Op-Ed | Why Are We Ruining Our Best Young Fashion Companies?

Lawrence Lenihan, managing director of FirstMark Capital, argues that the Internet provides a new model for building fashion businesses based on passionate and intimate relationships with consumers, but the maximum market size for these companies is inherently capped, something that overcapitalised entrepreneurs, and the investors who fund them, too often fail to recognise.

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NEW YORK, United States — We are ruining potentially wonderful companies out of sheer ignorance of the fashion industry and a lack of understanding of how technology will impact it. We are overcapitalising companies and forcing unnatural, unsupported expansion — and by we, I mean investors and the entrepreneurs who take too much of our money. We are not purposely killing these companies, of course. It’s just that we are not experienced enough with the subtleties of the fashion industry to understand how a relationship with a customer is earned and have misapplied lessons learned in building companies like Amazon and Google.

As investors, we are very skilled at taking the early trajectory of a company’s growth and extrapolating a presumed future revenue path. We look at Google and Facebook and Twitter and we see that early rapid growth portends future rapid growth. But, we fail to understand that these companies are not technology companies. What if, after a period of rapid growth, a brand or retail concept approaches saturation of its market and growth slows to single digits each year? What if the actual market sizes for these companies are less than we thought?

Technology has changed everything. What started with silly online fashion concepts like Boo.com gave rise to the incredible Net-a-Porter, which, in turn, has paved the path for a succession of high profile companies that address various facets and aspects of the fashion and retail industry. The beauty of such companies as Modcloth, Warby Parker, Nasty Gal, Fab and others is that they have embraced the Internet as a platform for an intimate and passionate relationships with their customers by connecting with them around their interests, what they value and whom they aspire to be. The more targeted the focus of these companies, the more meaningful the relationship that they have with their customers.

This is not a new concept: specialty stores and stores owned by brands have built empires on it. But our ability to access and target very specific groups of customers on the Internet amplifies it’s impact far beyond what any designer or merchant ever imagined: market segments defined by relationships with customers that are so much more meaningful because they are so much more intimate. Want to look like you are a cast member of Girls and live in Brooklyn? Check out Modcloth. LA starlet? Nasty Gal. Cool, Internet-savvy hipster? I have a nice pair of Warbies for you. These are not flippant comments by someone who wished that they invested in each of these (I do wish it!); it’s a slightly tongue-in-cheek, but accurate observation on the essence of the true brilliance of the intimate connection these companies have with their customers.

These companies are just the first wave: get ready for many more that are similarly laser-focused. They will disrupt and transform the entire industry by re-segmenting and sub-segmenting and micro-sub-segmenting the fashion industry to connect to customers who are craving for true connection and, in a way, to manifest their own identity in the form of a brand they love.

Before the Internet, a brand had two ways to access a customer: open a store or find a retailer to carry its product. Opening a store to access customers costs an enormous amount of money, especially in valuable locations where the density of potential customers is high. On the positive side, the capital required provided companies who could access these resources with enormous barriers to entry to protect against new entrants. Alternatively, retailers have functioned as gatekeepers for brands who could not afford their own stores or needed the credibility of a trusted arbiter of taste to represent the brand. The retailer controls the customer and, thus, the relationship.

The Internet completely changes the model of building a fashion company by enabling the creator of the brand to find customers first rather than finding a gatekeeper who controls the access to customers first. It removes the huge capital barriers to entry of building a physical store and the previous constraints around accessing a geographically diverse set of customers. It also provides a platform for community that enables a brand’s customers to participate in the building of the brand.

But, to stand out above the noise created by massive corporate brands, a new fashion brand needs to mean something more than the incumbents for a customer to switch. How can Nasty Gal succeed against H&M or Zara or Forever 21? By having a point of view! The brilliance of these new companies is that they recognised that people were craving for a point of view, something special and different and they gave it to them in a new form and in a way in which their customers participate almost as intimate friends rather than mere consumers. Fashion mirrors life: we are always searching for where we belong. On the Internet, you can search all over the world anywhere, anytime, in seconds. These companies connected with their customers (really, their people) who then told the world about the fact that they finally found their home. They are good marketers who did a great job telling their story and they have grown more rapidly than any traditional retailer or brand has ever done before.

This sounds great except for one thing: by meaning something so much more to a given customer, they mean so much more to a far fewer number of customers (and might even alienate others who don’t share similar values, interests and aspirations). It has to be so: you mean more because you mean something more specific, something more special, something more intimate. Because they are so specific, by definition, the maximum market size for these companies must be smaller than the market sizes for traditional store-based concepts that must target more generally to survive.

