Our goal with Klar is to support brands of all sizes in growing their revenue and profits. We do that by providing them with a BI infrastructure that allows them to understand the underlying drivers of their growth and uncover insights that are hidden in their data.

To do this effectively, we spent quite some time thinking about what makes DTC brands grow. As you know, there are different factors that contribute to growth. We forced ourselves to simplify it to its essence and came up with what we call the DTC Growth Formula.

A simple, elegant equation that captures the core components of what makes DTC companies grow. This formula is also the foundation that we now use to build the reports that you get access to in Klar.

DTC Growth Formula

Before we go into the details, here is the formula and a quick explanation of its different components:

Capital x CCC (Cash Conversion Cycle)

This essentially tells you how much cash you have available and how efficiently you use it.

CPV (Cost per Visit) / CVR (Conversion Rate)

How much it costs you to acquire a customer.

There are many different ways of expressing this. We like this one most because it highlights the adverse relationship between cost of traffic and conversion rate.

CLV (Customer Lifetime Value)

How much profit I generate per customer.

Since most marketing in DTC is done to acquire a customer, this should be based on Contribution Margin 2 (CM2). So your Net Revenue minus your COGS, Logistic and Transactions Costs.

CAC (Customer Acquisition Costs)

Average cost to acquire a new customer. Since CLV is CM2 based (so before marketing) deducting the CAC from the CLV, gives you the profit per customer.

So the first part tells you how many customers you can acquire and the second part what your profit per customer is.

Differentiation

We still felt like this was somewhat incomplete and there is one ingredient missing that differentiates the pace at which a DTC brand can scale. We believe this is differentiation.

And here we get into mathematically questionable territory, but placing it as an exponent describes the effect extremely well. Small improvements in differentiation can have a massive effect on the outcome.

Seems simple enough right? Well, it is. But there is more to most of them, then might be immediately obvious. So now we start getting into the details on each of them.

Capital & Cash Conversion Cycle

DTC are capital intensive, which is why one of the variables in the formula is how much capital you have available.

Even if the profit you can make is twice the price you paid to produce the product you can only grow so much.

When you start off with €10.000 you can only make €20.000 in profits. But if you have €1.000.000 you can make €2.000.000.

However, the amount of capital you have available is only one side of the equation. The other one is how quickly you can get the returns on that capital.

That's where the Cash Conversion Cycle (CCC) comes in. The CCC tells you how many times per year you can reinvest that money based on how long it takes you to monetize the inventory that you bought.

So staying with the example from before, if you have 1.000.000 and your CCC is 2, you can generate another 4.000.000 with that - 2x profit twice a year. This excludes compounding through reinvestment of your profit to keep it simple for now.

Traditionally, the CCC is calculated like this:

365/ (Days Sales of Inventory + Average Days Receivable - Average Days Payable)

So how many days you need to sell through your inventory, plus how long it takes you to get money from your customers, minus the time you have to pay your suppliers.

An extreme example of this would be Amazon, who is notorious for having a negative CCC, meaning they sell their inventory to their customers before they have to pay their supplier. If they can keep this up, they in theory could generate unlimited free cash flow.

A more realistic example would be that it takes you 120 days to sell through your inventory, have 20 days to pay your suppliers but get your money immediately from customers (which is typical for DTC brands). In this case your CCC would be

365 / (120+0-20) = (365/100) = 3.65

This means you can get a return on your capital 3.65 times per year. This value is often overlooked but of critical importance. If it's too low, you tie up your limited capital in your inventory without getting a return on it. If it is too low however, you might run out of stock should your sales spike. I would say that for most businesses 3-4 is a good benchmark (there are obviously many reasons why a lower or higher number might be better in certain situations).

Now, so far this hopefully shouldn't be completely new as a concept. However, for most DTC businesses, especially for retention-focused businesses, this formula is incomplete. It is missing a critical component we dubbed Customer Lifetime Value's (CLV) nasty little brother.

Because these retention-focused brands often don't buy their inventory upfront, but also their customers. That means they spend more on marketing than the profit they can generate from the first order.

These brands try to monetize their customers over a longer period of time to turn a profit while mostly just investing in marketing to acquire them initially. That makes acquiring a customer an investment that brings a return after some time. Just like inventory.

And here, we get back the CLV's little nasty brother - the Payback Period.

The payback period describes how many days after you acquired a customer you need for your CLV (Cumulative CM2 - more on this later) to get larger than your Customer Acquisition Costs (CAC).

Like I mentioned, for many high-retention DTC plays, this is not the first order. And only when this break-even point is reached you are turning a profit on your investment.

It can very well be that your CLV is bigger than your CAC but because your payback period is too high, you run out of cash before you can reach this point.

So for the CCC formula to be correct for DTC brands, it NEEDS to include the payback period.

