Executive Summary

In the traditional wholesale relationship, brands sell their products to retailers, giving brands access to captive audiences they don’t need to build on their own. This allows brands to focus on designing and producing high-quality products, while the retailer takes care of selling to the consumer.

As both digitally-native brands (those that started selling on the internet) and direct-to-consumer brands (those that sell directly to the end consumer) have stormed the field over the last decade, wholesale has lost much of its luster.

But as digital acquisition costs continue to rise, younger brands are embracing multi-brand retail—in their own way. Many of them are forming direct relationships with retailers while also being more selective about which of them deserve their products. These new and more strategic wholesale relationships are allowing both brands and retailers more creativity and increased competitiveness in the rapidly evolving retail environment while legacy parts of the wholesale relationship are getting left behind.

This report looks at:

  • How wholesale and the associated value chain is changing and its effect on brands, investors and real estate developers across the consumer economy ecosystem.
  • How brands, investors and real estate developers can take advantage of these changes to build more sustainable businesses.

Takeaways

  • The four main jobs consumer products companies can perform—designing, manufacturing, wholesaling, and retailing—will change over time as the market evolves.
  • Digitally-native direct-to-consumer brands bypassed the wholesale relationship early on, but many are now looking to wholesale as a crucial growth channel as online customer acquisition costs rise.
  • The wholesale value chain is shifting and brands are now choosing their wholesale partners carefully, negotiating revenue shares and pricing schemes, and requiring better displays for their products.

Case Studies

Apple, Coach, Harry’s, Ralph Lauren, and Warby Parker.

What’s happening and why does it matter?

Consumer product companies can perform four main jobs:

  1. Designing
  2. Manufacturing
  3. Selling to an end retailer (wholesaling)
  4. Selling to the shopper (retailing)

A brand can do any combination of these four things and the ideal combination will change over time as the market evolves. For example, Gap successfully started out buying Levi’s jeans wholesale and selling many varieties of them, giving shoppers several options. Gap then shifted to only selling its own products, which it designed and manufactured. There are also examples of brands, such as Tommy Hilfiger, which used wholesale as a jumping-off point to begin developing its own direct channels, while others chose to focus solely on wholesale.

Traditional wholesale

With traditional wholesale, a brand designs samples of its products, puts them in a showroom for retail buyers to view, and then orders enough products to fill orders from all of the retailers. Many small- and medium-sized brands will use third-party showrooms for this process, which take a percentage of wholesale sales, while major brands will set up their own.

Once the retailer buys a brand’s products, it is responsible for selling the products to shoppers, including merchandising, customer service and advertising—tasks that cost significant amounts of money. This is where retailers earn their margin. The wholesale relationship objectively increases the price of goods, since each member of the chain—from the factory to the brand to the retailer—needs to mark up the product to make the operation cost-effective. Despite the reality that wholesale products are significantly marked up by the time they reach consumers, the wholesale arrangement has produced hundreds of valuable brands.

One of these brands is Ralph Lauren, which started out selling wholesale in 1967. Once a salesman at a men’s clothing store, the eponymous founder decided to start a line of ties. He asked the manufacturer Beau Brummel to produce his products, which Ralph Lauren sold through third-party retail. Bloomingdales was his biggest account, where his clothes moved spectacularly. He used this success to expand into other clothing lines, accessories and a perfume. Using Bloomingdale’s as a strategic partner gave Ralph Lauren an initial audience, in addition to expertise and capital, which positioned the brand to sell profitably and grow sustainably. The brand was also able to focus on designing and producing quality products while its retail partners took care of everything else. Wholesale was key for the company to realize its growth—it had already reached $10 million in sales in its second year.

Old-school direct-to-consumer retail

Wholesale built many of the most successful brands of the 20th century. But during this same period (and although they have technically existed for much longer), direct-to-consumer brands, which bypass the wholesale relationship and handle the sale to the consumer, also gained prominence. The companies that took control of their relationships to consumers—Uniqlo, Tommy Hilfiger, Ann Taylor, The Limited, Victoria’s Secret and many others—had significant advantages, because they could not be commoditized by third-party retailers that would otherwise hold significant power over these brands’ pricing and distribution. Instead, these old-school direct-to-consumer companies created their own branded storefronts, which gave them control over their shelf space and the consumer experience. Differentiating themselves in this way was crucial, especially as brand competition skyrocketed— for instance, the handful of major blue jeans brands in the U.S. in 1980 mushroomed to more than 800 in 2013.

