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The Rise of Gilt Groupe: The Great Recession Fuels the Perfect Storm [Part 1]

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The Rise of Gilt Groupe is a three part series on the evolution of the New York-based fashion startup, Gilt Groupe, who dramatically reshaped the online retail market for fashion by building a community of high value consumers around limited-time, members-only "privates sales" for designer apparel at steeply discounted prices.

Part 1, The Rise of Gilt Groupe:  The Great Recession Fuels the Perfect Storm, describes the the unprecedented challenges that confronted the business environment for consumer-fashion brands in the wake of the Great Recession (GR) & the near collapse of US retail.

This is deeper dive investigation following the publication of a recent Business of Fashion article, The Rise, Stumble and Future of Gilt Groupe’s Business Model

1.   The Great Recession Fuels the the Perfect Storm

1.1   Pre-Great Recession Off-Price Retailer Selection Framework

1.2   Massive Demand Destruction Creates Huge Opportunities for New Players

1.3   The Quadruple Convergence:  The Perfect Storm for Gilt

2.    Gilt Ascends to Dominate the US Private Sales Landscape [Part 2]

[ Subscriber Graphs & Metrics ]

[ Revenue Graphs & Metrics ]

[ VC Financing by Round & Enterprise Value Implied Valuation ]

2.1   Four Critical Success Factors of Gilt’s Dominant Ascension

[ Subscriber Growth Charts & Metrics ]

2.2   Unique Strengths of Gilt’s Business Model

[ Gilt Groupe's Revenue Breakdown by Business Unit ]

3.    Gilt’s Strategy to Combat Full Frontal Assault by Competitors [Part 3]

3.1   Problem 1:  Scaling Undermined Core Value Proposition

3.2   How Gilt is Deftly Solving this Value Proposition Challenge

3.3   Problem 2:  Massive Influx of Competitors Destroying Market Fundamentals

3.4   How Gilt is Dominating this Challenge

3.5  Gilt Competitor Analysis

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Matthew A. Carroll currently runs an outdoor brand Cloven Footwear (raised $4.1m in Nov '10) and sits on the board of two tech startups in San Francisco, California.  You can follow (and show some social love) via@Fail_Harder, FailHarder on Facebook, and Quora.

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The Great Recession Created the Perfect Storm for Gilt’s Ascendency

In the months that followed the onset of the start of the 2008 Great Recession, the coastal waters began to recede providing consumer-fashion brands the first indication of the tsunami of macroeconomic demand destruction that would decimate US retail.  Seemingly overnight, wholesale inventories became unmovable as fashion & apparel retailers drastically reduced product inventory assortments and orders to create a unprecedented supply glut of inventory in the marketplace.

As a consequence, nearly all fashion brands were forced to liquidate excess (in many cases all) inventory positions, causing a sudden and significant supply glut for ’off-price’ goods. The problem was amplified by the fact that, at the time, there were very few ways to dispose of this inventory (at the scale of the demand destruction) that would not damage a brand’s price / value dichotomy, a process generally referred to as brand dilution.

[Graphic 1]

Brand dilution occurs when the customer gains knowledge of a product / price arbitrage opportunity to acquire a brand at below market rates that subsequently devalues the customer’s perceived value of the brand to a level in line with the discount.   This creates a certain cognitive dissonance in the cost / value dichotomy, whereby a brand’s retail price does not reflect the customer’s expectation of ‘worth’.  Prior to the Great Recession, brands would strategically position excess inventories in brick & mortar off-price channels, like Loehmann's, T.J. Maxx, Century 21, and Daffy's, whose secured significant discounts in exchange for acquiring large inventory positions of slow-moving/unpopular product in irregular sizes.

1.1   Pre-Great Recession Off-Price Retailer Selection Framework

Prior to the onset of the Great Recession, the basic selection framework that brands went through to select an off-price retailer partner was one that most effectively insulated brand’s target market from acquiring the discount information, maximized the disposition of excess inventory, and minimized the negative externalities from brand dilution.

1.  Foster Information Asymmetries: Before Twitter & Facebook, off-price channels presented brands with much lower risk when selling excess inventories mainly because it was difficult for information about a brand's discount opportunity to diffuse through a population & adversely impact the target demographics perception. Diffusion is the process of information, ideas, or trends spreading through a population.  In terms of brand impact, the diffusion relied heavily on word of mouth in a one to one relationship of one customer seeing a brand in an off-price channel & then directly informing select members of the customer's social network individually about the opportunity.  This was an expensive process in terms of time & cognitive investment (I need to call/email 10 of my friends to get the information out versus today I can update my Twitter status and 5,000 people would know).

This was a world before 800 million were on Facebook, 28.5 million Tumblr blogs, and 50 million WordPress blogs flattened & scaled distribution for everyone to have knowledge of style trends & ways to acquire them cost effectively.  In the old economy, customers could discover new trends through magazines or by interacting in the style capitals of the US (i.e. NYC or LA).

2.  Utilize High Transportation & Acqusition Costs: Off-price retailers generally could not advertise specific items that they have acquired due to the nature of excess inventory’s sparse assortments.  Most of the advertising for off-price channels focused on the most-premium fashion brands in to build customer mindshare (of this off-price channel having BrandXYZ) and pique the customer’s interest to “check out” the potential brand / discount opportunity.  Additionally, most brick & mortar off-price channels are located on the periphery of major retail markets to keep fixed costs low &, thereby, creating:

  • large transportation costs to be incurred by the customer traveling to the retailer
  • high acquisition costs in methodically sorting through a large assortment to find something ‘good’

These are large cost barriers that help quell significant negative stigmas from becoming general market knowledge.

