I am blessed with very smart partners who are really great investors. Unfortunately, as another flash sale site gets acquired, they probably don’t feel the same about me. For the past few years, I pretty much laid down on the tracks in front of every investment opportunity in one of these companies that came our way. In fact, just last night, I was giving my usual rant about why flash sale sites are business models based on stupidity to the class I teach at NYU. The point I was trying to make to my students was that the business model for these flash sale sites assume either that:
1) brands are stupid and will continue to over-produce goods that they will have to dump on the market at a huge discount at the end of the season or
2) once the brands stop being stupid and over-producing, they will make cheaper goods specifically designed for this channel hoping that the end customer will be stupid and not realize that all she is getting is a crappy version of the brand (just like the slop you get in the Polo outlet stores).
However, after another flash sale acquisition was announced, Hautelook by Nordstroms for up to $270MM, my partners Rick, Amish and Jerry are probably thinking that they have a partner who has an investment strategy based on stupidity!
So yes, based on this evidence and as of today, I have been very wrong on this space. I was wrong to pass on all these flash sale sites that have come through our office. All 180 of them. Maybe more. I was wrong because people are making money in them and for us, moral victories of being right in the long term don’t count. Monetary ones do! So I owe my partners and my investors a sincere apology that we did not jump on this bandwagon of discounting and brand destruction because I was too stupid to realize that, in fact, business models based on stupidity (unlike investment strategies!) are potentially good investments. Kudos to Rue la la, Hautelook and the others that have been acquired for lots of money.
But, I still think I’m right. There is no doubt that the retail industry will change more in the next 5 years than it has in the last 100. I am going to write about some of the changes that I see and I will try to predict what will happen in some future postings. Suffice it to say that these changes that are coming will alter the landscape of this industry completely and there will be lots of winners but lots of very big losers. What is not in my vision of the future for this industry is the continued growth of flash sale sites. There is a definite but limited role and only one or two will be successful.
You’re right -I am so deep in the hole on this one, why the Hell should I stop digging, right? Right! But, I truly believe that these flash sale sites do irreparable damage to brands by cheapening and diluting them, by breaking the bond of trust between a brand and its consumer, devaluing the essence of what is wonderful and exciting about fashion and shopping and by training their customers to shop on discount. Sure, the flash sale sites will say that they are a launch vehicle for brands and brand extensions by leveraging massive lists of potential customers and putting the brand in front of them (they also say don’t call them flash sales because that is not a nice word anymore). But if you are launching a new brand, is that really the first message you want to send as you establish that relationship: “come try me – I’m cheap and easy”? Don’t these brands understand this? I think the smart ones do and I think the new brands that will rise up will as well.
I’ve heard all the stories about how the flash sale sites aren’t really about flash sales, but I don’t buy it. I might buy it for Gilt, because they (in my mind which has obviously been wrong so far) are the best positioned with the best and most lucrative customer base. They also have enormous opportunity in other spaces. And TJ Maxx is killing it in the brick and mortar world. In the end, though, they are what they are and what is really happening is that all of these flash sales sites are selling crack to these brands who are now addicted to the easy money and are willing to mortgage their future for fast near term gain.
So as I go down in flames on my original investment thesis of how unsustainable these companies are, I might as well grab a couple of gallons of gasoline for the ride! I think I’m going to be right in the long term, but as a wise person once said, in the long term, we’re all dead…
PS. I am going to short Nordstrom tomorrow morning!
I think you are 100% right in the long term that the business model is not sustainable at all, market will probably be too saturated. In the short-term, as you stated, it will probably great for a lot of VCs and initial investors funding a lot of these flash sales sites (not only the Vente-Privee, Gilt Groupe, Roelala, etc.) The primary reason for this is I feel for Gilt Groupe to succeed in the future the only way it really can is either through vertical acquirers, or maybe horizontal acquisitions which would basically have to be of dealsites abroad. It’s the only way to diversify risk and increase growth. This has been apparent with the acquisitions of many country specific deal sites as of late by Groupon, Ebay, etc. What we have seen in this example is that the VCs, initial investors, and CEOs of the sites that were bought out were able to cash out. Moreover, if you look at Gilt Groupe’s recent foray into Japan it was probably primarily because Japan was performing poorly, 11Q1 GDP growth was -0.3%, last two years have been equally volatile as well. They recognize that they need to diversify their risk because its hard to sell HQ products at a sharp discount if the economy is doing super well, primarily because retail stores don’t need an intermediary to do that for them and steal their own margins. They only use Gilt because they have inventory.
Additionally, competitors are popping up all over the place. As a result its my prediction in the next few years (even now), that you are going to see a lot of deal sites pop up in economies with growth that is stagnant or bubble economies (some emerging markets come to mind) and these sites being acquired. If any of the aforementioned sites (like Gilt) IPO, this strategy will probably be the demand of the shareholders cause I don’t see how else they can grow or beat the competition. When the Economy shifts forward here in the States, which is apparent now, the Fed is nodding at raising interest rates and GDP growth rates are trending upward, it won’t make sense for high value brands to sell inventory to them when they can just sell it at higher prices on their own sites and stores.
