With physical stores shuttering worldwide in the wake of the coronavirus pandemic, fashion purchases are sure to migrate even more to online pure players. But will it be enough to lift these cost-intensive, discount-prone businesses to profitable growth, at last?
The online channel as a whole seems to be on an upswing in what could prove a pivotal moment for e-tail. In particular, the online market in China has been thriving, with players such as Taobao and WeChat witnessing robust growth due to restless shoppers who have been under quarantine during the coronavirus outbreak.
“Looking at the year-to-date performance on the total personal luxury market, we see that the online channel is maintaining positive double-digit growth in Europe and the Americas, while we registered a limited slowdown in Asia regions, mainly in China and primarily driven by a reduced overall confidence in luxury purchasing,” said Claudia D’Arpizio, partner at Bain & Co.
“More broadly, we believe that as a consequence of the current situation, the digital channel could increase its relevance both now in the short-term, and potentially in the future.”
Luca Solca of Bernstein said he believes the crisis will accelerate a channel shift that is already in motion, speeding up the demise of wholesale, and the rise of digital.
“I think consumers will be keen to buy online in the short term, and sure, they will go back to the stores when the war with COVID-19 is won — but I believe that digital distribution will still see a structural step up,” he said.
Michael Langguth, cofounder and chief operating officer of Poq, a platform for mobile app commerce, said e-commerce is on an upward trajectory anyway, and the fact that people are now forced to shop online will only steepen the curve. “That step from not shopping online, to buying for the home and garden online to buying fashion just got smaller,” he said. “At the very least, people are now buying their groceries online as well as health and nutrition products.”
He believes that living under lockdown has nudged even the most stubborn of brick-and-mortar shoppers into online shopping.
When his company Farfetch went public on the New York Stock Exchange 18 months ago, José Neves cited statistics saying the industry would continue to grow, with 25 percent of luxury sales expected to happen online in the next 10 years. “We’ll be focused on those opportunities,” he said.
Today, as Farfetch rushes to fulfill orders and deliveries in the midst of the crisis, Neves’ feeling about the future hasn’t changed much. Asked whether the coronavirus could be a tipping point for e-commerce, he said: “Growth was going to happen anyway as luxury is still very underpenetrated. Yes, this could accelerate things.”
He’s not focused on this as a golden moment, though. Neves is too busy doing the immediate job at hand, “helping the community, companies and designers that work with Farfetch,” driving sales to boutiques and brands, ensuring that inventories are at healthy levels, that orders are fulfilled and stores are trading.
Farfetch is even using its logistics capabilities to source masks for any boutique partners and staff who need them for operational roles.
Farfetch still plans to pay attention to brick-and-mortar, once stores in the various regions reopen. Neves said Farfetch is planning a marketing campaign for later this year that will promote online and off-line retail, “and get people excited again about these beautiful boutiques. It’s not just about trading over the next two to three months, but about igniting excitement off-line as well as online,” when consumer sentiment is better, Neves said.
While Farfetch has managed to keep the logistics wheels spinning, it and other e-tailers could be severely impacted in a few months’ time due to shuttered factories and delayed deliveries from China, and Europe, which is now the epicenter of the outbreak.
In a research note published on March 10, RBC warned that online apparel retailers “have the potential to be most impacted” by COVID-19 “given they source products from China and Asia Pacific (directly and indirectly) and so are at risk of supply shortages or delays in delivery.”
“We do not expect to see a sales impact on the spring-summer season. However, if the situation deteriorates, product availability and therefore sales could be negatively impacted for autumn-winter, although we would expect this to be at least partially offset by reduced markdown activity. The COVID-19 outbreak can also negatively impact consumer sentiment, and therefore demand,” the note said.
Christa Hart, a senior managing director at FTI Consulting’s retail and consumer products practice, said she expects that pure-play and online “traditional retailers” will see a bump in sales “while we’re all hunkered down at home. After that, I think that two forces will be at play — both requiring a ‘value’ play.”
As the economic impact of the health crisis bites, and employment is disrupted, pure-play retailers such as Farfetch, Net-a-porter and Matchesfashion could temporarily fall out of fashion with worried consumers.
“Consumers are nervous about spending given uncertain incomes, and pure-play retailers tend to be at higher price points,” Hart said. Secondly, the closure of physical retailers will put the focus on immediate needs, whereas “pure-play retailers tend to be more want-based than needs-based.”
There is another fundamental dynamic at play here, too. These businesses may be flourishing now, but they are expensive to run, and investors have to accept they will be playing a very long game.
Indeed, before the COVID-19 crisis hit, the money crowd was becoming increasingly vocal about the growing pains and shortcomings of the fashion e-commerce business model.
