James McKean wants to revolutionize the manual tooth­brush. It's January 2018. The 31-year-old MBA candidate at the University of Pennsylvania's Wharton School whirls his laptop around to show me the prototype designs. Bristle, as the product might be called, has a detach­able head and a colorful pattern on the handle--like faux wood grain, flowers, or plaid. Cus­tomers would pay somewhere around $15 for their first purchase, and then get replacement heads, at $3 or $4 a pop, through a subscription service.

There are a few reasons McKean likes this plan. A Bristle subscription would be more convenient than going to CVS when you need a new toothbrush--you'd order online, set your replacement-head frequency, and forget about it. Also, Bristle brushes are friendlier looking than, say, Oral-B's spaceship-like aesthetic. "To me, brushing your teeth is such an intimate act. You engage with these products by putting them in your mouth," he says. A toothbrush, he adds, is "almost an extension of your individuality."

A former McKinsey consultant and private equity investor from Utah, McKean caught the entrepreneurial bug from watching his clients. We're sitting in a small study room at Wharton's Hunts­man Hall, named after a fellow Utahn, the late industrialist Jon M. Huntsman. When it was established in 1881, Wharton became the world's first business college. Its alumni, in addition to Huntsman, include Elon Musk, Google CEO Sundar Pichai, hedge fund billion­aire Steven Cohen, and Donald Trump.

For most of its history, Wharton's reputation has been built on turning out the world's finest spreadsheet jockeys. But, a few years ago, four students met at Wharton and started a company that would help ignite a startup revolution: Warby Parker. The concept: selling eye­glasses directly to consumers (DTC) online. Few thought the idea would work, but today Warby is valued at $1.75 billion, and its founding story has become a fairy tale at Wharton. Co-founders and co-CEOs Neil Blumenthal and Dave Gilboa give guest lectures at the business school--as does Jeff Raider, the third Warby co-founder, who went on to help hatch Harry's, a DTC razor brand.

Wharton, in turn, has become a sort of incubator of DTC companies in product categories as diverse as lingerie, sofas, and, if McKean gets his way, manual toothbrushes. Wharton is by no means the only place such companies originate, but it is the most fertile ground--a fact that's not lost on venture capitalists. "I've basically pitched a tent outside of Wharton," says Andrew Mitchell, who founded the venture capital firm Brand Foundry to invest in digital-first con­sumer businesses.

The appeal of the DTC movement goes like this: By selling directly to consumers online, you can avoid exorbitant retail markups and therefore afford to offer some combination of better design, qual­ity, service, and lower prices because you've cut out the middleman. By connect­­ing directly with consumers online, you can also better control your messages to them and, in turn, gather data about their purchase behavior, thereby enabling you to build a smarter product engine. If you do this while developing an "authentic" brand--one that stands for something more than selling stuff--you can effectively steal the future out from under giant legacy corporations. There are now an estimated 400-plus DTC startups that have collectively raised some $3 billion in venture capital since 2012.

If Wharton has become the spiritual center of the DTC startup movement, David Bell is its guru. A tall and tousle-haired Kiwi who comes off more like an edgy creative director than a professor, Bell has advised the founders of and invested in most of the DTC startups with Wharton roots. An expert in digital marketing and e-commerce, Bell first got a taste for investing when Jet.com founder Marc Lore (another Wharton alum, now at Walmart) invited him to put early money into his first startup, Diapers.com. When the Warby Parker founders were still in school and conceiving their company, the professor helped them refine its home-try-on program, arguably the key to getting people to purchase glasses online.

Bell sees an almost limitless potential for more companies to challenge the old guard by following the Warby play­book. "If you went to your kitchen, your bed­room, your bathroom, your living room, and you went through all the stuff that was in there, from your toothbrush to your sheets and towels and curtains--you name it--it could all be Warby-ed."

Not all Wharton professors have the same optimism. Kartik Hosanagar, a Wharton professor of technology and digital business, has also put his own money into several student startups, but he worries that the opportunities to build large-scale DTC brands online are limited, because what worked a few years ago may no longer be possible. "I keep complaining that I don't want to hear another pitch from a student that's like 'the Warby Parker of so-and-so,' " he says. "I think there's a reckoning coming for these people. These venture-funded companies trying to scale are going to find out there's just no way to make the numbers work."

