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Gilt IPO Puts Eyes on Flash Model

As Gilt Groupe reportedly gears up for an initial public offering, the move stirs yet more questions over the long-term viability of the flash-sale model.

NEW YORK — As Gilt Groupe reportedly gears up for an initial public offering, the move stirs yet more questions over the long-term viability of the flash-sale model.

Pioneered in Europe by the likes of Vente-Privee and then in the U.S. by Gilt, Rue La La, HauteLook and Ideeli, flash sales became the darling of e-commerce after the Great Recession as brands rushed to get rid of excess inventories and consumers were eager for any bargain they could find. Gilt rapidly expanded to cover not only women’s apparel and accessories but also men’s wear, travel, home furnishings and even food. Competitors rushed into the sector and even department stores like Saks Fifth Avenue and Neiman Marcus began holding flash sales on their Web sites.

But as brands got better at managing their inventories and the flash-sale market became saturated, the buzz died down. Sources have said Gilt continually hinted that it was planning an IPO, only to repeatedly delay it. There were even claims — some made by department store chief executive officers — that the model was broken.

“No, I’d just say it just peaked early,” Sucharita Mulpuru, vice president and principal analyst at Forrester Research, said of the space, which was always confined by the amount of product available. “There were too many people who thought there was an infinite supply of high-quality merchandise.

“There was an infinite supply of unrecognized brands and not-very-appealing merchandise but that’s not what was going to sell. So shoppers have been jaded because I think a lot of the best is harder to procure,” she added.

Mulpuru doesn’t believe sites like Gilt are getting smaller; their growth has just slowed and the model has matured. It’s common among online companies, which often see rapid growth early on, followed by a significant slowdown of adoption.

“My perspective is that the model is relevant — consumers have become addicted to sales, and there will always be a market for people who want luxury at a value price. But in many instances, the flash-sales sites don’t deliver on some of the same customer value propositions as other traditional e-commerce models such as convenience (e.g. free shipping, returns, etc.…), and even in some cases price — often things on Gilt can be found for the same or less on Amazon, but with Amazon the transaction is a lot easier,” said Alanna Klassen Jamjoum, director of A.T. Kearney’s Digital Business Forum.

In an interview late last year, Gilt Groupe ceo Michelle Peluso was upbeat about the company’s growth. Sales from 2011 to 2012 jumped from $450 million to $550 million and she reported double-digit increases during the holiday season.

The company declined to comment on reports it has hired Goldman Sachs and is seeking an IPO later this year, as did Goldman Sachs. The hiring of Goldman Sachs was first reported by Bloomberg.

Steve Davis, Rue La La’s ceo, said the site had record growth last year, with mobile representing more than 60 percent of its sales on certain days. “We also recently welcomed our 10 millionth member during holiday, and member growth continues to accelerate as we quickly approach $500 million in sales,” he said.

But while Gilt and Rue La La are growing, observers foresee a different fate for competing flash-sale sites — some believing the crowded sector is ripe for consolidation.

Howard Feller, partner at MMG, an investment bank that specializes in fashion and fashion-related industries, maintained that many of these companies have hit the ceiling in terms of their ability to scale up due to the constraints on access to quality, branded product.

“It will wreak havoc on their model and their ability to attract further investments,” Feller said. “Some players will certainly go away, others will merge. You might see one or more acquired by other established retailers.”

One indication that flash-sale sites are maturing might be the valuations within the sector. Nordstrom paid $270 million for HauteLook in February 2011, while Groupon last month paid just over $43 million in cash to purchase fashion flash-sale site Ideeli in an attempt to build its fashion business. Ideeli will continue to operate as a stand-alone site.

There had been speculation Nordstrom was planning to absorb HauteLook into its off-price Nordstrom Rack business, but a spokeswoman for the retailer firmly denied this. “HauteLook is a growing and thriving business for us,” she said Tuesday.

William Peng, general partner at venture capital firm Red Swan Ventures, contends that the flash-sale model as a whole has gotten a bad reputation because the sites aren’t performing as well as originally anticipated. “This was supposed to be a massive business, and Groupon was the same. It was supposed to transform how local businesses engaged with their customers,” Peng said. “There was huge promise of flash-sale sites. [But] maybe these companies got ahead of themselves.”

For him, the way the market should look at any e-commerce IPO is more holistically, rather than just at flash-sale sites themselves. He details several key metrics from a quantitative standpoint that come into play when deeming whether a venture is a good investment. These are gross margin, marketing spend as a percentage of revenue, operating leverage and net promoter score — a measure of how likely customers will be to share your product with friends.

“I’d look at Gilt and ask those questions. They had an incredible brand when it started, but the question is, do they still have the clout today that they had in the beginning — being the one-stop-shop for products you love and can’t find anywhere else?” Peng asked.

He cited Zulily, a flash-sale site specializing in deals for moms, babies and kids with a $9.3 billion market capitalization, as approaching the model better than Groupon or Gilt have thus far. He contended that it’s “unfair” to lump all flash-sale sites together and say it’s a poor business model.

Zulily, founded in 2010, has capitalized on a passionate mom audience who cares deeply about what they purchase because “they only want the best for their kids.”

“It’s about the selection of products that are on the site in addition to the price, and ultimately the way they package it into a compelling brand — rather than simply a pricing differentiation, which turns into a Wal-Mart-type business that demands low margins and high volume to be successful,” Peng said.

By definition, flash-sale sites offer lower prices, but a problem develops if price becomes the sole differentiator. The result is that there is then only one way of beating the competition: by lowering the price further.

Peng, who refers to this phenomenon as a “race toward zero margin,” said the only way to escape this trap is by differentiating one’s organization beyond price.

“That’s the key to a successful flash-sale site,” he said.