The performance of the luxury segment over recent times has been outstanding, with one season after another characterised by soaring demand and impressive bottom-line outcomes. Brands forged deep connections with their core constituencies and ignited their creativity. This, in turn, has spurred certain consumers to trade up and seek out ever-higher levels of indulgence. Meanwhile, the continuing expansion of digital engagement and e-commerce has created a turbocharged effect — fuelling demand, unlocking new insights and promoting competition.
However, as the global economic cycle turns, luxury brands are set to see rising pressure on their business models and channel strategies. Retailers, meanwhile, are already feeling the pinch, both in physical and online spaces. In response, luxury brands are searching for new engagement models, while e-tailers are exploring how to productively work with brands to engage with consumers, facilitate market access, and add value as the technology landscape evolves.
In tough times, a laser-sharp focus on distribution can make the difference between success and failure — and even more so in a market increasingly led by e-commerce. One distribution model that has caught the attention of almost every brand is direct-to-consumer, but luxury brands in particular see a chance to capture wider margins by taking out the middleman, as well as realise benefits across economics, customer engagement and operations. With their strong brand equity and ultra-exclusivity, select luxury players, such as Hermès, have focused mainly on DTC distribution, which provides them with full control of brand positioning and storytelling. DTC has also allowed them to reinforce an even stronger sense of exclusivity: customers must come to the brand intentionally rather than coming across it randomly. And mastery over data has enabled brands to unlock personalised experiences — critical to stand out in a crowded e-commerce landscape — and forge deeper customer relationships.
Given its many potential benefits, a number of luxury brands see moving to 100 percent DTC as an aspiration, both in terms of their physical outlets and digital channels. However, the pure DTC club remains highly exclusive. For now, only brands that command market-leading customer attention, and have deep pockets to maintain DTC customer relationships across channels, are ready to fully engage with the opportunity.
Without the resources of an industry superstar, the majority of luxury brands are being realistic and opting for a gradualist and hybrid approach. For these companies, DTC remains an aspiration that for now should be considered alongside continuing engagement with multi-brand retailers. One reason is that multi-brand platforms bring a lot of value. Multi-brand retailers, for example, are virtuoso facilitators of customer engagement, and often bring their own powerful brand equity to the mix. Indeed, for many brands, wholesale partners are vital enablers of access to new customer segments. They also play an invaluable role in extending brand reach to niche areas of demand, as well as accelerating full-price sales when the opportunity allows and clearing inventory during slower periods.
Many brands plan to switch to more or all DTC are stymied by their e-commerce and digital marketing capabilities that have yet to scale. Furthermore, in the recent tough supply chain environment, most have suffered from delivery bottlenecks. And as economic headwinds become stronger, they face potential medium-term declines in volumes, which naturally in turn creates an aura of caution across go-it-alone plans, particularly as customer acquisition costs rise.
Depending on their market positioning and strategic orientation, individual luxury brands are likely to identify with different aspects of these challenges and realities. However, the task for many, as they consider the impacts of rising interest rates and new customer behaviours, will be to align with the needs of their core markets as well as identify effective channel strategies to pursue growth and create efficiencies through the value chain.
Current State of Online Luxury Distribution
Individual e-tailer approaches often must sit within the parameters of specific business models. First-party retailers such as Net-A-Porter, Matches Fashion and SSense have typically focused more on online wholesale business models, though models are evolving. They have continued to apply their expertise to match brand inventory to customer demand, carefully managing curation, and optimising pricing and merchandising. By focusing on these core strengths, they have been able to continue to create significant upsides for brands, including cementing consumer trust in the retailer as a curator. This, in turn, has enabled them to drive conversion as well as augment brand positioning — supported by dedicated content and marketing.
In a first-party environment, brands can face less inventory risk while seeing the positive impact of significant individual order volumes on cash flows and ongoing operations. On the other hand, brands are wary of the risks associated with retailers’ oversight of variables such as inventory and markdowns. Mismanagement can lead to unpleasant impacts on brand equity. As a result, the total share of online first-party retailers is under threat from new distribution models and the ability of digital to let brands control their own operations.
