Farfetch is an online luxury fashion retailer, a company that pioneered a tech-driven model that doesn’t rely on owning inventory.
They platformized the supply chain and created a new business model around high margins and fast turnover, shifting the retail fashion model in the process. Let’s dig a little deeper to see how they did it.
How does Farfetch make money?
Farfetch builds relationships with high-end fashion boutiques and brands, integrates them into their eCommerce back-end, and then sells their product to customers on Farfetch.com.
Unlike other platforms that look similar – like Yoox – Farfetch does not bear any inventory cost. Their original business was built around an innovative, technology-driven retail model where they make 25% commission on the sale of the goods, plus another 8% if they fulfill the order.
The key innovation is a retail model that is technology-enabled but doesn’t rely on owning stock
Felix Capital
The two customer profiles on the supply side are boutiques and brands. Boutiques do not have a website (or at least not a fully-functioning eCommerce site) and the brands opt to outsource their operations to Farfetch.
Combined, it gives Farfetch a dynamic inventory of luxury fashion, both men’s and women’s, from around the world. CEO Jose Neves’s vision was built around the idea of ‘distributed stock‘ where a particular item could be ordered, shipped and delivered to a customer in another country or continent.
The model of the future is distributed stock. The new inventory is made up of dozens — hundreds, in our case — of micro-warehouses.
Business of Fashion
Farfetch went public (Ticker: FTCH) September 21, 2018. As a result, they now report earnings each quarter and have subsequently reported around 3 revenue streams:
- Platform Revenues (~74% of Revenues)
- Platform Fulfillment Revenues (~23% of Revenues)
- In-Store Revenues (~3% of Revenues)
As Farfetch has grown in size, they have expanded their footprint, both online and into physical retail stores in select cities. Average order size has stayed ~$650 consistently over the last 5 years, meaning that they generate ~$150 USD in Platform Revenues per average fulfilled order, and then additional revenues on the back-end of the supply chain to deliver these orders.
Community-Centric or Commercial-Partner Strategy?
Beyond its business model, one thing that makes Farfetch unique compared to other tech startups is the fact that it’s a European-based brand that didn’t take any VC money from Silicon Valley. Part of the European story is the way that the company formed out of a community between Euro-based fashion brands and partners in London and Porto.
… there are many special moments but here is one that resonated particularly strongly when it happened, at one of the company’s “Gatherings”. José had pioneered the event early in the life of the company, to cement the relationship with our key partners, and create a stronger sense of community, gathering all the boutique owners and brands to Porto or London, once or twice a year for a couple of days (hundreds of people connecting). This was a great opportunity to meet many boutiques and brand owners, to explain the development of the Farfetch platform, and get feedback from users.
Felix Capital
This is one very interesting example where the foundations of the company are rooted in the community, yet the business model required partnerships to grow to scale. That’s because Farfetch’s main value proposition was the hybrid between fashion and technology, right-brain and left-brain, creatives and engineers.
Given the need to take an order from a customer in New York, fulfill the order in Hong Kong, and then ship it to the customer in New York – multiplied by millions of orders – it was essential that Farfetch has strong partners in both the fashion and technology worlds.
Interestingly, over the years and until the IPO, capital came essentially from European investors (Advent, Index, Felix or Vitruvian), strategic investors (such as Conde Nast, Chanel) and Asian investors (most recently JD.com). The company did not raise money from Silicon Valley which did not connect culturally with the luxury and fashion opportunity
Felix Capital
Capital came from a mix of investors – European VCs, Strategic Investors and eCommerce companies. Talent was poached from fashion brands and media houses in the early years to help shape the brand. When the company crossed the Unicorn Mark of $1 billion valuation in 2015, they had a development team of more than 200, something no other fashion brand was doing.
Nowadays, it has partnerships with major fashion brands such as Chanel, social-good platforms like Kiva (Positively Farfetch), and innovative pilot programs like Second Life where they aggregate second-hand goods for luxury retailers and offer users a credit to spend on Farfetch.
Overall, we see a hybrid between a community-centric strategy within the fashion world and a commercial-partner strategy to help achieve scale. The competitive advantage linked to this strategy is that they have exclusivity with 98% of retailers on their platform.
Fundraising and Valuation
Farfetch (Ticker: FTCH) went public last year, in Q3 of 2018, raising $885 million at a valuation of $6.2 billion – priced relative to its $385 million revenues in FY 2017. Despite surging 53% on its first day of trading, the company currently trades at a market cap of ~$2.5 billion due to investor concerns over its business model.