"If you went to your kitchen, your bedroom, your bathroom, your living room, and you went through all the stuff that was in there--it could all be Warby-ed." --David Bell, Wharton professor

Over the course of several months, I met with dozens of young entrepreneurs at Wharton and beyond hawking napkins, suitcases, mattresses, and tampons. They all offered to connect me with other companies, which sell razors, bras, strollers, and much more. Two themes emerged. One, nearly every product category will see at least one DTC challenger. And two, largely because of that proliferation, it's harder than ever to build a big, profitable business with the Warby model.

Not All Product Categories Are Created Equal

Perhaps you've heard a story like this one. A guy goes to a department store looking for underwear and finds himself befuddled by the selection. What's the difference between the $30 pair and the $3 pair? Between the Dri-Stretch and the Climalite pairs? Why does he have to be standing in this store, anyway? Light bulb: The underwear business is broken.

The underwear epiphany happened to Jonathan Shokrian, founder of MeUndies, a Los Angeles-based DTC underwear company whose CEO, Bryan Lalezarian, is another Wharton alum (2012). For Jen Rubio, co-founder of the luggage maker Away, it happened when her suitcase broke on a trip and, on trying to replace it, she realized there was a gap in the market between expensive designer suitcases and low-quality cheap ones. A former Warby Parker employee, she saw an opportunity to offer a better suitcase at a better price, and sell it online. She teamed up with another Warby alum, Steph Korey, and has since raised $31 million in venture capital from the likes of Forerunner Ventures, an aggressive DTC investor.

It might be easy to discount these founding legends as trumped-up mythol­ogy, but Jesse Derris believes they repre­sent the first step in building a great new consumer brand. Derris is founder of the public relations agency Derris, which earned its DTC cachet by making Warby famous. Derris has since worked with dozens of other DTC companies to estab­lish their identities, which all share a core narrative. "I believe I'm getting ripped off by X, so I launched a brand to solve the pain point," says Derris. "I sometimes call it a Seinfeld-ism. It's there, everybody's thinking the same thing, but nobody has verbalized it."

Bell, the Wharton marketing profes­sor, has a different characterization of what DTC companies exploit: "Millennializa­tion." Twenty- and 30-something consum­ers are digital natives with lots of buying power who have no attachment to mall brands and big-box stores. Since these founders are usually Millennials them­selves, DTC companies speak the mother tongue--Instagram, experiential market­ing, brands as lifestyles. Away's suitcase, says Bell, "is a decent-enough product"--he describes it as a 7 or 8 out of 10--"but the market­ing is 10 out of 10. The way it's priced, the way it's distributed, the way it's promoted, the way it's targeted, the way it's positioned--that's really the secret sauce that makes the thing go."

Whether a DTC startup can actually deliver better value than its predecessors, says Warby's Blumenthal, depends on how broken the existing market is. In his case, he learned that the eyewear market was dominated by one giant con­­glomerate, Luxottica, which makes everything from Ray-Bans to Oakleys. "The market charges too much for glasses, and that was due to a con­solidation of power within the industry that had been built up over decades," Blumenthal says, explaining that Warby was able to come in and charge $95 for a $500 product. Harry's and Dollar Shave Club saw a similar opening in the razor industry, where Gillette commanded more than 70 percent of the market worldwide, according to Euromonitor.

But, Blumenthal adds, "there aren't many industries with those dynamics." Take homewares, for example--table­cloths, bedding, flatware. Rachel Cohen and Andres Modak, life partners and co-founders of three-year-old DTC home-goods company Snowe, landed on the idea for their company when they moved to New York City after both graduated from Wharton in 2012. They wanted simple but chic home decor at reasonable prices, but didn't want to buy the same West Elm stuff that all of their friends had.

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"Our product is a product you would get at a super high-end home store, but we sell it for a 75 percent lower price," Cohen says. That sounds compelling, but when I pull up Snowe's website, the first product I look at--neutral-colored linen napkins made from a coveted natural fiber called Belgian flax--costs $36 for a set of four. On West Elm's website on the same day, a similar-looking set of four Belgian flax linen napkins costs $18 to $24. When I point out the discrepancy, Modak explains that Snowe's napkins are higher quality. But since Snowe sells only online, it's impo­ssible for me to experience the dif­ference without ordering the product. So how do you get the message across? "It's hard," concedes Modak.

