Redesigning the department store: A new business model for a new reality

Musings on the economic viability of showrooms as a stand-alone business

Showroom Business Model Recap

Brands have traditionally had two major options for distribution: sell wholesale to a retailer or sell direct in their own stores/online. Last week, I discussed how online and offline commerce business models are converging for certain categories requiring customer trial (e.g. apparel). My hypothesis was that because offline and online brands are looking to have a small store footprint and large online sales, showrooms could be a stand-alone, independent business model. Independent showrooms (effectively re-designed department stores/malls) could provide brands with a third option that could potentially yield more dollars of profit and more control of the user experience for brands than a department store.

Economics of Apparel Brands Today

To understand the potential for disruption from our showroom model, we need to have a sense of how the economics of brands and retailers work today. To that end, I have analyzed the economics of [i] brands that primarily wholesale (e.g. Ralph Lauren, Nike), [ii] brands that retail directly to customers (e.g. GAP, Zara, H&M), and [iii] multi-brand retailers (e.g. Macy’s, Urban Outfitters) to create the following very stylized summary of the brand economics. Everything is presented on a per-square-foot of retail space basis at a 35% tax rate to allow for apples-to-apples comparison.

On $300/sft of wholesale value goods, a brand will make ~$45 of profit if they go through a retailer or ~$110 of profit if they retail directly. Note that the return on net assets (RONA) of a brand is typically much higher than a retail business.

Brand Economics in a Showroom World

Below, I have recasted the same economics above but inserted the showroom model. I’m assuming the brands pay a showroom fee and share in the labor cost, which would also help them control the experience.

The model I propose allows the showroom to have the same ~15% RONA of a retailer while the brand makes $1.5 more in dollars of profit per sft. (The higher brand RONA is debatable as there may be incremental capital needs on brand level). This win-win outcome is being driven by the assumption of eliminating store-level working capital (roughly equal to inventory).

The benefit for the brand appears relatively limited but there are few levers that could make this economic model significantly more attractive:

• Offline/online model could be used to drive more sales/sft
• Store level capex could be reduced given the more modular nature
• Rent can be reduced through scale, larger box size, or anchor contracts

Verdict

To me, the showroom model looks economically viable. Given the superior dollars of profit of vertically integrating into retail, I see this as a route chosen more often by earlier stage brands rather than fully-scaled ones.

Moreover, like most new ventures, building the showroom business from ground-up requires significant customer education and capital risk. Thus, if anything, I could see the department store model slowly shifting towards this showroom model before stand-alone showrooms pop-up.

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