While selling direct-to-consumer can be deflationary (the absence of the wholesale relationship means less markup and therefore lower prices for shoppers), old-school direct-to-consumer brands did not always lower their prices. If brands had existing wholesale relationships, they often locked in their prices to maintain price parity in all of their channels, including their own.

When a group of New York City leather workers started Coach, creating wallets by hand with a unique material that softened over time, they sold wholesale for a long period. Then, after years of selling its products through third-party retailers, Coach decided to open its first retail store in 1981, which significantly increased sales. This was a smart strategy, which Coach has continually strengthened its commitment to over the past 30 years. In 2012, 89% of Coach’s total sales came through direct channels, which have higher order values than its wholesale channels. This has allowed the brand to control its own destiny.

Apple also used wholesale to sell its products in the early days, relying on partners like CompUSA. Over time, Apple’s wholesale channel fell prey to stagnating sales, which the company blamed on poor in-store displays and a lack of quality customer service. In 1997, to combat this poor experience, Apple started taking a more hands-on approach toward its retail displays, in addition to supplying its retail partners with trained product experts. Soon after, in 2001, Apple started opening up its own stores, which are now the most profitable retail stores in history.

Wholesale brands play catch-up

Wholesale paid dividends for both brands and retailers for decades, but the channel has recently struggled to grow. Because most wholesale took place offline, third-party retail stores are now stuck with too much space, too many products and not enough demand. As a result, retailers are excessively marking products down, which dilutes margins and brand equity. These shifts have forced many brands to try to sell in their own channels, so that their products aren’t sold in these conditions. But for many legacy brands—and the retailers that have supported them for decades—shifting their core business from wholesale to direct-to-consumer is immensely challenging, suggesting that the wholesale relationship desperately needs to evolve.

Ralph Lauren

Although Ralph Lauren started as a wholesale brand, the company’s extensive reliance on this channel has led it astray. In 2017, its top three retailers represented 31% of net sales—a problematic degree of concentration. Even though Ralph Lauren knows it needs to diversify its sales channels, the brand increased its wholesale points of distribution 25% between 2007 to 2017—from 10,643 to 13,337 stocklists—according to its annual reports. At the same time, the average revenue per wholesale stocklist declined from $307,780 in 2014 to $246,630 in 2016. Inventory, a key indicator of wholesale health, has swelled to support the brand’s wholesale efforts. Ralph Lauren held a record $1 billion in inventory between 2014-2017, evidence that its wholesale distribution both requires more supply to feed it and is selling less than expected.

While sales are up 56% since 2007, these gains come from potential over-distribution from wholesale—something that often results in short-term gains but long-term oversaturation. However, recent sales are falling, from $7.5 billion in 2014 down to $6.7 billion in 2017. The percentage of Ralph Lauren’s business that comes from wholesale decreased 9% from 2007 to 2016 (from 54% to 45% of net sales) and direct sales went up the same amount in the same period (from 44% to 53%). This is a promising change, as more direct sales lead to better margins and tighter inventory control, but the company did not change fast enough. As part of its 2016 Way Forward Plan, the brand is now planning to scale back its wholesale sales faster than ever, and is focused on ending distribution with 20 to 25% of retailers by the end of 2018.

Ralph Lauren is one of the best examples of the gift and curse of wholesale. It scaled quickly and widely on the backs of its retail partners, but over the last decade, this profound distribution turned from an asset into a liability. This shift from wholesale to direct sales, which many other big brands are undertaking, will benefit these brands over time, but have negative effects on third-party retailers if left unmitigated. Big brands already have massive distribution and brand affinity, which they can take advantage of through their direct channels. But as brands produce less product for their wholesale channels, big retailers are losing the lucrative inventory and partners they need to survive. Something needs to fill this gap.  

From direct-to-consumer retail to digitally-native

Starting in 2008, a new crop of digitally-native brands emerged, promising to bypass the wholesale relationship and deliver the savings to consumers. Instead of going through showrooms and finding retailers to stock their items, they relied on the theory that brands could sell online without any traditional gatekeepers or real estate costs. These companies built their marketing around “cutting out the middlemen,” which we call deflationary direct-to-consumer. Hundreds of companies soon learned of this formula, which worked well when advertising on Facebook and Google was relatively cheap—digital word of mouth was available and untapped.

