The digital disruption of the past couple of decades has been a challenge for traditional retailers like mass merchants and department stores, not just because online upstarts emerged as competitors, but also because brands could more easily bypass them in order to sell directly to consumers.
There are financial and marketing arguments in favor of this idea, but recent research throws them into question. In 2021, Coresight Research analysts touted the advantages of both direct-to-consumer sales and wholesale partnerships for brands. They noted that the DTC model leads to higher advertising and operating costs, but yields higher margins and a better understanding of the customer. But also that, while wholesale carries lower margins, it provides access to a larger customer base and more efficient marketing.
Now, extensive research from BMO Capital Markets challenges that further. To their own surprise, analysts there found that selling DTC often doesn't mean fatter margins. In a set of apparel brands studied by BMO, four out of the top five merchandise margin-getters had robust wholesale revenues. American Eagle Outfitters and Gap Inc. (two retail companies with minimal to no wholesale operations) have merchandise margins below wholesale-heavy Ralph Lauren and PVH, according to BMO's report.
"For all the conversation about reducing or eliminating the middleman or the middle person — because the middle person takes a toll — what we found is the middle person is actually a very economical way to grow a business," BMO Capital Markets Managing Director Simeon Siegel said by phone. "The most shocking is the gross margin piece. It's confusing that [selling DTC] wouldn't see higher gross margin, and I think ultimately the answer is tied to scale."
A new dynamic
Wholesalers and retailers have long had a fraught relationship, with each undervaluing the other's contribution, and perhaps overvaluing their own, according to Jeffrey Sward, founding partner and CEO at Merchandising Metrics.
Gross margin traditionally was a sore point, and there was a time, at least in the apparel space, when retailers took advantage of their power when they had it, Sward said by email.
"Retailers bought what they wanted to buy, and when the season-ending margins were not up to expectations, they demanded that the wholesaler literally write a check to get the margins back up to acceptable levels," he said. "Sometimes it was from the retailer making bad choices, and sometimes the wholesaler had an off season. But either way, the wholesaler had to write the check."
This tension (and even some level of brands selling direct via mail-order), pre-dates the internet, but e-commerce made it especially easy for wholesalers to throw up a website and sell directly to fans, Sward said. Whatever first led brands to avoid retailers, the practice has snowballed. Coresight found that, in 2020, DTC revenue at several brands grew by double digits, including at Canada Goose (21.7%), Levi's (17.8%) and Under Armour (11%).
For Levi's, DTC is about not just sales, but also its connection with shoppers, according to Sanjeev Mohanty, managing director of U.S. and Canada at Levi Strauss & Co. The denim maker has steadily turned away from wholesale, so that by 2019 it had declined to 30% of the business, down from about half of the business eight years before. Meanwhile, by the end of fiscal year 2020, DTC approached nearly 40% of Levi's business, from 20% in 2011, according to a filing with the SEC.
"Through our app, website and stores, we're able to deepen our engagement with consumers and create a truly unique experience that keeps them returning," Mohanty said by email.
But many brands are finding that it's not so easy.
"Wholesalers saw an opportunity to pocket the retailers' profit, but quickly discovered how hard that really is."
Founding Partner and CEO, Merchandising Metrics
"Along comes the internet and poof — wholesalers have direct access to customers! The wholesaler figures that if they are going to bear all the risk for all retail results, they might as well go direct," Sward said. "Then they discover that execution at retail is actually damned difficult, and expensive. Wholesalers saw an opportunity to pocket the retailers' profit, but quickly discovered how hard that really is."
It turns out that direct selling may not boost sales all that much, either, and in fact scaling back wholesale can mean a hit to revenue, BMO found. Over the last five years, for example, Skechers' sales expanded despite a decline in DTC penetration, while revenues at Vera Bradley and Michael Kors were generally flat despite greater DTC penetration. That suggests that any unit price lifts made possible by DTC sales couldn't make up for the sales lost by abandoning wholesale, per that report. "Said another way, revenue per unit may grow, but total company revenue does not," BMO analysts said.
The only way to grow
Streetwear brand Planet Brooklyn Academy has hit a growth ceiling, so it's time to go wholesale, according to founder and Creative Director Rob Norman.
"It's a volume issue," Norman, who also teaches product development of fashion at the Fashion Institute of Technology, said by phone. "I have a retail store and having online sales helps. But we are at a point where, basically, we're at a standstill, mostly because of our retail space — because of the size of it and the amount of products we can carry in it."
