Farfetch Faces Weakness in U.S. and China as Its Brand Performance Lags 

Senior Equity Analyst

Jelena Sokolova

Revenue segments as reported by the company.

Digital Platform Services Revenue

Digital Platform Fulfilment Revenue

Brand Platform Revenue

In-Store Revenue

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Farfetch is a leading global online distribution platform for personal luxury goods. It connects luxury buyers and sellers and offers a wide selection of products to consumers without exposing itself to unsold inventory risk. While we believe Farfetch’s business model exhibits traces of a network advantage moat source, we are currently wary of assigning it a moat, given the early stages of industry development, the company’s small size and reach (5% share of the online luxury goods segment, reaching around 1% of the luxury buying population), and lack of business model monetization. 

Although the online luxury segment is still relatively fragmented, we believe it could be dominated by a limited number of strong global players. Still, we think there is a low probability that any one player will dominate online distribution, given the market power of the big brands and their reluctance to depend on a single party for online distribution. But neither should the space be too fragmented, in our view, given that the brands are wary of over-representation in too many channels, with risk of brand trivialization, excess inventory, and discounting. We believe Farfetch has potential to become one of the strong players in the industry, given its value proposition to the brands (better economics than wholesale and control over inventory and pricing retained), retailers (which are engaged in the supply chain rather than competed with), and customers (through vast choice of products and unique items). 

We believe Farfetch is well positioned to take advantage of strong growth in online luxury goods buying, which we expect to increase to 35% in 2030. We expect Farfetch to increase its market share to 10% in 10 years’ time from 5% in 2022. We expect the company to turn profitable by 2024.

Business Strategy & Outlook

We believe that Farfetch currently doesn’t benefit from an economic moat. We think it displays traces of a network advantage, which is judged by whether existing and new users of the platform (buyers and sellers) benefit from the platform adding new users and whether the user base can be profitably monetized. Nonetheless, we abstain from awarding the platform a moat because the network remains subscale and is not yet being monetized and the industry is still in the early innings, making it difficult to identify the winners with a high degree of certainty. Thus, we lack the confidence in persistent economic profit generation that is needed for a moat rating. 

Wide-moat-rated marketplaces we cover, such as Amazon, MercadoLibre, and Alibaba, have around 10%-15% of the target population as their active customers. Once this threshold is achieved, we believe it becomes very difficult for competitors to unseat the incumbent and can lead to an extended period of excess economic returns. We believe that with its 4 million active consumers, Farfetch reaches around 1% of around 390 million luxury consumers globally. In fact, no participant in Farfetch's fragmented industry is near a critical customer scale, as YNAP, Farfetch's major competitor, reaches only around 1% of the luxury-purchasing population through its platforms Net-a-Porter, Yoox, Outnet, and Mr Porter, leaving an opportunity for leaders to form over the coming years.

Although Farfetch's third-party take rate is among the highest of marketplaces under our coverage, suggesting ability to monetize the network, the company has yet to show profits and positive cash flows, given the elevated technology investment levels and lack of leverage on general and administrative and fulfillment costs. There is uncertainty whether such high third-party take rates can be maintained in the context of increasing competitive pressures.

We believe luxury brands are more difficult to onboard to online platforms than midprice and low-cost brands, which protects the incumbent luxury online sellers, including Farfetch. Through our talks with luxury companies, we gauge that their concerns when picking online partners are the right brand representation, which includes appropriate user interface with "luxurious" feel, appropriate peer group (no luxury brand wants to be the priciest player in the retail channel, or the first one to come on board, creating a chicken-and-egg problem), no counterfeited goods display, and control over pricing. Farfetch overcame these hurdles over more than 10 years, first addressing luxury retailers and building credibility with the brands over time through personal contacts. Although new brands and luxury retailers on the platform increase competition, they also increase credibility of the platform as a luxury distribution channel, in our view, benefiting the incumbents. As an example, a brand like Prada would not be willing to be the only luxury brand on the platform of cheaper or lesser-known peers, as such a network wouldn't attract the right target audience, or worse even, have a damaging, "cheapening" effect on the brand. As a case in point, the CFO of LVMH said the group's brands are not suitable for distribution on Amazon, despite its huge addressable customer base. On the other hand, the presence of established luxury brands, provides a positive halo effect to the younger high-end brands that are still looking to establish themselves as luxury, supporting the case for suppliers to use Farfetch. Further, platforms can be a preferred channel over wholesale online partners for brands, due to better economics (brand margin is higher versus wholesale channel, even after Farfetch’s hefty cut), and since control over pricing is retained. Finally, Farfetch can help brands establish themselves with younger luxury consumers; luxury company management teams are concerned about appealing to the millennial demographic, given their rising purchasing power. Farfetch's average customer age is 36, and almost 70% of clients are younger than 40, versus 58% for luxury industry, according to the company (we attribute this to the higher propensity of younger consumers to shop online). 

We believe that platforms like Farfetch can have substantially more negotiating power with independent retailers than with big brands, given the wider distribution options available to the big brands and their sheer size (we estimate big publicly listed brands account for around half of personal luxury goods sales and further consolidating). Despite higher growth in retail revenue for the brands over the past decade, luxury wholesale remains major distribution channel, accounting for around 50%-60% of global luxury sales. This provides Farfetch with a wide array of potential retailer partners to tap into. Although partnering with Farfetch reduces wholesaler margin through a hefty 30% third-party take, a retailer's existing inventory is made available to a wider audience than would be possible for a stand-alone boutique; Farfetch has over 3 million active consumers. Further, the charge applied by Farfetch may be offset by increasing probability of full-price sell-through, as the existing stock is made available to this wider audience. We believe that exposure to a wider audience offsets the negative impact of increased competition, as more stores/brands join the network. According to the company, some retail partners also experience positive spillover effect on their retail store performance, as they can be less risk-averse with stock purchases. 

The value of the network to the retailers and brands can be seen through a third-party take rate around 30%, which outstrips even that of established marketplace peers, such as high single digits for narrow-moat eBay, 15%-20% for wide-moat Amazon, and 15%-20% for no-moat Zalando's partner program. 

We believe the primary client benefit of Farfetch’s platform is the wide choice of products available. With 5.7 million SKUs for the summer 2018 collection, Farfetch offered 10 times more SKUs than the next biggest competitor, according to the company's IPO filing. Since products are selected from boutiques all over the world, there is more chance to find exclusive merchandise not available elsewhere, especially since 98% of retailers work with Farfetch on an exclusive basis, an attractive proposition for the fashion-conscious consumer. The tricky part is product curation, as leafing through the variety of merchandise can be a daunting task. We believe that learning algorithms that analyze consumer purchases over time (online as well as potentially offline through connected stores) could increasingly personalize merchandise and the consumer experience, leading to better sales conversion. Personalized merchandise should in turn benefit retailers and brands since their products are displayed to an audience with higher buying probability (the equivalent of targeted ads on Google or Facebook).

None

Economic Moat

Farfetch

Farfetch Ltd. engages in the provision of technology platform for the luxury fashion industry. It operates through the following segments: Digital Platform, Brand Platform, and In-Store. The Digital Platform segment activities include the Farfetch Marketplace, FPS, BrownsFashion.com, StadiumGoods.com, and Farfetch Store. The Brand Platform segment is comprised of design, production, brand development and wholesale distribution of brands. The In-Store segment covers the activities of group-operated stores including Browns, Stadium Goods and certain brands in the New Guards portfolio. Its products include womenswear, menswear, kidswear, vintage, fine watches, and fine jewelry. The company was founded by José Manuel Ferreira Neves in 2007 and is headquartered in London, the United Kingdom.