Margins Are Shrinking, Debt Is Rising – What’s Next for Ecom?

[00:00:00] Taylor Holiday: Welcome back to another episode of The Ecommerce Playbook Podcast, the doomsday episode, just kidding. Uh, A belief that we're in that much trouble, but I am here to chat a little bit of the ruckus that I may have caused on Twitter this week. As it relates to that, I took some flack for being a little bit of a doomsdayer. So what I want to do is I just want to level-set reality.

 I just want to bring in some folks smarter than me to talk about what we're seeing in the e commerce world. So I brought two of my friends that I'm often DMing with about what they're seeing, because I trust their view. As much as anybody. So today I have Lio and Drew with me.

I'm gonna let them introduce themselves and we're going to talk a little bit about the data that we're looking at, what we see across e commerce. So Lio, why don't you kick us off? Who are you? And what do you do?

[00:00:43] Lio: Hey happy to be here. My name is Lio CEO and founder at Finaloop. We are an ecommerce focused accounting service. Yeah, helping many different brands get their books done in real time.

[00:00:56] Taylor Holiday: Great. And a guy who might even be edgier than me on Twitter sometimes in terms of how he comes off. Drew who are you and where are you up to?

[00:01:04] Drew Fallon: Uh, thanks for having me, Taylor. I'm Drew Fallon, Co-Founder and CEO of Iris Finance. So, we play like a similar role of final loop, except we're a little bit more focused on sort of the forward looking side of things. So doing your financial modeling, cashflow modeling, forecasting as well as providing some, some real time KPI analytics as well.

So, working with all, you know, all sizes, all shapes of, of brands on that front.

[00:01:26] Taylor Holiday: So the reason I like to talk to these two dudes. A ton is because I think they have like the actual source of truth I care about, which is like the financial realities of the businesses that we're serving. The marketing metrics are great and all the attribution folks are awesome and they've got lots of cool data and stuff like that.

But when it really comes down to it, the question that we have to answer is, are people making money? Are these businesses growing? And I got invited to go do. A talk out in Wyoming for a company called stored and I wanted to put together some of this visibility. So I hit up both these guys finally, it's been a long time partners of ours at CTC.

I'm a big fan of everything they're doing and we try and stay in touch as much as we can. And so I said, Hey, they'll, will you guys pull, like, give me some views of 2024 for eight figure stores. Like just some benchmark financial results. Just give me some median outcomes across a few different metrics. And that was the foundation of what really started this set. Was that that information I hit drew up with a similar question and he gave me a slightly different insight related to what was happening maybe on the balance sheet and what was some of the liability issues that we saw. And so that's, that's what we're going to use to frame this conversation today.

We're going to talk a little about what we see, what we think it means, and then what you can do about it and what might be true of the brands that a lot better than the median, but Lio, maybe. Can you tell us a little bit about what the data was that you pulled and how maybe you interpret it when you saw it relative to your expectation.

[00:02:45] Lio: Yeah, for sure. So we basically pulled a sample of 500 eight figure brands selling fully active in 2024. Just pulled the main, I'd say the main margin metrics you know, net sales gross margin, contribution margin and EBITDA. The results that we saw and, and, and basically the way we the way we pull the data, we basically clean the outliers.

So either, you know, financials that are not fully set up or you know, brands that are completely off chart. And then we focus on the 92%, which is you know, usually the outliers is around 8%. So the results that we saw for 2024. Is that the median across these brands in terms of net sales, which is the growth sales minus the refunds, discounts.

Is is is around the 85% which is kind of expected. I think it's very similar to what we saw in 2023 the gross margin which is basically the net sales minus the cogs which is the product cogs. The merchant fees shipping out and, and, and freight. The margin was, was 55%.

Contribution margin was uh, 28%. Which is. Also kind of expected when you see it on 2024 standalone, and then EBITDA is 8%. We're going to talk later about what it means also you know, when you take financing expenses. When borrowing that and how it impacts growth, but in general, I think the numbers on a standalone basis you know, doesn't surprise us, but I think when comparing these numbers to 2023 we see a trend which is not very optimistic if you see year over year.

Because what we see your year over year when comparing to 20 to 2023 is that actually you know, the net sales and the sales and the revenue. Grew nicely in 15% which is obviously a good thing. But the gross margin increased only in 3%. So you have 15% up net sales only 3% up in the gross margin.

But then contribution margin across these brands is down 5% compared to 2023. It means that people sell more however, the supply chain costs and the costs of selling their products increase. The cost of running ads increase, and then the contribution margin goes down. Obviously this impact significantly EBITDA and and and then net profit, if you take the financing and and, and borrowing costs.

So overall you know, we see a gradual decline from 2022 to 2023, and then to 2024. Optimistic side people sell more but the margins, the other margins are not corresponding with the with the increase in sales. I, I, I would say that within this sample, we excluded brands selling 50 million and more because these brands really, really, really succeeded in 2024.

And they would take the number completely off chart. So the outliers that I discussed earlier, many of them are big brands. And I think it's it's a trend that everybody, everybody sees. And we and, and, and we also discussed that really big brands are doing great. There are growing sales, but also the other margin and metrics.

Whereas the medium sized brands and the smaller brands are, are, are suffering. And this is you know, a trend that we, that, that, that we see across brands under 50 million a year.

[00:06:39] Taylor Holiday: Thank you. So there's a couple of things that I just want to point out because I think I misinterpreted a couple of things. 1 is I took gross margin as product margin. And so my calculations relative to inventory carrying costs, gross margins, 1 of those terms that I think gets used in both ways, right?

Where sometimes people are including all variable expenses. Sometimes they're not. So, in this case, to be clear, your gross margin included variable costs associated with merchant processing fees. Shipping and fulfillment. Would you say that all three of those were included in that gross margin calculation?

[00:07:06] Lio: Yes. Yes. So, so yeah, but, but, but I would say that the 11 percent that you mentioned in the thread is probably you know, it's, it's 9%, but it doesn't change any of the any of the analysis. 