Perhaps, as one industry observer put it to me, Snowe is "a brand in search of a problem that doesn't exist." That is, the home-goods market isn't fundamentally unfair in the way that eyeglasses and razors are, making it all the more difficult for Snowe to get consumers excited about an unclear advantage. Snowe's products might indeed be world class, but they don't fit neatly into the DTC playbook.

Beware the New Middleman

Every few months, a group of startup founders and friends from the DTC and Wharton circles get together for dinner in New York City. They call themselves the Directors Council and, says Bell, who is part of the group, one of the frequent subjects is how to deal with perhaps the most vex­ing piece of the DTC playbook: finding customers.

Back when the DTC movement was in its infancy, Amy Jain co-founded her fashion jewelry and accessories company, BaubleBar. It was 2011, around the same time that Warby Parker launched, and it was cheap and easy to get attention and win fans. "Social media was just starting. There wasn't a lot of noise," she says. Plus, the basic argument that clever start­ups were cutting out the middleman was a novelty back then. Warby was able to use PR to great effect in its early days and position itself as the friendlier, hipper, and cheaper alternative to Luxottica's many fashion brands. Dollar Shave Club, which launched before Harry's, was able to go viral with a hilari­ous YouTube video that made razor subscriptions seem revolu­tionary.

Today, those same tactics are harder. For Jane Fisher and Jenna Kerner, 2017 graduates of Wharton and the founders of DTC bra company Harper Wilde, launch­ing with a Dollar Shave Club-style humor­ous video seemed to make a lot of sense. The result--"What if Boxer Shopping Were as Frustrating as Bra Shopping?"--was good enough that a New York Times writer called it "one of the funniest videos I've ever seen." But, like most attempts to go viral, it didn't. Seven months since it launched, the video has been viewed on YouTube fewer than 6,000 times.

When they work, guerrilla tactics can jump-start a company's growth, but at some point, digital-first brands have no choice but to turn to paid search and social-media advertising. The advantages of the dominant online ad plat­forms are clear: They're inexpen­sive to set up, companies can target their desired audiences, and they can get smarter as they learn about which mes­sages and tactics work. The challenge, though, is that "those channels are increas­ingly getting more saturated and more expensive," says Bell.

"The temptation is to give the very best price, but then it becomes, 'Well, shit, we can't stay in business doing this. We have to make some money.' " --Stephen Kuhl, Burrow co-founder

The options for large-scale digital marketing are slim. "It's basically Face­book, Instagram, and Google at this point," says Daniel Gulati, a partner at Comcast Ventures, which has invested in several DTC brands. "They are able to extract more and more from advertisers, because they command so much more of con­sumers' attention than they did only a few years ago." According to a study by marketing-analytics company AdStage, during the first six months of 2017 alone, the average cost per 1,000 ad impressions on Facebook increased 171 percent, and the average cost per click increased 136 percent.

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For DTC companies, the problem can be especially acute, because many product categories now have multiple upstarts armed with tens of millions of dollars of venture capital, all targeting roughly the same users and, in the process, driving one another's marketing costs up. It gets worse when the incum­bents take notice and start pouring their fortunes into the same ad buckets.

What's more, says Wharton's Hosanagar, advertising on Facebook can simply become less efficient the more you use it. He saw this firsthand when he and his wife started a company called Smarty­Pal, which sold interactive child­ren's books directly to consumers. As they tried targeting a wider set of people, they saw the cost of acquiring a single paying customer climb from $60 into the hundreds of dollars. It became unsustainable, and ultimately they had no choice but to change business models. "It's now more of a B2B company," he says.

"I think there's a reckoning coming for these people. These venture-funded companies trying to scale are going to find out there's just no way to make the numbers work." --Kartik Hosanagar, Wharton professor

Comcast's Gulati has a phrase for this phenomenon: "CAC is the new rent." In other words, for companies reliant on paid marketing, their digital customer acquisition cost (CAC) is a lot like paying for brick-and-mortar stores in the old model, or selling wholesale. Essentially, this undermines one of the most basic precepts of the DTC movement, that these companies are cutting out the middleman and therefore can afford to charge much less for higher-quality goods.

In fact, Facebook and Google are simply the new middlemen. Instead of paying rent to a landlord or letting a third-party retailer mark up the price of your product, many DTC companies have to pay the internet giants to be their storefront. Add to this the cost of things like shipping, returns, and great customer service, and the cost structure is not necessarily more efficient than it ever was. "The majority of these brands don't grow fast enough to warrant venture capital and many don't work out economically," Gulati says.

