King of convenience: When will the DTC and quick-delivery bubble burst?
Are brick-and-mortar retailers really threatened by the emergence of burgeoning direct-to-consumer brands and what will future consolidation look like?
The terrifying arrival of the Covid-19 pandemic presented both an opportunity and a threat to traditional grocery retailers and supermarkets. Amid global lockdowns and the closure of almost all consumer-facing businesses, savvy retailers sought new channels and verticals through which to connect with their customers.
Director-to-consumer (DTC) has been a rapidly growing category for years and with internet access around the world more accessible than ever, the clear shift to online has forced many traditionally brick-and-mortar (B&M) sectors to invest in their digital footprint over the past five years. Take gambling as a prime example, what was once an industry founded on casinos and betting shops has (not very) seamlessly evolved into a largely online business with casino, betting and bingo apps now available at the touch of a button.
The transition for FMCG and retail has been much slower, and while online delivery has been available from a handful of B&M supermarkets for some time, the service has typically been slow and somewhat unreliable. Today, in what feels like record time for the emergence of a new vertical, rapid-delivery services are having significant investor capital hurled at them while gaining huge traction among consumers. And traditional retailers are taking heed of these developments.
Berlin-based grocery delivery start-up Gorillas closed a $1 billion Series C in October, in a round led by Delivery Hero. Its 10-minute service operates in nine European markets with help from 180 dark stores where groceries are held and prepped for quick and easy distribution. Perhaps the most notable piece of news to come from the swathes of investment and M&A headlines on Gorillas’ impressive recent growth is its partnership with UK supermarket group Tesco.
In a statement released on 28 October, Gorillas announced a pilot collaboration under which the company would establish co-located warehouses in five Tesco stores across the UK. “Utilising the existing Gorillas business model of micro-fulfilment centres to enable delivery of groceries within minutes for their combined customer base, the commercial partnership will grant Tesco customers access to its products, available for delivery in minutes via Gorillas,” the statement said.
This deal highlights the very real pressure felt by retailers thanks to the rise of the dark store and rapid-delivery model. “There’s always going to be healthy friction between the brands that are operating already within an online environment and the ones that are coming in with more data and a better understanding of their consumer,” Richard Brick, principal at consumer specialist private equity firm True Global (NI) says of the clash between traditional retailers and delivery start-ups.
For Brick, DTC and the emergence of ghost kitchens, are a primary focus for True in its search for new F&B investment. “I really like the Mindful Chef business,” Brick says. “[But] there are incredibly high marketing costs within those businesses which is a very different challenge. These DTC players have economics which are interesting but do have an end point because there is a different customer set that wants to shop in that way versus going to the store. The big retailers will always be very strong and the opportunity for them is [partnering with or acquiring] interesting DTC brands that have a ton of data they can then sell on to the retailers,” he adds.
Acquiring from within
Mindful Chef, which provides DTC recipe and meal-delivery boxes, was acquired by Nestle last year. The FMCG behemoth said at the time it shared Mindful Chef’s ambition to increase the availability and convenience of healthy food. Mindful Chef is one of a few success stories in the world of meal kit and ready meal delivery services. Nestle also purchased recipe kit company SimplyCook this year to further beef up its DTC expertise. “SimplyCook provided a tech platform and a consumer understanding, or an understanding of how to approach the consumer using a DTC platform, which Nestle didn’t necessarily have in-house,” Mark Lynch, partner at corporate finance advisory Oghma Partners tells NutritionInvestor.
Despite this keen interest, the category is likely to face tailwinds this year and next as Brick suggested, customer acquisition costs (CAC) are particularly high among DTC businesses. Add to that the normalisation of consumer shopping habits in a post-Covid world, and upcoming 2021/22 full-year revenues are projected to be significantly lower than last year. “There aren’t that many solely retail-focused businesses that are coming to market and are projecting both a strong 2021 and a stronger 2022 based on their 2021 results,” Oghma’s Lynch notes. “I think most of them are looking at some form of plateau or even a decline to reflect the fact that there’s been some sort of aberration that’s had an effect on the business.”