One of the first companies to take advantage of this was Warby Parker, which started out selling quality eyeglasses online that were cheaper than its competitors because it bypassed wholesale. While Warby Parker started online only, the company soon realized that in a world where over 90% of eyewear sales still happen offline, it needed a robust retail footprint. Warby’s direct-to-consumer margins gave it room to focus on building a compelling brand and offering high-end customer service. Selling direct-to-consumer also allowed Warby to ensure that its products always sold at full price. With a lower retail price than other competitors and excessive discounting, this method was key to the success of Warby Parker’s business model and making its margin math work.

Digitally-native brands go back to wholesale

While brands like Coach and Apple evolved from wholesale to direct sales, many brands today are taking the opposite approach. Wholesale used to be a stepping stone for direct-to-consumer sales, but today many direct-to-consumer brands are now looking to wholesale as a crucial growth channel.

The low-cost digital marketing that Warby Parker and other early direct-to-consumer brands took advantage of is waning as advertising costs rise on Facebook and Google; today, the average price for an ecommerce sale on Google Search is $46 and the cost of an average Facebook ad increased 9.6 times from 2012 to 2016. Rising marketing expenses have unwound the business models that many direct-to-consumer companies were founded and raised money on, forcing brands to invest in retail, and increasingly wholesale—more effective channels to acquiring customers than online-only approaches.

Harry’s, the brainchild of Warby Parker Co-Founder Jeff Raider, started off selling its razors direct-to-consumer online. It sought to remove the “middlemen” in the shaving industry and take advantage of the deflationary opportunity that selling direct-to-consumer affords. However, the company soon realized that it could not grow solely online and now sells its razors at Target, which accounts for 50% of the multi-brand retailer’s razor handle sales and 10% of its cartridge sales. The arrangement benefits both Harry’s and Target, making the retailer more relevant by carrying the modern brands consumers want—catering to shoppers’ needs instead of fighting the trends. Target’s razor sales have also grown as the partnership increases overall store traffic and lures more people into the razor aisle. (Interestingly, this is also increasing sales of Harry’s competitors.)

Harry’s is not alone. Brands are finding that cutting out the entire wholesale value chain isn’t always the best or cheapest way to grow. Bonobos, GREATS, MIZZEN + MAIN and Tommy John are selling in Nordstrom; Bevel and Harry’s in Target; Raden in Bloomingdales; and more companies are approaching wholesale every month. Wholesale still allows these brands to get their products in front of captive audiences during the consideration stage, when consumers are ready to shop—it is profit-based customer acquisition, while digital advertising is expense-based. The wholesale relationship still allows brands to focus on branding and product design, rather than digital marketing, while earning brand equity from associating with the right retailers.

The wholesale value chain is changing

While wholesale is returning as a crucial channel for digitally-native brands, the value chain is changing. These brands are engaging in more direct and strategic wholesale relationships that include different revenue share and pricing schemes, better displays for their products, and ultimately, more efficient sales. Brands can choose to sell items to retailers or employ a revenue-sharing program similar to that of shop-in-shops. Additionally, retailers are working more closely with brands to figure out how to stage products, access new ones and and become a core part of these brands’ growth strategies. Given these direct relationships, showrooms are now getting cut out of the process.

Because many digitally-native brands are “item-driven” businesses, where specific evergreen products are used to draw consumers in, many digitally-native brands are well suited to succeed with wholesale since products are often in stock year-round. This means brands can turn inventory faster and retailers can reorder products more quickly. Given the evergreen nature of their products, it’s also crucial that brands align prices across all distribution channels. To do this, some digitally-native brands are creating agreements that say their third-party retailers cannot markdown their products. Fast-growing digitally-native brands have a bargaining power advantage with retailers that seek younger shoppers and need to compensate for falling foot traffic and sales.

