Most would agree that Netflix has changed the way we watch Television, but that would be only half the story. What Netflix has changed in monumental proportions is the economics of entertainment. Netflix represents a class of digitally native companies that have built a deeply personal relationship with the consumer and continue to improve the affinity with every byte of data they collect. Amazon, Spotify, and Google are other examples of such companies.
Back to the economics of entertainment — let’s look at the two key aspects of the value chain — Production (producers, studios) and Distribution (networks, theatres, and streaming services such as Netflix). While Netflix started purely as a distribution company (distributing content that others produced to end consumer through mail and streaming), it has very rapidly evolved into a production powerhouse with an estimated spend of $12–13B in 2018–19, expected to grow to $22.5B by 2022. To give you some perspective, this number is just shy of the total currently spent on entertainment by all of America’s networks and cable companies. Take a moment and let that sink in.
But that’s not the most remarkable part of the story, what is remarkable is that it can produce and distribute content more profitably than any of its peers. If you asked why, then I applaud your curosity — in simplistic terms, Netflix understands the calculus of whether a show or film is worth making, better than any other player.
Here’s how: Netflix has created some 2,000 “taste clusters” by watching its watchers. Analysis of how well a show will reach, attract and retain customers in specific clusters, lets Netflix calculate what sort of acquisition cost is justified for such a show. It can thus target quite precise niches, rather than the broad demographic groups that broadcast television depends on.
With quantitative understanding and personalized marketing, Netflix has managed to revive canceled shows with loyal fan bases, such as “Gilmore Girls”, and take up shows others turned down, such as “The Unbreakable Kimmy Schmidt”. Documentaries such as “Wild Wild Country” have become hot not just by word of mouth, but by being pushed on the home screen poster by individualized poster. The Economist states that “Netflix can take risks on such projects because failure costs it less than it does others. It lets the company get better results for a lesser-quality show than its peers can by showing it only to those who will like it.”
Another great example is “The Kissing Booth”, a romantic high-school comedy released in 2018. Critics hated it. But it has been seen by more than 20m households; millions of teenagers targeted by algorithms seem to love its leads, Jacob Elordi and Joey King. (Source: Economist)
If at this stage you are wondering what does this have to do with Fashionomics, then let’s dive right into answering that question. From how I see it, Fashionomics is converging with Netflixonomics in 3 ways:
- Digital native retailers in Fashion will scale their own production just as Netflix has.
Large digitally native (Pure Play) retailers such as Amazon in more mass/premium market and Net-a-Porter in the luxury market will begin to build strong portfolios of their own brands powered by their deep understanding of the customer tastes and behaviors.
Just like Netflix, the retailers can understand very precisely what product attributes (color, size, style, fit, etc.) and customer interests (brands, categories, trends, etc.) work for which segments, using such information to estimate precise demand and produce only the necessary quantities to test, learn and iterate. Hence, reducing the risk of overstocks and obsolescence costs, a major drag on the profitability for any retailer.
For example, Amazon’s activewear brand, Peak Velocity sells a $79 hoodie that has a Best Seller rank of #38 in the Active Hoodies category, one of Nike’s strongest categories. While Peak Velocity’s ranking of # 38 (as of Dec 6th), may seemingly be unimpressive, what may change your perspective is that the brand was launched only in November, and quickly climbed up the ladder to # 38 of a category where 62% of the revenue comes from a long tail of brands other than the top 5 brands. Why? A highly targeted product with personalized marketing increases sales conversion.
And Amazon is not alone in following this strategy, leading digital luxury retailers such as Yoox-Net-a-Porter, with brands such as Iris and Ink (Outnet), MR. P (Mr. Porter) and Matches Fashion with Raey, are beginning to make serious investments in this space, learning from the retailers such as Asos, whose private label business contributes almost 50% of its revenue.
This is quite a departure from the traditional wholesale model, where a brand mandates a certain mix of products that a retailer must buy even though the selection is not entirely corroborated by consumer behavior on the platform. While Private Label strategy is not new to the playbook of retailers,
the large digital retailers are building a new moat — customer data and personalized marketing, something that traditional brands lack due to the absence of direct, measurable access to digital consumers at scale.
2. Increasingly influenced by data and algorithms, Production will become more agile and targeted
Just as Netflix is able to create “The Kissing Booth” and find 20M viewers for the movie through its intimate understanding of its customers. Large digital retailers can find niche targets to cater to and fill the small white spaces that large brands are less likely to worry about.
One can argue that Fashion is seasonal and the historical data may not be the best predictor of future demand. That could have been true a decade ago, when fashion products, as a complex amalgamation of attributes such as color, style, silhouette, pattern, etc. could not be decoded and decoupled.
However, with advances in machine learning and image recognition algorithms, a fashion product can be decoded into multiple attributes, and a more sophisticated predictive model can be created to suggest which attributes, based on onsite behavior and third-party data, are likely to be preferred by customers in the near future.
Retailers can then start with cherry-picking the most popular attributes and overlay with the customer segments that have the highest affinity for such attributes to start sketching out the blueprints of their private label investments.
