E-commerce grew at an unprecedented rate during the pandemic, but now the days of strong growth appear to be short-lived. After online shopping grew 30 percent year-over-year in 2020 in the US and Europe, a new reality is coming. Between 2022 and 2025, e-commerce is expected to grow at a compound annual rate of 10 percent in the US and 11 percent in Europe — much closer to the pre-pandemic levels seen between 2016 and 2019, where e-commerce grew 14 percent in the US and 15 percent in Europe. In China, online retail sales have grown less than 10 percent since the end of 2021, after growing more than 16 percent year-on-year in 2019.
Regardless of the extent to which fashion brands have built their businesses around direct-to-consumer sales online, slowing e-commerce growth requires a careful recalibration of channel strategies. Pure-play DTC brands themselves can offer lessons to others on how to manage the changes to come.
When the new generation of DTC labels hit the Internet over the past decade, the fashion industry was ripe for innovation. These DTC start-ups, backed by millions of dollars in venture capital, won over consumers with an enticing premise. By avoiding third-party retailers, they assumed they could break free from traditional trading restrictions to offer more innovative products, a wider range and a higher level of customer service than other brands. To get the word out about their products and services, they took advantage of earlier waves of low-cost, high-precision targeting in digital marketing.
“DTC” soon became a popular acronym in the industry, as digital brands in the category expanded rapidly. Canadian jeweler Mejuri, Brazilian brand Farm Rio, French contemporary brand Sézane and Chinese cosmetics brand Perfect Diary are among the companies that have grown in popularity among consumers.
The DTC model was further validated when the pandemic hit and most brick-and-mortar retailers were forced to close, either temporarily or permanently. Department stores that were already under financial pressure, such as Debenhams in the UK, filed for bankruptcy.
Meanwhile, established global brands such as Prada and a number of sportswear players have been shifting their focus to DTC channels, in a strategic move to gain first-party customer data amid increased e-commerce adoption and ongoing challenges to wholesale channels.
But in 2022, cracks appeared in the digital pure-play model. As DTC brands began to go public, their share prices began to fall. Share prices of 10 DTC apparel brands fell about 70 percent in the first three quarters of 2022, compared with a 32 percent decline in the MSCI World Consumer Discretionary Index over the same period.
For many digitally focused brands, profitability has proven elusive. A structural challenge many of these brands face is their narrow assortment: brands like Warby Parker and Allbirds are looking for ways to expand their offerings in an attempt to generate repeat purchases for a limited assortment.
Another major and growing challenge is the rising cost of digital marketing as social media platforms become more crowded and competitive, and new privacy regulations limit customer targeting through digital channels.
E-commerce brands also struggle with high return rates that squeeze margins. On average, retailers pay between $21 and $46 per returned product, including shipping, handling and other costs. In the US, return rates across all sales channels rose to 16.6 percent in 2021 from 10.6 percent a year earlier, with the average return rate for online orders even higher at 20.8 percent. US multibrand online retailer Revolve reported a return rate of 54 percent in the first quarter of 2022, while Boohoo’s UK return rate reached 33.7 percent in April, up almost 10 percentage points year-on-year.
Developmental role of physical retail
While brick-and-mortar chains have been forced to shrink their footprints or close entirely as much of the investment in the fashion industry has gone online in recent years, the decline in brick-and-mortar retail appears to be stabilizing. In 2022, US store openings outnumbered store closings for the first time in at least three years. Although retail traffic remains between 10 and 20 percent lower than in 2019, store productivity has increased: in the US, sales per square foot are up 13 percent year-on-year in 2021.
A number of digital brands have invested in opening their own brick-and-mortar stores, finding it difficult to make a profit through online DTC channels alone. Everlane opened its first permanent brick-and-mortar store in 2017 and now operates 10 stores across the U.S., despite its founder’s famous claim in 2012 that he would “close the company” before opening a brick-and-mortar store. Allbirds operates 54 stores globally as of September 2022, while Warby Parker has announced plans to expand its footprint to 900 stores.