Spending Money Is Easy, Making It Is Hard

The key to making the economics of DTC companies work is balancing acquisition costs with a customer's life­time value--how much the average cus­tomer spends on the company's products over the long term. There are generally two ways DTC companies try to do this. Those that offer expensive products that customers aren't likely to purchase frequently (a $295 suitcase, a $1,000 mattress) must be profitable on the first sale, and try to keep customers coming back by rolling out accessories or new product lines. Those that sell inexpensive items (razors, toothbrushes, socks) must try to lock in customers for repeat pur­chases, which many try to do through subscriptions. The underlying challenge, says Gulati, is that both acquisition costs and a customer's lifetime value are hard to predict. "Retention at the beginning of a company's life is anyone's guess, and startups tend to be overly optimistic about repeat rates at the outset," he says.

In many cases, these companies have raised large amounts of venture capital and use it to subsidize their marketing efforts. Davis Smith (Wharton 2011), co-founder of Cotopaxi, a Salt Lake City-based DTC outdoor gear manufacturer, says heavy VC investment demands aggressive marketing to pursue fast growth. "It's like a hamster wheel, and just about everybody is on it," he admits. "There are very few who are not."

Desperation leads to throwing more money at the problem. Many DTC startups have taken to subway adver­tisements, billboards, direct mail, pod­casts, TV and radio spots--essentially all the expensive, traditional ad formats that the digital giants were supposed to replace--despite the old-school ads' inability to target consumers and track campaigns' effectiveness.

"In the beginning, I think you really underestimate how much it costs to get people to buy," says Stephen Kuhl (Wharton 2017), who founded DTC sofa startup Burrow with Kabeer Chopra (Wharton 2017). Burrow ended up having to raise its sofa price from $795 to $850, then to $950, and then to $1,095--all in a year. (The last part of the price tag increase was to improve quality and move manufac­turing to the U.S.) "The temptation is to give the very best price possible," says Kuhl, "but then it becomes, 'Well, shit, we can't stay in business doing this. We have to make some money.' "

The Future Looks Awfully Familiar

One after another, many DTC startups have come to a reali­zation: If CAC is the new rent, then why not pay actual rent? SoHo in Manhattan has become a physical manifestation of this. Within a one-mile radius, you can walk into stores belonging to a dozen DTC brands--Away luggage, Allbirds sneakers, M.Gemi shoes, Untuckit shirts, Everlane fashion, Indochino menswear, Outdoor Voices active­wear, Bonobos men's clothing, and, of course, Warby Parker.

Every one of these stores is another alternative to the Facebook and Google hamster wheel. There's a good reason that hanging out a shingle was the original customer-acquisition strategy, after all: It works.

Take, for example, Away's New York store, on a chic block near the com­pany's office. It's one of four Away stores in expensive locations around the country--NYC, Los Angeles, San Francisco, and Austin. Accented with coffee table books about exotic, Millennial-friendly desti­nations, an espresso bar, and a few suitcases displayed like sculptures on white pedestals, the store could easily be mistaken for the lobby of a mini­malist boutique hotel.

When Away first launched, the founders assumed that traditional retail would never play a part in their future. But, says Korey, the CEO, after they tested a pop-up shop, "our hypothesis turned out to be totally wrong. We had person after person coming in and being like, 'Oh, I've been on your website, but who knows what seven pounds really feels like? Oh, that is light. OK, I'll take the green set.' " Away opened a real store, tried pop-ups in other cities, and discovered that every time it opened a store in a new market, it lifted Web sales in that market. "It's almost like we're opening a profitable billboard," Korey says.

"Ninety percent of these brands are going to fail. But 90 percent of all brands fail. It's cynical to focus on it." --Jesse Derris, founder of Derris public relations

To one frequent DTC investor I spoke with, though, any young DTC company's moving into retail early in its lifecycle is a red flag that it might be overspending on online marketing. "Because if it's working online, why all the retail stores? Why not stay online and scale over time? I could see one or two stores as PR plays, but why take on all the overhead, the cost of the build-out?"

Warby Parker has famously opened locations all over the country--66 of them so far--but there's a key difference. Whereas someone might buy a new suitcase once every five years, Warby has managed to turn eye­glasses into fashion accessories that people buy over and over, to refresh their look. Not only are the stores a bill­board for the brand--to echo Korey--they also help change shopping behavior and frequency. Indeed, Warby brought in more sales from its stores last year than it did from its website.

