if you're going to look at a Kroger and you're going to say, okay, let's say, let's assume that this is at least directionally right, even if not entirely right, Kroger’s in a better position than almost anybody to reinvent the center aisle and build experiences into the store and scale that if they've got a healthy cashflow, they've got a healthy business and a lot of grocers don't. And so if you're going to bet on somebody to succeed in whatever the transition is, that works. They're a good bet.
Peter: Yeah. I think your point where you started the long term view that Berkshire Hathaway and it isn't, you know, Warren Buffett's not doing this investment, probably it's, it's other folks that, that run that. But I think their philosophy of look at businesses that over time will deliver returns and have a business model that makes sense, et cetera, and are willing to change. And I'm assuming that it's their insight into the management teams and what their plans are that they have confidence in.
Rob: Yeah. Yeah. So, I mean, who am I to disagree with them on some level? But you know, also, even even for my chair, retailing is hard, Kroger's very, very good at it. They're better than most of their peers. And, and the, the, the big disruptors in this space have not been able to compete with them so far.
Peter: So speaking of which the, the, the other side of the coin, the, what brands are out, it has been a busy week in DTC brands in terms of, you know, the seems of achieving scale at a profit are definitely starting to show, first of all, we know a Brandless now kind of sadly lives up to its name in that it ceased operations last week. There was an article, on Protocol, a Biz Carson, at protocol, broke that news. Do you want to walk us through a Brandless? Is closure and, and do you think it has a broader implication or is it just a chose a sort of a bad way to do business?
Rob: Yeah, so Brandless for those that you don't know, they're, they're one of the SoftBank investments in this space. So SoftBank invested 270 some million dollars in them. At a, at a big valuation. So they were a high profile startup that was looking to disrupt retail. Now the Brandless model is, if I could sum it up, like everything is private label, but online, right? It's, it's a think of the trader Joe's or the Aldi strategy, but move it online and then remove what they were calling the brand tax. So if you go into like a trader Joe's, right? Like trader Joe's does phenomenal marketing on every single thing and every single piece of packaging that's in a trader Joe's. Their market is famously the overeducated, underpaid.
Rob: And so they're, they're looking to use grammar and fancy words to sell the, the romance of the things that are in the store. So instead of brown sugar, they call it turbinado sugar. And they use words like that all the time. And so what they do is they take a private label object, but they invest in the private label object to make it more appealing. And they're able to charge pretty good prices for these objects, even though they're private label and they're able to drive good margin. And Trader Joe's per square foot profitability for grocery is substantially higher than anybody else's in the United States. Now Brandless on the other hand, they, their philosophy was, let me actually take something that should be cheap because it's cheap from the manufacturer and the brands are just, you know, going to a factory and taking something out of the factory and slapping a label on it. You know, they're slapping Balance or Tide or whatever on it. Or Charmin and they're just, they're charging more because the Charmin label’s on it. Like imagine if you could buy Charmin, but it doesn't say Charmin and you could pay three bucks instead of eight bucks. That's basically the process. And I mean at, at the end of the day, people like brands, right? At the end of the day, people have loyalty and trust that's built into the brands that they interact with. And Brandless did not fill that gap with something else. Like, like Trader Joe's did.
Peter: Yeah. Their, their gambit was low prices and that's a really tough thing to scale. And, and also it, it meant that they, the customer acquisition costs, in direct to consumer, are getting higher and higher as social channels get, get, you know, overwhelmed with, with demand on their advertising side. So I think they just ran into a bunch of cost additions and the inability to scale. So Target started a low priced personal brand called smartly, which was 70% less than the national brands with a sassy sort of tone. And so I think it's hard to compete with that.
Rob: I think, I mean it's, it's easier to do private label from a position of strength than it is to do private label as a whole strategy.
Peter: Richie Siegel who's at the retail consultancy, Loose Threads said like Brandless and other direct to consumer brands are just better branded private labels is, you know, which is perfectly true.