Brands researching physical conditions may find that rents are more affordable in many key urban markets than they were before the pandemic. Rents in shopping centers and high streets in the UK fell between 20 per cent and 30 per cent compared to 2019 levels. In the US, shop vacancy rates in 2022 exceeded 2019 levels. Landlords became more favorable retail partners by offering special terms such as rent escalation, where the brand pays a low rate at the start of the lease followed by an increase over time in line with performance, thereby sharing the risk of opening a new store with the landlord. Menswear brand Drake’s has benefited from such conditions at its New York location, so if the brand performs well, the landlord is paid more rent.
At the same time, the role of brick and mortar is evolving. In order to generate more revenue, stores should be digitally enabled and fit seamlessly into the overall physical-digital multi-channel strategy. Strategies such as integrating mobile apps to optimize the in-store experience for customers can drive higher sales in each store, while radio frequency identification (RFID) product tags allow brands to track and maintain appropriate inventory levels. With one store already in Los Angeles, Amazon Fashion opened its second brick-and-mortar store in Columbus, Ohio, in October 2022 with a range of technologies, including allowing customers to scan QR codes using the company’s shopping app and add products to the fitting room.
The stores also provide marketing value, allowing brands to bring their aesthetics to life, such as Balenciaga’s faux fur pop-up for the launch of the Le Cagole bag in central London, or Uniqlo’s flagship store — also in the UK capital — showcasing the restored art-deco design of a 1920s barbershop. which previously occupied the space. Others offer spaces exclusively to high-end customers, such as Chanel’s plan to open boutiques that will be accessible only to high-spending clients, starting in key cities in Asia.
“Retail is the last point where you can actually strengthen the relationship you’ve already built through wholesale and through DTC [online]”, said Andrea Baldo, CEO of Ganni, which expanded from digital channels and wholesale partnerships to monobrand stores.
In a similar way that brands (and their landlords) are rethinking brick-and-mortar stores, department stores are changing their approach to partnering with brands. This can create opportunities for brands even as department stores continue to face their own inventory and foot traffic challenges, and have historically required the brands they sell to agree to less favorable terms around delivery schedules and discounts.
“Before, traders dictated terms; now it’s a collaboration, a partnership between brands and retailers,” said Domi Szabó, group wholesale director at European fashion holding Vanguards.
Carefully selected partnerships with high-quality wholesalers and multi-brand retailers can create value for brands. DTC unicorn Glossier, for example, announced its first wholesale makeup and skin care deal with Sephora in 2022, significantly expanding the brand’s distribution. In 2022, analysts credit a 20 percent increase in sales of sportswear brand Puma in the first quarter of 2022 to a newly expanded wholesale strategy.
Department stores and boutiques are increasingly willing partners in special retail installations, which can benefit both the retailer and the brand. Such a tie-up can help multi-brand stores attract new customers and allow brands to understand where and how to open their own brick-and-mortar stores. French designer label Jacquemus, for example, opened a high-concept, surrealist pop-up at UK department store Selfridges in spring 2022 before experimenting with its temporary locations in other cities in the months that followed.
Even as e-commerce loses its pandemic-era appeal, brands are exploring ways to reach new customers online beyond social media and their own websites. In China, where platforms such as Tmall, Taobao and JD.com are well established, third-party marketplaces account for as much as 80 percent of luxury e-commerce spending. Outside of China, many brands are considering new or expanded partnerships with marketplaces such as Zalando and Farfetch, which offer access to large customer groups and can allow brands to control their own shipping and logistics. In the US, retailers such as Macy’s and Walmart have launched their own marketplaces to compete online.
At this point, only a handful of companies with the highest levels of brand loyalty — like Chanel or Nike — or clean slates — like Zara, H&M and Uniqlo — have shown they can drive growth through a DTC-first model.
This is how the handbook for physical stores and wholesale has evolved. Today’s customers expect brands and retailers to intertwine digital conveniences with physical services, such as the ability to pick up or return online orders in stores. As such, physical presence is increasingly critical to scale, and innovative store formats are key.
To be sure, direct digital channels will remain a core part of the omnichannel mix for years to come — especially for repeat brand customers. But direct sales can be complemented by a diversified channel strategy that attracts new customers and provides a strong foundation for growth.
This article first appeared in The state of fashion in 2023a comprehensive report on the global fashion industry, jointly published by BoF and McKinsey & Company.