In recent years many brands and retailers believed it was “ecommerce or bust!”. When the pandemic forced stores to close, most saw this as proof of concept that online was now defining retail. Financial reports and earnings calls quoted senior leadership saying that they were pivoting to a ‘digital first’ strategy. Other brands have opted for a ‘digital only' model, closing all of their stores, opting out of wholesale and relying solely on their online stores.Today the buzzword for a growing number of brands is DTC (direct to consumer). The sector was launched by brands that only sold online (digital native brands), unlike the traditional model where brands would either have their own stores or do wholesale - or both. High profile digital native brands including sports brands Vuori and GymShark, online eyeglass brand Warby Parker, Allbirds, Zappos and others were showing phenomenal sales growth - and Wall Street was rewarding them with staggering valuations. Established brands that typically relied on a multichannel approach that included both own stores as well as wholesale - across online and offline - are now pulling back from wholesale to focus on DTC.It seems that wholesale is now seen as old school and out of fashion.Brands moving away from wholesale cite two driving forces: better margins and having more control over their brand image.For the right brands and the right market conditions, that can certainly be achieved. But DTC comes with its own set of challenges that many brands overlook until its too late. Trading Sales for ProfitsSome would argue that by going direct to consumers brands can push success levers harder when times are good, and are better able to pivot when times are not as good.While that is true for certain brands, for most brands the reality is that DTC provides better margins, but fewer unit sales.A recent analysis by BMO Capital Management revealed that in general as companies increased DTC penetration, sales growth slowed. However, while sales grew more slowly brands were able to capture a greater portion of the selling price per item.The study tracked the five year performance of Vera Bradley, Tempur Sealy, Ralph Lauren, Nike, Skechers, Columbia Sportswear, Canada Goose, Carter’s, Under Armor, Puma, Urban Outfitters, Deckers Outdoor, Tapestry, Canada Goose, and Levi’s as well as several third-party retailers.“Although revenue per item grows at DTC, the units lost by abandoning wholesale generally overwhelm the unit price lifts at DTC. Said another way, revenue per unit may grow, but total company revenue does not,” according to the study, which aimed to examine the widespread belief that DTC is more profitable than wholesale for brands. Whether that is a better or worse outcome depends upon the end goal.For some brands, there is a solid business case for fewer unit sales but at higher margins. It can mean being able to create more exclusivity and pull consumers into your brand's ecosystem. It can be an opportunity to create more meaningful conversations with consumers and capture data that might not be accessible through wholesale channels.In other instances, it is about focusing on your ‘true fans’ - those customers who are willing to pay full price or a premium for your products - and then going deep on developing products that really resonate with this narrower audience. This is something that becomes less feasible when brands are prioritizing growing unit sales. To grow sales volumes usually means expanding assortments and modifying products to appeal to a wider customer base. But that also usually means more competition on price. Profit PressureMost brands pursue DTC models with the intent of boosting margins. However, BMO's study showed that almost every company that reports (or has previously reported) EBIT margins by channel showed meaningfully higher EBIT rates at wholesale versus DTC.Most companies ignore the costs to run DTC operations, which in most cases, offset the gross margin gains, according to BMO.The study found that only four of the seven companies reporting DTC penetration growth saw gross margin expansion over the last five years. Michael Kors and Nike, two companies that have accelerated DTC growth, saw gross margins erode while several firms with a slower shift to or reduced DTC penetration showed strong improvements, including Ralph Lauren, Skechers and PVH.Despite the overall finding that DTC gross margins average 2,350 basis points above wholesale, many DTC-only businesses had merchandise margins well below companies that derive as much as 50 percent of their revenues through the much-lower gross margin wholesale segment. For example, American Eagle and Gap’s merchandise margins were below Ralph Lauren and PVH that rely heavily on wholesale selling, according to the study. What’s Killing DTC MarginsEcommerce comes with its own set of costs including fulfillment, logistics, greater advertising costs, MarTech investment, and a higher level of returns. These expenses can quickly offset any benefits from not having to operate physical stores. For digital native as well as multi-channel brands, digital marketing costs - typically associated with customer acquisition (CAC) - have jumped over 60% over the last five years and are the number one cost that is killing margins. In Warby Parker’s IPO filing it said that customer acquisition costs increased 49% in 2020 to reach $40 per customer up from $27 per customer in 2019 as a result of a “deliberate investment in media spend.”A brand like Nike can drive up margins by focusing on DTC because of the high demand for its products, driven by the promotional activities it's already doing. It is one of few brands that has ‘cult brand’ status - where customers specifically seek out Nike products. It has its own fleet of stores and so pulling out of retailers that don’t align with Nike’s brand image could be a profitable move.The cost of customer acquisition online has become so expensive that by comparison operating a physical store is a bargain. Not surprising that after years of eschewing physical retail in favor of online, even digital native brands are now moving into malls, department stores and high streets where customer acquisition costs are more affordable. Today it is much easier for a brand to be discovered in a mall or department store than in the very crowded and noisy world of online marketing.“It’s really hard to acquire customers online,” said Sucharita Kodali, a retail analyst at Forrester. “The way you get in front of people is through traditional tactics like being in places where people gather.”Now that pandemic restrictions have been lifted in most countries, people will be spending a lot more time in ‘real life’ settings - including malls, entertainment venues and on high streets. Wholesale is Here to StaySo should most brands be moving to a DTC model? Probably not. For brands that are already multi-channel and have their own online and offline stores, it's a matter of losing the added sales volume that comes from a solid wholesale operation. Brands that pull out of wholesale, without having their own stores, “open themselves up to greater competition from other online brands without having the distribution opportunities through retail,” according to Andrew Blatherwich, chairman emeritus, Relex Solutions.But even brands with a strong offline presence might want to think twice before throwing away the additional sales and exposure they get from wholesale. Especially with the current supply chain snafus and frontline worker shortages, there’s further reason not to ditch established retail channels. Most analysts agree that few brands actually do better with an exclusive DTC model. Even Apple sells its phones through wholesale outlets (electronics stores, Amazon).