“Rent-to-Buy” the Chinese Runway

Interview with YCloset COO Michael Wang

Michael Wang, YCloset COO

Today we catch up with my good friend Michael Wang, who is currently COO of YCloset, an online clothing rental and subscription service that raised $20m Series B in March and has already scaled to 40 cities in China. Before YCloset, Michael was on the other side of the table, having spent a few years at KKR before joining IDG Capital, where he was also the lead investor for YCloset’s Series A+ round. As such, Michael offers a unique view, speaking from both an operator and investor perspective, and can help us understand the following:

Clothing rental companies only recently became popular in China, whereas comparable companies abroad such as Rent The Runway have been around since 2009… what’s different now? How does YCloset compare against global and domestic competitors? What are key success factors in this market, from optimizing logistics to central dry cleaning to capital accessibility? What role do China’s tech giants (e.g. Alibaba or JD) play in this arena? What is the “rent-to-buy” model, and what might this market look like in the near to medium term?

Listen to the podcast on SoundCloud (here)

Audio transcribed by Shaolong Lin, edited by Yvonne Yan


Journey from VCs to Start-ups

Adam: Michael, it’s been many years since we first met while interviewing for Morgan Stanley in Hong Kong. Glad to be sitting here on a couch with you at YCloset in the exciting realm of technology. Thanks for joining us.

Michael: Thanks Adam. Yes, we’ve known each other for a long time, and it’s great to see you again. Just a bit of background about myself. I grew up in China, and I finished my high school in Guangzhou before going to Berkeley for undergrad. I majored in Math and Industrial Engineering, and after I graduated, I came straight back to China to work for KKR. I spent two years there, and I mainly covered late stage private equity investment, with some public company deals as well. That was very interesting and a great learning experience.

But after two years, I felt that I was more passionate about innovation, disruptive technologies and new business model, so I decided to move on to do venture capital. That’s why I joined IDG, which was the first foreign venture capital firm in China that’s been around more than 20 years and invested in two of the BAT, Baidu and Tencent, and is also one of the first investors of Xiaomi.

I did 2 years of venture capital at IDG, and YCloset was actually a company I invested in 2016 in their series A+ round. The reason I invested in YCloset was because we looked at many sharing economy companies in China: we’ve looked at Didi, in the food industry there’s a Huijia Chifan (回家吃饭) and ele.me(饿了吗) these kind of food delivery companies. Then we felt that maybe in the apparel market, there might be something going on, even though in the U.S., we also have similar business model there that’s doing relatively well as well. So we’ve looked at pretty much all the companies in that sector at the time, and later we decided to invest YCloset.

Interestingly enough, after we closed the deal, I was talking to the founder about the strategy of the company, about what operating metrics we should look at. It wasn’t long before she began asking me to join the company with her because she felt that we could work well together. She had 12 years of experience in fashion industry, but she thought that this business was very operational heavy, requiring a lot of analysis, strategies and capital. So she invited me to join.

And for me, this was a great opportunity because I’ve always been a big fan of entrepreneurship. So I felt that maybe at this age it’s probably the right time for me to take some risks and really experience something different. That’s why I joined the company as a co-founder last year. Right now we are past series B, and we are looking to raise another round.

Adam: Thanks Michael. Before we get to YCloset, I want to ask you about moving to a start-up from the VC side. Is this common place in China? I see this happening in the U.S., but based on my short time here, it seems like there are a lot more career investors in China, even in the VC realm. So tell us more about this transition.

Michael: I actually don’t think it’s very common. Referencing my colleagues at IDG, in the past 3 to 5 years, there are very few of them who actually ventured into the start-up scene. If you look at the difference in personalities of investors and entrepreneurs, investors tend to be more risk-averse. When they make an investment they tend to diversify their portfolio. But for the entrepreneur, they have to go all in on the first day.

For most people, the opportunity cost is very high. Building a startup from the ground is too risky, especially if you are joining at an early stage as the co-founder. The chance of you getting to the next round, and even making to the IPO stage, is very low. If you’ve been in the venture capital industry for a long time, you’ve seen so many failures, examples that start well but don’t end optimistically. I think people tend to get more risk-averse after staying this industry for a long time. When I first joined the VC industry, my colleagues told me that if you stay here for more than 2 years, you would never want to do start-ups. Because you’ve just seen too many failure examples.


