Brand = makes the goods
Retailer = sells goods that brands make
For the last 150 years, the companies that made the products were independent of the companies that sold the products (e.g. Nordstrom, Macy’s). The traditional model for consumer product brands to get-to-market was to be sold via distributors, specifically brick-and-mortar retailers. The retailers could provide convenient access to a wide set of merchandise, and specialize in providing good service. And the brands, who didn’t have capital to build their own distribution via stores, could focus on designing and making the products. This generally worked for the customer, with the caveat being both the brand and the retailer were looking for a 2-2.5x mark-up. Said another way, the mark-up from costs of goods to the customer was generally at 6-10x when you including intermediary distributors and manufacturer mark-up.
In the last 30 to 50 years, brands have started to open their own brick-and-mortar stores to own the production and distribution, think GAP. Because there are heavy overhead costs associated with building large storefronts across the country, and a baseline price at which their retail partners needed to sell. The prices didn’t go down for customers, and hence a 6-10x markup remained. Only when brands started to move away from selling via retailers were customers starting to get more value for their money. The brand was now able to dictate the price independent of a retailer mark-up; e.g. Old Navy is the fastest ever apparel brand to reach $1BN in sales, and their pricing model could never work if they had to sell that via retailers.
More recently, as more of us take our credit cards online, we see the next evolution. Add a further catalyst of the post-2008 value-based economy, and we see global e-commerce growing by 19% in 2013 alone. In a world where anyone can access any brand via the internet, the role of retailers has diminished dramatically. As a result digitally-native brands are seeing an opportunity to rethink the traditional pricing and mark-ups of their products. You see this with brands: like Warby Parker, an eyewear company selling glasses for $95-145 at a similar quality to what you’d see at retailers going for $400-500; or Everlane, a basics company selling designer-quality t-shirts for $15 instead of $50.
Mark-ups exist, at their essence, to cover the cost of selling the product and having a competitive product. But the cost of selling a product is lower than ever, and competition is as fierce as ever. In fact the pendulum on mark-ups is swinging the other way pretty dramatically. Digital brands, ourselves included, are flying incredibly close to the trees, leaving a very small operating margin in an effort to deliver more value to the customer. Go to a Nordstrom today to buy a custom shirt, and they start at around $150 and can get up to $300 pretty quickly with additional customizations. They’re taking a third-party ‘private label’ brand who has their mark-up, then adding the Nordstrom mark-up. Blank Label shirts go for around $83 when you buy into the 3 for $250, and that leaves just enough to support the team that designs, sells and services the product. The most extreme version I know is brands that are launching and losing money on every product they sell, i.e. the price it sells to the customer is lower than the cost to make the product. They only can make a profit when they get to significant volume and benefit from economies-of-scale on the production side. And the difference in the meantime is funded by investors.
This has major implications for retailers and brands that have invested significantly in brick-and-mortar. It’s no secret that traditional retailers are struggling to catch-up. Borders and RadioShack shutting down are just the beginning. And although these new digitally-native brands still benefit from an offline presence, it’s at a vastly different cost base to brands that started offline. Jack Spade and Kate Spade Saturdays recently announced they’re closing all their standalone stores and focusing on e-commerce and retail relationships. Billabong, a surf company with revenues exceeding $1BN last year filled for bankruptcy. This is akin to when Rockefeller no longer need Vanderbilt’s railroad for transporting Standard Oil. There is all this expensive infrastructure that exists, that has been necessary for the majority of the last 150 years, but that value is eroding quickly.
The value of brick-and-mortar in the next 20 years is as a form of media. In-person brand education, feeling of fabrics, sizing of garments, and the sensory experience are all incredibly important and valuable, and cannot be replicated online. But the days of 6-10x mark-ups are very much a thing of the past, and the business model of brands for the next couple of decades is currently being set.