This inventory problem you mentioned is the crux of the problem for deal sites like Gilt Groupe. There is no way for them to expand or to be able to allow more users to come into their exclusive site and the same time offer a large volume of high quality products that are current. The only thing they can do is allow for noname brands to come on board, or brands will come on that are poor quality. This is apparent when just looking at their brand list, where there are a lot of noname designers that are touted as being exclusive. Their business model also reminds me of what happened to Overstock.com which had tremendous growth that just nodded off after it hit a billion in sales, and that company also ran into the fact it couldn’t get inventory to match its growth.
Moreover, the other thing about sites like Gilte and Groupon is that the users are not your traditional repeat buyers. Their userbase has now just become people who are looking for deals. If you are a premium brand on a deal site, you lose your old customers who feel cheapened, which is unfortunate when the economy begins to trend up since they won’t come back. Additionally, with Groupon, a lot of those offering deals are just retail companies with poor products that don’t sell and are willing to take a deep discount so customers come to their stores in the future (doesn’t happen). Even then most of these retailers are disappointed with the experience, Groupon being the extreme example (A study of 150 businesses running Groupon promotions between June 2009 and August 2010 found that those coupon campaigns were unprofitable for 32% of the businesses that ran them. And more than 40% of the response group said they would not run another social coupon promotion again.) It’s a short term solution for those companies but at the same time the only thing they are telling the market is we are in survival mode. They are in turn diluting the brand value and that shortsightedness is much more costly.
Additionally, Google having being snubbed by Groupon is also entering the space, and I am pretty sure they know what they are doing. They are planning on a site called “Google Offers”, and I am certain they see the synergistic value in potentially combining a website like that with boutiques.com site which could rival Gilt Groupe.
My last comment would be that one site that seems to be maintaining the whole exclusivity aspect is Mintbox. It was founded by an NYU Stern undergraduate and Harvard MBA. It focuses more on the experience versus the actual selling of highly discounted low quality products. They allow users to shop for discounted current lines of HQ products both in store and online, and additionally users are able to get access to fashion show tickets and private events. If they continue that aura of exclusivity and restrict member size, which they sort of have to do given the perks they offer, it should prove to become an example of a deal site that will do well.
Fascinating post, which I unfortunately came across a few months too late! A few thoughts:
I doubt brands will ever stop overproducing because, with massive gross profit margins, the cost of a stock-out is several times the cost of overproduction. With demand for new fashion lines highly variable (I guess that’s why they call it “fashion”), this stock-out/excess cost ratio forces persistent overproduction.
I agree that over time, the high-end luxury brands will not prostitute the brands and offer deep discounts. The graveyard of fashion labels is littered with companies that sold cheap or sold in discount outlets (e.g. Wal-Mart). Moreover, if brands continuously dump excess inventory through flash sale sites, this will become a de-facto new channel as opposed to a one-off promotion and cause channel conflict with their retailers. This will leave them with mid-range brands; which indeed what all these sites flog.
Academically, this post deals with the most fascinating part of commerce in the last 20 years: monetizing spare capacity. The web has allowed endless businesses to sell their spare inventory and yield manage. The more perishable that inventory, the greater the potential to make a market in liquidating it. Few things are more perishable than last season’s fashion line and the siren’s song of price discrimination means there will always be enough brands willing to discount. Therefore, I think the category will survive. What I see as the fatal flaw in all these businesses, including Groupon, is zero barriers to entry. There are now thousands of Groupon look-a-likes which have driven Groupon’s gross margins down dramatically. I predict the same fate for fashion discount sites. This cannot end well for any business in the space. Either (a) brands will realize they can dump inventory easily on numerous sites and eventually raise prices as they gain confidence in selling out or (b) these sites will have to become brands themselves in order to avoid a price war; which will make them a very expensive and risky bet.
As a complete aside, the customer issue with these sites and Groupon is they are both a “push” model. Both businesses go out and do deals with suppliers with they than push to their client list. This means 99% of deals are irrelevant to the subscriber. Wouldn’t a much more compelling model be a group-buying or discounting service that plugged into the browser and alerted you to deals on sites you were already searching on?
-An old Broadviewer
But the problem remains of how you condition your customer. If they expect to buy discount, they will. I am going to try to write up something this weekend on the death of Missoni as a luxury brand with the Target launch, but that is a little different than what I am talking about here. Yes, brands will overproduce, but what is the cost in terms of brand equity? I think it is deep, but we will see. I also don’t buy the fact that a flash sale is an branding opportunity. Sure it is, but at what cost?
[...] spiral that had been facilitated by their addiction to the crack cocaine of flash sale sites (click here to see an earlier blog post I wrote on my take on flash sales). Just stop discounting and it will [...]