[00:07:18] Taylor Holiday: End of the year with the Chinese New Year looming. A lot of brands are making that moment where that PO is the largest one of the whole year. So you're right. At 9 11, it's all in this range. The whole point was to be directional about the problem more than So thanks for all the Twitter, Twitter thumbs that called me out on the miscalculation. Fair enough. Fair enough. But it's all, all still similar. So Drew, I want to come to you now. So thanks Lio for laying that out. That's super and there was another thing that you called out that you had found that sort of contributed to my concern as I was thinking through this.

Will you share a little bit about what you saw when you look back through sort of some of the financial data?

[00:07:54] Drew Fallon: Yeah. So, was interesting to hear Lio his data. Cause our data overall corroborates basically that exact same story. Um, and so nothing really to add there, but to Taylor's point, sort of like what, what I maybe double clicked into was kind of like the balance sheet. Cause, um, while I was poking around here, I had sort of, you know, my team aggregate anonymized, like it's all, you know, pretty high level stuff.

So, the one thing that kind of jumped off the page to me was just like the overall leverage profile of the universe. And so. Our our subset was about 45 brands in the eight figure range. We did not exclude anybody over 50 million. So a bit smaller than, than, than Lio's sample size as expected.

But the average year over year increase in in leverage was like in excess of 50% which on the surface I was like, highly concerned about, I was like, holy crap, like this is bad, bad, bad. Just like anecdotally you know, obviously like rates are a lot higher and capital is, is, is harder to come by.

So like, not only is, is that like leverage profile rising, you know, pretty quickly, but it's probably worse debt than it was from like a borrower perspective a couple of years ago. So you kind of have these, these two, you know, compounding factors of. The only thing that I would also want to add, because I think it's kind of important and it kind of plays into what Lio said around, you know, the big brands are doing really well. If you look at overall, just like overall, like net leverage, like, if we're going to take, like, sort of the total liabilities and then also factor in like the trailing 12 months of EBITDA growth the sort of net leverage profile is rising a bit slower than 54%. It's about half actually. So 25 ish percent. Um which I think gave me like, a little bit more you know, like relief but it's still, it's still meaningful sort of, you know, liability growth. So, I think it is, you know, I'll kind of double down on on the, the tale of 2 cities where it's like, you know, the big guys are doing really well. And as they continue to grow, you would expect leverage to increase, but at the same time, like, there's there's smaller companies that are also taking on more leverage that.

Yeah. You know, we'll, we'll see how it, how it plays out. But if those earnings grow, earnings growth doesn't kind of stay commensurate with the, with the leverage profile growth, then, uh you're going to see those lenders at some point and come for their money and it's going to be pretty ugly.

[00:10:01] Taylor Holiday: thanks guys. That was super helpful. So there's so much here that I think it is important to brought to acknowledge a few things. One is that what is generally true is never specifically true for everyone. So there, let's just start with that. Like, there are lots of people winning. There are lots of people in different situations.

What we're trying to understand is some of the underlying realities of the aggregate view. So let's just, let's just start there because I think it's important to, to take what we say and then put Really overlay your individual experience and really obviously act from that first. What concerns me when I think about this is that I actually think that like a margin profile at the end of the day of 8% EBITDA is like not a terrible outcome. It's like, actually like you've made money that that is actually not terrible. if that outcome. Can't produce positive cash growth. That is where I sort of look at this and go, man, if, if, if you work so hard to actually win the game, but the current game still prohibits you. With a 90 day, because the other, the other important metric that you shared with me, Lio, was that median cash conversion cycle for these brands was 92 days, which I think, again, this is an important piece of the puzzle here too, because the complexity in this environment is all about that.

It's all about the way in which you have to move cash through an e commerce business, which introduces this. Real complexity to the process of purchasing inventory appropriately for growth if you want it. So look at this and go, yeah, if, if my calculation maybe was, was excessive on the amount of inventory you're purchasing to 9%, I think by interest calculation. Was also conservative relative to what is probably on the books for these businesses. And when this debt exists, not only like, are you going to struggle to go get more debt? It's going to be progressively, probably more challenging terms, but they're also, then you're, you're not distributing any cash to yourself with this outstanding and growing debt.

So the idea that there's any distributable cash, cause this is where Sean kind of piled on and was like illustrating to everyone that like, You can't put money in your pocket in this kind of design of a system. It feels like, man, if I won the game and I produced 8 percent profit, my liability still grew and my bank account, I can't pay myself any more than the salary that I'm playing. This feels like this game really sucks right now. It feels like that to me, I look out and I'm like, I don't want to pull that board game off the shelf because it feels. Like, even if you win, it's really hard to realize value.

[00:12:21] Drew Fallon: I think one way to kind of contextualize like the cash conversion cycle and like, it's, it's like relativity to like an 8 percent EBITDA would be like, If you take like the total net change in working capital, then you divide it by the total revenue. Right. And so like, in that case, if it's 8%, just said, then like your cash for like operations is actually just zero.

Right And like for context, more like further, like 5 percent of like a working capital absorption would be like best in class. So like, mostly it's like 10 to 20%. So like, you need to be pulling like those net margins, you know, in excess of that, if you want to actually see any cash come into like the retained earnings, basically. And so you can kind of do this, like, You know, classic, how did the three financial statements link together? And you have to hit certain thresholds on each one. So I think, you know, it's, it's, it's really, really critical because, you know, 92 days, I didn't pull this for Iris, but I would, I would, I would, I would totally buy that.

I think 92 days is probably extremely accurate in terms of like. Well, it's not great, but I think it's probably pretty just based on all the breakdowns that I do when I see 90 days, like, it's the middle. So, like, you know, I don't know exactly. It depends what that was sort of transfer into in terms like working capital absorption, but like, 8 percent it's like, not terrible Taylor, but like, it's not covering a ton of that working capital.