PR maven Derris says DTC companies are realizing they "are not digital only--they're digital first." That's a major clarification: They can use the internet to get around the traditional barriers of entry, but once they've arrived, it's more like business as usual.

DTC razor brand Harry's is now selling its product through Target, the very middleman these brands claimed to be cutting out. Wholesaling means not only that Harry's gives up a large chunk of its gross margin to a big-box retailer, but also that it can't track those customers and learn from their data.

"It's just pure scale," says Wharton's Bell. "There are only so many people you can reach online, but there's a massive segment of people who are still shopping offline, and you want to be able to address that market. Target is the way to do it." In February, Harry's raised an addi­tional $112 million in venture capital to pursue a sort of new-age Procter & Gamble strategy. It recently invested in DTC hair-loss-prevention company Hims, and Harry's co-founder Raider personally invested in DTC tampon startup Lola--both of whose products you can imagine appearing on Target shelves. (Other DTC brands selling in Target include African American personal-care brand Bevel and mattress company Casper, which reportedly received $75 million in funding from the big-box retailer.)

BaubleBar is going even further. Early on, CEO Jain knew she and her co-founder, Daniella Yacobovsky, had identified a promising category for DTC. Fashion jewelry--like $35 tassel earrings and $45 resin necklaces--is a high-turnover, trend-based product with massive 90 percent margins that retailers are always hungry to sell more of. (Costume jewelry is the fashion equivalent of the gum you purchase impulsively while waiting in line at a 7-Eleven.) Why limit BaubleBar's potential customer base to those who sought out its new brand, when there was a much bigger play--supply fashion jewelry to anyone who wanted to sell it?

So the company has spent the past seven years doing just that--selling DTC through its website and then making private-label and white-label products for other designers and retailers like Target. After taking little VC funding, says Jain, the now-profitable New York City company earns 50 percent of its revenue from those other retail channels. "We don't look at our industry and say, 'We're disrupting a Luxottica.' We are building one because it doesn't exist," says Yacobovsky.

Of course, only a few companies will ever have a chance at the kind of land grab that Harry's and BaubleBar are making. "Ninety percent of these brands are going to fail," says Derris. "But 90 percent of all brands fail. That's what's meant to happen, and it's cynical to focus on it."

The Shakeout

Even as Kirsten Green of Forerunner Ventures continues to fund more DTC startups, she admits that "there are a lot of com­panies, so many com­panies, that are venture backed that shouldn't be." In many instances, she says, founders might be better off by taking less ven­ture money, building their companies more conserva­tively, and ending up owning larger stakes of $50 million or $75 million businesses, than by risking every­thing to build an unlikely $1 billion company.

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MeUndies, for example, has raised about $10 million since it launched in 2011. It became profitable early on and it still is, on sales north of $50 million. "I have friends who start DTC companies," says CEO Lalezarian, "and I often try to talk them out of raising VC for the sake of growth at all costs. You need it to get the business off the ground, but in that phase between launch and profit­ability, it can put you on an unsus­tainable track."

Many startups are already on this unsustainable track, and if Derris is right, what will become of the 90 percent that don't become the next Warby? Some will fold, as the Burrow sofa competitor Greycork did in 2017. Some will merge, especially in crowded categories like mattresses. While Dollar Shave Club sold itself for $1 billion to Unilever, many more will likely follow the path of DTC menswear company Bonobos, which last year sold to Walmart for $310 million--not exactly the dream when you consider it raised more than $127 million in venture capital.

Rather than prompting a retail revolution, perhaps this new gen­er­ation of DTC companies will become something like an innovation pipeline for the old guard they are angling to disrupt. "For legacy companies, it's a cheap way to get a new customer base, marketing insights, e-commerce expertise," posits one DTC founder. "When I think about it from a VC's view, it's a smart strategy. It's almost like a risk-free bet: Here's $1 million, and I know at minimum I'll make $5 million." Says another founder: "We all have to screw up a lot to not have at least a positive outcome."

After nearly a decade helping these startups craft their brand messages, Derris now wants in on that math. The newest arm of his PR business? A venture capital fund that, in part, invests in DTC startups. Similarly, Wharton's Bell has moved to New York to launch Idea Farm, a company that builds and invests in DTC brands, advised by major players in the DTC scene, which include the Warby co-founders.