As we have seen is the trend in 2019 with Unicorns going public, concerns mount among Wall Street and large Financial Institutions around these companies abilities to generate significant and sustainable, long-term profits. In Q2 of 2019, the company lost $90 million.
Furthermore, they spent $675 million on the New Guards Group acquisition in order to ‘future proof the business model’ by having an exclusive platform to launch new brands.
Prior to going public, between 2010 and 2017, the company raised approximately $700 million. Given the company’s successful IPO, those private investors would have all made money; however, the new group of public investors is underwater.
The key challenges surrounding Farfetch’s business model in the current environment are three-fold: rising customer acquisition costs (CAC), lack of clarity on the revenue model given the new acquisitions, and deepening quarterly losses.
Farfetch Business Model Canvas
A business model is defined as:
“the rationale of how an organization creates, delivers and captures value.”
Alex Osterwalder et al invented the Business Model Canvas to help individuals and organizations conceptualize how to analyze, create, and develop business models.
Farfetch Value Proposition
- Future fashion retailer. Combines a zero-inventory eCommerce model with distributed bricks-and-mortar warehousing and sales
- More than 3,000 curated brands for consumers
- Boutique brands don’t have to build their own eCommerce channel
Farfetch Business Model Analytics
Farfetch drives its Margin (or Take Rate) by effectively splitting the Retail Margin with the retailer. In most cases, the Value Proposition that Farfetch offers to the retailer exceeds the loss in Margin through their collaboration with Farfetch; plus the retailer typically gains significant additional volume when they launch on Farfetch.
This type of business model can really only work in luxury retail where you have a high AOV and a high number of repeat customers.
AOV (Average Order Value): ~$600 USD Gross (Profit) Margin: ~45% Repeat Customers: ~55%
As of 2018 (when they IPO’d), their business model was fairly clear. The strength of their model was their LTV (Lifetime Value) they generated relative to their CAC.
They were able to stabilize their CAC (Customer Acquisition Costs) and continue growing their customer Cohorts on a quarterly basis, thereby creating a profitable business model at scale.
The business model analytics that were outlined here, along with those shared by Theta CLV in their Customer-Based Corporate Valuation (CBCV) model, showed the true value that the company was creating beyond technology. In fact, LTV (Lifetime Value) became the headline metric that was shared by their CEO in many of their future quarterly earnings calls, highlighting the importance of customer loyalty (hence low Churn) to the underlying business model.
Farfetch-Richemont Partnership
Farfetch has had a very bad 2022, with its stock down nearly 90% YTD (Year-to-Date) and almost 95% from its Q1, 2021 peak.
There are a myriad of reasons to try and explain Farfetch’s fall from grace, which include (but are not limited to) the following:
- Poor M&A (Mergers and Acquisitions) selection and execution
- Increasing CAC (Customer Acquisition Costs)
- Shifting their core focus away from fashion into markets like ‘digital goods’
- Macro trends and events that have affected the luxury market
Farfetch built an innovative business model that was effectively a license to print money in luxe fashion, but have spread themselves so thin to the point where their P&L is difficult to understand.
Even though Farfetch did have a profitable year in 2021 with a net income of $1.47 billion, it was driven by a $1.64 billion gain from embedded derivatives (within convertible notes), a $156 million gain from Chalhoub put option, and a $246 million gain from Alibaba and Richemont put options
Seeking Alpha
At the beginning of December 2022, they hosted a Capital Markets Day and outlined a new strategy and partnership deal with luxury fashion house Richemont.
“Pending regulatory approval, we’ll be adding Net-a-Porter, Mr Porter and the Outnet, plus Cartier and Chloé followed by an additional four Richemont brands in 2024,” says Kelly Kowal, chief platform officer. The remaining 12 Richemont brands will be integrated in 2025.
Vogue Business
This deal comes on the heels of acquiring a 47.5% stake in YNAP (Yoox, Net-A-Porter) in August from Richemont in exchange for 50 Million+ FTCH shares, a deal that forced Richemont to take a €2.7 Billion write-down from their acquisition of the companies in 2018. The deal comes with the possibility of Farfetch acquiring the remaining shares in the future.
