VC-backed ecommerce businesses often generate a ton of revenue. But somehow few have reached consistent profitability. It’s not an accident: their size makes them unprofitable.

I’ve previously written about how few VC-backed ecom businesses have reached profitability. For example, in the last 12 months:

  • Allbirds: $266mm revenue, -$121mm profit
  • Warby Parker: $654mm revenue, -$64mm profit
  • Bark: $504mm revenue, -$58mm profit

This is just a sample. The average public VC-backed ecom business does $100mm+ in revenue but loses $50mm+ a year. Why?

It’s well-understood that VC returns follow the “power law.” That means that a small percentage of investments make up the vast majority of VC returns. For a company to provide a great return on investment, it needs to reach “scale.” That means get big.

For traditional VC investments, the path to a company getting big is clear: VCs invest in loss-making businesses with high fixed but low variable costs. As the business grows revenue, fixed costs stay fixed and the company eventually turns a profit.

For example, the prototypical VC investment was semiconductor (chips) manufacturing. It’s very expensive to design cutting edge chips and set up a chip plant . But after you do, the cost of producing each chip is fairly low. Software businesses are similar–expensive to write software but basically free to distribute afterwards.

Chip and software businesses have economies-of-scale. That means costs, as a proportion of revenue, fall as the business grows. The largest companies have the lowest costs, the most profit, and the best investor returns.

Unfortunately, ecommerce is not like this. In fact, in ecom, costs often rise as the business scales.

The starkest example of this is with marketing. Most DTC businesses acquire customers through Meta and Google ads. Unfortunately, digital ad costs tend to increase as spend increases. Larger businesses often pay more to acquire each customer than smaller ones.

Another disadvantage of larger size in ecom is competitors. Getting to a large size proves out the market, attracting competitors who drive down prices and profitability. While this is true in all industries, the key difference in ecom is low barriers to entry for competitors because of low upfront costs to start a competitor. It’s much easier to launch a new DTC brand than build a new chip factory.

Finally, for ecom businesses, variable costs are almost always much higher than with traditional VC businesses like software. That means as revenue rises, overall costs do not drop much as a proportion of revenue. Therefore, the business has a much harder time growing into profitability.

And that’s what we’re seeing from the VC-backed ecom brands. In order to realize a viable return for VC investors, ecom businesses had to grow revenue to be “venture scale.” But unlike traditional VC investments, due to the nature of ecommerce, larger scale has not translated into consistent profitability.