YCloset: Business Model, Strategy, and Sharing Economy

Adam: Let’s hope the younger cohort of more optimistic investors give this a shot. Because it seems to me from a VC platform standpoint, you see so many companies, you see different sectors, you know the key success factors. It seems that this type of person would be very valuable for start-ups especially at the early stage.

So now, please tell us a little bit more about YCloset. What do they do, what do they sell, and what are the key next steps for you guys?

Michael: For YCloset, we are right now the largest fashion rental company in China. We got our inspiration from Rent the Runway in the US, but we adapted it into the local environment. We are a subscription company, so the users can pay 499 RMB per month, and they get an unlimited access to the cloud closet that we built in China. They can make unlimited orders every month, and each order can only be up to 3 items. On average, our users can wear 12 items a month, whereas with 499 RMB they could probably only buy one dress from Zara. That’s the experience we are offering, and we’ve been growing very fast.

Right now we have up to 1 million users, and we are still doubling every couple months. That being said, in China we are still trying to educate people on why they should and can wear second-handed clothes. I think we could never have imagined this ecosystem 5 years ago, but right now since everybody is getting more and more open minded and accepting towards the sharing economy, it’s a good time for us.

Adam: You bring up an interesting point that you can’t see this happening 5 years ago in China. But Rent the Runway was founded back in 2010, and they’ve been doing quite well for the past 7 years. Can you tell us a bit more about the difference between both markets. What drives these differences?

Michael: That’s a very good question. We pretty much need to answer that every time we talk to an investor or any partner. I think Rent the Runway is a great business. It started in 2009, a long time ago. That is even before Airbnb and Uber. So I think the value proposition for Rent the Runway is very suitable for the U.S. market, because the products they are offering are actually gowns, party dresses, which you need on special occasions. In the U.S., there are a lot of these type of special occasions, and that’s why I think their value proposition is strong, and it doesn’t make sense for you to buy it; you only wear it once and you don’t want to wear the same thing next time. So I think there are actually very strong demands.

However, if you look at this business, the difficulty is also very obvious. Demand is seasonal — usually the highest during the end of the year or summer, when events like high school prom and wedding parties took place. But the supply of the business runs all year. The dress need to sit in a warehouse all year but the demand is seasonal. That makes it difficult for you to operate as a business and scale up this business.

If you are only addressing this type of occasion wear market, that would limit your market. We are taking a different approach. In China, there’s not much demand for occasional wear because most of the events, they don’t even have a dress code. Even if they do, most people don’t follow them anyway. Sure in Shanghai, the population is more westernized. But for the rest of China, there’s very low demand for the special wear market.

That’s why our subscription market only targets daily wear. We are targeting the fast fashion daily wear market where people can wear our products to work, during the weekend and also to a party. I think that our value proposition really targets the population that has limited budget, but that want to change clothes and try new styles. But also, I know that Rent the Runway started their subscription market last year as well and has been growing quite fast. I think both of us will do well with this new model.

Adam: You said that this is more daily wear subscription model, so the point is for the user to try something new. What if they like it, would they actually buy it separately?

Michael: That’s actually a very big part of our business model. If you are only doing occasional wears, there’s no point for you to buy them anyway. That’s the only reason you are not buying. But for daily wear, people see it as not only a platform for them to rent, but also to try different things. When they try different styles and good designer products that they don’t normally know, they tend to keep them if they like. I think that’s a big part of our business model, which helps us generate profits easily, creating a big cash flow. We are promoting the purchase of products through our platform, which distinguishes us from traditional rental markets. We position ourselves more like a subscription based e-commerce company that bridges brands and designers with our customers.

Adam: Seems to be a very interesting proposition for the users. But in terms of logistics, can you walk us through how you operate that? For 12 different clothing per month, you need to ship back and forth. That seems quite difficult.

Michael: We have 4 orders per month. You actually receive one box every week. Here’s one big difference between our subscription model and that of Rent the Runway. If you look at the cost of this business, most of the costs are logistics. We estimate that our delivery costs only account for less than 20 percent of our subscription fees. But for Rent the Runway, that percentage is much higher, because the logistics in the U.S. is 6 times more expensive than that of China, and the experience is even worse. So I think that’s really helpful for us to do this business in China. If you have a very high logistic costs, it’s very difficult to make money, and the unit economics will be very bad because you are wasting so much money shipping clothes back and forth.