From the Farfetch side of the equation, it does three key things:
- consolidates Farfetch’s control of the eCommmerce distribution channels for luxury (which is why they state ‘pending regulatory approval’)
- moves Farfetch deeper into the ‘hard luxury’ game, as luxury brands like Cartier (watches), Van Cleef & Arpels (jewelry), and Buccellatti (jewelry), giving Farfetch an expanded market presence with brands who do not work with other wholesale partners
- expands the ‘Shopify Component‘ of the Farfetch business model – Platform Fulfillment Solutions – which is used by other high-end luxury fashion brands
More growth is planned for its Farfetch Platform Solutions business, the whitelabel arm of the company used by Bergdorf Goodman, Ferragamo and others to run their e-commerce sites.
Vogue Business
Farfetch Outlook – 2023 and Beyond
Despite market corrections due to rising rates, consumer pressures due to inflation, or macro events that cause supply-chain disruptions, there is no escaping responsibility if you are managing a publicly-traded company that is down nearly 95% in 18 months.
Even since the Capital Markets Day on December 1st, the stock has continued to plummet, down about 50% since that day. Despite enthusiasm on the recently announced deal, skepticism remains about the future profitability of the company due to their declining net margins.
We can again see that the idea of profitability seems incredibly farfetched given Farfetch has never been able to deliver a positive operating margin and given total SG&A has a strong tendency of surpassing gross profit
Seeking Alpha
But we know that markets offer rare ‘buy-low-sell-high’ type opportunities, and since we are talking about a company that could once again dominate luxury eCommerce markets around both fashion and hard luxury, its ~$1.65 Billion market cap will look like a ‘potential opportunity’ from afar for some investors.
The company guides towards a $10 Billion EBITDA in 2025 in the following areas:
- Farfetch Platform Solutions (FPS) is projected to bring in $4.3 Billion in GMV (Gross Merchandise Value) in FY 2025 and become the dominant revenue stream, with annual growth rates increasing exponentially due to the Richemont deal+
- Marketplaces is projected to bring in $3.8 Billion in GMV in FY 2025, yet will become the secondary revenue stream and only grow at 5 – 10% annually
- Brand Platforms is projected to bring in $1.5 Billion in GMV in FY 2025, with annual growth projected at 5 – 10%
The kicker is that FPS is projected to see EBITDA Margins of 20%, while Marketplaces and Brand Platforms only are expected to see EBITDA Margins of 5%. As a whole, they guide to a FY 25 adjusted EBITDA Margin of 10%, which is why the stock continued to decline since Capital Markets Day.
From a purely business model perspective, it seems that the company’s struggles with rising CAC Costs put tremendous pressure on the Marketplace margins, where GMV actually declined in real-terms in Q3 ’22 due to forex losses.
The business model shift towards FPS via the Richemont deal makes a lot of sense for Farfetch. Markets didn’t react well to the company’s FY 25 forecast because they are in a ‘prove it’ mode right now. Really any company that has had a ‘growth-first, profitability-later’ story has been hammered in 2022.
Ironically, it is the earliest-stage CBCV concepts discussed by ThetaCLV at the Farfetch IPO that will likely determine whether Farfetch is successful in returning to prominence:
- Finding New Channels to lower CAC costs – you have to wonder how much the company is dependent on Paid vs. Organic at this point
- Customer Retention – what made their business model work early stage was an ability to retain the majority of New Customers and convert them to Returning Customers
- LTV Focus – the company used to be heavily focused on Lifetime Value of its customers
The majority of the narratives around Farfetch focus on top-line revenue growth. Even in their Capital Markets Day 2022 Presentation it is predominantly about the top-line amid a fairly complex ecosystem of various brands and product offerings.
Much of their current LTV strategy around centers around ‘Private Clients’ (who have much higher AOVs) and the ‘Loyalty Program’ (to increase engagement). As we know relative to CAC, as markets grow the CAC increases. In luxury markets, this effect is likely multiplied.
While ‘vision’ is what turned Farfetch into a luxury-fashion, eCommerce phenomena several years back, the Street expects profitability. As we look into 2023 and beyond, ‘mixed signals’ is the best way to describe what to expect:
- Farfetch has the levers for growth and the technology to execute, but their strategy is in the crosshairs.
- The business model has a lot of moving pieces, yet FPS could bring a lot of stability to their bottom-line projections and improve investor confidence
- Is a loyalty program and focus on private clients the best way to re-ramp their LTV/CAC metrics? Doubtful, but time will tell.
Top 3 – Learn More
Is Top SEO Positioning the New Prime Retail Space?