The second dominant approach to luxury distribution is that offered by third-party online retailers, such as Farfetch, which also enables platform solutions for small and medium-sized retailers. Rather than taking ownership of products, these digital players provide brands with significant electronic real estate and large volumes of customer traffic as well as valuable logistical support. In the most common approach, a brand retains inventory risk and controls consumer-facing variables such as assortment and pricing. This enables full control over key performance levers, including pricing, assortments and inventories, among other benefits.
The ability to keep a hand on the tiller can lead to elevated price perception and shield against potential threats to brand equity. In addition, it can allow brands to more closely manage seasonal calendars and develop a perception of scarcity, a critical differentiator in the luxury space. Meanwhile, a higher level of control over curation, merchandising and content, means brands can manage and apply data more effectively — an increasingly valuable advantage in a world of artificial intelligence and machine learning — as well as leverage deep data mining to refine and enhance marketing campaigns.
The share of third-party models is likely to rise, reflecting the potential benefits to brands and retailers alike. Indeed, amid increased desire among brands for scarcity and exclusivity, they are conspicuously making efforts to reduce their exposure to first-party models. “We are stopping all online wholesale for our brands,” said Kering chief executive François-Henri Pinault, citing issues with discounting on the first-party channel. Prada is also among the brands reducing wholesale exposure, with co-chief executive Patrizio Bertelli saying, “We are still rationalising further [wholesale] … and we think that this rationalisation will make the e-commerce activity and sales in our [directly operated stores] even more efficient.”
As luxury brands renew their online distribution strategies, many first-party retailers are investing in developing hybrid offerings, taking the best of both models. For example, retailer Mytheresa — which formerly used a first-party model — has developed a “Curated Platform Model” for working with brands. Mytheresa will continue to manage curation and logistics, but brands will own their inventories and pay a concession on sales. Meanwhile, Yoox Net-a-Porter has entered into drop-shipping arrangements with brands such as Prada. And after Farfetch recently acquired a 47.5 percent stake in YNAP, the shift from a traditional first-party to a hybrid first- and third-party model is expected to accelerate in the months ahead.
Cumulatively, these hybrid models are estimated to account for a small percent of pure-play online retailer GMV today. However, the share of the total is expected to rise as brands seek alternatives to traditional first party.
A Vision for the Future
Given shifting consumer behaviours that favour digital engagement and the macroeconomic challenges facing brands, the mechanics of distribution are approaching a tipping point, which will affect both brands and retailers. With luxury brands focusing on DTC, along with work-in-progress digital and customer-centric business model transformation, five key trends are set to emerge over the coming period:
Growth of e-tailing, particularly the rise of third party, will be at the expense of physical wholesale and traditional retail: By 2025, luxury players will expand their share of the DTC market to 25 percent from between 15 percent and 20 percent.
Online DTC and third-party e-tailers will drive growth: Online DTC and third party will account for the majority of growth (with online DTC GMV growing approximately 2.5 times and third-party GMV growing more than 3 times between 2021 and 2024).
Third-party models will be the preferred choice for brands in the near term: Brands will increasingly favour third-party models over first party, in order to keep a tighter grip on brand positioning, achieve higher margins (between 5 and 10 percentage points), and steer traffic acquisition and data collection.
First-party models will be relevant for brands that are at the highest risk during a potential economic slowdown: They will be anchored on their ability to take on inventory risk and help brands navigate economic headwinds.
Scale and consolidation will be required to take third-party models to maturity: Third party appears to offer a winning proposition but requires mature operators with greater reach, rather than currently, which is characterised by fragmentation across countries and brands. This will enable platforms to attract the attention of brands and consumers beyond that offered by products alone.
Luxury players, retailers and consumers will be impacted by these changes in varying degrees. However, the ability of businesses to reap the benefits is contingent on their flexibility to adjust to a shifting market while remaining aligned with consumer behaviours and a dynamic economic environment.
The potential impacts on luxury brands: In the current economic climate, only a few brands will have the capabilities to move decisively and immediately to a DTC model — and even the handful of brands that could make such a move will likely wait for economic conditions to brighten. A more likely scenario will be that brands transition from traditional wholesale and online first party into third party, while working to minimise any loss in GMV. This will enable them to capture some of the benefits of DTC while insulating themselves against excessive risk. The extent of recessionary headwinds will be a significant factor in dictating the speed of the shift.