Adam: In the U.S., you mentioned that overall logistics costs are higher. Why is that, is it because the wage cost per delivery is higher; I suppose density plays a role as well.

Michael: I think the density is an issue. That’s why the e-commerce infrastructure in the U.S. is generally worse than China. In China most of the people live in the cities. In the U.S., cities are more spread out. Logistic costs are all about density. If you have that high density, then you are able to lower the costs. Like I said, the delivery cost is the key component of this business, that would significantly change the unit economics of this business model.


YCloset’s Competitive Advantage

Adam: What about some of the local competitors you guys play against, like Ms Paris or Dora’s Dream? Could you walk us through some of these competitors and how you position yourselves against them?

Michael: I think luckily we actually see fewer competitors than other tech companies in China. Because if you look at this business, it is very operational and capital intensive. That places a big challenge for startups, because if you follow this model, you need to have a lot of inventory to start with. You need to have a very good reverse logistics system and run your own dry cleaning facilities, which are big challenges for a lot of start-ups that need to raise capitals.

Against our competitors, we actually have very different propositions. Ms Paris started in Shanghai and targeted more of the special occasion market; more like Rent the Runway. So they are basically copying the Rent the Runway model from day one. But we are taking a different approach. The other competitor called Dora’s Dream, which started in Chengdu. They target the third, fourth tier cities with very limited income, and their monthly fee is half of ours.

We think that the unit economics for them is not working out very well because the logistics cost is the same for the both of us. If we charge twice as much as they charge then we will have a much better margin than they do. I think that’s basically the competitive dynamics of these two players; we are targeting different markets, we have different strategies. But I think over the long term, this market is large enough for a couple players.

Adam: Got it. So sounds like at least currently among these disruptive smaller start-up players, you are addressing a relatively large market size. Dora’s Dream and Ms Paris are kind of in a more niche place right now that also capture opportunities. Do you see this market consolidating over time?

Michael: Well I think it will definitely consolidate, but I don’t think there will be one player left. To be honest I think in this market, this business model is being undervalued by the investors. We are not raising enough eyeballs as bike share companies. I actually want them to do well because otherwise it would be us raising the eyeballs and raising funds and attention from the investors. If all of us do well and get good funding, then I guess we would attract more attention from not only the public, but also the VC world.

Adam: Moving beyond the smaller competitors. You mentioned that YCloset is kind of a sharing economy company business, but also seems to have a lot of e-commerce component as well. Can you tell us a bit more about larger e-commerce players like Alibaba, JD, etc. How do they fit in the picture?

Michael: That’s another good question. Because in China, if you ever want to create a start-up in an e-commerce world, that’s the same question that people ask you over and over again: how do you compete with JD, Ali. That’s extremely difficult because over the years there have many start-ups trying to cut a share from these two guys, but almost all of them failed. I think the key value of these businesses is that you have to provide a very different experience for the customers, and it has to be under a very unique operational model.

For us, the reverse logistic system in our company is the most powerful one in China. We own one of the three largest dry cleaning facilities in the country. We had to learn it from zero. Nobody has these experiences, and there’s not a centralized cleaning facility in China. That’s a very strange know-how that we have managed to pick it up, because we never thought we would need to dig into this industry when we first started this company.

At the same time, it placed a very high entry barrier for the other players in e-commerce because their models are entirely different. Alibaba is a marketplace model. They don’t own delivery guys, they don’t own a warehouse. They are a pure marketplace, whereas JD runs an online to offline retail model. They own warehouses and have a very strong logistic system in the entire country. They operate on a heavier model than Alibaba but their costs are also higher. Their growth speed is definitely not as strong as Alibaba because of the heavy model.

I think we operate on a different model because we tackle the fashion industry using the rental model, I often tell this to investors: we are like a rental company. It’s like a car rental company and car retail company; they are fundamentally different operating models. They don’t compete with each other. Even if they want to compete with each other, it’s difficult for a car retail company to enter the car rental space because the car rental companies have a very unique operating model. I think that’s why we think our entry barrier is high for new entrants and these big players as well. We just need to continue to build out this business and eventually scale this business out.