Rob: Yeah. So I look at the brand list thing and I think sad, but maybe, maybe it was the wrong business model, right? I mean again, you, you compare it to the in store version. Like try a Trader Joe's is all private label Trader Joe's didn't raise a quarter of a billion dollars from SoftBank and try to go after everybody all at once. Trader Joe's famously expands really, really slowly, one store at a time and is very careful about supply chain is very careful about overstretch. It's not, it's not a highly leveraged bet or anything like that. And so I, and retail's hard. Retail margins are tight and you can't just say, I'm going to underprice somebody who's already good at operating at scale with tight margins. I mean the average margin of a grocery store in the United States is what, 1.7% yeah. I mean you're going to underprice that you're going to out margin a 1.7% spread.
Peter: I mean it’s the wrong thesis. But, it's always easy in the, in the rear view mirror. But I think a lot of people knew this early on but thought, Oh, can this sort of magic of direct to consumer actually work? But they didn't put together the right combination that it takes to make that direct consumer brand successful. And you know, SoftBank, who's the investor who's putting this all in turns out investing is also hard because they, we work kind of the same story, sort of visionary CEO, this big idea, Oh, this, this has a greater halo of value than, than it should when you look at the, at the multiples. And so their CEO said at their last earnings report last week, the era of growth at all costs are over.
Rob: Yeah, it's, it's funny. I mean, look, I think everybody with a pen and a voice has made fun of, we work in SoftBank and in the last year and now we will too. But in all seriousness, I think the, the thesis that SoftBank got wrong is that they're winner take all markets require there be zero or as close to zero marginal cost of serving the next person as possible. And you look at a Brandless or you look at you look at, Wework or you look at Uber, there's marginal costs in every single transaction. And so getting the next person in and getting that next transaction going costs money. It costs money. And sales, it costs money advertising, it costs money to fulfill and when you've got marginal costs and distribution, you tend not to have winner takes all market. It just requires increasing investment.
Rob: And in fact, you know, getting the millionth person to use something is often more expensive than getting the 10th person to use something cause a 10th person is, you know, your core marketing and somebody who sees what you're doing and say, yeah, I'm in the million person. You know, they don't care to do that to me.
Peter: Yeah, make this worth my while to even pay attention to you. Right. And that's the interesting thing I think also about D2C brands is that they require direct attention. Like I have to be loyal to you as opposed to just seeing it pop up in a store somewhere and being like, Oh yeah, that's familiar. I'll take that with me. It requires you, you have to subscribe to their channels and you have to sort of listen to what they're doing and be engaged. And that's tough to do at scale. To your point, to the next million or the next million customers.
Rob: If you look at the, the Brandless thing there was I remember when they first came out, I bought a few, bought a few things from them and read their message statement. A lot of it was was, you know, these brands charging a brand tax, you know, and at the end of the day, I don't think the average person looks at Charmin and says, you know, I hate you Charmin, I hate you bro. They just, you know, they don't have that type of negative reaction. So they were trying to cash in on on, on sort of a groundswell that, of feeling that just that just doesn't exist, doesn't exist. And so, yeah, I mean, it's easy to see in the rearview mirror 20/20 hindsight. But you know, this is the thing about, this is the thing about venture capital, and this is the thing about investments and this is what's great about this era is that one might've failed, but Go Puff raised a ton of money and go, puff is crushing it.
Rob: They're doing awesome. It's a, it's a new model. It's competing with CVS and Walgreens. And it, it, I mean there, it's a great model. And so, you know, for every, every failure or maybe even for every five failures, there might be one success that changes the whole industry. So like I look at Brandless and say, well, you know what, that one didn't you know, but, but there's more.
Peter: Speaking of more and but it kind of in the sort of out out story that we started off with, I feel like the, the different actor in this case was not the realities of the market, but rather the government coming in, in the middle, the FTC, coming in the middle of Schick Maker Edge Well’s $1.4 billion bid for Harry's and essentially screwing up that deal. So that deal is now off the table. Harry's has responded and said it's growing profitable, well capitalized and excited about the opportunities ahead for our business. But it must be a blow between, I was expecting to get a $1.4 billion check and okay, now we're still going out on our own. Love your thoughts on, you know, cause I think there's somewhat of the same thing going on here, right? Like how do these things scale? Harry's has done a great job but I think they're now running up against that bigger scale. But nonetheless, pulling it off.
