Recent reports in the press about the problems Fab is facing got me thinking about the lessons one might learn from its meteoric rise and spectacular crash. Professional investors always give this disclaimer; Past performance does not necessarily guarantee or predict future results. Similarly, Fab’s experience is not necessarily a precedent that will always be proven true. However, it is my responsibility as an investor to try to update my understanding of how what has happened to Fab should influence the investment choices I make in the future, after all that is one aspect of my fiduciary responsibility to the KEC Ventures’ limited partners. ((Any errors in appropriately citing my sources are entirely mine. Let me know what you object to, and how I might fix the problem. Any data in this post is only as reliable as the sources from which I obtained them.))
In this case study will I examine; Fab’s market, Fab’s business model and some risks inherent to that business model, the competitive landscape it faced, Fab’s history as reported in the press, and last I will outline some lessons early stage investors might draw from Fab’s experience. ((I do not have the benefit of knowing anyone at Fab. This post is based entirely on public information. My employer KEC Ventures is an investor in JustFab. We made that investment in 2014. Fab and JustFab sued one another in 2013.))
Fab was founded as a social network for gay men in 2010 by Jason Goldberg and Bradford Shellhammer. It pivoted in June 2011 and adopted an e-commerce business model focused on selling a wide range of products to individuals on the basis of daily design inspiration. It became immensely popular, and within a month of its launch reports suggested it had more than 350,000 members and that it processed more than 1,000 orders each day. It’s membership was growing at a rate of about 5,000 new members per day. ((Tricia Duryee; Flash Sales Site Fab.com Raises $8 Million to Be a Step Up From Etsy. Accessed online on Nov. 27, 2014.))
The E-commerce Market
Fab entered the e-commerce market selling directly to the individual consumer. E-commerce is an enormous market according to estimates from eMarketer. The chart below provides a sense of the size and scale of the market.
The following table provides an estimate of the distribution of b2c e-commerce sales by region.
Evidently, e-commerce is a large, and quickly growing market. Global growth will be driven by increasing economic prosperity in China, India, Argentina, Brazil, Russia, Italy and other markets in which e-commerce has not yet reached maturity. At the time it launched Fab seemed well positioned to exploit the expectations of future growth in e-commerce sales in North America, and in other parts of the world.
You might guess that e-commerce is a fiercely competitive market. Fab faced direct competition from Fancy, Achica, Hay Needle, Rue La La, Open Sky, Etsy, Beyond The Rack, Gilt Groupe, Rent The Runway, Zulily, Ideeli, Privalia, and Touch of Modern, among others. ((There are too many indirect competitors to count.))
Fab’s Business Model
Fab built a classic e-commerce market-place. It acted as a curator of products characterised by “great design” where what qualified for that categorization was determined by Bradford Shellhammer’s taste and design sensibility. For example, consider this description of the process by which products featured on Fab were selected; ((Tomio Geron. From Gay To Pay: How Fab.com Became The Hottest Online Retailer. Accessed Nov. 27th, 2014.))
He’s demonstrating the “Beach Thingy,” a flat, brightly colored plastic back of a chair with two spikes that anchor it in the sand. One of the buyers says it’s just a piece of plastic. Shellhammer disagrees. “It’s perfect because you can lay your towel down and slide up or down. And with a stomach like mine I hate getting in and out of the chair and having to suck it in. It’s perfect. This is why I’m a good salesperson,” he says, laughing.
The buyers take turns pitching Shellhammer stuff they think belongs on Fab.com, which means almost anything: cutlery, T-shirts, dog food bowls, wall planters and wine refrigerators. The common denominator is that it has to be something Shellhammer likes, which usually means brightly colored, whimsical, something you haven’t seen before, from a young designer no one’s heard of. When a buyer strikes his fancy, approval comes punctuated with “Love!,” “Holy sh-t!”, “Very nice!” or all three.
Simply put, on one side of the market Fab created a community of product designers from whom it curated the products that it would present to its members. On the otherside Fab developed a community of users or members who were the consumers of the products produced by the designers. Fab ensconced itself between these two groups and acted as a platform facilitating the interactions between them. In exchange, Fab collected fees for each transaction that it facilitated. Fab took care of logistics, transaction processing, customer relations, and marketing. It could do this by building proprietary systems, or by partnering with providers of modular solutions and other services which it could incorporate within its “platform” for a fee. For example, it might use the payment processing technology developed by another startup, and rely on drop-shipping services from UPS, FedEx, USPS or another shipping service. Fab’s business model combined product curation with flash-sales. Presumably, the trend that made such business models popular between 2010 and 2013 was based on consumers’ desire to acquire social status through the discovery of unique, exciting, scarce, exquisitely designed, and affordable products. The flash-sale mechanism was used to create a sense of urgency in order to drive purchasing behavior. Every day Fab would send an email to its members in which the flash-sale of that day was announced.
In 2012 my colleagues and I were studying an investment in Ideeli. As part of our analyses we debated the merits of the business model I have described. On one occasion, we were discussing Fab with an early stage venture capitalist based in New York City who was paying us a visit at our office in Manasquan, New Jersey. He told us Fab would easily justify its status as a billion dollar company and even exceed that by a mile because of its design-centric approach. In his words; “I actually want to open my email from Fab because I know I will always get great design.” In his defense, Fab’s founders confidently echoed that sentiment in interviews; Forbes reported that Jason Goldberg, the CEO, said;
What hadn’t been done is bringing excitement to ecommerce. Not just commodity items. ((Tomio Geron. Fab.com Aims For Amazon-Sized Business. Accessed on Nov. 27th, 2014.))
The same article quotes Bradford Shellhammer as saying;
The product assortment is very emotional. That’s why we feel this business is very hard to replicate.