Adam: I’m going to push this a bit further. Take a U.S. comparable, Amazon. They do a lot different things. They are an e-commerce company, they also have a lot of AWS service structure. They recently acquired Whole Foods for over $13 billion. In China, if you looked at the BAT and JD, they have their fingers in different areas as well. Ultimately these platforms want to diversify and maximize access to consumer demand. At least it seems to me that it very well could be future where a large player, instead of building up their own function when it comes to sharing dresses and other articles of clothing, acquire and as a result add up to the entire service offerings. Any initial view on that? Is that too far into the future?

Michael: I agree with that. I think that’s very different from 5 to 10 years ago because remember 5 to 10 years ago these BAT and these gigantic internet companies in China, they tend to copy from small models/start-ups and built it themselves. And now they realize there’s too much for them to do. It doesn’t make sense for you to do everything yourself. Sometimes if you have to have a good team / target that’s doing very well in their sector it makes sense for you to work with them and to invest in them instead. But I think Alibaba took on a very different approach than Tencent or JD. From my experience, Alibaba tends to get control of the company and look at the company from a strategic perspective, so they can enter the company in a later stage. This is different from Tencent, who does a lot of passive investment, most of which were very little. I think these two companies use different strategies, but they’re not trying to do everything themselves, but rather try to work with superstar entrepreneurs, and then incorporate that into their own ecosystems.


Opportunities for Expats in China

Adam: There are clearly a number of opportunities in China. So given that our podcast audience come from the U.S., the U.K., and other countries… for folks who want to actually come to China and work here, maybe at YCloset, do you have a message for them or any suggestions on how to go about doing this?

Michael: I think definitely be ready for challenges because in China, starting a company is difficult even for the Chinese, not to mention people that are not familiar with this market. So definitely be mentally ready. Secondly, find some friends. It’s very important for you to have some Chinese friends that can guide you through the process and tell you more about China and help you with the lifestyle and everything here in China.

And of course you need to have passion for what you do. I actually got an email from an Indian, obviously he pays very close attention to Rent the Runway, but he thinks that this model can take off in China and can take off much faster than the rest of the world. So he wants to join us, simply because he is passionate about this model. To be honest, I actually didn’t know what he could do. But his passion really inspired me and I really wanted to work with this guy and listen to what he said. So I think, like I said, it’s very important to have passion in what you do and show to the Chinese companies that you know this business well and can offer advice and experience that no one else can. Those are a few suggestions that I would give.

Adam: I think increasingly these days, learning Chinese is very critical. I recall 10 years ago, coming out to China, there were a number of expats that could just get by with English. It was fine, there were still opportunities for expats without a Chinese background, but increasingly a lot of the top companies have very talented Chinese staff. Some of them go abroad and come back but still they have very good Chinese, but also a good understanding of western culture and what’s happening globally. So again, I’d definitely encourage people come up to China, but make an attempt to learn Chinese because it’s increasingly the primary language here.

Last question for you. As you look ahead to YCloset’s growth over the next quarter or several quarters, what can you tell us about what you guys have planned, what your key objectives are?

Michael: First of all we are going to scale this business up. Meaning that we will continue to grow. Our target is to grow 10 times over one year. I think that’s a very big target, but I’m very confident that we can achieve that. As I said, we don’t see ourselves as a rental company, but instead a retail company that really connects the brands with our customers. I think in the next 12 months we really want to work with more prestigious designers and brands, and we want to introduce this new “rent to buy” model to them so they don’t have to limit themselves to either open offline stores that are operationally heavy and take a lot of capital and time, or are going to online e-commerce market where the competition cost is high and user acquisition cost is high as well.

We want to provide them with a third channel with this rent-to-buy model so actually the designer of the brand can offer their products to their customers for them to try first before they want to buy. I think that’s something that we want to do in the next 12 months. We don’t think we are just a rental company. We really want to work with every brand, every designer in the world. We want to be a true marketplace for fashion brand and true unlimited closet for our customers so they can actually try anything they want before they buy it.

Adam: Thanks so much Michael. It’s an incredible business based on what I heard — wish you guys well.