Building a Fashion Company on the Internet? Please Stop. Just Stop. And Read This.

by melanie_io

It seems like every time I read TechCrunch, some new “Fashion 2.0″ business just got funded. Investors love these lightweight “new retail” businesses that do not carry inventory or manufacture anything. Many investors find it hard to resist a deal utilizing an old world business model (retail) with none of the old world problems (inventory risk, high working capital requirements, large start-up capital requirements, significant dependancies on partnerships). However, these old world problems, from which most investors shy away, are actually where energies should be focused. These are the areas where the big problems in apparel lie and where true disruption can occur.

In fashion, trust me, that are MANY problems that need to be solved: a highly antiquated supply chain, non-standard, un-linked computer systems, non-standard sizing that varies even within the same line, inefficient pricing methods. For christ’s sake, buyers still buy clothes based on what they look like on anorexic people! Discoverability is NOT one of those problems. Yet, it seems that every new fashion start-up is focusing on some derivative of “discovering and sharing” new products. The problem with business models of this type – the ones that do not touch the supply chain and instead make money from affiliate fees or advertising – is that it is incredibly difficult, if not impossible, to build a large, scalable business in this way within the apparel industry.

Take, for example, a traditional retailer such as Opening Ceremony. After shipping, merchant fees, packaging, and COGS, they produce an average gross margin around 40% (the industry standard) – after accounting for photography expenses (which most affiliate sites do not have), let’s say the margin is around 30%. Whereas a fashion site that generates revenue mainly from affiliate fees will collect only 3-8% of the revenue on each sale. That means that the new, lightweight fashion site must sell 4x-10x more inventory than Opening Ceremony in order to produce similar profit margins. On the hierarchy of risk, figuring out a way to sell 10x more than your competitor in order to just stay in the game is a much larger risk than the inventory management issues of a traditional retailer.

VCs and Angels who have traditionally focused on consumer Internet investments and are now dipping their toes into retail, tend to amplify this problem. They see a lightweight business model without all of the “problems” of traditional retail and they think, “this is cool, it’s getting a ton of new users, let’s just focus on getting millions of users and worry about refining the business model later.” However, in retail, the business model is not one that needs to be “figured out” or “refined.” Sell a better product, at a lower price, and with better service than your competitor. That’s it, you’re done. While the “get a million users, worry about revenue later” strategy has worked well for businesses that have created entirely new markets (i.e. Facebook, Twitter, etc.), in apparel, the market and the business model are clear: sell physical fucking products. If you are not directly dealing with the supply chain in some manner (either by making products, transporting them, or buying and selling them) then you are not in the business of fashion – and you do not have a sustainable competitive advantage.

Why so few people focus on the real problems in apparel boggles the mind. I could understand if fashion was a super-small market – but apparel sales in the U.S. reached $160 billion last year – so what gives? My guess is that the “back-end” supply chain / software / inventory management problems are just not as sexy as the “front-end” consumer-facing problems, or maybe the consumer-facing problems are just more intuitive.

To be clear, this is a trend that I am seeing, and in no way encompasses every fashion start-up. There are some notable exceptions: Bonobos, Warby Parker, One King’s Lane, to name a few. These are all very much retail businesses, with well-managed supply chains and inventory plans. And each has been able to use the web to get an enormous amount of low-cost distribution on a level at which their predecessors can only dream. However, these types of business models – you know, the ones that focus intently on creating a better product – do not make up the majority of fashion companies I see being talked about, funded, or built.

This is bad for the entire fashion ecosystem: if the majority of fashion start-ups that receive financing ultimately end up failing because of a poor understanding of the market, then what does that mean for the fashion start-ups that actually have a great product and full understanding of the market? Do they get lumped in with all of the other failed fashion deals and get passed over for funding because “we already invested in two fashion companies this year” or “we feel like it’s just too hard to make money in the apparel business” or some other bullshit investors doll out when they want to avoid an industry?

In the end, Fashion 2.0 is really not that much different than Fashion 1.0, in order to win, one must focus intently on building a better product that solves a real problem – you know, just like every other successful business in the world….