Thus, the updated CCC formula for DTC brands includes both the traditional CCC but also the payback period and weighs them based on the percentage of your investment. This is important as oftentimes you will spend more on marketing than you will on inventory.

Building on the previous example, let's say you invest 30% of your budget in inventory and 70% in marketing and your payback period is 75 days.

In that case your updated CCC would be:

365 / ((120+0-20)*0.3)+(75*0.7)) = (365/(30+52.5) = 365/82.5 = 4.25

Now you might think: Great, that’s a lower number. But that would be wrong as previously we only applied it to your inventory investment but now we are also applying it to your marketing investment.

You could complicate this further by factoring in how long it takes for your customer to convert after your marketing investment and add that to the payback period but this is a) difficult to accurately measured and b) for most DTC brands not the most critical factor.

Cost per Visitor & Conversion Rate

Now with the updated CCC in place, what do we want to do with this capital? Well, mostly acquire customers.

How do we do that? Simple. Get people to our website and convert them. That’s what this part of the equation expresses.

How much it costs us to get someone to visit our website and what percentage of these I can convert.

So if it takes me €0,75 on average to generate a visit (from people that are not customers yet) and 3% these visitors buy from me, it costs me €25 to acquire a new customer

Well, maybe this is simple in theory, but we all know that reality can be a lot more complicated. The main reason is that there are a lot at variables at play in this equation

That’s also the reason why this area is so prone to people looking for "hacks". They hope that they can game the system and skip the hard work. You can’t.

For Cost per Visit the most important factors are:

• Channel Mix - what channels are your visitors coming from. Different channels have different prices.
• Targeting - who are you targeting. Different audiences have different costs and likelihood to convert (see below).
• Creative - how good is your ad in getting your potential customers' attention in your product.
• Messaging - how well can you communicate your benefits so that they get interested and click.

For Conversion Rate the most important factors are:

• Quality of Traffic - traffic can be cheap, but often comes at a lower quality (likelihood to buy for reasons mentioned above like targeting)
• Messaging/Audience Fit - building on the above, does your site and product actually deliver on what was promised in the ad and communicated in a way that is meaningful to your visitors.
• User Experience - is the site guiding the visitors to purchase and answering all their questions along the way.
• Page Speed - we all hate browsing a slow site. The slower your site, the more people will stop buying even if they are interested.

Most of the hacks you see online are in the creative and UX section and while they are important they are just two out of eight possible options.  

But there is one thing that has a bigger impact on both, the CPV and CVR, than any other variable. Yet, you hardly ever see anybody talking about it.

The Offer.

So the product that you are selling. Most DTC stores just come up with an offer once and then just run with it.

But there are many things that you can, should or even must test.

1. The product/bundle you are offering
2. The price of the offer
3. The positioning of the offer
4. The distribution channel of the offer
5. The buying journey after the offer is purchased

And we understand why there is less talk about this. It's much harder.

You might have to develop new products, align with your operations team, and come up with new material.

It takes a lot of work. But that's where the results are hidden, even if you have already a great working offer.

You can also have multiple offers running simultaneously to different types of customers. There is a ton of flexibility. The only prerequisite is that you end with a CLV/CAC ratio that supports long-term growth.

What does that mean? We’ll explain that now.

Customer Lifetime Value & Customer Acquisition Costs

We already mentioned the Customer Lifetime Value (CLV) and Customer Acquisition Costs (CAC), so let’s talk about them in some more detail.

Let’s start with the CAC. Like the name suggests it tells you how much you spend on marketing to acquire a customer. Therefore its formula is:

CAC = Marketing Costs / Number of New Customers

Most DTC brands spend more than 90% of their marketing budget on acquiring new customers and aim for them to return organically or with limited marketing investment. If that is the case for you, you can simply use your entire marketing costs for this calculation.

Note: If you invest marketing in branding focused campaigns, you can make the argument to not include these costs when calculating your CAC. However, I would only do that if you are larger and in a solid financial situation as otherwise it skews the healthiness of your brand.

The other question is what makes a new customer a new customer. At a later stage you might want to define someone that hasn’t bought from you in 2+ years but then buys again as a new customer but to start off I would just keep it simple and just count a customer once.

So now that we know how much it costs us to acquire a new customer, we must know how much profit we generate with each customer.

That’s the customer lifetime value.

Don’t mistake value with revenue. If someone shows you a CLV that is based on revenue, you should run. DTC businesses have real costs for every order placed and therefore the CLV needs to be based on the Cumulative Contribution Margin 2 (CM2)

CM2 = Net Revenue (after discounts, returns and taxes) - Cost of Goods Sold - Logistic Costs - Transactions Costs

So excl. all Variable Costs apart from Marketing.