Rob: I mean different founders and different investors want different things from their investments and some founders like famously here in Boston, HubSpot is here. Brian Halligan and Dharmesh Shah want to run HubSpot forever. They're not selling that thing. There are, they are on the record really clearly. They do not want to sell HubSpot. They don't want, they want to keep running the business. Right. and then so for Harry's, I don't, I don't know the founders, but it's possible that they were building a fast growing company. At some point they wanted to sell it or whatever and step aside and do the next thing. And a lot of entrepreneurs are like that too. So the, I mean this indicates that maybe it is a blow for them on a personal expectation level. From a market perspective. I don't know that I agree with the FTC here. The FTC’s argument is they're going from four major manufacturers of razors in the market to three, right? And the, the, the four are number one is Proctor and Gamble’s Gillette brand number two I believe is the Edge Well, Schick brand number three is Unilever's Dollar Shave Club brand. And number four is Harry’s.
Rob: And I might have the exact order of those wrong, but in broad strokes, that's what it looks like. Right. And also depends on how you measure it. Like I saw recently dollar shave club has 5% market share. If you look at dollars spent on razors, but they have 15% market share. If you look at number of razors sold, that is disruption, right? I mean, so they've captured 15% of the market from I. And I think that's, that's an interesting way to look at it. Yeah. So you know, if, if you're the FTC and you believe that more companies competing is better for the consumer and competition is a thing, then, then that's your argument. You know, you'd rather have four than three. On the other hand, if you believe that scale matters in, in terms of ensuring healthy competition and you see increasing consolidation around dollar shave club and Gillette and let's say that Edge Well is losing market share and, and you know, an Edge, Well and Harry's combination could actually be better for, for competition because it means that there's a third viable growing competitor instead of there just being too.
Rob: Right? so I don't know personally enough about the, the market, but to me it doesn't feel like going from four to three materially changes the competitive landscape. And there, there's a, there's a lot to like about that combination. So it's, it's, it feels too bad. It feels like a little bit of a regulatory miss on principle rather than a regulatory hit based on a deep understanding of how the competitive aspects of the market work.
Peter: I agree with you when you, when you think about the path forward, now that that aisle has been, has been cut off, what is Harry's do? A Deutsche bank researcher said Harry's will likely seek financing from other sources to continue to expand both in the US actually not perfect SoftBank, their wallet is closed. So Deutsche bank actually said that they believe Harry's is not profitable, but Harry's is saying that they are. So obviously Harry's no more is about their balance sheet, but who knows, you know, they're trying to position it, but if you're not profitable and the other sources of funding are likely more private funding, where do, where does this end if not in acquisition? Like, like what is…
Rob: They get, I mean there's a lot of options said that there's shorthand. There is so much liquidity right now that's looking for a place where there is growth, that investing in a private company that's growing and Harry's, Harry's is growing, like whether or not they're actually profitable is sort of beside the point, right? Like if they've actually got good unit economics and they are losing money because they're spending on sales and marketing, there's a lot of ways that the math works out there where the company could actually be pretty profitable. If you, if you, if you taper back growth.
Rob: And so the, the, the classic investment there where you get a late stage growth firm that invests in a pretty healthy company and expects to either go public or to exit at some point, that's, that's reasonable. Harry's may be pretty close to the scale where they could just go public and issue stock and fund themselves on the public market like companies used to do. Harry's could sell to a private equity firm which could come in and run the firm and slim costs and make it more attractive to another CPG buyer. I mean, there's, there's there's other giant CPGs that are multinational conglomerates that are not in the razor space that might love to own one of the big four, just like Unilever bought into the space through Dollar Shave Club. There's, so, I don't know. There's, yeah. To me, I look at their position and everybody knows Harry's brand, strong growth…
Peter: Great story, really good products at a reasonable price.
Rob: Yeah. I think they've done, they are a classic. We, they did this right and they did it right first to do it. Daphne Howland at Retail Dive, she wrote a great article about sort of linking the Brandless and the Harry's news together that that even though their business models are different Brandless retail only and Harry's wholesale the challenges of scale and profitability, they're, they're just real for direct to consumers. In that article she quoted from a national retail Federation speech from Adam Spivak at Comcast Ventures, basically saying the pendulum has swung regarding, you know, VC expectations and you know, pointing out that it's easier to launch a direct to consumer company that is to grow or just or sustain one. Do you buy that as kind of the linkage between these things? Do you think this is going to be a, the 2020 will be the year of, of the veil has been lifted off the glamour of DTC?
