Yesterday, we reported the impressive success of Gilt Groupe, a two-year old ecommerce company that expects to generate about $150 million in revenue this year.
Specifically, we reported that Gilt is raising another $40 million or so at close to a $400 million valuation from General Atlantic and Matrix.
We also noted that Gilt’s business, private sales, has developed into a big and burgeoning sector of the ecommerce industry. The sector is led by France’s Vente Privee, which is now a $750 million business.
(For those of you unfamiliar with Gilt and the private-sale business, here’s how it works: Gilt offers occasional deep-discounted private sales of designer fashion and other merchandise that is normally be sold at high-end retailers. Gilt announces the sales to its members by email. Each day, when that day’s sale starts, members click through and check out the merchandise and the prices. They decide on the spot whether or not to buy. And they have to hurry–the sales often sell out in minutes).
Upon reading our post, many readers applauded Gilt’s success. Others were dumbfounded: Could those numbers really be right? Still others accused us of just shilling for a company founded by the co-founder of SAI (Kevin Ryan)…and demanded that we actually do some analysis.
So here’s some analysis!
First, growing from $0 to $150 million in revenue in two years is pretty fracking impressive, no matter how you look at it. That’s way faster than Amazon grew in its first two years, for example. (Yes, the Internet is much bigger now).
The fact that Gilt’s US business is reportedly cash-flow positive is also very impressive. It’s one thing to generate a lot of revenue. It’s another to generate a lot of revenue with enough margin to put the company in the black, which Gilt has reportedly done in the U.S.
Part of the company’s cash-flow generation is the magic of the online sales cash cycle: When you sell online, you often collect cash for your product sales long before you have to pay the vendor you bought the products from. Amazon benefitted heavily from this dynamic in its early days, and was cash-flow positive long before it started to generate net income. But part of the cash-flow success is also the power of the business model.
Gilt thinks it can get to $500 million in revenue next year, which seems plausible. The company is expanding both horizontally into other product categories (it started with fashion, and is now moving into kids, travel, etc.) and other geographies (it already has 20 employees in Japan). The 2010 revenue estimate also makes the reported valuation of this latest round–close to $400 million–seem reasonable. It’s less than 1X projected revenue.
After Gilt gets to $500-$750 million, though, the going is likely to get tougher.
Specifically, the challenge of regularly procuring huge volumes of high-value private-sale inventory at prices that enable Gilt to sell it a profit.
In one key way, the private-sale business is similar to the closeout-and-remainder business. Unlike standard retailers, which buy a steady and regular supply of inventory for sale at full prices, closeout retailers sell batches of irregular inventory at deeply discounted prices. For obvious reasons, buyers go nuts for the prices, and this enables the retailers to grow at a very rapid clip. As long as the retailers can continue to source more and more inventory at a reasonable margin, the companies can get big really fast.
The classic example of this in recent years is Overstock.com, which had a moon-rocket trajectory earlier this decade. Eventually, however, execution and inventory issues tripped up the company, and its revenue has flatlined beneath $1 billion for the last few years. The same thing happened to uBid, SmartBargains, and a bunch of other companies in the same business: The supply of cheap, deep-discounted inventory just isn’t regular or predictable enough to support a steadily growing multi-billion-dollar company (at least not without the company beginning to take major inventory risk).
The private-sale business is different from closeouts in an important way, in that it’s supported by the product manufacturer. But to avoid upsetting their normal retail channels, manufacturers can only sell certain types of inventory through deeply discounted channels (including private sales).
Private sales are an excellent way for manufacturers to shed excess inventory in a controlled, high-end environment, but most vendors could not open full-fledged, full-service deep-discount “stores” on Gilt without destroying their full-price offerings. Thus, Gilt’s sales growth will likely eventually be constrained by the challenge of steadily procuring enough “batch” inventory at reasonable prices. This will be especially true when the economy recovers and manufacturers can sell more of their inventory at full prices. And the problem will be exacerbated by the fact that many other companies have spotted the private-sale opportunity and are leaping into the sector with both feet. More competition for the inventory will mean higher-prices paid and, thus, lower margins (or higher prices to consumers, which will weaken the value proposition).
In the closeout and remainder industry, there seems to be a sales hurdle around the $1 billion level. Assuming there’s a similar glass ceiling in the private-sale market (if anything, it’s likely to be lower), Gilt’s future growth will eventually depend on its diversifying successfully into many other geographies, verticals, and possibly even businesses. To do so, it will likely want to buy companies in addition to building its own (especially as the number of focused competitors proliferates). One day, for example, Gilt might want to offer a full line of full-price inventory, in addition to its occasional private sales.
But, for now, all that is years away. And the company can cross that bridge when it comes to it.
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