To turn CM2 into CLV you need to cumulate it across orders. So let’s say you acquire 1000 customers who have an average CM2 in their first order of €20. Now let’s say 300 of these customers come back over the next months and years and place on average 4 more orders with a CM2 of €25 per order. Your CLV then would be

CLV = ((1.000*20)+(300*4*25))/1.000 = (20.000 + 30.000)/1.000 = 50

If your CAC is €30 it means that you effectively generate €20 in profits per customer that can go towards covering your fixed costs and generating a profit.

A big problem for many young DTC companies is that they don’t really know what their CLV is. It develops constantly as loyal customers, depending on your product, tend to buy over many months and years and thereby increase the CLV.

Our tool Klar helps you to understand how your CLV is developing over time so that you can make a better forecast. But, in our opinion it is less important to understand early on what your exact CLV is but more important what your payback period is (see above).

The quicker to break even, the better.

Once you are more established, understanding your exact CLV becomes more important as it will tell you how much you can invest in a new customer, meaning what your CAC target should be.

Depending on your maturity stage, CLV should be 2-3x your CAC.

The first step for you is to understand what your current CLV and CAC is. But you also need to be aware that with a surge in new DTC brands starting, legacy brands entering the market, and increased data privacy likely reducing efficiency of algorithm-based marketing, CACs are going to rise.

Putting the equilibrium you might have at the moment in danger. And potentially many DTC brands out of business. There is nothing really you can do to change these underlying trends, so how can you preserve your CLV to CAC ratio?

We see two main drivers:

1. Strong differentiation - more on that below
2. Understanding your customer by shifting reliance on third-party data (eg. the Facebook algorithm) to first/zero party data - eg. what customers do/tell you. We build Klar to support you in that.

Both these things are core to move from a transactional- to a relationship-based approach. Which will boost CLV and thereby allow you to stay in balance even if CACs continue to rise due to the mentioned trends.

Differentiation

What do you think when you look at these websites below?

They all look pretty cool, right. But also kind of the same. Many DTC brands have been built on the same brand formula:

• Exclusive, yet affordable
• Instagram Aesthetic
• Save the planet

Now, that might have been new 10 years ago. But it isn’t today. Every category has at least five DTC companies competing in it with a very similar product. Not even mentioning legacy brands.

So if that is your only branding strategy, you are ten years late. You need more.

You need to be differentiated in the eyes of the customers.

Differentiation is similar to brand, but not exactly the same. There is more than one way to achieve differentiation and strong differentiation is a much more resilient competitive advantage.

Looking at the DTC formula, differentiation is an exponent. And like I said it is mathematically questionable but it describes its effect extremely well.

If your differentiation is average, your factor will be 1. Which would mean it has zero impact and everything will stay the same.

But the more differentiated you are the quicker you grow, exponentially.

10^1.1 = 12.6

10^1.2 =15.8

I only increased differentiation from 1.1 to 1.2 which is equivalent to a 9% increase. Yet the outcome increased by 25%.

That means, the more differentiated you are the easier it will be to grow. And in reverse, the less differentiated you are, the harder it will be. It’s still possible. Just a lot harder.

What will strong differentiation look like in reality?

• CLV will increase because people feel good when using your product
• CACs go down because people tell their friends about you
• CACs will stay consistent even when you scale up spend drastically
• Retailers are more likely to list your product at better terms
• And much more…

These things are not always easy to tie back to your differentiation, so you need some trust in its effects.

So the big question now is how do I become differentiated? There are many different ways but for DTC brands three are obvious candidate:

Unique Narrative

This is probably very close to what most would consider brand. Since we always felt like brand was a quite abstract term, we call it narrative. The story that you tell. You can argue that many of the early DTC brands focused on building a brand, but most of them are not really telling a unique story.

Narratives need to be unique to really differentiate. One example might be highlighting and/or raising awareness for previously taboo issues like The Female Company, which focuses on female health and ties it into the entire customer experience.

For a narrative to be strong and truly differentiating you must stay consistent, especially when your positioning hurts your bottom line. While it might not be considered as a DTC brand by all, Patagonia is a great example of this with its “Don’t buy this jacket” ad during Black Friday and it’s Recrafted platform, where people can buy used Patagonia products.

Both of these actively reduce the amount of product they will sell. But they strengthen their positioning and make it believable. Strong narratives are all about sacrifice. So if you come across them, lean in. You are on the right track.

Another example of narratives that can be powerful is going extremely niche in your communication. Liquid Death core brand topic is sustainability which is extremely widespread and therefore not differentiating. But, the way they communicate is extremely specific and certainly not for everyone.

Again, they are sacrificing. By doing something that 9 out of 10 people will not find appealing, but the 1 person loves. We believe that many, especially smaller, but highly successful brands, will be built in niches (and subcultures) in the future.

