Online apparel has reached a turning point.
Conventional wisdom suggests that apparel is one of the hardest categories of consumer products to sell online. Fit issues drive high return rates, especially for new brands with unfamiliar sizing standards. Apparel merchandising is essential, but expensive. In many categories, apparel margins are too low to subsidize innovative business models.
At Lightspeed, we’re generally not big fans of conventional wisdom. The companies who defy it create the most value, and it’s our job to invest in those companies. We’ve been involved in online commerce for more than a decade, and my partner Jeremy Liew has blogged about the industry since 2007. As far back as our first e-commerce investment in Blue Nile, we have seen the tide of investor sentiment ebb from and flow towards such businesses with each passing investment cycle.
In apparel, this conventional wisdom has begun to sound particularly hackneyed, especially in light of some exciting new data.
$50B of new spend up for grabs
The $300B domestic apparel & accessories industry has turned a corner with respect to online. According to a report from Goldman Sachs released last week entitled “Apparel’s radical shift online”…
Online is the fastest channel of growth in the [apparel] industry today. It is almost 15% of the apparel and accessories market and has been growing 20% over the last few years….
Looking ahead, we model sustained online channel growth of almost 20% against overall apparel spending of about 2%. This means an additional $50B of sales will migrate online over the next 4 years, a revenue base equivalent to the apparel and accessories sales of Macy’s, Nordstom, and Kohl’s in all channels combined.
Other than Amazon, the greatest beneficiaries of the shift to online in the apparel industry have traditionally been established retail players like Walmart, Macy’s, and T.J. Maxx — but that too is changing. The last few years have seen a declining market share of online sales for public retailers, according to Goldman:
Combined with their relatively flat offline businesses, the retailers are in a tough spot — no longer winning in the fastest growing apparel channel on the planet. That means at least half of the $50B of online apparel sales to be added in the next 4 years should come from online native companies — roughly $6.3B per year.
Of course, the biggest of these is Amazon. Goldman estimates that it will take 20% of the total online spend, “which compares with the 25%-30% share we estimate Amazon has of overall e-commerce sales in the US.” Removing Amazon’s estimated $2.5B per year (or $10B in total spend) from the $6.3B leaves almost $4B of new annual spend for online natives to soak up.
Our view is that three types of startups will be best positioned to capture this spend: (1) what Bonobos CEO Andy Dunn calls “digitally native vertical brands” (DNVBs), (2) online retailers with proprietary customer data, and (3) apparel marketplaces with strong network effects. Ideally, online apparel startups can develop along all three dimensions over time.
Digitally Native Vertical Brands
Andy does a better job explaining DNVBs than I could:
A digitally-native vertical brand (DNVB) meets four criteria:
1. It’s primary means of interacting, transacting, and story-telling to consumers is via the web. In almost all cases the brand is born digitally. Hence the term digitally-native.
2. It’s a brand, and that brand is vertical. The name of the brand is on both the physical product and on the website. It requires the commercialization of an e-commerce channel, but that channel is an enablement layer, it’s not the core asset.
3. The DNVB is usually maniacally focused on customer experience and on customer intimacy. The experience tends to be three-part bundle of physical product, web/mobile experience, and customer service that collectively become the brand in the consumer’s imagination.
4. While born digitally, the brand rarely ends up digital only. This means the brand can extend offline, eventually. Usually its offline incarnation is through its own experiential physical retail or highly selective partnerships. In nearly all cases of partnerships, the brand controls its external distribution versus being controlled by it.
Some great examples of DNVBs are Bonobos*, Casper, Everlane, Frank & Oak, Harry’s*, Honest Company*, Hungry Root*, JustFab*, and Warby Parker. To Andy’s third point, online is a great asset because it allows you to form a direct relationship with your customer. That often drives increased purchase frequency and higher repeat rates, which in turn drives more predictable revenue growth and creates a more compelling business than a traditional apparel brand.
Online retailers with proprietary data
In addition to brand, proprietary customer data can also be a strong feature of an online apparel business. Stitch Fix* has a team of 60 data scientists that “augment human judgement with machine algorithms” to match clothing to specific buyers. One of Stitch Fix’s stylists explains the company’s marriage of human and machine:
When a client fills out a profile and is ready to be styled, we are able to see what the algorithm is suggesting based on the data collected from her profile — everything from sizing to location, geography, body type, fabric preferences, colors and pattern preferences. It helps to not have to worry about the broad strokes of what a client does not want. Then we can make creative decisions about what will fit her body and her lifestyle.
Over time, that data set becomes significantly more accurate at predicting a given customer’s needs. It ultimately drives repeat purchases and customer engagement, which contribute significantly to the value of the business.
Apparel marketplaces with strong network effects
Secondhand apparel has always been a large category, at $14B in the U.S. alone. By creating the first online marketplace for apparel, thredUP* unlocked an additional $8B of clothing value that sits in American closets ignored. As thredUP and its competitors build a mainstream experience for secondhand, they will eat into the value retail market as well — a $175B market today and dominated by legacy players like Ross Stores and T.J. Maxx.
What this means is that thredUP’s marketplace is effectively replacing the value retailers with a much more attractive, asset-light business model, just has Uber has done in transportation and Airbnb has done in hospitality. The network effects inherent in such a business create a strong incentive on both sides of the market to consolidate around a handful of players, which (again) drives repeat engagement to the platform.
Change is generational
You might wonder why it’s taken so long for the natively online players to “flip the bit” on the apparel market. Perhaps it’s the generational change in buying behavior brought on by the millennials. Nearly 35% of them spend more than half of their apparel dollars online, and that proportion is increasing each year, with Gen X not far behind:
New generations of consumers who are natively comfortable with online apparel purchasing will drive the industry’s growth from here on out. Amazon will certainly claim its pound of flesh, especially with its entrance into private label; but startups who build online brands, utilize proprietary data, and build business models with network effects will thrive in this new environment.
* Disclaimer: Lightspeed is an investor in Bonobos, Honest Company, Hungry Root, JustFab, and Stitch Fix. I am an investor in Harry’s and thredUP (board role) via a former venture partnership.
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