Consider the opinion of one of the industry’s greatest entrepreneurs, Bernard Arnault, who weighed in on online pure players at an LVMH Moët Hennessy Louis Vuitton results presentation earlier this year.
“They’re all losing money. That’s not a great sign. And the bigger they get, the more money they lose. We’ve been asked several times to participate in these businesses, and I’ve always said no,” Arnault said at the time, acknowledging that the French group’s e-commerce site 24S.com, launched in 2017, is no exception.
“It’s also losing money, but it’s not losing a lot because it’s small. We’re growing it modestly. We hope to find a way to make it profitable, but for the time being, we haven’t. We shall see,” he said.
Industry observers don’t see much light at the end of the tunnel, citing fierce competition, high operating expenses tied to technology and the costs of customer acquisition and retention (fashion and luxury customers tend to be more loyal to brands than they are to stores). Then there is money spent on returns, taxes, currency and shipping costs, which leaves little room for retailers to maneuver despite the steady migration from physical stores to digital commerce.
Some predict a wave of consolidation coming — even as Amazon prepares to make its own online luxury foray with an e-concessions model, and the German giant Zalando pushes into the premium and preowned sectors. The fate of Mytheresa could also indicate where high-end e-commerce is headed: According to multiple sources, the company’s owners, Ares Management and the Canada Pension Plan Investment Board, which also own Neiman Marcus Group, are pursuing a dual-track strategy for the Munich-based fashion and luxury site, and will either take the company public on the New York Stock Exchange, or sell it to private investors.
Both processes are said to be “well advanced,” although any chance of an imminent initial public offering are almost nil, given the ongoing meltdown of global stock exchanges — not a good environment for an offering.
Last year, 12 percent of personal luxury goods were purchased online, according to estimates by consultancy Bain & Co. and Altagamma. That compares to a 10 percent share in 2018. As Neves said, that number is set to shoot to 25 percent in less than a decade.
Pure players like Farfetch represented the largest share of the luxury fashion market at 38 percent, versus 34 percent for brand sites and 28 percent for traditional retailers that offer bricks and clicks, according to Bain and Altagamma’s most recent luxury study. But the data shows that market share for web-only sellers has been slowly eroding — it was 41 percent in 2016 — while brand dot-coms are gaining share, and retailers are roughly holding steady.
While fashion’s top e-tailers arguably have more cachet for brands and consumers than the elite boutiques and department stores of yore, investors and equity analysts look dimly on their ability to generate returns.
In a recent research note, RBC highlighted that Compagnie Financière Richemont’s acquisition of Yoox Net-a-porter “has been fueling the bear case on the stock in the last 18 months or so, diluting the investment positives from its leadership in jewelry. Richemont is now exposed to fierce competition in e-commerce, where it is notoriously difficult to become profitable given the ongoing race for grabbing market share.”
Further, the note lamented that “Richemont does not provide any guidance for YNAP, but the shares would benefit from management articulating a long-term path to profitability for YNAP (ex-amortisation of intangibles), perhaps with a couple of long-term financial targets.” It rates the stock as “outperform.”
True, Richemont is in the thick of sorting out the online retailer acquisitions it made in 2018, upgrading them and integrating them into the business — at a serious cost to the bottom line. In the first half, operating losses in Richemont’s online retail division increased by 79 million euros to 194 million euros due to higher promotion and shipping costs, and increased investments in technology and logistics migration, marketing and internationalization.
Looking ahead, YNAP also wants to stretch its services to more countries, be more client-friendly, and ramp up localized services in places like the Middle East and China, all of which will require intensive investment — and, inevitably, delays to the profits that shareholders are craving.
While YNAP’s investment in a complex technological platform migration may come with high costs, it will give the business a competitive advantage in the long term, say industry insiders.
In her January report, Redburn luxury goods analyst Charmaine Yap said “the outcome of YNAP, its JV with Alibaba in China and the digital support to Richemont’s maisons, will take time to manifest. In a competitive online retail environment, defending Net-a-porter’s leadership position in luxury online might necessitate short-term gross margin investments or sales volatility, but the aftermath can be rewarding.”
YNAP isn’t the only site facing massive costs as it aims to build scale, upgrade its technology and keep up with nimble giants like Alibaba, JD.com and Amazon.
While Farfetch may have ended its fiscal year on a high note, it has certainly battled its share of challenges — and watched its losses widen — as a public company.
The online luxury platform reported more than $1 billion in revenues — a nearly 70 percent increase from 2018 — and more than $2.1 billion in gross merchandise value last year. But the company also incurred losses of $374 million for 2019, compared with $156 million in the previous year. In 2019, a combination of serial acquisitions, link-ups and lackluster earnings deflated its shares.
“The model is very expensive,” said D’Arpizio, leader of Bain’s personal luxury goods vertical, referring to steep costs for acquiring customers and personalized services, in addition to lavish packaging and speedy delivery. A source familiar with the dynamics of luxury e-commerce would agree: “These businesses need cash. Their problem is scale and business model.”
