E-commerce grew at an unprecedented pace during the pandemic, but the days of heady growth now seem short-lived. After online shopping grew 30 percent year-on-year in the US and Europe in 2020, a new reality is setting in. Between 2022 and 2025, e-commerce is expected to grow at a compound annual rate of 10 percent in the U.S. and 11 percent in Europe—much closer to the pre-pandemic levels seen between 2016 and 2019, when e-commerce grew 14 percent in the U.S. and 15 percent in Europe. In China, online retail sales have grown by less than 10 percent since the end of 2021, after growing more than 16 percent year-on-year in 2019.
Regardless of how much fashion brands have built their businesses on direct-to-consumer sales online, the slowdown in e-commerce growth requires a careful recalibration of channel strategies. Pure-play DTC brands alone can offer lessons for others on how to manage future change.
When a new generation of DTC labels came online in the last decade, the fashion industry was ripe for innovation. Backed by millions of dollars in venture capital, these DTC start-ups captivated consumers with an enticing premise. By avoiding third-party sellers, they assumed they could break free from traditional sales constraints and offer more innovative products, a wider assortment, and a higher level of customer service than other brands. To get the word out about their products and services, they benefited from earlier waves of low-cost, high-precision targeting in digital marketing.
“DTC” soon became a popular acronym in the industry as cross-category digital brands scaled rapidly. Canadian jeweler Mejuri, Brazilian brand Farm Rio, French contemporary brand Sézane and Chinese beauty brand Perfect Diary are among the companies that have gained popularity with consumers.
The DTC model was further validated when the pandemic broke out and most brick-and-mortar retailers were forced to close temporarily or permanently. Department stores 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 shifted their focus to DTC channels in a strategic move to capture first-party customer data amid increased e-commerce adoption and ongoing challenges with wholesale channels.
But in 2022, cracks appeared in the digital model of pure play. As DTC brands began to go public, their stock prices began to suffer. 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 goods index over the same period.
For many digitally focused brands, profitability has proven elusive. A structural problem many of these brands face is their narrow assortment: Brands like Warby Parker and Allbirds have looked for ways to expand their offerings in an effort to generate repeat purchases for a limited assortment.
Another big 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 across digital channels.
E-commerce brands also struggle with high returns, which erode margins. Retailers pay an average of between $21 and $46 per returned product when shipping, handling and other costs are factored in. In the US, the return rate across all sales channels increased to 16.6 percent in 2021 from 10.6 percent the previous year, with the average return rate for online orders even higher at 20.8 percent. US online multi-brand retailer Revolve posted a 54 percent return in the first quarter of 2022, while UK Boohoo’s return rate reached 33.7 percent in April, up nearly 10 percentage points from a year earlier.
The evolving role of physical retail
Although brick-and-mortar chains have been forced to reduce 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 outpaced store closings for the first time in at least three years. Although retail traffic remains 10 to 20 percent lower than in 2019, store productivity has increased: in the U.S., sales per square foot in 2021 are up 13 percent year over year.
A number of digital brands have invested in opening their own brick-and-mortar stores as it is difficult to generate 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., although its founder famously said in 2012 that he would “close the company” before opening a brick-and-mortar store. Allbirds operates 54 stores worldwide as of September 2022, while Warby Parker has announced plans to expand its footprint to 900 stores.
Brands exploring brick-and-mortar stores may find that rents in many key urban markets are more favorable than before the pandemic. Shopping center and high street rents in the UK are down 20 to 30 percent compared to 2019 levels. In the US, store vacancy rates in 2022 will exceed 2019 levels. Landlords have become 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 with subsequent increases depending on performance, thereby sharing the risk of opening a new store with the domestic. Menswear brand Drake’s has benefited from such conditions at its New York location, so if the brand does well, it pays the landlord more in rent.
At the same time, the role of stone buildings is evolving. To generate more revenue, stores should be digitally enabled and fit seamlessly into an overall physical-digital multi-channel strategy. Strategies such as integrating mobile apps to optimize the in-store experience for customers can increase sales in each store, while Radio-Frequency Identification (RFID) product tags allow brands to track and maintain appropriate inventory levels. Amazon Fashion, which already has one store in Los Angeles, 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 with the company’s shopping app and add products to the fitting room.
The stores also provide marketing value and allow brands to revive their aesthetics, such as Balenciaga’s faux-fur pop-up to launch 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 20’s barber shop . the years of the 20th century, which previously occupied the space. Others offer spaces exclusively to high-end customers, such as Chanel’s plan to open boutiques available only to the highest-spending clients, starting in key cities in Asia.
“The retail store is the last place where you can really solidify the connections you’ve already built through wholesale and through DTC [online]” said Andrea Baldo, CEO of Ganni, which has expanded from digital channels and wholesale partnerships to mono-brand stores.
Just as brands (and their owners) are rethinking brick-and-mortar stores, department stores are changing their approach to brand partnerships. This can create opportunities for brands, although department stores continue to face their own inventory and footfall challenges and have historically required the brands they carry to agree to less favorable terms regarding delivery schedules and discounts.
“Before, merchants dictated terms; now it’s a collaboration, a partnership between brands and retailers,” said Domi Szabó, director of group wholesale at European fashion holding Vanguards.
Carefully selected partnerships with high-quality wholesalers and multi-brand retailers can create value for brands. For example, DTC unicorn Glossier announced its first wholesale makeup and skin care deal with Sephora in 2022, significantly expanding the brand’s distribution. In 2022, analysts attributed 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 for special retail installations that can benefit both the retailer and the brand. Such tie-ups 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 brand Jacquemus, for example, opened a high-concept, surrealist pop-up at UK department store Selfridges in spring 2022, before experimenting with its own temporary locations in other cities in the following months.
Even as e-commerce loses its pandemic-era charm, 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 up to 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 allow brands to manage their own shipping and logistics. In the US, brick-and-mortar retailers like 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 sheer scale—like Zara, H&M, and Uniqlo—have proven they can drive growth through a DTC-first model.
With this, the manual for brick-and-mortar stores and wholesale has evolved. Today’s customers expect brands and retailers to connect digital conveniences with physical services, such as the ability to pick up or return online orders in stores. A physical presence is therefore increasingly important for scaling and innovative store formats are essential.
It is certain that direct digital channels will remain a core part of the multi-channel mix for years to come – especially for brand loyal customers. However, direct sales can be complemented by a diverse channel strategy that attracts new customers and provides a solid foundation for growth.
This article first appeared in State of Fashion 2023an in-depth report on the global fashion industry jointly published by BoF and McKinsey & Company.