Meanwhile, companies with lower brand awareness, weaker cash flows or inventory accumulations will likely take a more cautious approach, remaining on first-party platforms to support near-term growth.
In aggregate, the market will be polarised across brands forced to choose between first party as a means of mitigating unfavourable market conditions, and third party in order to establish greater control over customer data, inventory and pricing.
The potential impacts on retailers: First-party players will be the most challenged in the near term but will weather the short-term impacts of a challenging macroeconomic environment. It is expected many will use this window to develop their third-party capabilities and create hybrid offerings. By 2024, we expect all major first-party players will develop third-person, concession-based alternatives alongside traditional wholesale models.
Retailers will bid to become hyper-distinctive in at least one area. This may be through the ability to facilitate discovery of up-and-coming brands and designers, curation and assortment, editorial content, the ability to optimise sell through and minimise waste, or best-in-class logistics. Some will also look to develop ancillary revenue streams, for example in data services or shareable logistics. First-party players that fail to differentiate will come under pressure, potentially leading to consolidation or market exit.
Based on the current trends and shifts observed, luxury goods distributed through third-party models are forecast to triple over the next two years. Meanwhile, traditional omni-retailers will leverage both models online. Already, some well-known retailers, such as Harrods, are partnering with digital natives to develop and manage their third-party solutions. Others may consider separating their online businesses, via spin-off or divestiture, to better optimise the technology focus needed to be a winning platform.
In the near term, winners of share will be e-tailers that are best positioned to capture the transfer of volumes from offline to online, and primarily those that successfully offer third-party models.
The potential impacts on consumers: As the competitive playing field resets, consumers will find they are offered fewer markdowns (especially after the current negative market momentum) across online platforms. Indeed, online platforms will no longer be seen as portals to the best prices. On the other hand, the shift to third-party models and DTC should mean that consumers may find more streamlined assortments on their favourite first-party destinations. They will also overall see more refined and enhanced services online, alongside faster innovation and improved customer service. They may also start to use platforms to support lifestyle choices, for example in discovering new brands and ecosystems. Finally, they will benefit from speedier, transparent and more reliable deliveries.
As the economic environment evolves and the impacts of the transition to more digital engagement continue to play out, luxury brands face strategic choices over how they can best engage with their customers and stakeholders, as well as support their business priorities. As leading brands seize the DTC opportunity, the majority face more nuanced decisions over the best way to play and the pace at which they should embrace new models. For many, the most prudent short-term strategy will be to adopt a hybrid approach, in which they begin to realise the control benefits that can be gleaned from third-party models, but hold onto the security offered by first-party approaches. For retailers, the task at hand will be to cater to these competing priorities, but also to make judgements around the probable pace of change and how that may play out. As they invest in their platforms, leading players will also explore possible routes to differentiation, both in respect of brand needs and consumer demand, where value-added services will become an increasingly important factor in willingness to engage and loyalty. As brand decision makers process these drivers to set budgets and make decisions, the likely winners will be those that distil their choices to reflect their specific segment needs, while expertly optimising investment and efficiency to steer through the choppy waters ahead.
Achim Berg is a senior partner in McKinsey’s Frankfurt office, and leads McKinsey’s Global Apparel, Fashion & Luxury group. Anita Balchandani is a senior partner in McKinsey’s London office, and leads the Apparel, Fashion & Luxury group in EMEA and the UK. Dale Kim is an associate partner in McKinsey’s New York office, and a frequent contributor to The State of Fashion. He focuses on Apparel, Fashion and Luxury, Private Equity and M&A. Andrea De Santis is an associate partner focusing on Apparel, Fashion and Luxury in Italy. He supports luxury companies in brand strategy, assortment repositioning, digital and customer-centric transformation. Sarah André is an engagement manager in McKinsey’s London office. She supports apparel and luxury companies in topics such as brand strategy, digital transformation, sustainability, go-to-market and M&A. Meera Singh is an engagement manager in McKinsey’s San Francisco Office, focused on growth topics within Apparel, Fashion and Luxury.
The authors would like to thank Erwan Rambourg, Édouard Aubi, Emanuele Pedrotti, Michael Straub and Franck Laizet for their contribution to this article.
This article first appeared in The State of Fashion 2023, an in-depth report on the global fashion industry, co-published by BoF and McKinsey & Company.