In addition, technology — and consumer demand — are evolving quickly, and keeping up is costly business.
According to one industry insider, when companies decided to build their e-commerce platforms, “everybody just put their cheapest little shed in the garden, and now that’s coming back to bite them. It is massively costly to rebuild a platform, and if you want to do things quickly, you have to chuck resources at it, and if you’re working at speed there’s more likely to be human error, so these companies are creating more problems as they fix the old ones. These legacy platforms are put together in a really old-fashioned way, and they are really creaking. It’s a bit like the difference between the London Underground and the Paris Metro. Just 20 years’ difference in technology is huge.”
Undercutting it all is a promotional environment and a war for market share. Meanwhile, e-concessions could be a way to manage bigger brands that look dimly on discounting by third-party sites — a whole other issue that’s plaguing the big online players.
“Fashion has a scale problem, and margin problem. In order to optimize your margin, you need to go to volume, and homogeneity. As a company you also need scale to benefit from the cost of all your logistics,” said one industry observer. “The retailers are buying in volume, but if they get it wrong, hundreds and hundreds of items are left on the shelf, and then they have to discount. So they’re feeding the discount machine.”
Indeed, there is a big question mark hovering over just how early online retailers — and brands — will begin to discount due to the impact of the coronavirus.
“Our focus is on being a full-priced business, but due to these unprecedented times we are having to work through contingency planning,” said a spokeswoman for Matchesfashion. “As a global business, we’re well positioned to respond to shifting patterns of demand across the world. The economic impacts of coronavirus were felt first in Asia, and Asia will be the first region to recover; indeed we are already seeing some early signs of that. Our global footprint gives us some flexibility in how we respond to the challenges we face.”
FTI’s Hart said with regard to pure players that assemble brands in the model of a physical department store, “the only way you can compete is price,” adding that “it’s difficult in that environment to get customer loyalty.” She characterized price competition as a key headwind in a sector where “gaining customers has proven expensive and problematic.”
An expensive business model and the pressure to discount are not the only problems these retailers are facing. There are myriad other pressures, too. D’Arpizio said given the complex — and costly — scenario for online retailers, she and her colleagues at Bain expect “a consolidation phase to happen. The challenge of scale that is needed to be profitable is pushing toward a consolidation.”
Others would argue that consolidation isn’t necessarily the answer. Instead, it’s data. One European luxury insider said stand-alone brands and big retailers can thrive as long as they know — and treasure — the customer.
“The big brands aren’t going to survive if they don’t get their heads around their customer data and understand how to acquire new customers. Most of them still have their heads in the sand around what their new customers might look like. Brands like Net-a-porter know their customer inside-out, and that’s the key,” the person said. “You need to maintain your existing core customer base and also learn about who your next customer will be. And you do that through data modeling. You need to understand where you are looking next for your next customer.”
Amazon has already been transforming its data into gold: It knows (almost) everything about its customers: What they buy, where they live, their preferred form of payment, the ages of their children. And they use that information to anticipate what current and future customers might need.
At least one retailer, who oversees a high-end bricks-and-clicks operation, would agree that a detailed knowledge of the customer is king. “The heart of luxury distribution is knowing your customer, but there has to be a human element, too, and you have to stay connected online and off-line.”
FTI’s Hart also predicted a shakeout or winnowing to a few dominant players as online commerce “tends to reward size and scale.”
The broader picture is also one of decelerating online growth — in the U.S. and the U.K. in particular.
According to FTI’s most recent retail forecast, online sales growth notably slowed in recent quarters to the 12 percent vicinity, versus 14 to 17 percent growth over much of the last decade. IMRG Capgemini Online Retail Index, which tracks the online sales performance of more than 200 retailers in the U.K., said February’s pre-coronavirus numbers were not encouraging.
In February, the month before COVID-19 really hit, online retail sales growth was down 0.4 percent year-over-year. The index said despite the surprising upturn in late 2019, February’s result continued the weak growth seen in January 2020. Month-on-month growth was down 0.7 percent — in line with last year’s figures, but from a lower base.
According to FTI, the apparel and accessories category has slowed for four consecutive years, from 20 to 11 percent, and the organization projects “an ultimate market share ceiling of approximately 35 percent” reached toward the end of this decade.
“Efforts to drive more apparel sales online will be collectively met by diminishing gains,” it warned.
One luxury brand executive, who requested anonymity, said the business model of pure players is flawed, with Google probably the biggest beneficiary as e-tailers, brand dot-coms and retailers alike shell out for online visibility. “It reminds me of the gold rush,” the executive said. “You know who made the most money out of that? The ones making shovels and buckets.”