[00:13:30] Taylor Holiday: Yeah. That's, and that I think is, is the fear is like, okay. And the other thing that helps to frame for me for people is that lot of times people are trying to understand what does winning mean, right? Like, what does it actually require to win this game? And I think that if someone said that they had a 10%, even a e commerce business, we all might go like, Oh, Hey, you know, that's like pretty good.

You should, you should feel good about that. But like, I think the Delta to understanding that that also means that you have Zero retained earnings to pay yourself is not a story that like is obvious to people as they enter into and play this game. And it reframes for me, this idea that like winning, we have to reframe the winning expectation closer to 20.

Like you actually have to build and design a business to produce a higher margin outcome than maybe you thought when you started this process. And I think that is the piece that I think is. We're beginning to educate into is that like, to actually make money out of this thing, to create liquidity for you and your shareholders, like one, the transaction game, like is kind of stalled up right now.

It's kind of jammed up, like outside of a very small set of cases, like. There's just not a lot getting through. So what do we do? Well, to create liquidity at the bar is actually higher. It's actually a substantially higher. So Lio, how does it, like, have you gone through the balance sheet or it is follow up to this?

Did you go look into any of that on your side? Are you seeing anything similar on the debt or leverage side?

[00:14:44] Lio: yes, yes, definitely. So, so we do see that that is basically eating significant part of of the EBITDA result. And, you know, if, if you're looking at brands that on the one hand want to grow and need to finance the inventory. Then this thin margins needs to be planned really, really well just to support growth if not you know, taking money home.

And also the expected, the expected swings in the economy is also concerning because you have very little margin to play with. So I think. You know, there's there's I'd say interesting changes. You know, one, it looks like the margins, even though businesses are growing, the margins are shrinking, putting aside any Trump policy.

And then if you want to grow, you need to find a way to finance the growth. But money becomes more expensive. Not sure how, you know, the economy in in a few months would look like and whether interest would go down. So I think all these factors with a thin you know, net EBITDA, you know, EBITDA minus the interest expenses.

It, it, it's very interesting how all of this is going to play out in the next couple of months.

[00:15:58] Taylor Holiday: Yeah. Cause the other thing you pointed out, and this is why, if I heard you right, is that, you know, The contribution margin percentage from 24 to 23 went down, which that people are spending more in marketing, right? Like really the difference between gross margin and contribution margin in your case is just add dollars. And so if that's, it's sort of this inverse behavioral profile that also doesn't make a lot of sense to me, which is that, and this is where, like, I think there's this, there's this. There's these underpinnings of expectations that drive the behavior of these organizations that are disassociated from the financial reality.

That's, that's part of like the, if I were to put myself on a box and yell it in town square, it'd be that it's like the underlying expectations of your business are disassociated from the financial realities of it. Like that's the problem because you're spending money as if the reality of that spend is creating. I gain to the value of this enterprise and it's not, it's actually destroying it. Like, and so you've got to stop because next year you year over year is such a powerful idea to people that like next year, your comp to that is going to be even more inefficient. Like it's just, it becomes this pattern of attempted overcoming and even worse profile.

Like, and so I just look at that and go, how businesses need to let go of their revenue reality and reset to an entirely different profile in some cases. So I don't know. How to, how to help get through that because the cost is really high to get through it. But what do you see as forward?

Drew, like you've been on the opera, you've been on the brand side. You've been an operator. You're not just a SAS guy. Like what, what do you see as the path forward?

[00:17:26] Drew Fallon: Yes, I'm not just a sleazy sass salesman. Although that is my role today.

Um So to be clear,

Yeah. So, you know, so, okay. I, I wrote like really, really extensively sort of about, I think I called it like, like VC times DTC and like what went wrong. And like, to be honest, like it goes all the way back to like the dollar shave club days and like how these businesses, like they really did at one point resemble like software businesses.

Like if you could get a really high margin product on a subscription, like. lot of ways that looks like SAS the, the sort of,

[00:17:58] Taylor Holiday: traditional model. Right.

[00:17:59] Drew Fallon: yes, exactly. Exactly. like, we could talk about this, but the three to one is the gold standard because it's when you have enough money to reinvest that the curve looks exponential and not linear.

So two to one is 45 degree and three to one is exponential. So good point. And so like, you know, Dollar Shave Club like had that and got bought for a billion dollars. And then like, right after that, there was however many billions, I mean, 10 billion, maybe, I don't, I don't know the numbers off my head, but like Thrasio was like two of it and like these VCs just started like pouring money into here and they were saying, okay, like, You need to hit like this dollar shave club type outcome.

And so all these brands, and this is, this is why I started Iris. Like all these brands, you know, are operating at a scale where like the marginal cost to acquire that next customer is so high because they don't want your product. There's not that many people that want your product. Right? So like you have to pay so much money to get them to buy that it's actually just squeezing out your P and L.

Like Lio just said, I mean, throw on some tariffs and throw on some interest, you know, raising interest rates. I mean, my God, you're totally screwed. So like. What you have to do is like, there's like, Facebook is like a beautiful, huge auction, right? And like, there is an equilibrium of supply and demand. And when you try to violate that equilibrium, your business is not economically viable because it shouldn't be.

And so like, you know, there's tons of brands that are like trying to run at 70, 80 million, like all birds is a great example. You know, all birds would be the best 60 million DTC brand ever created. But no, instead they tried to get a 400 million and they're fricking IPO for like, what? Well, I mean, to be clear, like those founders I'm sure did fine.

But like, you know, in general, like, it just comes back to like this idea of like, you know, the reason that Dollar Shave Club did what Dollar Shave Club did, and I, I use that as sort of an example. I don't know if it's, you know, they deserve all to blame but like it was a huge arbitrage. Like people just like bought Facebook.

It was, and I was, you know, with, with my brands back in the day, like. Put a dollar in, get 6 out. Like, it's just not like that anymore because the, the, the ecosystem has matured and like, as growth slows in a mature ecosystem, like the margin must come out, it's because investors demand either growth or profits.

