Is this E-Retailer the Amazon for Luxury Brands?

Although Farfetch generates most sales through its marketplace platform, the company has invested in retail operations, such as the Browns acquisition in 2015, and is working toward solutions for an integrated online and in-store experience through its "connected retail project." It also provides white-label website services for luxury brands through its Black & White division.

The idea for Farfetch materialised when founder Jose Neves noticed that the stand-alone website for his shoe retailer SIX London physical stores had growth limitations needing significant human resource and marketing investments, which are hard to justify for a small business.

Farfetch's platform aimed to facilitate and lower the costs of physical retailer access to the online space, while providing customers with the opportunity to browse initially tens of stores' assortments without having to visit each store's website, saving time and effort. Not holding inventory, Farfetch could be bolder with new designers and more extravagant styles, providing a wide merchandise selection for consumers.

Unlike other marketplace players, such as eBay, Farfetch does product curation at a retailer level, besides just finding a store to partner with. Farfetch managed to overcome the initial resistance of luxury retailers to online channels through personal contacts with fragmented, family-owned businesses.

The timing may have been right as well; the company started out in 2008 amid the financial crisis, with retailers looking for opportunities to increase revenue in a tougher environment. As a result, the platform managed to extend its network of suppliers from 35 boutiques in 2009 to almost 1,000 branded and retail suppliers currently.

Notably, the number of brands on the platform increased from 49 in 2015 to 375 mid-2018. In 2017, Farfetch partnered with Gucci to provide a 90-minute store-to-door delivery service in 10 global cities. In 2018 it signed a deal with Burberry, according to which all the brand's inventory would be available through the e-commerce platform, including some capsule collections exclusive to Farfetch. Farfetch successfully attracted growth funding with investment from JD.com in June 2017 and Chanel in 2018.

Farfetch Could Warrant a Moat Down the Road

We lack confidence that Farfetch will be able to enjoy sustainable economic profits over the long-term horizon, given its currently limited customer reach – its active customers are less than half a percent of the luxury purchasing population, by our estimates – and lack of monetisation, even at elevated third-party take rates with potentially intensifying competitive pressures, given the industry's early stages of development.

Nonetheless, we believe Farfetch's business model displays traces of a network advantage, as it is currently one of just a few early aggregators within the luxury industry, although the platform's reach is still not mature enough to be awarded one. Key considerations for a network advantage moat source are if the existing and new users of the platform benefit from the platform adding new users, and whether the user base can be profitably monetised.

We look at Farfetch's network advantage from the perspective of its main stakeholders: brands, retailers, and end consumers. We note that wide-moat-rated marketplaces under our coverage, such as Amazon, MercadoLibre, and Alibaba, have around 10%−15% of each 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. As a comparison, no-moat Zalando reaches around 10% of the population in its core Germany, Austria, and Switzerland region, but only 4% in the newer European markets.

We believe that with its 1 million active consumers, Farfetch reaches less than half of a percent of 350 million luxury consumers globally. In fact, no participant in Farfetch's fragmented industry is near a critical customer scale, as YNAP, the biggest luxury online retailer, 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.

Finally, although Farfetch's third-party take rate is among the highest in the industry, suggesting an ability to monetise 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 expenses and fulfillment costs. Also, we aren't certain whether such high third-party take rates can be sustained in the context of increasing competitive pressures.

We believe the brands and their content associated with Farfetch help us define the purpose and advantages of the company's platform. We see several benefits a brand stands to gain from a presence on Farfetch's platform, such as credibility and positive halo effects from a growing platform, favorable economics, and distribution that reaches important demographics.

That said, we believe luxury brands are more difficult to onboard to online platforms compared with mid-priced 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.