Which brings us neatly to the next option.

Owned Audiences

Differentiation helps you to create preference for a product that by itself is not differentiated. A narrative is one way of doing that by creating likability around a brand.

The other way around would be using the existing likability of a person or entity and then creating a product on top of that. That’s what owned audiences are.

That’s what we see happening a ton right now with influencers starting their own brands. They leverage their existing audiences and monetize them through a product. As long as your product is not much worse than competing products and you have a strong bond with your audience, you can find success here.

The downside of this approach is that the size of the business is limited to the size of the existing audience. So unless you are or have a massive audience, brands that are starting out this way need to start adding an additional means of differentiation soon if they want to to keep growing by staying differentiated in the eye of a larger audience.

Intellectual Property

The most powerful way of differentiation is through product. If your product is truly different and/or better than what your competitors have.

Unfortunately, this one is also the hardest to accomplish and defend. You need to have significant global patents on your product (aka Intellectual Property). Otherwise, someone will come in and simply copy what you are doing as soon as you are seeing some success.

A great example of this would be Air Up whose drinking bottles use scent to flavour. They have patented this approach and to date I am not aware of similar products in the market which makes theirs differentiated.

A word of caution. Don’t try to do all of them at once. Strong differentiation, like most things, requires focus. If you are strong in one of them, you will likely be more differentiated than your competitors already as most brands by the very definition are not really differentiated.

You can always add a second layer of differentiation later, but start with one and focus intensely on it.

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Where to start?

Ok, that was quite a lot to take in. We hope it gives you a good mental model of the different components that make your DTC brand grow and how these components work together.

And while it is important to understand this formula, its components and their interaction, optimizing them is not the first thing that you should be doing. But the last thing.

There are other things that you need to accomplish first before you start to optimize your DTC Growth Formula. Let’s look at them together.

Understand your customers

That is the foundation to every successful business. Which is also why solving a problem you have yourself makes things a lot easier. You can relate much more.

But don't make the mistake that you represent all customers. The best brands continuously speak to their customers on a weekly basis to understand them deeply so that they can articulate their needs better than they can themselves.

Aaron is setting an example for everyone 👇

Define your Differentiation

We just spoke about this. The more differentiated you are in the eyes of your audience, the easier it will be for you to grow. So before pressing down on the growth pedal, work on your differentiation. Small improvements here lead to exponential returns.

Obviously this is an ongoing process and you can’t be fully differentiated from the start. But you should have a very clear idea of what you are going for and what sacrifices you are willing to make for that.

The earlier you have clarity on this the better.

Product Market Fit & Offer Market Fit

When you understand your customers, you can develop a product and/or brand that they will love. That's Product Market Fit.

Very likely it will not be on the first try, so keep gathering feedback and improving the product.

How will you know if you have product market fit? For retention-focused DTC brands, I believe you can measure it. Look at how much your CLV is increasing from the first order within the first 90 days of a customer.

You should be aiming for at least 30%. If you are still very small and acquiring customers through non-scalable means, you should probably be aiming for closer to 50% as that number will shrink as you scale.

Note: Klar, our reporting tool for DTC brands, provides you with this number.

However, there is also a second aspect that is often overlooked. Product Market Fit only tells you if customers like your product.

But for them to love it they obviously need to buy it first. That’s where Offer Market Fit comes in. It doesn‘t matter if your product has a market fit if the offer you build around it is not attractive enough.

Those are two separate things and need to be treated as such.

Offer Market FIt depends obviously on the product you are selling, but also the way it’s bundled, the price as well as the communication.

Many brands make the mistake and go broad immediately. They hit on everything. Trying to make the product relevant for everyone.

That's just not possible.

It's better for a 1000 people to love your value proposition than a million people kinda like it. The former will always buy, the later will not.

So to get to Offer/Market Fit, go niche.

And make it 100% specific to a narrow target audience. Frame the product in a way they can relate to. Answer specific questions only they will have.

If you have conquered one niche, you can always start targeting an additional niche later.

Optimize your DTC growth formula

Ah, we have arrived. Once you went through the previous 3 steps it is time to make the DTC growth formula core of your business and start optimizing KPIs that have the largest impact on growth.

But remember, this is not a final destination.

You always need to stay in touch with your customer.

You need to constantly improve your product and reevaluate your offer. Especially when you target a new audience or create a new product.

But also if you are not.

So yeah, don't be that overambitious type that skips or neglects the first 3 steps. It's the best time investment you can make.

When you have reached this stage, you need a solid reporting base to measure your efforts and learn from them. Klar is the perfect tool for that. If you are interested in learning more, we’d be happy to give a demo and show you how Klar can help you grow your business. Simply click here and sign up.

Talk soon 🙏