Right. And so like we're at this point where investors have, by investors, I mean, you know, the market basically they demand profits. And people still have almost totally not let go of that idea of growth. And so, you know, the reason that I started Iris is because like, I was like, this is the future of, you know, this is the, this is the path forward is like, we need to get people away from like refreshing their Shopify dashboard and like get them into, you know, their accounting ledger, like Lio's or, you know, whatever case.

So, like, you know, it's, it's a total mindset shift in. I, I, I hate when, you know, people, I, I, I, Taylor, you mentioned like, you know, founders are sort of disassociated. I've referred to this concept as like founder delusion. And it usually manifests itself as in like, okay, my, I did 25 million in sales last year.

I'm a supplements company and, you know, X supplements company just sold for two X sales. That means I'm worth 50 million. And like, they get this like sales multiple idea, like in their head and not really realizing that sales multiple is just a proxy for like an earnings multiple. I'm like, think, you know, it's going to take little bit more pain, honestly, before people are totally willing to let go of those comps.

And like, I think, you know, Steven Borrelli, I was talking to the other day and he sort of mentioned this, like 2021 should like be your, or 2020, maybe he said, like, should be your baseline for growth, like not, you know, the huge COVID wave. And I think it's just like, I mean, look, like I, I faced it in the companies I was running.

It's like, it's really hard to like, stop spending those ad dollars and like give up that growth, even though it's the right thing to do. It's, Maybe it's not, it's hard to say, but it just comes down to like, eventually all the people that don't adopt will or adapt will just not exist.

[00:21:25] Taylor Holiday: So that's so good, man. Thank you. So, so Lio, one of the things that's why I've been excited about interacting with you is that I, I have this sort of maybe romantic hope that it's just an education problem that it's not deeper. It's not psychological delusion. It's just lack of available information to make good decisions.

And I don't know where I sit on that hope right now. I think I probably. more towards the psychosis being true, but, but what are you seeing? Like, are you seeing the increase in financial sophistication lead to behavioral change? Like, how do you see that happening in our space right now?

[00:21:59] Lio: Yeah, I mean, it's it's it's a really great question. I'll start by saying that You know, the, at the end of the day deciding how much to grow and kind of putting egos aside and just you know, take just you know, a data and numbers approach it's just the art of managing cashflow.

Right. So, you know, people that have, have the. Let's say IQ and capabilities off carefully managed cash flow and understand how much budget they could put in expansion. And then how much cash budget they need to finance the inventory and based on that decide on the growth goals. I think this is something that is manageable even for the median 8 percent EBITDA, right?

Yeah. You have many companies above that but a company at 8 percent EBITDA can well managed You know, the cash flow taking into account the budget, the free cash flow, the inventory turnover and then you know, the cost of boring and then put the targets for growth in terms of the ecosystem.

And, and, you know, I, I, I think you two have have contributed a lot to it. I think the ecosystem moved a step forward. In terms of, you know, the realization that the mindset should change from revenue. contribution margin to profit. And I, I, I actually tried to quantify just based on our interactions with brands and, you know, people that are on final people that you know, you know, tried us and didn't move forward and try to think how would I split the ecosystem based on.

What I call the financial IQ or the desire to get you know, to get this education. And the, the, you know, it's, it's, it's, it's still something that we are exploring, but just, just, you know, my, my, my gut feeling and based on obviously a lot of discussions, I, I would split the market to 20, 20, 60.

I think the 20 percent of the brands are sophisticated, both in understanding the margins, measuring the margins, but also, you know, understanding what to do based on this, you know, financial information. So, you know, take the financial information, the financial, the financial information is. You know, it's the data level and then, you know, these brands understand what to do it on the action level.

Then the next 20 percent are brands that are pushing to get the data in and understand the margin, but not always know how to translate the margin that they see. So, you know, they can go to FinalLoop or to Iris and see the margins, but then translating the margin, what they see into an actionable plan is still a challenge.

Thank you very much. But they still see most of the market, which I would estimate the 60% as people that are great marketing people but working with their gut feelings about how the business in doing and miss both the data. You know, they don't understand. And obviously if you don't have the margin or understand the margin you cannot come with any actionable plan.

You know, let alone managing the cash flow and, and, and putting some growth targets based on budgets.

[00:25:22] Taylor Holiday: Yeah, that's that's that's interesting. It's a super compelling breakdown. that I've found that is hard about the idea of education as the solution is that educating people about finance doesn't create product market fit. And so one of the things that I found is that there's these cases where we will help a brand to realize that the mechanism for growth that they're using. Creates negative value, but the problem on the other side of that is, well, what is there? there's not actually, it's not as simple as like, Oh, just scale back to spend and you'll be profitably growing because the LTV is so bad that there's not actually like, it's like 30 percent in a year. The margins mediocre, and there's no organic demand for this thing at all. And it's been propped up by media decline that for a while was profitable and now just isn't, and there's no actual pathway back to profitable because it's now the category is so completed away or commoditized and they're left kind of going like, Okay. But what do I do? And the problem is like, the thing is not extraordinary.

It's just not yet something to your point earlier, Drew. That's like the market has to have such that they will buy it at a way that you can generate the efficiency for it. And I think that's the cold reality that I think a lot of brands are staring in the mirror is that the demand that made the thing appear profitable in its acquisition engine was a function of inflated external demand that doesn't exist anymore. And so in light of that, what do you do?

[00:26:42] Drew Fallon: I think, I think I want to add something really quickly here. So, cause I think like the last three sort of blurbs that we've, we've talked about are all kind of connected. So like, basically like, like, you know, we're saying, okay, like there is like, it's too expensive to acquire the marginal customer.

Cause like, it's not as important a product or whatever. And Lio, like I. And I love that 20, 20 60 idea because what's, what happened, and this comes back to what I said just a couple minutes ago is like when the industry was growing, so like e commerce as a percentage of the, of the, of, of retail was growing. Growth was rewarded. Right. And so you didn't really need need, you actually at the time should not have focused on your margins the way that you need to now, and kind of, like I said, like, as that growth matures I, I actually refer to the like sophistication spectrum as like pre and post institutional ownership. So like, usually like you want it as a, as an entrepreneur, like you were rewarded if you grew a brand into a place where you were Where P or some strategic would come in and pay you 500 million bucks. And they would take it and they would actually monetize it by like knowing how to run a business.

