Author: Chris Rigas, Vice President of Media at Markacy
Here’s a hot take: DTC companies employ way too many people.
Payroll costs are very high for DTC companies
The allure of direct to consumer is the possibility of cutting out the middleman and expanding margins; if you don’t sell to wholesalers at discount, you can keep more of the profit for yourself. And indeed, DTC brands often find themselves experiencing better gross margins than legacy brands in similar categories. Take the below graph (exhibit a), which shows Allbirds’ cost structure compared to Nike’s for the first half of 2021, when DTC demand was strong and sales were growing: Allbirds’ COGS was 46% of sales, compared to 54% for Nike.
However, their other costs are too high: marketing and other operating expenses for DTC companies have been much higher as a percentage of revenue than for legacy brands, resulting in the DTC companies making loss after loss. The marketing side of the expense has been well documented: customer acquisition costs have gone up as competition increases, and brands overspend when they are flush with investor cash and eager to capture market share. In 2021, marketing expense was 22% of revenue for Allbirds compared to 9% for Nike.
But I want to consider the other expense component in a balance sheet, selling and general administrative expense (SGA), or simply, overhead. This includes payroll and other corporate overhead, as well as expenses for opening and managing retail locations. For 2021, SGA was a whopping 45% of revenue for Allbirds, compared to 23% for Nike.
I’ve further broken down SGA into two categories: payroll and non-payroll, assuming that the cost per employee for Nike and Allbirds is the same, which if anything understates the cost of payroll for Allbirds relative to Nike. Allbirds’ payroll cost is estimated at 24% of revenue, compared to 12% for Nike. For 2021, Allbirds had a -12% operating margin, or the difference between their payroll as a percentage of revenue and Nike’s. Unlike marketing, where the higher cost is expected for a DTC company, the payroll cost is more concerning. A DTC company should theoretically require less overhead, so Allbirds should be able to reduce their payroll cost to be similar to Nike’s at the worst. Especially notable here is that in 2021, Nike had approximately $580,000 in annualized revenue per employee, while Allbirds had more like $290,000 in annualized revenue for each of its 700 employees.
I think that if asked about this, Allbirds would say that it expects payroll expense to decrease as a percentage of revenue over time, because as its sales increase it won’t need to continue to spend a corresponding amount on new hires. This is theoretically plausible, but it doesn’t engage with the question of why the payroll is so high right now.
DTC brands could be as effective with significantly fewer staff, particularly within marketing.
The reality of direct to consumer marketing is that it isn’t overly complicated. A simple playbook of media management, customer retention, content creation, and site management is more than enough to drive strong results when executed with intelligence. Each of these core focus areas could use a team of 2-5 people, with 5 on the upper end of what is necessary.
Crucially, running the Allbirds DTC business ($50 million+ in yearly marketing spend) is not extremely different from running DTC for a complete upstart with less than a few million in yearly spend. The types of content, site strategy, and key media channels are not materially different. Allbirds may need to expand into a wider variety of media channels, but the strategy and tactics for those channels, as well as the required competencies for someone managing them, will not differ too much from the core media channels.
With marketing being a core function of Allbirds, it’s fair to assume that 50+ people at the company are in the marketing department, far more than necessary to successfully manage a DTC business, and even before considering any 3rd party contractors or agencies Allbirds works with.
All-in-all, it’s reasonable to surmise that in 2021, Allbirds would have had a path to profitability by reducing overhead/SGA as a percentage of total revenue. If payroll costs were simply in line with Nike’s, Allbirds would have broken even, and if total overhead costs were in line with Nike’s, they would have achieved a healthy profit margin.
In 2023, markdowns have caused gross margin compression and further underperformance.
Fast forward a couple years: instead of riding a wave of pandemic-era demand, Allbirds is in a much tougher market in 2023 and its results reflect that, with the stock having fallen from the first day close of $28.64 all the way down to $1.60.
Given that Allbirds was unable to achieve profitability during a period of high growth and demand, it’s unsurprising that its results got worse in 2023, when the growth rate of consumer demand slowed considerably.
The below graph compares Allbirds cost structure in the first half of 2023, when its operating margin fell from -12% to -41%. There were a couple main reasons for the underperformance:
- Gross margin compressed from 54% in 2021 to just 43% in 2023, reflecting inventory markdowns that were endemic across the DTC industry and caused by a lower overall level of demand for consumer products. While this impacted results, it can be attributed to an unusual economy and presumably inventory planning will be on more solid footing in the future, averting the need for as many markdowns.
- Marketing spend actually fell to 18% of revenue, compared to 22% in 2021
- Meanwhile, SGA exploded from 45% of revenue to 66% of revenue
- Our estimate of payroll cost increased from 24% to 27%, and the revenue per employee fell from $290,000 to $280,000
- Non-payroll SGA increased from 21% to 39%, as a result of opening more stores and the costs associated with those.
It’s much harder to envision a path to profitability from here for Allbirds, but we can suggest a couple starting points:
- Fewer marketers: Allbirds has more than twice as many employees as Nike per dollar they earn. There’s no reason for this to be the case, and the discrepancy is a big factor holding back profitability.
- Fewer stores: though Allbirds doesn’t provide figures for revenue by channels (stores vs. online) it’s fair to assume that opening more stores helped it maintain revenue growth between 2021 and 2023 and cover over a significant decrease in online sales. However, it has clearly come at a high cost, as stores were the biggest factor in SGA rising to an untenable level in 2023, in a way that suggests the stores have been a net negative for profit in 2023. Beyond the economics of specific stores, the introduction of a non-online channel complicates the business and requires additional corporate payroll and other overhead. Lastly, there’s likely cannibalization happening between store sales and online sales that will not be fully reflected in a naive accounting of store profitability.
There is undoubtedly a profitable business buried inside Allbirds: the company owns a very strong brand. Unlike other areas of DTC, Allbirds is not commoditized: consumers are willing to pay a premium for the shoes and marketing spend is not excessive. By focusing on the core competency of selling shoes online and maintaining a strong brand, Allbirds could uncover that profitable business.
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