Rob: I mean, I don't know. I, given the fact that DTC brands have non zero marginal costs, so software companies have zero marginal costs. You create a piece of software, you can make it available to everybody basically for free. That's what gives leverage in VC investments. So there's a large upfront cost to develop the technology and then there's zero costs or close to zero cost to make it available to more people. So the VC model, you can get very, very big returns on a software company. The VC as applied to venture as a, as applied to DTC brands, the math is different, right? Because the, it still costs you to grow. The next consumer that you service costs you something, the margins are lower. So the return expectations and the multiples on the investment are going to be lower. But that doesn't mean you can't make money on it.
Rob: It just means you're not going to make software company money on it. So I don't know. When you see, when you see DDC taking a few punches in the mouth, I mean the Casper IPO being being down a little bit.
Peter: Half its value from the private valuation.
Rob: Yeah. Right. Or you look at Brandless going out or you look at the Harry’s acquisition falling through. I mean there's doubters out there. There's always going to be doubters out there. There's going to be people that come and pile on. Another one of the quotes from the article are from Chris Walton. A direct to consumer is just a distribution point. That's all. It's just a new way of talking to the consumer. I would put Away and Casper in the same bucket at the end of the day, they're not anything different than what we've seen before. So we've got to be rational in the valuation of these companies against what the comps are and sure.
Rob: But that doesn't, that doesn't make the investments bad investments, right? Like if you can invest $100 million in a company and five years later, you get $300 million from that investment. You know, that's not a 10 X, but that's still pretty good. You know, it's, so I, I'm, I'm not as down on the model as other folks. Just like any VC structure though, most of them fail at most software companies that are startups fail, that get VC investment. So therefore, you know, you look at DTC, most of them should fail too. It's just sort of how the math works and some of them won't fail and those that won't fail where I'll have pretty good returns. And so yeah, I don't know. I'm not going to be as quick to pile on here. And there's a clear market demand from consumers for interesting compelling brands that they can connect to even though I just sort of slammed how they, you know, it fills up Instagram but people are, are acting on it and they're enjoying particularly, Salsify has some research coming out soon, some consumer research and there's a, there's a clear, for parents with kids that are under 18. They are vastly more likely to be open and amenable to new brands and particularly brands that are driven by their kids' social interactions. So I think there's, there's clearly a hungry market for these kinds of things if you can make the connection to the consumer.
Rob: Yeah, I mean just in, in my role, I like to buy products from new companies so that I can understand who they are, what they're producing and how they fit in the landscape. Right now I'm wearing limbs shoes underneath that. I've got Bombas socks, I'm wearing a, an UNTUCKit shirt. I mean these are all relatively new brands and Bombas and UNTUCKit are crushing it. And so, I dunno, I think it's way too early for people to then to put the tombstone on direct to consumer or on the VC model for direct to consumer and college debt. I mean, just be, just because you have a couple that don't work out, it doesn't mean that the whole thing is busted.
Peter: Yeah. It's human nature to sort of report on the disasters and be less interested in the success.
Rob: And it's also media nature to find quotes from experts that are negative.
Peter: Right. And just pioneers slam. We worked in a media slam too. Well I will not slam the, the very talented writer Daphne Howland at Retail Dive cause it was a really, I thought, compelling article to sort of pull these things together and maybe there's a bit of a strange connection to it, but, but I do think there is something to keep an eye on as we go through 2020. So that's our show for today. If a, if these kinds of topics and strategic challenges are on your mind in 2020, I really do want to encourage you to attend the upcoming Digital Shelf Summit in Boston on May 20th. It's all for brand manufacturers and what the challenges are that they are confronting that you are confronting in in 2020 and beyond. So you can check out the agenda at digitalshelfsummit.com/register. In meantime though, please follow us on the institute’s Linkedin page tweet at us @windigitalshelf and if our content is useful, we would love a review wherever you get your podcast. Thank you so much for being part of our community.
