Sustainable Fashion Marketplace Business Model

The Sustainable Fashion market is heating up and with that comes new market entrants – big and small.

While everything sustainable sounds innovative and exciting, the realities of any new segment in retail is that the margins still matter. That’s why we dig into the margins to see how the business models in #SustFash are evolving.

Sustainable Fashion Business Model

A sustainable fashion business model?

“It’s about future-proofing their business models,” said GFA’s Kruse. “Those ready to adapt and rethink the models will be the ones that will survive best.” 

Business of Fashion
Fashion - Billions of Garments Made Annually - Sustainability Visual
Source: Business of Fashion

While the world’s most renowned fashion house are themselves trying to clean up their act and become more sustainable, there are a host of marketplaces that have started up to themselves become the future leaders in the sustainable fashion segment.

The average consumer browsing on one of these marketplaces may not know how the business itself works with its brand network/partners, which is why we are going to contrast the business model between e-Tailers who traditionally hold/purchase inventory, and the Platforms that simply process the transaction and hold no inventory themselves.

All of the major eCommerce brands in fashion themselves have a sustainable fashion arm:

  • Yoox – YOOXYGEN
  • Net-a-Porter – Net Sustain
  • >Asos – Green Room

Then there are the major women’s sustainable fashion brands that have built a cult following like Reformation, Everlane, and many others.

We are not going to talk about the major eCommerce brands, nor the major women’s sustainable fashion brands in this post. There are many lists that highlight the best ‘Sustainable Fashion Stores‘ online, which will number in the 100s or maybe even 1000s globally.

We are going to focus on the model of the smaller sustainable fashion e-Tailers like Reve en Vert, Mamoq, etc. who must scale their core business model around sustainable fashion alone without relying on any pre-built scale from traditional business lines.

We will then contrast this against the platforms like Farfetch who operate a high-margin marketplace business model that is completely different from the traditional eCommerce model.

e-Tailer Model versus Platform Model

The value chain starts with a cottage industry of small, sustainable fashion brands who source materials, hire designers, and produce the garment(s) unique to their brand. For them, cashflow is usually tight depending on their size, so they prefer any business model where they get cash upfront to feed into working capital.

The margins in fashion for the brands that produce them can be ridiculously high, but in sustainable fashion where there is an emphasis on ethically-sourced materials, craftsmanship, and eco-conscious production practices, they don’t typically produce a $10 shirt that can be sold for $40.

Their goods skew towards luxury, yet by listing them on certain sustainable-fashion platforms they hope to avoid that cachet.

In any respect, assuming that we are not talking about fashion brands that are primarily D2C (Direct-to-Consumer), large wholesale orders are the best-case scenario for young brands. Consignment can work as well, depending on the brand.

A platform-marketplace model where they don’t receive payment for 14 – 30 days (as is typical) is not ideal unless the volumes are high.

There are many emerging niche eCommerce Retailers (e-Tailers) in the segment like Reve en Vert, etc. who buy and sell from suppliers on a wholesale or consignment basis, then mark up the price and sell it to their own consumers. These e-Tailers all tend to be low-margin, as we will see below, and require high-volume to make any money in the mid to long-term.

They also carry inventory risk but can get up and running on eCommerce platforms like Shopify and avoid big investments in technology.

Then there are innovative platforms like Farfetch (Platform model) that hold no inventory and take a % of each sale. Inspired by Farfetch, there are a small array of affiliate-like platforms like Market45, etc that hold no inventory and direct their customer base to purchase from a curated network of sustainable fashion brands.

The Take Rates (as a % of Gross Merchandise Value) tend to be 20% or more on the Platform models, but they require an investment into the creation of the digital platform and corresponding logistics/inventory management system; therefore, the lack of inventory risk is sometimes offset by the required investment in technology.

Then there are ReCommerce (Resale Commerce) models like thredUP and RealReal that are selling secondhand clothes to consumers at high margins – they tap into the sustainability category as well, but only sell Resale garments.

Business Model Innovation - Resale Fashion Banner

BMi – Resale Fashion

We won’t analyze ReCommerce in this post, we only mention it to say that there is crossover between the secondhand/vintage market and what is defined as ‘sustainable fashion.’ Both models – e-Tailers and the Platforms – can use these categories of products to bolster their own product mix and overall strategy, but it doesn’t change the business model overall.