Right. Because they were on the mature end of the spectrum, but now what you're seeing is like the entire industry is like basically matured. And so if you, if you're one of those 60%, you better become the 20%. Otherwise you're going to be gone because the Taylor's point. You're creating negative value and you can only do that for so long.

You're, you're effectively subsidizing whatever category you're in. And like, it's like the economy, it's zero sum, right? So like, you're going to lose five bucks. Like I'm going to get, it's like when Uber's cost 6 to go 30 minutes back in the day, like it was awesome, but like at some point, like they couldn't do it forever.

So like, I think that 20, 20, 60 thing, that's a banger. That's like, we should track that, you know, and not that we can, it's probably impossible, but like. That is the key to all of this. And that 20 percent will, will get bigger slowly, even if the whole pie gets a lot smaller, right?

[00:28:29] Taylor Holiday: And what are the ways that I've watched it manifest? And so I think this is a good jumping off to figure out like, okay, what does it look like when it goes well? How are brands winning in light of this? And because I sort of, I have this talk, which is this idea of like DTC evolution, which is that the brands that are actually thriving in this environment, I've seen some of the best e commerce businesses I've ever seen because they've sort of evolved this set of superpowers relative to the lack of available capital that make them really, really good. Right. And so. And so I use this example where a, you take a marketing brand owner who really intimately understands his community and actually can build really compelling ideas and you equip them with knowledge about cash conversion cycle, and they do like really amazing things with that idea. Right. So I use the example in the deck or the talk that I gave about born primitive, a customer of ours and bear is this former Navy seal. Incredibly intimately connected to his consumer, first responders, people in the military in a way that he is them. He knows them. He knows the stories that matter to them, but what he didn't understand for a long time was cash conversion cycle.

And so they would like overbuy their leggings and they would, they had terrible supplier terms and he would always be frustrated because his business would be paper profitable and he'd never have any money in the bank. And he'd be like, why don't I have a bunch of money? But when he released his newest product, what he did is the thing he spent the most energy in was negotiating his supplier terms, where he functionally turned them into his financier, right?

Like where he got to net 90 delivery on a product that his leggings were closer to 50 50. And all of a sudden he went from a product with a 20 percent return rate to one with 5%. He went to one with. More gross margin dollars and better cash inversion cycle. And the same marketing story suddenly worked better. efficiency of the, of the thing might actually pretty close, but all of a sudden the bank account grew and it was like, what the heck? And connecting those ideas became like a superpower for him to realize, Oh, okay. I can be just good at and marketing and product and serve my customer, but when these underlying attributes are right, too.

All of a sudden I have money in my bank account.

[00:30:28] Drew Fallon: It's kind of, it kind of comes back to three to three to one LTV to CAC. Right. Like what you just described is like something that I about not that long ago. I called it like the net revenue margin. I don't know if you guys have like a better word for it, but it's basically The inverse of discount rate kind of at the end of the day. Um and like, if you can basically, if you take your discount rate from 15%, 10%, like that's five points of gross margin, which like is five points theoretically, you know, ceteris paribus of, of contribution. Um and like, that just kind of pushes you into that ability where like, if you have three to one, it affords you the privilege of investing in exponential customer acquisition.

And so like, I'm not totally surprised to hear that like, know, if you just get a few things in order, like, yeah, like unlocks a huge, a huge

[00:31:09] Taylor Holiday: happens and like one, I love what you're calling out to is one of my fights with people on their PNL. I see a lot of people pull their sales line item directly in their pails and they don't have gross sales minus discounts. They don't even create visibility for themselves to that because I think discount rate is one of the biggest, most destructive forms, things to margin in this point, because what would happen, what would happen for them is like leggings.

Like the thing about the internet is that we think of the internet as infinite, but the actual digital real estate in which we sell product is actually very finite. Like the SERP page for leggings is actually very finite in terms of the amount of space that's occupied there and all the profits get competed away.

Like they get competed down to nothing. And so what happens is like, if that's your category and you're in it. You, the only way to continue to win a little bit more is you tend to see the discount rate expand. And this is like a trend we saw over time as discount rates were growing. And it's especially true when you're the same category over and over and over again. And what happens is novelty or newness to your customer base often offsets the need for that. And so there's just this piece of that too, where. You see that growth come from that novelty where you give up, you don't give up that discount rate. And all of a sudden the whole thing starts to make a little bit more sense.

So I totally agree that people might be like, well, why are you showing me net revenue as part of the median growth rate? And it's really a proxy for understanding how discounts play in our ecosystem.

[00:32:23] Drew Fallon: And it's like, so it's so important in apparel because like the big unlock and apparel is, is, and I'm not like an apparel expert or anything, but like, it's, it's, you can get people to spend a lot of money, right? It's like a hundred, 150 AOVs. The key is like, how do you get them to come back? And like, if the answer is like, they come to spend for the winter drop another 150, but you're doing a BOGO, like. It just makes it really tough. And so I think yeah, like the gross net revenue rec is like always extremely popular in retail. Okay. And here I'll jump back on the soapbox. Cause it's like the gross gross net revenue in in retail is, is the only thing basically that matters. Right. And then. People in e commerce while it was growing, nobody gave a shit about gross and net revenue wreck. But now that e commerce is growing more slowly, very similar to retail. All of a sudden, those types of things, people are like, Oh crap. Like that actually does matter above all else. And like, I can't just look at like a GMV number and be like, yeah, I'm tripling you every year when my discount rate is 40%. And so like, it's like these attributes that they, they're there. It's happening. It's, it's definitely happening in industry. Like it's slowly coming into play. People are kind of waking up. People are kind of realizing. It's happening. Because again, like, if you don't, you're just screwed. Like it's

[00:33:32] Taylor Holiday: it. So Lio, what else? So sort of threw out that I'm seeing people turn their suppliers into financers as a, as a mechanism, absent the availability of capital to leverage those relationships. And what I often see people do is like, they're being willing to give up points of growth of the actual cogs to do it.