Brands are also using dropshipping as almost a compromise between selling direct and selling wholesale. Dropshipping is when a company lists its products on a third-party retailer’s website, but holds the inventory itself and fulfills the order on behalf of the retailer. Sometimes the margins in this arrangement are better than both selling direct and selling wholesale, since the third-party retailer still brings a captive audience to the table. But for this arrangement to work, brands need the logistical prowess to successfully fulfill orders at scale.

As more digitally-native brands sell through third-party retail and bypass showrooms and distributors, maintaining these relationships at scale will also become increasingly burdensome. Brands will either need to hire in-house sales teams or work with showrooms, especially as they expand internationally. New showrooms might sprout up that give brands these capabilities while taking less margin, while adding in PR services and other local market intelligence.

 

What does this mean for you and what should you do about it?

Brands & Retailers

Controlling the cyclical process

Brands and retailers have changed their sales strategies throughout the years from focusing on wholesale to retail to the internet and then back to wholesale. Brands that rely too much on one channel need to diversify—the effectiveness of individual channels grows and wanes as consumer preferences shift.

  • Why are you selling in the channels you currently are? How have your channels changed in the past and why might they change in the future?
  • What might happen that could seriously threaten your channel mix and how would you respond? How do these considerations impact your bottom line?
  • How are consumer preferences, for both products and shopping experiences, driving these shifts? How are you balancing sales channels versus brand-building channels?
  • Is there a specific channel that you are focusing because it’s a cash cow that brings in most of your revenue? What would happen if that channel disappeared and how would you respond?
  • Do you have the logistical and team capabilities to support one channel over another? Is dropshipping possible given your current scale?
  • How could you control the digital assets and merchandising in new wholesale relationships? How do you stay consistent across all distribution channels catering to a retailer’s target demographic?
  • How do sell-through expectations change over time depending on the channel, accounting for changes in receipts and/or sales? How do you compare inventory levels across to determine “healthy” benchmarks?
  • Are there different considerations with international and in-country wholesale models in terms of profitability? How do you approach distributor relationships differently while maintaining price parity?

Cultivating younger brands

Retailers are starting to partner with popular younger brands that initially did not focus on wholesale, in order to increase interest in their stagnating stores.

  • Is your goal to reach new customers, offer more attractive products to your current base or both? How does your brand outreach support these goals?
  • How can you create programs that successfully bring younger brands into your retail stores? What types of brands will fit well with your product mix, and what types of brands might fall outside, but are worth experimenting with?
  • Does working with younger brands cannibalize the sales of your legacy brands? How will a shift in brand portfolio impact your current perception to long-standing customers? How can you mitigate these challenges?
  • How can you show younger brands that you can provide them with lower customer acquisition costs than they currently have?
  • How should you structure your deals with these younger brands? Should you remain adamant in purchasing wholesale or should you shift your strategy to one of revenue and/or cost sharing?
  • Would you be willing to forego markdowns on younger brands if they are unwilling to participate? Does limited sale participation jeopardize the customer’s willingness to browse sales as she might have previously?
  • Should you look into creating private label business to engage these new shopper preferences or should you partner with other companies instead? Could you mix these two strategies?
  • How will your marketing shift to accommodate the new brands? How will you partner with younger brands to implement a new strategy while also staying consistent to the brand’s vision?

Investors

Symbiotic relationship between retailers and new brands

Retailers need younger brands for relevance and these same brands need retail for distribution and lowered customer acquisition costs.

  • How can you help facilitate relationships between both parties? How can other brands in your portfolio support these efforts and make introductions?
  • What new distribution and back-end processes can your portfolio companies use to facilitate the relationship between these two players?
  • Which metrics should be used to gauge the success of retailers and new brands? Should they measure sales, net promoter score, cost per customer acquisition, or other features? Which metrics should brands optimize in this channel and how would each affect the end result?
  • Should a wholesale relationship be considered earlier or later in the brand’s lifecycle? How would funding and capital expectations change to support this?

Stagnating growth factors

As older legacy and newer direct-to-consumer brands and retailers experience decreasing, stagnating or less accelerated growth, it is important to look at which metrics are changing and why. For example, once Ralph Lauren noticed that its wholesale accounts were each selling less after years of increasing reliance on these channels, it produced the Way Forward plan. Other brands may notice that their customer acquisition costs are going up, resulting in a lowered net margin they can increase with strategic wholesale.

