VCs Flock to Exclusive Shopping Sites

Scott Collins isn’t the kind of guy who wakes up early to shop. But when he heard that Tumi travel bags were being sold online at 70% off the retail price, he just couldn’t resist.

“I had to wake up at 7 or they would have sold out,” he says.

Collins is one of millions of consumers flocking to private sale sites to snap up bargains on luxury items ranging from designer clothing to jewelry to home décor. But Collins is more than just your average shopper looking for a great deal. He’s also a managing director at Summit Partners, an investor in Vente-privee, the site where he bought his Tumi suitcase.

“If you are not fast, the best stuff is gone quickly, so you’ve got to get there early to have a better chance of getting what you want,” he notes.

Collins’ could just as easily be talking about his investment in Vente-privee. After all, venture capitalists are piling into private shopping space (see table). They invested more than $200 million in at least 14 members-only shopping sites over the past few years, including more than $97 million in eight companies in 2009 alone, according to Thomson Reuters (publisher of VCJ) and press reports.

Sites with upscale names like Gilt Groupe, HauteLook, Ideeli, One Kings Lane and Rue La La have quickly become a major force, attracting millions of shoppers, generating billions of dollars in sales, and netting huge valuations by VCs eager to capitalize on the latest e-commerce trend.

Ripe for Acquisition?

I think what makes these sites work is the element of social shopping combined with a game-like quality that adds immediacy to the entire experience.”

Chip Meakem

At least one of the private shopping sites has been acquired, producing a hefty to return to its venture backers, and another is rumored to be negotiating a multibillion sale. Vente-privee, which is reportedly in acquisition talks with, has displayed remarkable growth over the past few years, reaching sales of 650 million euros this year, boasts Collins. Summit invested an undisclosed amount for a 20% stake in the Saint-Denis, France-based company in 2007. That deal valued the company at $1 billion, according to BusinessWeek.

“We saw a business with a huge amount of head room and the ability to dominate in France, as well as the opportunity to expand to other major countries in Europe, and even beyond that,” says Collins. “The overall market size is really, really big.”

Private shopping sites operate on a “members only” basis, though becoming a member requires little more than providing a name and email address. The sites generate a sense of excitement and competition among shoppers by selling a limited number of items each day, and providing a very limited time frame—often 36 hours or less—in which to make a purchase. The idea is that when people see an item they like, they are compelled to buy it quickly.

Upside of Recession

Private sale sites have shot to prominence during the global recession. They are benefiting from the perfect storm of consumers desperately searching for discounts, and major brands anxious to unload excess inventory that would otherwise sit idle on retail shelves. The sites buy overstocked goods from top brands, and then slash prices like crazy. They send out email blasts to their members announcing the sales, and then sit back as frenzied shoppers descend on their sites.

“I think what makes these sites work is the element of social shopping combined with a game-like quality that adds immediacy to the entire experience,” says Chip Meakem, a general partner at Kodiak Venture Partners and an early investor in Ideeli. “The economics really make sense.” Ideeli, which raised a Series B round of $20 million in December, now boasts 1.3 million members.

There are two main reasons these private sales sites are able to offer such steep discounts. First, they are selling excess inventory that brands are more than happy to get rid of. Second, the sites rely on word of mouth, so they don’t have to spend significant money on marketing and advertising.

In 2009, brands were left with all this excess inventory, and along came Gilt and Rue La La that helped them get rid of it. But what will happen this year?”

Sucharita Mulpuru

But why are so many new private shopping sites popping up now? For example, One Kings Lane and Zulily were both founded and raised venture capital last year. But the concepts of overstock, consignment and sample sales are not new to the retail industry—and Vente-Privee has been around for about nine years.

“I don’t really have a good answer for you,” admits Meakem.

Neither does Sucharita Mulpuru, an e-commerce analyst at Forrester Research. “Private shopping sites could just as easily have happened five years ago,” she says. “There is no new technology fuelling their rise.” The only difference, she notes, is the feeble state of the economy and the fact that many brands were left with inventory they could not sell through normal retail channels.

But here’s the big, unanswered question: What happens when the economy recovers? Many designers will no longer have overstocked goods, making it harder for private shopping sites to secure brand-name merchandise and attract new customers.