Fashion e-Tailer Model

The data presented below is hypothetical and used only to give a picture of the mechanics of the business model.

With so many sustainable e-Tailers launching in the marketplace, on pace with the trend of rapidly-expanding demand and market size, it is important to remember that despite the enthusiasm and excitement in the market, these companies are governed by the the margins of the eCommerce business model.

In sustainable fashion, in particular, one of the challenges is the pricing relative to the mainstream market. Most of sustainable fashion is small-scale producers who are making goods using:

  • premium materials (organic cotton, ethically-sourced wool, etc)
  • market-sensitive labour (paying workers a fair wage for the market it is produced in)
  • on-shore, sustainable production methods (make the garments ‘on shore’ in Western countries, testing new production methods)

Because the actual supply of these ‘sustainable garments’ (what is defined as sustainable is still open to interpretation) is somewhat limited, and demand is strong, the prices of these garments would naturally be higher than mainstream garments.

But since consumers in the sustainable fashion category tend to be younger, and more eco-conscious, they are not as likely to make large orders as the typical mainstream consumer.

Furthermore, because the industry is so nascent it makes it challenging for e-Tailers to bundle products as efficiently as they would in the normal retail model (ie. cross-sell certain shoes with a certain dress).

This means that despite the pricing being premium relative to fast fashion, the Average Order Values (AOVs) are not likely to be similar to the luxury fashion segment, which will thus in-turn require most sustainable-fashion e-Tailers to generate significant volume to make money.

eCommerce Fashion Business Model

For every garment(s) sold there will be a corresponding Gross Margin, which nets out the costs to deliver the product to the end customer.

Sustainable Fashion Marketplace - Gross Margin Visual

Landed Cost

Whether goods are purchased wholesale or through consignment, the average e-Tailer will probably markup the cost of the garments between 2 – 2.5X the landed costs, depending on various factors.

Packaging (+ $3.50 per order)

RePack – a European pioneer in Sustainable Retail – offers sustainable packaging innovation to avoid having to send consumers throwaway packaging with each and every order. This type of packaging will be slightly more expensive than traditional packaging (thus affecting margins), but likely to be necessary to help the industry deliver on its value proposition to be more sustainable than industry peers.

RePack Visual - Sustainable Fashion (packaging)

Shipping (+ $10 – $20)

Many sustainable fashion marketplaces offer ‘free shipping’ on orders over a certain amount (typically $100). There are usually geographic restrictions as to where these bands apply, but generally you are looking at a minimum of a $10 shipping cost that gets eaten at the margin on any e-Tail platform.

Taxes & Duties (if applicable)

Thank god for modern-day eCommerce software to help manage the complexity of these rates, as it can get quite confusing. Some countries like the UK bundle the tax (VAT of 20%) into the price, while other countries like Canada add the GST (Goods & Services Tax) on top of the price. Duties depends a lot on trade deals between nations, but remains relevant with so many of the world’s top clothing brands being based out of Europe.

Payments (1 – 2.5%)

While a small percentage of the whole, payments fees will add up in the long run. The fees will be dependent on volume and who the payment processor is, but on average they are sitting at around 1.5 – 2.0% these days.

Gross Profit and Net Profit

In total, between all of the Logistics Costs (Free Shipping, packaging, payments, etc.) and Returns, they will account for a Cost of Revenue (or Costs of Goods Sold) that is roughly 30% of the retail price of the garment. When you factor in the landed cost, that leaves an estimated Gross Margin of let’s say $40 – $50 (30%*) on a $150 Garment.

That actual Gross Margin will be netted out based on discounting and any inventory that is sold to outlets, a new trend that is emerging in retail as a result of the Retail Apocalypse + Pandemic dual combo.

For argument’s sake, let us say that the actual Gross Margin on each and every garment sold here is 25%.

Fashion eCommerce Visual - Margin & Gross Profit per order

If the Average Order Value (AOV) is $150, then that means the Gross Profit would be $37.50* on every order.