I had severe doubts about that aspect of the business model. The question I asked myself was this; Do people open the daily emails from Ideeli impulsively as a form of transient self-entertainment in the absence of a more interesting alternative, or is there something fundamental about human nature that ensures that people will continue to behave in ways that make that kind of business model viable over the long term? No one could give me a satisfactory answer so I argued against making an investment in Ideeli. ((My concerns were amplified once I performed some financial statement analysis. That exercise confirmed my suspicions; among other things, it failed my tests of its earnings quality. Each of my two other colleagues at the time had also reached a “Don’t invest.” conclusion by looking at Ideeli from other angles.))
Fab integrated social networking in its business model. At one point as many as half of its users had come through social networking. People would make a purchase on Fab.com and then share the news about that purchase with their friends on Facebook and Twitter. It incentivized people with a $5.00 credit to use on the website if they allowed their purchases on Fab to be automatically shared to their social networks. ((Kristen Nicole. How Fab.com Brainwashed Me Into Broadcasting What I Buy. Accessed on Nov. 27th, 2014.))
The results were phenomenal. Fab reported $100 million of sales within a year of going into business, after growing to more than a million members between June and September of 2011. A year later Fab removed the requirement that individuals had to become registered members of Fab.com in order to browse products. This happened even though it had grown its membership to 1M faster than Facebook, Twitter and Groupon and said it had more than 10M members by December 2012.
On the strength of that performance, Fab raised a $1M seed round in July 2011. That was followed by a $7.7M Series A at a $20M valuation and then a $40M Series B at a $200M valuation, in August and December respectively of that year. It raised a $105M Series C tranche in July 2012, and a $15M tranche in November that year, at a $600M valuation. Between June and August 2012 it raised a $165M Series D in three tranches. The valuation for the Series D was reportedly between $1B and $1.2B. Its sales at the time were reportedly around $115M, giving it a price-to-sales multiple between 8.7x and 10.4x. Altogether, it raised $336.3M. ((I obtained this data from CBInsights and Crunchbase.))
External signs that Fab’s rocket engines were beginning to sputter and fail started appearing in 2013; in July it laid off 100 employees in Berlin and moved others to New York, in October it cut 20% of its worldwide workforce by eliminating 101 jobs. It also made a pivot from the flash-sales model. Bradford Shellhammer left the company around that time. In May 2014 rumours about further lay-offs began circulating in the press, suggesting that as many as 60 of its 305 employees would be let go. Most recently it is reported that Fab has slimmed down to 25 employees, that it was burning $14M per month at its peak, and that some of its problems began because it only secured half the amount of capital it originally set out to raise in its last round. Yet other reports suggest Fab might be sold for as little $15M.
So what went wrong?
What questions might have suggested to Seed and Series A investors that the realities Fab is facing today had more than 50% probability of becoming the reality within their investment horizon? ((In performing my assessments of early stage startups KEC Ventures might invest in I assume we will hold a Seed or Series A investment for at least 10 years. Also, I assume we will not be in a position to engineer a favorable exit within that horizon.))
The study of economic moats is useful in trying to avoid making investments that evaporate into thin air before the investor has harvested returns. In this case the investor would be performing a forward-looking assessment. But first, what is an economic moat? An economic moat is a structural feature inherent to a company’s business model which protects it from the deleterious effects of competition. Economic moats help companies preserve and sometimes enhance the advantages they enjoy over their competitors. There are five ways in which a startup can build an economic moat; Branding, Intellectual Property or Intangibles, Efficient Scale or Cost Advantages, Network Effects, and Switching Costs or Buyer Lock-in.
Let’s quickly go through each of these for Fab, remember that we are pretending this is 2010/2011 and that we are studying Fab for a Seed or Series A investment.
- Brand: High; because consumers have come to associate Fab with great curation, great content, and great design.
- Intellectual Property or Intangibles: Low, or non-existent; because there’s nothing proprietary about what Fab is doing, contrary to the claims made by Messrs. Goldberg and Shellhammer. Other great designers would be able to replicate what Fab is doing. The notion that Fab could develop a monopoly on emotionally inspiring design is specious at best. Also, Fab failed to fully harness technology to its advantage by operating with a relatively low level of automation.
- Efficient Scale or Cost Advantages: Low, or non-existent; the use of social channels only confers an advantage for as long as other startups do not incorporate those methods into their marketing and sales processes. Moreover, there is no way to create exclusive relationships with the social networks through which Fab acquires users without incurring high sales and marketing expense.
- Network Effects: Low, or non-existent; popularity in-and-of itself does not reflect the existence of network effects. Neither does virality point to the existence of network effects. In fact, one might argue that businesses like Fab exhibit a negative network effect – each individual user has a less enjoyable experience as the user base grows if social status is in fact a key driver of Fab’s relationship with its members or users.
- Switching Costs or Buyer Lock-in: Low, or non-existent; because members suffer little to no pain if they decide to stop using Fab and instead take their consumption to one of its competitors.
The conclusion one draws from the preceding analysis is that although Fab appeared to have found a way to grow remarkably fast, that growth could end in very short order. Of equal concern, Fab’s business could deteriorate just as fast as it had grown, if not faster.
Another way to look at the issue is this; In the absence of its near-irresistibly seductive revenue and user growth would Fab be the kind of business that the Seed or Series A investor would be comfortable owning for 10 years or more?
So perhaps one is asking the wrong question when one asks “What went wrong?” or “How did that happen?” in reference to Fab. A more appropriate question might be; “Why did investors believe a startup with no inherent advantage over its direct and indirect competitors could defy the gravitational forces of competition and changing consumer tastes?”
For that answer, you’d have to speak with one of Fab’s investors.