Norman has crunched the numbers and found that ordering in the bulk amounts needed to meet wholesale demand drives down his costs at the factory, among other savings, making his profits at wholesale similar to selling direct. "So let's look at other retailers as being my store," he said. "They're carrying my products, and that's better because I don't have to deal with the headache of rent and all that stuff because they're selling it out of their stores."
Many DTC brands fail to grasp that, according to Siegel. "For the most part, third-party retailers have very low gross margins," he said. "The fact that their gross margins are so low suggests they're not expensive to the brands that are selling to them. And I think that's a key part of the story, that third-party retailers are an inexpensive sales force."
"So let's look at other retailers as being my store. They're carrying my products, and that's better because I don't have to deal with the headache of rent and all that stuff because they're selling it out of their stores."
Founder and Creative Director, Planet Brooklyn Academy
Moreover, brands like Nike and Levi's may be turning more to direct sales because their wholesale business is quite mature.
"Wholesale has become this dirty word, which is effectively forcing smaller companies to steer clear of a channel that they probably should embrace," Siegel said. "What we're finding is that companies that pivot to direct are actually signaling that their wholesale is tapped, not that wholesale is bad."
Good news for department stores?
Brands discovering (or rediscovering) the advantages of wholesale sounds like a dream come true for department stores, given how much Ralph Lauren, Coach and others have scaled back those partnerships in recent years.
Planet Brooklyn Academy will also avoid department stores; Norman said the brand is looking to work with boutiques whose vibe and customer match its own. But that doesn't make department stores a "bad" channel, according to Siegel.
"There's nothing good or bad about department stores," Siegel said. "Figuring out which brands belong in Nordstrom, which brands belong in another department store, which brands belong in off-price or which brands belong where — that is a key part of every brand's internal storytelling. But the notion that a channel is universally bad is lazy. Department stores are not going to zero. They're still huge revenue generators."
Like Planet Brooklyn Academy, Levi's is looking to find its customers in more than one place. For them that does include certain department stores, Mohanty said.
"We've built a robust network of wholesale partners to ensure we stay close to the consumer while also remaining true to our brand identity," he said. "At the same time, these channel partners provide another distribution point and an opportunity to attract a broader consumer audience that's interested in quality products at all price points from premium to value."
Recognizing the upside of wholesale is important when weighing its costs.
"Here you have a company that's willing to put its staff on the floor and sell your product in real life or online for a fairly nominal fee," Siegel said. "Everyone hears the word 'fee' and thinks it's bad, but the reality is, whether it's your sales force or others, ultimately, people get paid to do a service. The question is, how effective are they at it?"
Brands that hate third parties also love third parties
Much is made of the fact that many DTC brands that once only sold online have opened physical locations, after finding that customer acquisition costs are much lower at brick-and-mortar stores. But some of those brands are also tying up with other retailers in search of growth.
In 2022, online pet company Bark partnered with Walmart, adding to a wholesale network that already included REI, Target, Costco, Petco, PetSmart, Amazon and others. The strategy puts Bark's products into more than 33,000 physical stores.
"Here you have a company that's willing to put its staff on the floor and sell your product in real life or online for a fairly nominal fee. ... The question is, how effective are they at it?"
Managing Director, BMO Capital Markets
Does that mean that a brand like Bark is losing its connection to its customer? Generally speaking, the concern is unfounded because most DTC brands already routinely partner with third parties when it comes to customer communication, according to Siegel.
"The biggest pushback to this report that I've gotten, as to why brands embrace DTC, is that if you're direct, you're closer to your customer data, and you have more control over your brand image and don't have to trust it to someone else," he said. "What I think is fascinating is that every single digitally native business has publicly acknowledged that they embrace marketing agencies. So companies that suggest they would never give up their distribution are comfortable outsourcing their actual brand imaging and storytelling — which is also a third party, which is also a middle person, which is also an additional fee."
Some wholesale deals are at least as much about branding as about distribution, according to David Schneidman, director at Alvarez & Marsal's Consumer Retail Group. The Sun Bum sunscreen brand began online, then turned to wholesale. Selling through "reputable hotel chains or beach clubs only elevates their equity while giving the consumer a premium experience," Schneidman said by email.
But every brand ultimately needs some channel for mass distribution, too, Schneidman also said. And these experts all noted that consumers are availing themselves of every channel. That includes the retailers that some brands won't partner with.
"The beauty of omnichannel that people forget is that it's got to be more than one," Siegel said. "'Omnichannel' used to be, 'Don't forget about e-commerce.' But over the course of the pandemic it basically became, 'Do just e-commerce.' What we need to internalize is that there's no such thing as a bad channel. There's just different fits."
Article top image credit: Daphne Howland/Retail Dive