  • 100 Orders would be $3,750 in Gross Profit
  • 1,000 Orders would be $37,500 in Gross Profit
  • 10,000 Orders would be $375,000 in Gross Profit

Volume is required to make the business model work, because the Gross Profit must be applied against all of the costs to actually run the business, including:

  • Operations (Customer Service, Warehousing staff, Logistics software, etc)
  • Sales and Marketing (Marketing Teams, Ads, SEO, PR, events, etc.)
  • G&A (General and Admin Costs) including executive salaries, legal, etc.
  • Warehouses, Leases (any Fixed Costs)

Let’s say these costs were applied monthly, and the total amount was $25,000 per month. That would be $300,000 per year (12 x $25,000) to run the business (Operational Expenses), which is excluding any Interest on debt, Taxes, etc.

Fashion eCommerce Marketplace Visual - Net Profit

10,000 Orders per year would generate a Net Profit of $75,000 in this example. That is ~833 Orders per month. The Break-even point on this model would be 8,000 Orders per year, which would be ~667 Orders per month.

The higher the volume, the more that economies of scale can be used to reduce costs and generate higher margins; the problem is that this is partially antithetical to the entire principle of sustainable fashion, which can’t itself scale-up to the levels of fast fashion in the same way.

That’s why the majority of sustainable fashion e-Tailers are likely to become niche players in the long-run, as we will see when we look at the Platform Model.

Fashion Platform Model

Just like in the mainstream market, certain entities who understand the fashion business model and the realities at the margins have gone on to build tech-enabled marketplaces where they simply sell the product on behalf of the brand and take a % of the profit.

The Farfetch Model – Positively Conscious

Farfetch has its ‘Positively Conscious’ fashion line, which is representative of its selection of designer ‘sustainable’ goods.

Farfetch - Positively Conscious Marketplace
Farfetch – Positively Conscious

Farfetch discusses the entire strategy is has around ‘Positively Farfetch’ in its recent Annual Report.

Farfetch aims to be the premier platform for good in luxury fashion, while empowering everyone we work with to think, act and choose positively.

Farfetch – 2020 Annual Report

Notwithstanding its ambitions to affect change in the market, Farfetch’s business model operates with high Take Rates (28.8%) and Gross Margins (46%). Their Take Rates (the % of a good’s retail price that they take in as Revenue) are net of any of the ‘Logistics’ costs that we discussed above.

“Farfetch accepts products from boutiques generally starting from €80. Exceptions are made for items with a very deep stock or best-sellers. When Farfetch launches with a new boutique partner, it covers for the first three months the costs of sending the product to the studios in Portugal to be shot and uploaded on the website. The commission for shops is calculated as 26.8% of the net item price (price paid by the customer, excluding shipping costs and taxes). In addition to that, the boutique is responsible for the operating expenses of payment handling, fraud management, credit card fees (2.5% on the final transaction value), packaging (EUR 1.50 per box) and free returns (1.5% on the net item price).”

Farfetch Distribution Strategy – Case Study

Once Farfetch has onboarded and merchandised stock from a new boutique or atelier, the other party is responsible for order fulfillment costs, payments costs, and a cost related to free returns.

This ‘commission’ mentioned in the quote (26.8%) above is the Take Rate, and is industry leading because of how advanced Farfetch’s inventory, distribution, and supply-chain management system is.

Farfetch - Margin Visual
Source: Farfetch S-1

This model is the same for Farfetch’s selection of garments from luxury brands and sustainable brands; therefore, not only do they have the reach and resources of $20 Billion company, but they also have a business model that enables them to sell sustainable garments and make money.

Keep in mind that while Farfetch holds no inventory, they are not simply an affiliate where they drive demand to a given boutique or brand and that’s it – their product is their entire platform to manage the transaction from end to end, ensuring the end consumer has a positive experience.

Fashion Affiliate Model

The ‘Farfetch model’ has inspired many smaller platforms to try and operate in the sustainable fashion sector as marketplaces, where they similarly index an array of products, merchandise them, process the transactions, and take a % of the sale. The transaction processing can occur on their own site or on the brands’ own website depending on the economics of the model.

The difference is that the affiliate-like platform is finished with the transaction at that point, the corresponding brand/boutique is responsible for everything related to distribution, packaging, returns, customer support, and everything else in relation to the customer experience.

Farfetch – in contrast – has its own packaging, deals with customer support on orders, offers returns to any store that is part of its partner network and owns the customer experience. It aligns its incentives with all the brands and boutiques on its platform.