They're being willing. To do it for the sake of lower MOQs, they're being willing to do it. Like all of a sudden they're not just negotiating the nickels and pennies on the unit costs. They're actually thinking about the other terms and leveraging that. What else are you seeing people who are succeeding are doing in this space?

What are the kinds of other attributes that are illustrative of these evolved brands that are surviving in this environment?

[00:34:06] Lio: Yeah. I think drew referred to very correctly. I think the visibility think creates the drive to iterate right to iterate on pricing to iterate on, you know, I have a discount rate of 20%. How do I, Reduce it to 10 percent to 5%. We see, we, we saw this year a few brands increased prices.

They didn't increase the price for a long time because they thought that you know, demand would would drop, but actually they were able to generate the same amount of You know, unit sales for a higher price. So, so I think what, what I see brands that are succeeding is experimenting and iterating on the different margins and not only on the marketing.

Right, because you can iterate on the discount rate, you can iterate on the sales price. You know, you can buy more you know, payment days with your vendors. So go through the PNL and iterate on every single line item. And then the, you know, people tend to think that they need to go to the, you know, the, the, the, they need to come up with major.

Changes to the business in order to change the margins. And one day we're gonna sit around the table and we're gonna brainstorm about this huge change that we're gonna do to the supply chain. But what I see you know, what, what I see that help brand brands succeed in this environment is the incremental changes and the iteration on different parts of the p and l.

And then the small iterations. Has a huge you know, with all the, you know, the different margins and and, and the impact of the small incremental financial improvements. The impact on, on the net margin net profit margin sometimes is just like mind blowing. So, so I, I, I, I, I think that.

You know, the brands that I really see succeeding are the brands that are deeply into the numbers, right? Put this, put aside marketing and product market fit just referring to the financial, to the financial part, like understanding the margins really well iterate a lot and then are open to incremental improvement and not one day we're going to see it with with the entire team and think about the huge change.

[00:36:23] Taylor Holiday: I think that a lot of that has to do with incentive design, I think, which is that what forces people to go look at solving those kinds of problems is that I think a lot of brands would do better to change their organizational goal from grow, EBITDA or revenue X and like distribute Y cash at end of year.

Like if you literally set goals around the use of cash, it'll change everything you look at. Like it just alters the entire sequence of how you behave as an organization. If you go, we want to make the bank account X on December 31st. Like it just, it changes everything about the behavior of the system. Yeah. And so I think that's like a piece of it too, is a lot of this is just like a downstream incentive flow where everybody's behavior just flows out of some organizational hierarchy of like, we have to grow 20 percent and so everyone rightly just acts according to the expectation that's placed on them. So I think there's a piece of

[00:37:16] Drew Fallon: there's like, sorry, I just want to add, like, this is my my infatuation with financial modeling is what, is what you just described, right? So like you said that if we want to end the year with X dollars of cash, like you can build a simulation that business. And along the way, you are going to plug in a series of drivers, whether it's AOV or CAC or, Cash conversion cycle or whatever you have to come up with those drivers in a simulation in a model to get to that end dollars of cash.

And then each of those drivers, like, should be the KPI for the responsible department. Right? So, like, if I'm saying that, like, in this financial model, my cac is 45 and that's how I end the year with 5 million in cash. Okay. That's like, Hey, pay performance marketing. Like that's your KPI. Hey ops. Like if our cash conversion cycle over any three months stretch, you know, drops below 92 days, you're all fired.

Like, like we, if, if we don't hit these drivers, like you are missing your KPIs in the financial model will not manifest in this specific way that we're trying to accomplish. And like, that's why, like, it's pretty numbers on a spreadsheet, but it's, it's not, it's, it's like, it's, it's like a story. It's like an amalgamation of, of, of incentive and art and science.

And it's. And it's probably just a block of numbers to most people, but I find it like so fascinating because it incorporates like all these things that you're talking about.

[00:38:33] Taylor Holiday: the constraints are really powerful. There was a moment in when CTC was really struggling where our external board said, If next quarter your cost of service, so payroll plus my total labor cost, was above 70%, you're fired. And it was like, many ways, it creates a freedom that cascades all the decisions that we solve the problem, the margin expanded like surprise, like that was never a metric.

That was the driving hierarchic decision making framework for me, right? Like it was one of maybe the things I would look at. But all of a sudden, when you sort of reorder the sequence of like, This is the expectation or that's it, then you'll watch people's behaviors to like, my favorite phrase is like, your system is perfectly designed for the outcome.

It's getting like, and so if it's producing negative cash, you've designed a system to produce negative cash. You could redesign the system, redesign it to produce cash. Now, again, that's not to diminish the complexity and how hard of the problems are you got to go solve, but My experience is people are really fricking smart.

They'll like go solve the problem you give them. You just got to frame it appropriately. Okay. This is awesome. I have a bigger question that we'll, we'll sort of end with as a discussion that I, I'm sort of wondering, which is what is the role of the e commerce channel inside of these brands? So I think that when we started, there was this theory that it was like a margin expansion channel that it was like, Oh, you're going to cut out the middleman and you're going to expand the margin of the overall business.

Okay. now I've watched some really big businesses that we partner with, basically swing the pendulum the entire other way, which is that this is zero sum marketing to drive growth across all of the business. And the margin is actually inconsequential and I don't care if it grows at all. Go 85 percent of transactions still happen at retail. That's the growth sector e commerce. If we can make it break even and drive tons of awareness using digital media and all these things. Then fantastic. But like the idea that I'm going to strangle this thing or try and suffocate it down to margin. And those are sort of ends of a spectrum. I think that I've seen for behavior just curious, what do you guys think the role of it is?

What's, what's the answer for how brands should think about this as a relation to all the other channels?