Agility is the key here. Rachael Proud, the designer who is leading Matches Fashion Private Label — Raey, says “If we’ve got a jumper and it’s a best seller and we’ve only ever done it in blue, we are immediately thinking: let’s do it in black,” she says, adding that if fabrics and trimmings are in stock, Raey can deliver product in as little as four weeks. (Source: BOF)
Proud and the Raey team have data on their side: they have a deep level of information evaluated on a weekly basis, from cost-per-click to real-time sell-through.
The unprecedented access to data allows these retailers to react in ways traditional brands can’t.
Example: In 2016, MatchesFashion, shifted Raey’s deliveries from seasonal to monthly collections that arrive on the site each week. These more frequent deliveries also help drive traffic to the site, says Proud. (Source: BOF)
While most of these retailers are focusing their initial efforts on the Basics (low risk, high turnover category), they will eventually start pushing the boundaries to scale their private label contribution. Something that a player such as Zalando is already demonstrating by conjuring up 17 private labels since 2010 and now generates 500 million euros ($599 million) of its 3.64 billion euros in annual sales from them, offering everything from Pier One sweaters costing less than 30 euros to Mai Piu Senza high-heeled boots at 170 euros or more. (Source: Bloomberg)
Obviously, these retailers will have to find the balance between scaling their own labels and protecting relationships with the brands that represent a sizeable share of their revenue. If retailers start to eat the share of the brands, it may take away the preferential treatments that these retailers get from the brands such as exclusive collections or early deliveries.
A more likely scenario is that the retailers and brands will co-develop capsule collections by combining their respective core expertise in consumer behavior mapping and product development. As an example, Calvin Klein partnered with Amazon recently to launch an exclusive collection online and in Amazon pop-ups. A trend that is definitely likely to continue.
Finally, just as Netflix is able to attract both successful writers/directors and identify and bet on new/emerging talent, digital retailers can command the same advantage. Net-a-porter recently launched a group of emerging designers through The Vanguard Program. While it is projecting this program as a mentorship program, it is really a way to both cater to the needs of the niche and emerging segments (white spaces) and to get greater control of their supply chains and thus improve profitability.
3. Distribution will increasingly become cheaper, personal, and global
Netflix is increasingly becoming a global household name in entertainment. It has very successfully created regional content and found an audience for such content globally, hence, improving the ROI on the content investments. For example, Dark is a German original released in the fourth quarter of 2017 that did well in its home country, and, according to the company, “has also been viewed by millions of members in the US and has outsized watching throughout Europe and Latin America.”
With e-commerce penetration expected to get into double digits across the globe, fuelled both by in-country and cross-country growth, the cost of logistics (cost per order) will continue to decline. Amazon is already achieving such scale and costs, where you can get free next-day delivery (in India, with Prime) and cross country delivery for under $10 (US to Dubai for less than 500 GMS of package).
While the last decade was about marketing to segments based on demographics, the sophisticated personalization and marketing tools can allow you to do so based on specific interests.
This means that a product sitting in any part of the world can be matched with the interests of a person sitting in another part of the world, and not only marketed but also shipped seamlessly. Farfetch is one of the leading retailers that is connecting this global supply with global demand, unlocking value for local boutiques and brands through global exposure.
Very soon, if not already, a customer living in Australia can discover and buy a local designer dress (say, an Abaya) by a Lebanese designer operating out of Dubai, all because of the power of personalization algorithms and cheap global shipping. While these cross border sales are still a small portion of the overall e-commerce, this share will continue to grow rapidly.
If you are a digital retailer, the playbook to scale profitably and thrive is emerging clearly. To fight reliance on markdowns or promotions and boost profitability, you need exclusivity and scarcity as weapons. Not placing bets in the areas above will only make it harder to fend off the competition and to grow in a world where customers are overwhelmed with digital noise, and thus
will increasingly give their business to retailers that intimately understand their tastes and can respond to their Insta-fashion needs that can change in a snap. (pun intended)
For brands, it’s time to accept that your turf is under siege.
The new breed of tech businesses has clearly demonstrated that platforms which own the consumer relationship and leverage data to deliver a highly personalized experience, will continue to eat away large portions of the value chain.
If the majority of your business is driven by a wholesale business, it’s time to think diversification and find ways to get closer to the customer. One sure way is switching to the marketplace model with digital retailers in exchange for customer insights and data, leading to co-development of products, to reduce the inventory risk and obsolescence cost from the value chain.
Co-developed, smaller, exclusive and non-seasonal collections can help brands maintain both the novelty and profitability. Obviously, this requires rethinking of the brands’ supply-chains as the long lead times are a challenge, especially for luxury brands. Needless to say, it’s not going to be easy, but who said it’s easy to thrive in an industry that is silently being disrupted.
While Netflix has reinvented the economics of the entertainment business and started a gold-rush of original content distributed through personalized marketing, can large Fashion digital retailers follow this lead and achieve such scale?