There are a finite number of people on this planet. And therefore there is a finite number of people in a segment, sub-segment or micro-subsegment. The Internet connects us to each one, potentially, so if a company is accomplished at customer acquisition it will grow rapidly, unconstrained by store build-outs or other capital-intensive barriers. It will use all means at its disposal and it will be able to scale at an unprecedented rate. But at one point, the company will hit a saturation point where growth begins to slow and no matter how much it spends on marketing or customer acquisition, the incremental cost of each new customer gets to be very high because there are far fewer new potential customers left with whom its message resonates. To attract new customers, the brand expands into adjacent segments, and so it now means less to each of its very loyal customers as it tries to mean something to new customers that were not attracted to its original promise. New entrants seize on this vulnerability and capture customers who feel abandoned by the brand they loved.

There is a maximum market size for every company. These markets might be $5 billion or $50 million in size, but there is a ceiling beyond which a brand cannot grow before it collapses. This maximum market size differs for each company based on the market it addresses and the specific nature of the brand’s message.

But so what?

What if the largest possible market size for a company is $250 million, at which point it is only growing 5 to 10 percent each year. Is that a bad business? Well it depends. It could be a great business if it has been financed at the right valuation, with the right amount of money at each stage, raising more money as the business model and the market size become clear, but only enough to create a profitable, healthy business. A $250 million, profitable company could be a home run for everyone involved. Or it could be a disaster.

Rather than understanding that the revenue curve begins to flatten as it approaches its maximum market size, we assume it can scale forever. We build an expense structure to support this theoretically multi-billion dollar business and we raise a ton of money to fund it. But no matter how much money we spend, sales will not grow enough to support this more ‘modest’ sized (at least relative to our wide-eyed expectations) business. It will collapse, founders will leave or be fired, there will be an employee exodus and investors will lose a lot of money. Same company, two different outcomes because we only recognised the opportunity presented by the Internet, not the constraints.

We live in a world where we are never satisfied unless we become the next Google. Why can’t we be satisfied with creating something incredibly beautiful that connects with its customers in a way that enriches their lives and generates a great return for everyone involved? That’s probably a question better saved for a long discussion after a couple of cocktails, but it strikes at how potentially great companies are being ruined by not understanding their market, ignoring the revenue curve that is inherent to the market they have chosen and creating an unsustainable operating cost structure that results in disaster for everyone rather than the certain victory it would have been otherwise.

It’s time to face facts: the next generation of fashion companies will be smaller. But there will be many of them and they will change the face of this incredible industry if we can only get out of our own way and let them.

Lawrence Lenihan is the managing director of FirstMark Capital and an adjunct professor at New York University’s Stern School of Business.

The views expressed in Op-Ed pieces are those of the author and do not necessarily reflect the views of The Business of Fashion.

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  1. This is an absolutely useless summation … almost all small businesses flail, some fail and some simply exist. There are breakthroughs … sharp, unpredictable and extremely wildly profitable.

    Nothing new here. Just words.

    madeleine gallay from Santa Monica, CA, United States
  2. Fantastic article. Well written and insightful. We feel the same way over at Jeanography dot com.

    Jonathan Heaton from Stoke-on-trent, Stoke-on-Trent, United Kingdom
  3. Madeleine, I have to respectfully disagree. Lawrence is saying that in fashion, creating a connection with a client-base takes time, something that initially heavily-funded fashion startups miss out on because their focus automatically shifts from building a faithful base to being a company that is profitable (i.e. sells a lot of merchandise, notice the impersonality of it), to keep its investors happy.

    I am the creative director of a leather goods company that, in Lawrence’s words, “creates something incredibly beautiful that connects with its customers in a way that enriches their lives” (well, we hope :-)). Over time, we’ve come to understand that our goal is to find and focus on the subset of people with whom our story resonates, globally. Then to reinforce that connection through our new collections, editorial content and service. This may take time, but there is a fulfillment in maintaining a human connection — which, we find, is what most customers want anyway.

    Funding is great for fashion companies and emerging designers, but smart funding, done in stages with targeted and realistic goals that don’t always include ‘mass-’, is even better.


    Kunmi from Barcelona, Catalonia, Spain
  4. I did start my online store knowing that and it is ok. There are some, like asos.com, that probably defeat this theory.


    Teodora from Lawrenceville, GA, United States
  5. I will also respectfully disagree with Madeleine. The VC community seems intent on a software mindset that doesn’t translate well into fashion. Points of view in fashion aren’t “defensible” in the intellectual property framework, so unique fashion start-ups aren’t worthy of investment. Fashion companies that own technology IP then get over-funded.

    As the CEO of a fashion start-up, we fight this learning curve every step of the way. Where are the VCs that see this landscape as clearly as the author? Please introduce me!

    Thank you, Lawrence, for perfectly capturing these challenges and proposing an adjusted vision for fashion investing.