Threat of Improving Economy

“In 2009, brands were left with all this excess inventory, and along came Gilt and Rue La La that helped them get rid of it,” says Mulpuru. “But what will happen this year? It’s likely these same brands will decrease their manufacturing lots and be able to sell out at retail, which means private sale sites will be challenged to get quality inventory.”

Summit’s Collins says that a good relationship with brands is the key ingredient to building a successful private shopping business. He says that at Vente-privee the real customers are the brands, not the buying public. “You really need to be concerned about access to brands and getting the best products at the right time,” he says. “Our business works precisely because brands believe Vente-privee does a good job in helping them represent and liquidate their excess stock.”

You really need to be concerned about access to brands and getting the best products at the right time.”

Scott Collins

Vente-privee has 18 photography studios at its French headquarters and professionally shoots every item displayed on its site. It also produces its own music trailers for each sale, ensuring that products are presented in a sophisticated way to preserve their designer image.

Vente-privee, which pioneered the private sale concept, has done well in both a good economy and a bad economy, says Collins. “We can get our hands on the merchandise, and that’s what makes this such a durable business model.”

By contrast, he wonders how new, U.S. based sites, such as Gilt, HauteLook and One Kings Lane will fare. For one thing, these sites face huge competition not just from each other, but from a well-established overstock infrastructure that includes outlet malls, sample sales and consignment shops like TJ Maxx and Filene’s Basement. Even high-end department stores have entered the off-price space. Nordstrom has its Nordstrom Rack subsidiary, and in October, Saks Fifth Avenue held its own online flash sale, a 36-hour event open only to customers on its mailing list.

Nick Beim, a general partner at Matrix Partners, an investor in Gilt, is confident that private sale sites are here to stay. Brands need them and customers love them, he says.

But, like everyone else, Beim is slightly uneasy about the plethora of private sale companies launched over the past two years. “It will be interesting to see how many the market can sustain,” he says. “Given the venture capital overhang, I think the market will likely become oversaturated pretty quickly, but I think the opportunity for the winners is substantial.”

A Few Big Winners

Beim believes both consumers and brands will coalesce around just a few sites because of the limited appetite of consumers to subscribe to multiple private sale sites, and the limited appetite of major brands to deal with more than just a few partners. Clearly, image-conscious brands would prefer to deal with a smaller group of substantial players, rather than spreading their merchandise around to 20 or 30 vendors.

I think the market [for private shopping sites] will likely become oversaturated pretty quickly, but I think the opportunity for the winners is substantial.”

Nick Beim

But for those sites that do come out on top, the sky could be the limit, especially in terms of their ability to expand into new categories.

Gilt, for example, is expanding into men’s and children’s clothing and home furnishings. It has also entered the travel business through its JetSetter subsidiary, offering steep discounts on luxury travel packages. Meanwhile, Vente-privee is now offering almost everything under the sun, including tickets to first-run shows and technology gear through dedicated websites serving France, Germany, Italy, Spain and the United Kingdom.

Today, online private sales are undeniably hot. New York-based Gilt reports that its revenue reached $85 million in fiscal 2009 and that it expects sales to more than quadruple to $400 million this year.

“There are lots of things that can happen in this category,” says Kodiak’s Meakem. “The world changes extremely fast and you’d be foolish to think that in a market as dynamic as this one that nothing is going to change.”

This raises a critical question. Should VCs continue to ride the wave and pour money into these companies, or should they try to flip their investments before growth rates start to cool?

“Most of these companies need to cash out now before too many entrants come in and consumers start to tire of the concept,” advises Forrester analyst Mulpuru.

Indeed, GSI Commerce Inc. paid $350 million in October for VC-backed Retail Convergence Inc., which owned Rue La La, according to Thomson Reuters. That produced a hefty payday for the backers of Retail Convergence—Breakaway Ventures, General Catalyst Partners and two undisclosed firms—which invested $25 million in the Boston-based company in April 2008, according to Thomson Reuters.

Another liquidity event may be in the works. TechCrunch Europe reported in December that was in “deep and secret negotiations” to buy Vente-privee for $3 billion. Such a purchase wouldn’t be out of the ordinary, considering Amazon bought online shoe seller for $930.1 million last July.

Collins would not comment on the Amazon rumor, but he did say that the better players in the private sales space still have the opportunity to grow larger and more profitable, and ultimately become publicly traded companies.

“Right now, the only thing Vente-privee is focused on is becoming a 1 billion euro business,” he says.