[00:40:34] Drew Fallon: I had I had a really nice conversation with one of the founders of MOLUS, the investment bank, probably a year or two ago. Uh not Ken, but one of the other ones. And I asked her the same question. And the way that she described it to me was like, pendulum is always swinging. Right. And so, you know, five years ago it was e commerce, now it's retail and it'll be e commerce again.

And then, you know, what the, from a strategic, like acquire perspective, like there's always like, sort of like the next reason to buy buy the company. so, you know, the overall perspective I think is, is to like, almost not have like a defined perspective, because like, if you're going to say, okay, like now it's retail. And then in two years, like that pendulum swings again, like, okay, now you're out of favor. And so it's, it's kind of like a, a sidestep answer of just saying like. Omni channel obviously. Right. And so, I don't know if like e commerce is, you know, certainly today it is not like seen as like the sort of profit center of, of the business model. That could change again. And so I actually would, I probably answer your question by saying I'm not willing to answer your question and just saying that, like, as long as you would like, look at the business.

[00:41:39] Taylor Holiday: Cause I agree the future might change, but what if I time bounded it? What if I said today?

[00:41:43] Drew Fallon: If you said today, then I would say it's, it's probably in like, to your point, there are exceptions to the rule, but it's probably a pretty good way to get into retail.

[00:41:52] Taylor Holiday: Okay.

[00:41:53] Drew Fallon: If you can prove yourself online. Like I, like you build your build your, I say, build your brand online, build your business offline.

Kind of a thing.

[00:42:00] Taylor Holiday: yeah. So, so Lio, what do you think? Do you have a different opinion? Are you in the same vein? What do you think?

[00:42:06] Lio: I, I, I mostly agree that I, I think a really good way. I mean, going from retail to online you know, it's, it's, I think it's it's just a different business if you are a retail first company or business but if you want to get the retail and this is the, and this is the you know, the main end game, I think the best way to end up with retail is to start with e commerce.

And get, you know, get the product, right. It's, it's very hard to succeed in retail before you know, you nail down product and people love what you build what you build and, and are willing to pay for it. And you kind of, you know, sharpen the, the unit economics. So, at least, at least what they see is that.

You know, every e commerce has the aspiration to go retail. Not all of not all of the businesses succeed, but I, I, you know, I, I, I still think that the best way to get into retail if you don't start in retail is you know, starting in, in, in, in selling online. And and, and then it becomes a margin game, right?

If you're doing great online. Then retail becomes less attractive. If if you're doing great on the retail side you know, you see the online activity and the online efforts slowing down, obviously, because the margins are different.

[00:43:31] Taylor Holiday: I think one of the most underappreciated stories in our industry is native children. And I think that that playbook it's it's so quiet because it's PNG. Right. And so they don't, they're not very public about a lot of the information, but getting to sort of see inside of it. It's so counter to anything I would have thought of when we started them, so I love, I love that Lio. I think one of the most underappreciated stories in our industry is native deodorant and what PNG has done with that brand and sort of how they pick that up as a DTC darling. And it would have been really easy. In the same way, I think Unilever tried to do with DSC a little bit, which was to say like, Oh, the future is. The e com and we're going to grow the online business, but they knew all along that that business's future was not about making. com revenue grow 50 percent year over year. And what they did is they plugged it into their massive pipeline of retail distribution. They use the online media to support the vast majority of the business, which is not online. And that product category sort of sequencing to your point where they validated demand for an idea. Styling customers, et cetera, used it to set up distribution, but understood where the bulk of deodorant gets purchased is not the internet.

And it's not going to be for the next 40 years, probably. It's going to take a really long time if that ever changes. but for now the future is there and the TAM is massive. It's actually a really big brand that could sell a lot of money and it can become really powerful. And so I think part of that is this design from the beginning of the thoughtfulness of. where does this purchase for my product category happen? And then how am I going to access it relative to the rate of competition in each of those channels and. Obviously they have unique leverage and advantage in different ways. But but I think, I think there is every story now there still is like, look, there's tons of brands that are e comm only win at really high margins, but most of them, most of them have either massive LTV cause their subscription and supplement and et cetera, or they have some organic audience leverage that drives really just they, where they just can extract CAC basically.

But without those things, if you have to pay your market rate at every part of the PNL. You have to pay it at OpEx. You have to pay it at CAC. You have to pay it at gross margin. It's just really hard to make that channel massively profitable. Especially with the cost of capital as it is. So I don't know.

I would, I would be leery enter into it. Drew, I think you got out right time. We'll that. Anything else you guys would leave people with that you see is like, you're in situation, what can we do? How do we give them sort of a path forward if they're experiencing it? Any other advice you'd give?

[00:46:03] Lio: I think. Yeah, I think it's worth talking about the, the expected changes to the supply chain when it comes to, you know, when it comes to your margins because, you know, we just started this conversation with, okay, eight percent EBITDA on the median is, is, is not so bad. But then if you are adding the financing costs You obviously get to a very tricky margin.

Now, you know, if you think about what's upcoming, right? You already see that the Trump is, is, is using financial incentives and, you know, disincentives domestically and internationally you know, all across. You see that. You know, cheap labor may become expensive labor. And then you're gonna have you know, different forces, right?

Whether it's the tariffs again, the, the cheaper labor becomes more expensive. On the other hand you may enjoy lower tax rates but, but this would apply only if you're profitable. And then if you mix all of that, right, the policy, the, the, the, the, the labor, the tariffs this would change the supply chain.

Now, if the supply chain is more expensive as, as we see, even without any policy in the past year, right? Prices would go up. You would need to increase your prices and see if people are willing to pay that. But in general you know, inflation could go up. The expectation now is that interest would go down, but if it stays the same or go up then you have a greater problem because you know, boring becomes more expensive.

So think about. You grow your sales, your margins are still squeezed. But now the supply chain is more expensive. Inflation goes up, borrowing more expensive. So margins are shrinking. So this 8 percent EBITDA becomes, you know, 5 percent EBITDA on the median. And then the borrowing costs becomes more expensive.