  • Which metrics are causing stagnating or lowered growth? Can engaging in strategic or direct wholesale reverse these downturns?
  • How can you create forecasts to determine the mix of direct-to-consumer, online, wholesale, and strategic wholesale that your brands should engage in?
  • How does the value chain change when direct-to-consumer brands go wholesale? With this shift, how can direct-to-consumer brands ensure that they can sell items at the same price to the consumer even with added middlemen?
  • From a profitability standpoint, is it worth your portfolio companies exploring a joint venture, royalty or management partnership agreement model with third-party retailers?
  • How will you guide your brands to deal with the contractual minutiae that wholesale often creates? How can these contracts be simplified so brands can move faster?

Foundational online presences

Successful digitally-native, direct-to-consumer companies were able to bypass wholesale and showrooms by cultivating an online presence that drew consumers in and made them household names that retailers could no longer ignore. However, it is more difficult for older stores to create successful online business given their heavy reliance on wholesale and retail. Brands like Anthropologie are finding that when they close stores, they lose shoppers who don’t come back to the brand online either—they just find somewhere else to shop.

  • Facing store closures, what tactics should stores use to ensure that consumers find a company’s portfolio brand online instead of forgetting about the brand altogether? What tactics can stores borrow from successful digitally-native brands and which can they ignore?
  • How can stores create an online headquarters that will continue to attract consumers, even if they start closing stores?
  • What type of user experience talent will these companies need to invest in to make a smooth and smart transition online?
  • What are the inventory and logistical differences between an online business and in-store model? Do they have the marketing, capital, talent and expertise to make the transition?

Real Estate

Anchor tenant’s new needs

Retailers are focusing less on wholesale and more on strategic wholesale partnerships and private label brands at the same time that consumers are looking for new and fresh ideas from their retailers.

  • How can you shift your real estate space to provide anchor tenants with store-within-a-store areas and more creative store displays?
  • How can you market yourself and communicate to anchor tenants to show that you are thinking about their problems and have woken up to the new consumer economy? Where can you take the lead in negotiations and strategic conversations with them?
  • Should you have a different strategy for suburban malls, urban spaces and other retail locations? How should strategies differ depending on the needs of consumers in a specific space? What additional behavioral research should you conduct to determine your strategies?
  • What type of signage should you have inside your malls to orient people more to anchor tenants and highlight the diverse brands and experiences they carry?
  • How do your minimum sales expectations change as retailers shift their business models?

Malls built for trust vs. excitement

The importance consumers place on brand trust has been replaced with the need for novelty and excitement as traditional shopping formats become humdrum and less captivating. This pressures retailers to ensure that their stores provide more value and psychological benefits. This also affects malls, which need to ensure they are carrying the right mix of brands so shoppers don’t feel like there is any kind of deficiency in their shopping experience.

  • How can you ensure that you have a good mix of the digitally-native direct-to-consumer brands consumers crave? How can you diversify your strategy to bring in new tenants when they don’t all come from the same value chain as before?
  • How can you work directly with retailers in your malls to address their distribution and store traffic needs? Which best-in-class examples can you show them to help them achieve strong store traffic and engagement?
  • How can you work with direct-to-consumer brands through your anchor tenants? How can you ensure that shoppers don’t feel that they are missing out on new brands that provide them with better value? What type(s) of communication and which retail partners would you need to execute this?

Going Forward

The value that third-party retail provides brands cannot be ignored, even in the direct-to-consumer and digitally-native age. The distribution, brand equity, and captive shoppers that retailers bring to the table are extremely valuable in a world where companies can no longer reach people as cost effectively on the internet as they originally thought.

At the same time, the wholesale channel is shrinking as retailers go out of business, see falling foot traffic, and rely more on private labels, exclusives and collaborations. For example, Macy’s plans to increase the percent of its private label and exclusives from 29% to 40% of sales, according to its Q2 2017 conference call (it did not say when it seeks to reach this goal). While the wholesale opportunity exists for younger brands, they need to act quickly to prove the mutual benefits of this model before retailers give up on buying from multiple vendors entirely.

This puts the onus on brands to employ a differentiated channel mix, so they don’t fall prey to rising distribution costs. All brands must have a long-term strategy to differentiate themselves and remain the first priority for consumers. Brands should be open to any path that makes this a reality—even wholesale.