For example, if a brand’s primary target market is Urban Sophisticates, in a major metropolitan city like NYC, then New Jersey would be a strong secondary market (supporting the target demographic narrative - but geographically diverse enough to inhibit action by the core target demographic) for a brand to sell excess inventory via one of the off-price retailers in the area.

3.  Maximize Opportunity Costs: When working with physical off-price channels, a brand was incentivized to try & minimize inventory availability at any single location - as a fast inventory turn reduced the amount of time in the market for dilution to occur.  As such, brands worked with a geographically diverse off-price retail network with each location receiving a relatively scarce supply of prime product from prime brands.  The supply scarcity was mutually beneficial for both the off-price retailer & the brand (weighted more in favor of the brand - as the off-price channel is riding the years of brand & mindshare investments) as the wide dispersion of off-price opportunities drove a self-reinforcing cycle of uncertain product availability - compelling value seekers to make immediate purchase decisions to capitalize on discount opportunity & maximize the opportunity costs of losing the discount by uncertain future availability.

Should one customer distribute information of a brand's off-price opportunity - it was highly probable that by the time other customers acted on this information & incurred the transportation costs the opportunity would not longer be available.  The product scarcity meant fostered an economic uncertainty cost that if customers incurred the transportation costs that they would be rewarded with discount on the product - thereby deterring future entrants to the market for any individual instance.

1.2   Massive Demand Destruction Creates Huge Opportunities for New Players

The extreme market conditions of the Great Recession generated an acute ‘cash conversion’ financial imperative that, with retailers (full & off-price) awash in an ocean of available inventory, left brands almost without any sales channel, much less one protection brand positioning, to convert these large inventory positions into the most crucial resource in retail - cash.

[Chart 2]

There was an unprecedented level of supply in the marketplace & current demand sources via physical off-price channels could not absorb the influx of inventory.  Additionally, the massive assimilation of Facebook into the lives of average web users enabled audiences of scale, once the dream of late-90s Tech Boom, that drastically accelerated the diffusion process & created a new demand source of consumers not artificially constrained by information asymmetries and high transportation, acquisition, and opportunity costs of traditional off-price channels. These factor’s created the right business environment for an direct to consumer, email marketing startup to capitalize on the price opportunity of an inordinate level of excess inventory.

1.3   The Quadruple Convergence:  The Perfect Storm for Gilt

The entire Fashion & Apparel business landscape was fundamentally disrupted by the Great Recession that each played a distinct part in ushering in the rise of Gilt Groupé.

1.  Collapse in Consumer Demand Drives Retailers to Dramatically Cut Inventory:

In Graphic 1, nearly 10% of industry revenues evaporated as the consumer was paralyzed by massive layoffs, a seizure in capital markets, and frantic retailers.  In Graphic 2, the red and blue inverse lines underscores the unprecedented discounting that Clothing Retailers were employing to move inventories.  Major discounting at the retail level imbued a new purchasing psychology that has governed consumer behavior for the last three years - retail price doesn’t matter anymore.

Gilt capitalized on this by enabling members to acquire secure huge discounts on clothing through their “private sales” daily-deals.

2.  Inventory Supply Glut Destroys Economics of Traditional Off-Price Demand Model:

With retailers dramatically cutting inventories, consumer-fashion brands needed a new sales channel to sell product.  The existing capacity of traditional off-price channels, like Loehman’s, T.J. Maxx, or Century 21, was insufficient to soak up the enormous influx of new supply into the marketplace, which lead to major price decreases in response to the supply increase.  Additionally, the Pre-Recession Off-Price Retail Framework for protecting brand dilution collapsed under the financial imperative for the solvency of the firm (i.e. brand dilution doesn’t really matter if the brand cannot continue as a “going concern”).

Gilt was strongly positioned to acquire highly desirable product at highly favorable prices & distribute them to a demographic at significant discounts.

3.  Facebook & Twitter Enable Audiences of Scale Flatten Information Asymmetries:

Before the Great Recession, the world of off-price retailing was fueled by information asymmetries to drive purchasing.  In response to the Great Recession, the business position pivoted from being responsive (relying on the customer to incur transportation costs and visit an off-price retailer) to proactive demand generation to inform the consumer that an off-price retail opportunity was available.

Gilt’s changed the world of off-price retailing by proactively delivering the retail experience in a work-flow optimized manner (directly in the member’s email) that generated new demand through the use of newly assimilated technologies

4.  Technology Adoption & E-Commerce Assimilation:

In 2008, the technological landscape was undergoing a dramatic change with customer’s gaining more experience & fluency with online retailers like Amazon & Zappos, Apple’s iPhone driving integration of the web more closely into the daily lives of smartphone users, and retailers more fully embracing email & internet marketing as core channel in their marketing & communication strategy.  It was these developments in the technical landscape of e-commerce that drove an acceleration in e-commerce fluency for the average web-user.

Gilt’s as an online retailer was enabled by the rapid rise in sophistication of the average consumer and delivered a platform that was truly responsive to this medium.

Part 2 -->  The Rise of Gilt Groupe: Gilt Ascends to Dominate the US Private Sales Landscape