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The Rise, Stumble and Future of Gilt Groupe's Business Model

Gilt Groupe warehouse | Source: Fantabulously Frugal
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Today, BoF takes an in-depth look at the past, present and future of Gilt Groupe’s business model and speaks with Gilt Groupe CEO Kevin Ryan on his plans to continue the company’s ascendance.

NEW YORK, United States — Back in November of 2007, BoF was amongst the very first media outlets to write about Gilt Groupe, the New York-based start-up that went on to dramatically reshape the online retail market for fashion, building a community of high value consumers around limited-time, members-only "flash sales" for designer apparel at steeply discounted prices.

The timing of Gilt’s launch couldn’t have been better. In the months that followed, fashion and apparel brands began to feel the impact of a global recession that would ultimately give rise to one of the most challenging macroeconomic environments in the history of modern retailing. Seemingly overnight, wholesale inventories became unmovable as retailers drastically reduced product assortments and orders.

As a consequence, many fashion brands were forced to liquidate excess inventory positions, causing a sudden and significant supply glut for “cut out” goods. Prior to the Great Recession, brands would have sold this excess inventory through off-price channels like Loehmann’s, T.J. Maxx and Century 21. But as the economy sank, these retailers were asking for discounts as high as 90 percent, while merchandising clothes in a haphazard fashion which did nothing to protect the high-end image brands had spent years cultivating.

What's more, the extreme market conditions of the Great Recession created an acute financial imperative for retailers — off-price, as well as full-price — to convert their own excessively large inventory positions into cash, leaving many brands almost without any viable sales channel, let alone one that would protect brand equity.

Gilt charged onto the scene like a knight on a white horse, providing a novel, efficient and brand-sensitive way to liquidate excess inventory and enjoying explosive growth in the process. Based on this momentum, Gilt Groupe raised $138 million last May in a new round of financing, valuing the four-year-old company at $1 billion.

But fast-forward to the end of 2011 and flash sales are facing significant challenges. Here, BoF examines the rise, stumble and future of Gilt Groupe's business model.

Although impeccable timing was critical to Gilt Groupe's meteoric rise, there were other important factors behind the company's success. Firstly, Gilt's member base is largely comprised of one of the most desirable demographics in retail: urban sophisticates. The typical Gilt customer has a bachelor's degree, is in his or her mid-thirties and "significantly over-indexes in higher household income buckets, when compared to the general online population," according to a spokesperson for Gilt Groupe.

To build this quality customer base, Gilt leveraged online network effects to great success, starting with friends of the founders and early employees. "This is a business that has grown predominantly through word-of-mouth marketing," one of Gilt's founders, Alexis Maybank, told The Wall Street Journal last year. "75 percent of our membership has come from the suggestion of a friend, using our on-site 'Invite Friends' feature. That's how we launched. We sent invites to a list of about 15,000 people — friends, former colleagues and classmates, dating back to grade school!"

Second, Gilt’s business model succeeded in driving consumer demand in a novel way: offering designer product at significant discounts, distributed directly to email inboxes, with timing and supply constraints to compel immediate action. Fifty percent of Gilt’s deal revenue is generated in the first hour after a sale starts.

Gilt’s email demand generation strategy also went hand in hand with a strong product assortment. From 2007 to 2009, the company’s core team had powerful relationships with fashion and apparel brands that, in conjunction with Gilt’s high value customer base, enabled them to secure highly desirable product, delivering a unique value proposition to their members.

And finally, Gilt managed to liquidate inventory in a way that protected the image of participating brands. Generally, brands are careful to close out their inventory in a manner that both optimises cash flow and ensures that their target audience doesn't see it. But, amazingly, the quality of Gilt's product offering and customer base enabled brands to sell excess inventory at a discount, while still maintaining a positive image.

How did Gilt start to stumble?

Ironically, it was Gilt’s massive success and the demands this placed on securing greater and greater volumes of desirable product that began to undermine the company’s ability to deliver on its core value proposition: great product at a great price.

From 2009 to 2010, Gilt's revenue rose from $170 million to $425 million, according to estimates published by Internet Retailer. This significant growth created the need for more and more quality product to feed the Gilt machine, something that was difficult to fulfil in ever-increasing volumes.

While Gilt Groupe itself was inspired by the French private sales behemoth Vente-Privée (which recently launched its own a US-focused flash sales venture with American Express) Gilt's success also spurred hundreds of other competitors to enter the flash sales market, from start-ups like Ideeli and Rue La La to strategic players like Amazon's MyHabit and Nordstrom's Hautelook.

With a flood of new Gilt-like clones actively looking for supply, the glut of excess inventory from the mid-2000’s economic boom dried up even faster. Additionally, in response to the global recession, many brands began producing at volumes that were lower than in the heady days of 2007. As a result, brands who were once price takers became price setters, increasing the cost of securing inventory.

An anecdotal comparison of the brands and products available on Gilt today versus those available in the company's first couple of years shows that, over time, quality level has gone down. Back in 2009, it was possible to find prestige brands like Ralph Lauren Purple Label and Porsche Design on Gilt, in stark contrast to the many unknown brands that populate the site today. This meant that each time a subscriber opened an email and the product did not communicate the excitement-to-value ratio that had originally made Gilt so successful, their inclination to open subsequent emails from Gilt, and the brand's position as a curator of style, suffered.