“Mindful Chef came to market in February last year and 2020 revenue was more than 3-times what they initially thought it would be,” Brick adds. “But it just doesn’t work in a pre- or post-Covid environment. Fundamentally the model is a little bit hurt, but for Nestlé, it’s hedging the group’s losses in different parts of their business. It’s a bit of a systems and talent hire acquisition as well as R&D.”
With this forecast in mind, the investment bubble for DTC may well burst within the next couple of years. And future M&A in the space is expected to happen among the strong DTC players, versus retailers or investment firms like private equity. Consolidation among these delivery firms is already rife as operators seek to expand their geographical reach and acquire additional operations in key markets. Multibillion-dollar delivery start-up Getir snapped up smaller player Blok in July to gain access to Spain and Italy and in November, US food delivery service DoorDash bought Northern Europe-focused start-up Wolt to help it break out of North America.
“It’s a reflection that there’s a lot of cash around chasing the excitement around foodtech, of which DTC is one element,” Lynch says. Managing director for investment bank Duff & Phelps, Farzad Mukhi agrees. “I see it being more consolidation of providers within these categories versus diversification into other categories, just because we’ve already started to see people go back to how they were shopping before the pandemic. This service will really only cater to a certain type of consumer who really sees that value proposition around convenience” Mukhi tells Nutrition Investor.
More broadly, Mukhi and Lynch are doubtful whether DTC provides at present a real long-term threat to traditional retailers. “Is that threat any greater than eating out?” Lynch muses. “If the retailers really wanted to, they could take on these models. I think perhaps the greatest threat might be Amazon and the reason I think that is because their tentacles are much deeper with the consumer. They are an understood concept with huge amounts of money behind them.”
Ardian Mula, chief executive of UK online food ordering company Foodhub, believes industry consolidation presents consumers with less choice, fewer promotions and higher delivery and service charges. “Generally, the more providers there are, the better it is for the consumer because there are discounts and promotions and a war on price among providers,” Mula says. “But lately, especially in the last six or seven months, that has gone the wrong way and commissions are now quite high.”
Mula expects the DTC investment bubble to burst in the next year or so, particularly as slowed post-Covid growth sets in. The Foodhub chief executive believes many brands will branch out into new categories to maintain and improve profit margins in coming quarters. “These companies will have to become more economic-focused,” foodtech investor and former entrepreneur Neeraj Berry agrees. Back in 2013, Berry founded one of the very first meal delivery services in the US. Sprig: Dine and Demand served more than two million meals in three and a half years and raised $59 million in venture capital.
Reflecting on the business’s eventual demise, Berry acknowledges that much of the infrastructure for delivery businesses has now been well-established as many B2B firms provide back-end services that were not available in his time. “If I were to restart the business today, I would just focus on one or two areas and leverage existing infrastructure for the rest of it,” Berry notes. “You could develop a business that only worked on the physical infrastructure of holding facilities, you could only cook or produce the food or you could only provide the delivery service. I think now there is the flexibility to choose whatever best suits your skillset.”
Berry is now an investor in Gorillas as well as sustainable DTC grocer Farmstead and B2B delivery service Buffalo Market, among others that are storming the space. “It’s hard to say exactly when [further consolidation] will happen but I think we’ll see a handful of players become dominant globally and I think it will be in the five to ten range,” Berry predicts.
Although Covid-19 accelerated the proliferation of DTC food businesses, the consensus within the sector is brick-and-mortar shopping experiences are still necessary. Speaking at wellness industry trade show the Balance Festival, Damian Soong, chief executive for meal replacement brand Form Nutrition, said direct-to-consumer was making way for a new iteration of in-person shopping experiences, forcing retailers to really connect with their customers. Adrian Boswell, buyer for food and wellness at luxury retailer Selfridges, told the Balance audience that the store’s latest strategy was to merge its digital and in-person shopping experiences.
Conversely, DTC brands will need to gain access to traditional channels to survive long term. Mindful Chef recently hired a commercial director to secure partnerships with traditional supermarkets and distribute its frozen ready meals. “There is most definitely a drive [for DTC brands] to deliver that innovation to a new market, and ultimately all the [B&M] retailers want is NPD (new product development) which drives sales per square inch,” True Global’s Brick concludes.