    Michelle Crawford from Niceville, FL, United States
  6. Build – Grow – SUSTAIN = the secret sauce to success in the Fashion Biz. Think about it.

    SarahLord from Norwalk, CT, United States
  7. Brilliant and Long Overdue! As a consultant that works with Fashion and Beauty companies to use and optimize Technology I completely agree!

    jonathan from Fresno, CA, United States
  8. In reply to Michelle’s question “Where are the VCs who see this landscape as clearly as the author? Please introduce me!” He’s on the page in front of you, my dear. His words of wisdom are made of gold.

    Brenda from Boerne, TX, United States
  9. Fantastic article. Whenever VC money comes into play it seems like for most start-ups the technology driven scalability outweighs the product / relationship aspects. It is very difficult not to succumb to pressure to “go big” in light of huge companies like Gilt, Facebook etc. However, the main question really is: what exactly do you want to achieve with your start-up? Overfunded high scalability followed by an exit that makes your investors happy or building a company that has a purpose beyond cashing-out? I chose the latter and it’s not easy, but worth every drop of my sweat equity.


    Karolina from New York, NY, United States
  10. Loving all the ‘plugs’ in this comment feed.

    Ha, can’t hold SMEs down!

    Brittany Lee Waller from Saint Ives, New South Wales, Australia
  11. Nail on the head. Found this article to be most informative, intelligent, concise, and an accurate depiction of the future, and of all whom it impacts.

    L from Chicago, IL, United States
  12. Interesting… What you’re saying is that we should change our perspective and all will be well in the fashion industry. I like the idea being presented, although I don’t necessarily agree with putting a cap on your market. If you hit all of your target customers, you find a way to sell them other things and expand on your product offering rather than trying to appeal to more customers. I believe there is always room for growth and it can’t be as simple as that.


    Edgify Me from New York, NY, United States
  13. Excellent article and completely to the point on every aspect. It mirrors my experience in fashion e-commerce. You don’t need to be big (and likely won’t be), you need to be profitable

    Efm from Halethorpe, MD, United States
  14. Great, provocative and insightful article… in fact I just asked two of my classes at FIT the very same question that Mr. Lenihan addresses! …. I think that Steve Jobs and Mickey Drexler ( and many others in traditional fashion brand building) share a view of marketing and brand building that Mr. Lenihan would endorse: customers buy who you are, not what you sell… brands are built around the concept of what the brand represents, not what it sells… early internet fashion attempts are learning that… the brands that develop those deep customer relationships connect with their customers because they successfully define who they are. When you build a relationship with a customer based upon who you are, she will buy what you offer her.

    Henry Welt from New York, NY, United States
  15. Fantastic article.

    Long live the laser-focused fashion business. I think in a world of corporate monsters, we often forget knowing an individual’s shirt size and preference can trump a multi-million ad campaign in getting them back in store / online.

    Loyalty is more valuable than acquisition.

    Ben H from Malvern, Worcestershire, United Kingdom
  16. This is a fantastic insight into how it really is starting up a fashion label in the current economic climate and with the internet playing such an important part in reaching new customers. I’m starting up my own fashion label and specifically looking only at investors who fit our strategic goals and long term focus and see that there will not be unlimited growth in terms of sales in connecting with a very specific set of men and women. If the investors are not in for deliberate growth that will plateau at a certain point and realize there is a laser focus and a limited number of potential buyers of this particular brand then they are not the right investor for us and yes this will mean limited profits past a certain point too. It helps if they can complement us in some way i.e. put their corporate might and experience with financial institutions and banking behind us so we don’t trip up and fall and in turn their association with us will build credos for them in terms of reaching their goal to get more SME into business. I think there has to be more in it for the investor than simply money, they have to have a strategic reason for being involved with the business in some way.

    Maree MacLean from Auckland, Auckland, New Zealand
  17. Great point, not every business, especially a business that has established itself in a niche market, can grow beyond that niche into something huge. The trick is to estimate the real market potential of a business and capitalize it accordingly, rather than hope that any business has the potential of becoming a multi-billion dollar empire.

    Bottom line, I guess, is that if you know where you’re going, you;re more likely to get there, and that includes knowing if the bus you’re on goes as far a you want.

    David Kaiser
    Business Coach

    David Kaiser from Arlington, VA, United States
  18. Fantastic article, enjoyably written. I don’t doubt the shift will happen, but not the way round you so effectively advocate. It’s the customers that will lead the way: The collective mass will become as aware and fastidious with their brand choices. This shift will then dictate the behaviour of “curves” and, in turn, investment.

    Nevertheless… I’m starting a niche label myself, and get very excited at how I can interact with a smaller customer base that means as much to me as the brand does to them.

    Joshua Kidd from United Kingdom