To be fair, these are challenges that have impacted all flash sale players and are not unique to Gilt. But they nonetheless present a significant threat to the company's core business model.

What is Gilt doing to address the issue?

"Today because we are bigger and more well known, we get inventory that we didn't get before," Gilt Groupe CEO Kevin Ryan told BoF. This may simply be a matter of showing strength in the face of adversity as market sources suggest that inventory is indeed a major issue for flash sales players.

That said, Mr. Ryan did go on to explain a number of initiatives he has put into place to try and ensure Gilt’s continued ascendance. “We do some things that we didn’t do before," he said. “We do more cuttings and we are increasing private label,” he continued. “We do pack and hold. At the beginning of a season, brands will go out and get orders from Neiman and Saks — and then we’ll order it as well. You can’t always count on this, but let’s say they end up with 15,000 orders and the minimum from their Chinese producer is 20,000. They’ll come to us and say, we’ll produce 2,000 for you, but you have to hold it until the end of the season.”

Leveraging its database of more than 5 million members, Gilt has also built a number of new businesses, launching Jetsetter, a travel deals site; Gilt Taste, a business unit focused on gourmet food deals; Gilt City, a Groupon-like local deals site; Gilt Home, a deals site for furnishings, home décor and gifts; and Park & Bond, a full-priced menswear business.

“What I do is try and sell more things to my existing customers,” explained Mr. Ryan. “We have new categories: hotels, restaurants, home, which have unlimited inventory,” he continued. “Within our overall business, two years ago, 95 percent of what we did was end of the season men’s and women’s. Today, that’s probably 35 percent of what we do. We’re in most of the big categories I want to be in right now, but we’ll add one or two over time.”

Performance of their new vertical product extensions is mixed, according to annual gross revenue estimates provided by Mr. Ryan. Compared to the size of the original men’s and women’s business (over $300 million), Jetsetter and Gilt Home (each close to $100 million in sales) have been successful. Currently less successful, though only 15 and 7 months old, respectively, are Gilt City (in the $50 million to $100 million range) and Gilt Taste ($10 million to $20 million). But Gilt clearly recognises the need to capture a larger share of their customers’ disposable income and seize adjacent revenue opportunities.

Gilt is on track in a number of other areas, as well. The company recently launched global e-commerce, shipping to over 90 countries, and understands social marketing in a way that many retailers do not, actively engaging with its large audience of fans and followers. Gilt has also seized the opportunity in mobile and tablet, deriving between 17 and 30 percent of revenue, depending on the day of the week, from mobile platforms, according to Chris Maliwat, a former vice president of strategy at Gilt Groupe.

But the negative impacts of reductions in supply, upward pricing pressures and growing deal fatigue are here to stay and will continue to create an increasingly challenging environment for Gilt and its flash sales peers.

What should Gilt do now?

First of all, Gilt could reinvigorate its vendor value proposition and focus on building new relationships with brands. Here, the most valuable asset for the company is the demand source of their customer data, a fact with which Mr. Ryan concurs.

“[Customer data] is a hugely valuable part of our business. I think we have the best personalisation of anyone, maybe second to Amazon,” he said. “For example, when you get an email in the morning, that’s one of 2,000 versions that goes out. The data is run every night, based on the sales, based on what we think [individual customers] are going to buy. When you open up the [website] you get a different page than I do; I actually get different sales than you do.”

But Gilt is not making the most of this data or sharing its full value with vendor partners. For example, Gilt could better quantify and harness the total value of their relationship with customers by doing things like delivering email analytics and driving social media for brands.

Taking a page from fast fashion, Gilt Groupe would also do well to further its focus on analytics, transforming itself from a data-rich, but insight-poor platform to a vertically aligned organisation driven by actionable information derived from its wealth of data. Retailers like H&M and Zara have upended the traditional seasonal approach to retail through intensive use of analytics coupled to a modern, vertically integrated manufacturing machine. Indeed, it's their ability to transform analytic insights into demand-responsive product compositions that is their core strategic value proposition.

"Store managers communicate directly with Zara designers and feed them data on what sells well and what doesn't," reported The Wall Street Journal in September. "If managers say a polka-dotted-black dress is flying off the racks, it is able to turn around quickly and churn out polka-dotted dresses in other colours and have them in stores in a matter of weeks."

But Gilt has a significant competitive advantage over fast fashion retailers in the structured nature of the demand signals (clicks, views and purchases) the company can read, meaning that it’s possible for Gilt to automate the identification of trends, while retailers like Zara must rely on store managers to proactively surface these insights.

As this game-changing start-up looks ahead to 2012, Mr. Ryan remains confident that the initiatives he has put in place will support a potential IPO and move the business into profitability. "The overall company is not profitable yet," he said. "Sometime next year we'll cross over. The zone where we might go public, and I think we probably will go public, is between fourth quarter next year and fourth quarter the year after," Mr. Ryan told BoF.

Matthew A. Carroll currently runs outdoor brand Cloven Footwear and sits on the board of three tech start-ups in San Francisco, California.

Editor's Note: This article was revised on 19 December, 2011. An earlier version of this article misstated that Gilt Groupe was not targeting sales to specific consumers based on their shoe size. It is. The article also misstated Chris Maliwat's affiliation with Gilt Groupe. Having previously served as vice president of strategy, Mr. Maliwat left the company in November 2011. The article also neglected to mention that new business lines Gilt City and Gilt Taste are 15 and 7 months old, respectively, at the time of writing.

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