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The Problem With the Online Luxury Model

It's not just department stores breaking down during the pandemic. Luxury e-commerce, which has a more captive audience than ever, is facing similar challenges.
A 2019 MatchesFashion brand campaign | Source: Courtesy
By
  • Chantal Fernandez
BoF PROFESSIONAL

NEW YORK, United States — The pandemic has driven some of the world's biggest luxury department stores to the brink. It hasn't been much kinder to their online competition.

Net-a-Porter had to close its distribution centres just as its customers were entering quarantine. MatchesFashion is behind on payments to designers.

And all of these sites face the prospect of months, if not years, of heavy discounting to move merchandise that went unsold during the pandemic. Luxury spending could shrink by as much as 35 percent this year, according to Bain & Company. Consumers are shopping more online, but not enough to offset what economists expect will be a deep recession.

So while online retailers once pitched themselves as the natural successors to declining department stores like Neiman Marcus and Saks Fifth Avenue, they too are now locked in a seemingly unwinnable fight over a rapidly shrinking market. Where a multi-billion-dollar sale or public listing was the goal before the pandemic, surviving without jeopardising relationships with shoppers and designers is all that matters now.

“Everyone’s exit opportunities have changed,” said retail and fashion consultant Robert Burke. “For them to get through this time period, and maintain their business, is really important. Or there will be a natural elimination of players.”

E-tailers have had a remarkable run of bad luck over the last two months, even as their customers are stuck at home with seemingly no option but to shop online.

Though they don’t have to worry about how to retrofit stores to comply with new health regulations, online retailers have had other logistical issues. Net-a-Porter shut its warehouses in the US and Europe for six weeks. When they reopened at the beginning of May, the store sent shoppers an email linking to its health measures, including temperature checks and smaller workforce in the warehouses.

“We hope you are continuing to stay safe and we look forward to you visiting us again soon,” the retailer wrote.

The pandemic has also erased other key advantages. MatchesFashion opened a creative studio in East London in 2017 to photograph merchandise and create other content to give its website a luxe feel. Now, like at some of its competitors, new items are shown on mannequins or against blank backgrounds.

Ambitious expansion plans are on hold, or in retreat. MatchesFashion's 5 Carlos Place, the linchpin of its physical experiences strategy, is closed, except for private shopping by appointment. Moda Operandi shuttered its men's business in April after less than two years.

These sites and their competitors have taken the step of offering discounts on spring collections in the middle of the normal selling season, including up to 30 percent off some spring items at MatchesFashion and Moda Operandi.

Everyone's exit opportunities have changed.

And Gucci, which makes many of the hottest items sold on these sites, sent chills through the wholesale sector last month when its parent company said it would steer more of the label's sales to its own stores. Other brands are likely to follow, denying websites and department stores alike access to some of the most coveted products.

Pre-Pandemic Challenges

Many of these problems stem from the wholesale model itself, rather than whether a retailer operates via a website or big stores in major cities.

Take Gucci’s decision to reduce its reliance on wholesale. The label was already generating 85 percent of sales through direct sales. But it sees some of even the remaining sliver as bad for the brand, now that department stores and online retailers are struggling with excess inventory and deep markdowns.

“Exclusivity will be ever more paramount than before,” Kering Chief Financial Officer Jean-Marc Duplaix told analysts in April.

LVMH Chief Executive and Chairman Bernard Arnault seemed to write off the whole concept of multi-brand online retail in January when he told investors that "all of them are losing money … the bigger they are, the more money they lose."

Amazon built an online retail empire mainly through categories like books, where customers value a wide selection. Luxury shoppers prefer to browse for particular brands. For up-and-coming labels, a wholesaler can be invaluable, helping to get new collections in front of shoppers (Kering's Bottega Veneta has used this strategy to promote Daniel Lee's new designs to great success.)

But once a brand becomes established in consumers’ minds, it can count on fans to buy from its stores and website directly. Appearing on racks next to lesser competitors — or in a grid of products on a website — becomes a liability.

Online, shoppers can price compare across sites, so if one puts an item on sale, others feel pressure to follow.

