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Why Digital Brands Are Invading Department Stores

Traditional retailers are bringing internet-born, direct-to-consumer brands into their stores as a way to draw millennials, creating new models for wholesale partnerships in the process.
By
  • Cathaleen Chen
BoF PROFESSIONAL

NEW YORK, United States — Department stores are adopting a new tactic as they battle for younger customers with internet-born, direct-to-consumer brands: If you can't beat them, join them.

Traditional retailers are carrying more direct-to-consumer brands in their stores and on their websites, sometimes agreeing to wholesale terms that would have been virtually unthinkable even a few years ago. This spring, Seattle-based department store chain Nordstrom agreed to sell apparel from Reformation and Sézane, adding to its growing slate of digital-native partners. In April, Bloomingdale's included M. Gemi and Margaux in its New York flagship's revamped shoe department, where they have dedicated floor space — an arrangement similar to mainstays like Gucci and Salvatore Ferragamo.

Until recently, such partnerships between digital brands and brick-and-mortar retailers were rare, or limited to pop-up installations. Department stores didn’t want to promote online competitors that were stealing their customers; e-commerce makes up 20 percent of US apparel and footwear sales, up from 9 percent in 2012, according to Euromonitor, while department store sales have declined every year since 2012, according to data compiled by the Federal Reserve Bank of St. Louis. Meanwhile, e-commerce companies were reluctant to accept the lower margins that come with wholesale deals and balked at ceding control over marketing and in-store displays.

But both sides are learning the value of compromise. Startups reaching the limits of their growth online are turning to department stores as shortcuts to the mass market, while retailers are betting that buzzy online labels will draw millennials and that a potential sales bump is worth accepting their terms: many e-commerce companies won’t accept returns of unsold clothes and ask to be excluded from seasonal discounts, two staples of wholesale agreements.

“What’s happening now is a convergence,” said Cowen analyst Oliver Chen. “The digitally native brands are understanding the need to go physical and the old guard of retail is looking to transition into newer avenues in order to compete.”

At Bloomingdale’s 59th Street flagship in Manhattan, M. Gemi and Margaux control their own space on the shoe floor, from merchandising to how salespeople are trained, a common arrangement with luxury brands. More unusual: both companies fulfil orders from their own warehouses, rather than stocking inventory at Bloomingdale’s, and customers receive in-store orders a few days later. Bloomingdale’s, however, has final approval on product displays.

M. Gemi operates its own “fit shop” in Soho, but signed on with Bloomingdale’s to put the brand in front of more potential customers, said M. Gemi president and co-founder Cheryl Kaplan. Maintaining control over how the shoes were presented was key, she said.

“We chose to work with someone who was willing to create the same environment and experience, and have that direct relationship with the customer,” she added.

Bloomingdale’s was in informal talks with Margaux for two years before the new shoe floor offered an opportunity to test the waters, said Erica Russo, the chain’s vice president of fashion direction for accessories and beauty. So far, sales for both brands have been strong, she added.

“The success of direct-to-consumer brands has changed the landscape and I think it’s smart for retailers to be always on the lookout and embracing new ways of doing business,” continued Russo.

Retailers and online brands can clash over how to reconcile their business models. E-commerce start-ups typically see higher margins on their clothes compared with wholesale-driven brands, though they often must funnel those extra profits into customer acquisition.

It doesn't sit perfectly with how we usually work with wholesale. We have to be pretty nimble, and challenge ourselves to find solutions for roadblocks in supply chain or payment terms.

Unsold inventory is another sticking point. Retailers normally send unsold products back to manufacturers at the end of each season. But though Ralph Lauren can pass on returned clothes to off-price chains or outlets, e-commerce companies without those relationships often won't agree to take back merchandise. Most retailers are also accustomed to buying from wholesale samples in a showroom, but that's not part of the typical online model either.

“It requires some flexibility and a more strategic approach to really listen to what’s important to the brand,” said Tricia Smith, executive vice president and the general merchandise manager of women’s apparel at Nordstrom. “It doesn’t sit perfectly with how we usually work with wholesale. We have to be pretty nimble, and challenge ourselves to find solutions for roadblocks in supply chain or payment terms.”

Before its deals with Reformation and Sézane, Nordstrom had carried products from digital brands Everlane and Allbirds on a temporary basis. The brand was also the first US retailer to carry Topshop in 2012, followed by a partnership with Madewell in 2015.

Direct-to-consumer brands have other ways to find new customers, but they have their own drawbacks. Wholesale agreements are routine with online platforms like Net-a-Porter and MatchesFashion. But those sites take a cut of sales just like department stores. They also draw customers who might otherwise have gone directly to the brand’s site, which is less of a threat when partnering with brick-and-mortar retailers.

A growing number of digital brands are opening their own stores. Some, including suit maker Indochino and eyewear designer Warby Parker, have dozens of locations. But building a physical retail network is a slow and expensive process. Rent alone can swallow up to 15 percent of revenue for smaller brands, said Cowen’s Chen.

Cuyana, an online leather goods brand founded in 2013, is “seriously considering” entering into agreements with retailers, said co-founder Karla Gallardo. The company initially found customers through online marketing, and now operates three stores, including one that recently opened in New York. But it can take up to a year for each location to earn back in sales the cash required to open it, she said.

“It’s very hard to acquire customers one by one,” Gallardo said. “You can’t grow a brand by advertising online, but you can’t open a million stores either.”

Some brands say handing over control of key elements of the retail experience, like pricing and presentation, to a department store is too high a price to pay for growth.

Ariane Goldman, founder of Hatch, a maternity apparel line that can be worn before and after pregnancy, said she negotiated details like marketing and order management with Saks before agreeing to sell her clothes through the Hudson’s Bay-owned chain in 2017. Even so, the partnership ended after three seasons. Goldman said she is willing to work with retailer partners who can host events and put their marketing chops behind the brand, but has turned down some offers.

“I never really wanted to grow the brand without that control,” she said.

Still, analysts see deals between department stores and online brands only growing more common. Startup clothing labels in particular face pressure from private equity backers to maintain high rates of growth, which may only be possible by partnering with established retailers, said Ricardo Rubí, partner at retail consultancy Simon-Kucher.

“This will be a growing trend in the market because the more you have some of these new brands, the more of them will be bought by private equity companies that put tighter pressure on growth,” he said. “This means that they’ll start looking for quicker ways to grow and the wholesale business gives them just that.”

Reformation signed its first wholesale deal with Nordstrom earlier this month. Founded by Yael Aflalo in 2009 with a commitment to sustainable manufacturing, Reformation has raised $37 million since 2015 and is backed by growth equity fund Stripes Group and venture fund 14W. Aflalo told BoF that the partnership will allow her brand to reach customers beyond the coasts without having to open additional stores.

Cuyana’s Gallardo said she believes more retailers will be open to direct-to-consumer partnerships in the coming years.

“I don’t think they’re stubborn, their systems are just very inflexible and they’ve been working like this for decades," she said. “At the end of the day, everyone is trying to be smarter. This isn’t something new, it’s just a model that will be more efficient for everyone.”

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