Farfetch Bespoke Packaging

The problem with the affiliate model is that the goal is simply to drive volume to its own network of boutiques and brands – they will typically take a % of the top-line revenue that can range from 10 – 40%. As we can see above, however, if this amount is being charged to a boutique as what can effectively be called a Customer Acquisition Cost (CAC) then it eats into their already tight margins.

An emergent brand that actually makes the clothes may be happy to lose margin to increase sales in the early-stages, but at scale the model requires increasingly sophisticated logistics, inventory managements, and customer support to manage. Without the holistic value proposition that Farfetch offers, it is difficult to see this model emerging as a winning model in the future.

Loyalty & LTV (Lifetime Value)

ARPU, CAC, LTV Unit Economics - Business Modelling banner
Modelling – ARPU, CAC, LTV

And so in the maze of trying to make sense of the different business models for sustainable fashion marketplaces, we come back to the simple principle of loyalty and LTV.

Whether a marketplace goes the eCommerce/e-Tailer route or the platform route, they will need to create a memorable customer experience that makes any consumer loyal to them.

When we look at the LTV Calculation, we can see that the way to win in the retail market is to create a loyal customer base where the majority are repeat buyers that will continue to purchase products over several years time.

LTV = Lifetime Value ARPU = Average Revenue Per Users CAC = Customer Acquisition Cost

LTV diagram

The goal is to build large Cohorts of high-value customers who spend repeatedly over the long-term.

ARPU diagram

While a relatively new concept in the world of retail and eCommerce, we have explained how the concept of Customer-Based Corporate Valuation looks at the data on consumer behaviour with leading online brands like Farfetch to determine how much a customer is likely to spend over time, versus how much it costs to acquire that customer.

The more Repeat Customers, the lower the CAC, and the higher the LTV.

Farfetch - Repeat Customers vs. New Customers (2017)
Theta CLV – Farfetch

Generally, CAC trends up over time as markets become more competitive. In this period of time below, Farfetch was able to keep their CAC flat, an impressive feat.

Farfetch - CAC data 2015-2018
Theta CLV – Farfetch

Quarter over quarter, we can see ARPU per customer post acquisition. This leads to a high LTV.

Farfetch - Revenue per Customer since acquisition
Theta CLV – Farfetch

Farfetch’s LTV/CAC ratio is one of their key headline metrics for assessing the profitability of their business model.

Farfetch - LTV/CAC ratio 2015-2017
Farfetch S-1

What these images collectively show is that once you originate a customer on a given platform, you want to keep that customer coming back and spending over the long term.

Farfetch customers generate approximately $500 in marginal profits after they are acquired, in net present value terms.

Theta CLV – Farfetch

These ‘marginal profits‘ offset all the costs we discussed above about margins. The reason is because Gross Margin is – ex – Customer Acquisition Costs (CAC). If an e-Tailer sells a garment for $150, makes $37.50 in Gross Profit, but then needs to spend $20 – $30 in Marketing Costs per customer, there is virtually no marginal profits (~$15 net of CAC) generated on that initial transaction.

But if the customer comes back and keeps spending each quarter, for example, then the marginal profits generated for each repeat purchase is the full $37.50 in gross profit. The ‘Cohorts‘ profiled above are always a segment of the total customer base. As a base assumption, assume that the top 20% of any customer base will drive the majority of purchasing.

If an emergent marketplace in sustainable fashion can get the top 20 – 30% of their customer base to become repeat purchasers, then these marginal profits will help vastly improve the chances of the business model succeeding for that respective platform or eTailer. The strategy of how to drive loyalty is another story, but the data is certainly clear that it can dramatically improve the margins for any business.

Early Days For Sustainable Fashion Marketplaces

While there are many platforms/brands – both incumbents and upstarts – that will jump out to an early lead in this market, it is very early days. The process of transitioning an industry that produces 100s of Billions of garments globally every year with more sustainable alternatives will be a long one.

That’s why understanding the mechanics of the business model of sustainable fashion marketplaces is so important, as selling sustainable clothes is one thing, but building a sustainable business model is a whole other thing.

Overall, sustainable fashion is an exciting, high-growth segment that is leading to innovation across the whole value chain. The marketplaces that have popped up to capitalize on the trend will need to themselves innovate and adapt at the margins in order to thrive long-term.

More Fashion Posts

Business Model Innovation – Resale Fashion

Business Model Trends – Vintage Fashion Resale

Business Model Canvas – Farfetch