The competition was weighing on retailers' balance sheets before the pandemic. Richemont said its business unit that includes Yoox Net-a-Porter saw widening losses last year, and MatchesFashion's operating profit plunged 89 percent in the year ending in January 2019. At the start of 2020, Moda Operandi laid off 50 people and shut its Shanghai office. Existing investors put an additional $100 million into the company.

“It’s a very expensive venture,” Burke said. “They were working on very tight margins, very narrow margins — and that was pre-pandemic.”

It could be worse: Neiman Marcus filed for Chapter 11 bankruptcy on May 7, with $5 billion in debt. But online retailers are under pressure from shareholders or private-equity backers to rein in spending while still growing fast. That’s difficult to accomplish without discounting and marketing on social media — the same combination that got them into this predicament in the first place.

“We see this over and over again ... you have to spend a lot more on customer acquisition or go mass or promote a lot in order to scale,” said Sucharita Kodali, retail analyst at Forrester. “What do you have to compete on other than price?”

Caught in the Middle

Farfetch, which is perhaps best positioned to survive and grab market share during the pandemic, will release its first-quarter results on Thursday. It expects the gross merchandise value sales (meaning the value of products sold on the marketplace, not the revenue Farfetch takes from the sales) to increase between 43 and 46 percent. While it expects losses after tax to reach between $70 to $125 million, Farfetch still expects to break even sometime next year. And its stock price has increased more than 35 percent since the beginning of March.

What do you have to compete on other than price?

But smaller sites with a clear point of view are also in a stronger position than their larger rivals, analysts say, including Munich-based MyTheresa, which offers a tight edit of brands and unique customer service; Montreal-based Ssense, known for streetwear and bold luxury; as well as stealth wealth-friendly Browns (based in London and owned by Farfetch since 2015).

MatchesFashion and Moda Operandi look like they’ve outgrown that category. At Matches, founders Tom and Ruth Chapman’s edit separated the site from its blander rivals and traditional department stores. Private equity firm Apax Partners acquired the retailer in 2017, at a reported $1 billion valuation.

Chief Executive Ulric Jerome unexpectedly left the company in August. Ajay Kavan, an Amazon executive, succeeded him in February. The retailer has fallen behind on paying brands, sometimes by more than six months, people familiar with the matter told BoF. Many other online retailers are late with payments right now, but MatchesFashion’s problems appear to reach far beyond the pandemic.

“We have had some issues with late payments and there are a number of reasons for that, including the introduction of a new accounting system last year,” a representative said. “It is our absolute priority to resolve all outstanding payments over the coming weeks.”

The representative said that during the pandemic, the retailer has seen traffic and social media engagement increase by double digits, with “positive signs in regions that are already coming out of lockdown.”

Moda Operandi, which offers trunk show runway pre-orders, has historically focused on ultra-rich shoppers who spend more than $1,000 per order. The site has been trying to expand its reach, with new branding introduced last year to appeal to more types of shoppers, though co-founder Lauren Santo Domingo told BoF earlier this year that top tier shoppers are still the priority.

What Comes Next

The pandemic has put plans to go public on hold or complicated ambitions to find buyers. Valuations will likely fall, and retailers will need to find a way to survive longer with the cash they’ve managed to raise so far.

“Their runway just gets shortened,” said retail consultant Steven Dennis. “Most of those retailers are going to go away or be retrenched so much that their existence is going to be questionable.”

Sites could merge to survive, much like investors are hoping Neiman Marcus and Saks Fifth Avenue will do. Neiman Marcus' MyTheresa could find a new parent.

Amazon is also inching further into the market. On Thursday, it launched a small and medium-sized designer marketplace with Vogue and the CFDA as part of the A Common Thread philanthropic initiative. The shop could remove some of the stigma of selling on the massive e-commerce platform.

Many analysts see online luxury retail splitting into two camps. On one side will be big sites built around a marketplace model or concessions, where brands control how their goods are sold. Farfetch is in this group.

On the other side will be niche sites built around tight edits or personalised service. Half of Moda Operandi’s sales are already facilitated by a stylist, and MyTheresa is known for its responsive customer service. Businesses built around such a high level of personal interaction are by definition limited in how big they can get, however.

The future for these sites hinges on one question, Kodali said: “What do you have to compete on other than price?”

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