Op-Ed | Why Are We Ruining Our Best Young Fashion Companies?
BY LAWRENCE LENIHAN THURSDAY, 23 MAY, 2013
Source: Shutterstock 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.
bof.com