I think this is something that that we're going to see in the next year and you know, brands would would, would need to first respond quickly and second, understand the, the, the impact on their. Different margins.

[00:48:25] Taylor Holiday: I think I, I was surprised to find out how many brands using 3, 2, through Mexico. And like when they look at this, like 10% China tariff, it's not actually 10%, it's actually 35% because the original 25% that got enacted before.

And so that, like a th if you just say gross margin is 55%, let's say product costs are 30% whatever, somewhere in that range. If you take 25 percent on that number, like it's gone, it's all gone. Like there's just nothing left. Like, so I think it's a great point that like, I think the trouble I have talking about it is that I don't know that any of it's real, it's changing every day.

It feels like a negotiating tactic. Like it just feels like seconds later, you see a tweet from the president of Canada or prime minister Canada just say, no, we worked it all out. And it's like. What did anything just happen? Like what actually changed? So it's hard to understand what's real. So, oh, drew, what do you think about that?

[00:49:21] Drew Fallon: Well, I'm kind of like in the nothing ever happens camp. Like, this is like, why I said like TikTok, like, and that's why I didn't bet on it on like poly market or whatever, because like, what does TikTok getting banned mean? You know, like, did it get banned? Like, would have lost that bet according to whatever definition poly market wanted, but like nothing really happened. Right. And like Trump or Trump, like with the tariffs, it's like nothing really happened. And it's like, I don't know, like until, until like something like actually happens and it feels like it's going to stay. Like, I mean, look, the guy there, he's a savage. There's no doubt about it. Like, he just like head faked the entire, like North American continent with like recession threats and like, is going to end up getting what he wants.

So like. Yeah. You know, I'm not, it's not an endorsement here, but like, he, he seems to be an effective negotiator and he's just not willing to kind of bluff for it. So like on the tariff thing specifically, like, I'm not sure there's like a huge reason to get super afraid right now. I am by no means an expert on tariffs, but I think this is just kind of, it's kind of the MO for, for this guy specifically, like, he's just trying to cut a deal.

Like, he's not trying to send the entire, like Western hemisphere into a recession.

[00:50:26] Taylor Holiday: I think it's this dynamic environment though, that it does seem that we haven't found things that are moving us the opposite direction in terms of the margin expansion. Right. Like, and I think that the labor thing is interesting too. I do think that that you're seeing more and more of this outsourced labor profile begin to comprise OPEX.

But, but the problem for that with the e commerce is that. Not my business. My business is 7 percent 70 percent human labor costs. Like there's a lot of room to improve efficiencies through AI and outsource labor there like e commerce. It's like 10%, like, like how the, the, the amount of additional labor leverage that you can create is actually pretty low which is hard.

Right. So it's like of all the industries that are going to benefit from that. Yeah. Like there's definitely some for sure. But it's not the one that's going to benefit the most, right? There's still just so much cost tied up in the marketing and the product side that it's like, man, how do you get there?

So, I don't know, are you guys hopeful? Where would you put your current optimism rate for the year? 2025 scale of one to 10, 10 being it's April, 2020 of COVID a one being, I don't know, some other terrible day,

[00:51:26] Drew Fallon: Oh, man, the second quarter of 2Q20, man. What a, what a ride. That was, that was awesome. I would say I'm, I'm, I'm more bullish this year than last. I think there's been setup for M& A this year. I think, uh, you know, we'll see what happens with rates, but overall probably a downtrend. I think for, for founders that, you know, continue to adapt and sort of subscribe to the ideologies that we used for the last hour talking about, like they, they'll, they'll start to be rewarded. But so I, I would, I would say, you know, the, the worst is behind us. If I was a four, you know, when I quit e commerce I might be like a six now.

[00:52:03] Lio: Yeah, I, I, I believe that 2025 would be better in terms of year over year revenue growth. I think the, the, the, the industry will expand. I, I, I'm, I'm not too optimistic in terms of the margins. I, I believe that we're gonna, we're gonna speak the beginning of next year and we're going to see the margins squeezed even more.

And I think, like, if if I thought about you know, 11 take away for this year assuming that the economy will expand is just to be very, very tight on the margins and make sure you know, to keep a close eye on how to at least maintain them. But, of course, try to improve them, but at least maintain them.

[00:52:50] Drew Fallon: What do you think Taylor?

[00:52:51] Taylor Holiday: I. I think that there is markets, like sometimes we'd like to believe that we're creating the growth and sometimes surviving is the period's best execution. And I think that for a lot of brands that you would do well to reward yourself with feelings of success related to survival and that there'll be better days.

Like, I think you're right, Drew, that we're going to find innovations, things are going to change, new categories are going to open, new channels will emerge. Then there'll be growth again. And it'll come for different people at different moments. And if you're in a period where it's like, if we just make it through this year, that would be a win, like. That's okay. Like to get through that. And I think that this, for a lot of, for the, if we go with the median, I think for half of them, if you survive this, you've done a hell of a job for the other 50, let's go take market. And there's lots of exciting things to do. And you've got cool new product and it's working. So, it's a tale of two cities. I, and I think that's my experience with my customers. There's somewhere it's like, we're smashing, let's go. And there's somewhere it's like, oh my God, I don't know if I'm going to make it. And they're both unique battles and they both have victory that are just going to be defined differently. But regardless guys, I appreciate working alongside you to try to increase the financial knowledge and do better for the brands. You guys have awesome content. If you're not following drew and Lio do so on Twitter, check out final loop, check out Iris. These guys are smart dudes and they're, they're, they genuinely feel to me, part of the reason I like interact with them is I feel like they're building in service of our community, like genuinely trying to be helpful in these areas.

And so guys, thanks for stopping and thanks for sharing information as generously as you do.

[00:54:22] Lio: Thank you. Thank you.

[00:54:24] Taylor Holiday: Bye. 

[00:54:24] Drew Fallon: both. 

[00:54:25] Lio: Thank you guys. Bye. Bye.