Building the business case for circular business models. Part 1: Resale

The potential of circular business models continues to grow in the apparel market—more and more rental and resale experiments and pilots are being launched and market growth is outpacing traditional retail. Nevertheless, for brands looking to design and launch a circular business model, there are many real and perceived barriers associated with their adoption. One such barrier is the lack of clear evidence of the financial viability: the business case. Currently, the best proof that the industry has on the long-term financial viability of rental and resale business models lies in the market’s anecdotal success stories and several key industry reports on the topic.

The latest 2-part article in the Switching Gear series takes a closer look at the business case and financial feasibility of circular business models in the apparel industry. Using illustrative case studies from our partners and network PwC, Lindex, Lizee, Fashion for Good and Accenture, we clarify the associated risks and benefits associated with both resale and rental business models and outline key learnings and considerations.

Why is there a need for a strong business case? A strong business case will support your rental or resale offering in successfully achieving scale and, over time, allow it to displace the traditional linear offering. Furthermore, you need a strong and healthy business case to secure the resources needed to dip your foot in the water to develop and launch a pilot, and eventually implement the model. While there are plenty of ways to optimise this case, it is key to also take into account the value it brings to your customer and the environmental and social impact of the model on society. A new circular business model will ideally be optimally designed to meet three key criteria for success:

1. It will have a value proposition that is convenient and affordable for your customer
2. It will have a financially viable business case that can compete with and, in time, even cannibalise your primary business model;
3. It will have a net-positive impact on people and the planet.

Importantly, a circular business model that looks great on the balance sheet but that doesn’t make sense for your customers or the planet will ultimately fail to meet its full potential. For example, when designing a resale business model, you must determine whether or not you will accept lower quality products—such as items which are worn, broken or damaged—or only high-quality items—in near perfect condition. Cherry picking the highest quality items will surely bolster your business case, but it ultimately turns a blind eye to the bigger issue of textile waste. If you are not reselling a large part of the second hand items collected, what to do with these items? The impact potential of your model—its ability to extend the active life of clothing and to divert textiles from landfill—is being curbed. Similarly, customer convenience may also be compromised, as donating customers might be frustrated that they can only drop back a small selection of the items they no longer wear.

In order to discern whether your business model will create value, you must have a clear understanding of where the recurring costs and revenues are and where one-off investments are needed. To get started, a detailed end-to-end customer journey is key. A thorough overview of front of house actions will allow you to answer critical questions that drive the business case: what quality and quantity of clothing will we collect from the customer? Will the take-back be incentivised and if so, will we supply a fixed or variable reward? Will we offer take-back online, instore or both? What % markdown is acceptable for our second hand products, in the eyes of the customer? And how does offering second hand products alongside new products affect our markdown strategy for new products? Given that both rental and resale are relatively new concepts in the apparel industry, there is limited information available regarding topics such as standard or expected collection rates, resellable rates, repair rates, resale values etc. However, these metrics have a large impact on the results of the business case. Therefore, brands who are developing new circular business models will need to make intelligent assumptions, conduct a sensitivity analysis when starting out and continuously update the business case as these key metrics are validated in the market after the model is launched. In addition to front stage actions with the customer, brands must also consider the impact that the model will have on the value chain. Backstage processes such as reverse logistics, sorting, cleaning, repair and remerchandising—whether conducted by external solution providers or inhouse—will have a cost, in some cases per used item handled. Naturally, it is not possible to have a complete picture of these costs until the nature and volume of the used or rented garments is known.

Furthermore, it is wise to consider what investments may be needed overtime, to scale or improve your model. What technologies will be needed? As outlined in PwC’s article “evolving face of digitally enabled sustainable fashion” in 2020, and in the Circular fashion report 2020 - Year Zero, digitalisation could radically improve efficiency and reduce costs in the supply chain (e.g. digital tagging, virtual reality, artificial intelligence, automated sorting, data/analytics, internet of things, robotics, blockchain etc.). However, they come with their own investment requirements. What marketing budget will get your new offering seen by the right customer? Rental and resale both require the consumer to adopt new and comparatively unnatural or inconvenient behaviors. So they require a concerted effort to tremendously increase the attractiveness of this alternative way of consuming. Finally, becoming circular needs a whole system to change and therefore often requires a business transformation.. Especially in established organisations, the full adoption of circular models like resale or rental—and the displacement of the traditional business model—will not happen without aligning the organisation’s culture to its sustainable strategy. The sum of employee values and beliefs determine an organisation’s culture, and organisations will not change if people don’t change. In order to support this transition in earnest, a sustainability strategy should be defined and include clear, measurable objectives to be integrated in the annual employee performance management cycles. Furthermore, investments are often needed in areas such as process redesign, improving product longevity, training the workforce and hiring new, specialised staff. As we will see, there are different financial considerations to keep in mind depending on whether you are pursuing a rental or resale model.

Reports like the ThredUP market report demonstrate that the acceptance of second hand is growing and more and more people are buying preloved items. For every secondhand garment bought, there is a second hand garment sold—be it by a brand, a third party innovator or an individual themselves. And while the ‘resale’ element is certainly important to the business case because it drives revenue, the take-back process is equally, if not more, important. One of the biggest challenges when it comes to the financial viability of a resale model is keeping the variable costs related to the take-back and processing of second hand items down. On the take-back side, the key levers for the resale business case are many and include the reward structure that’s in place for the seller, the processing costs, the volume and quality of what is collected and the resellable rate. On the resale side, the single biggest key lever is the quality of inventory, which dictates the resale value of the garment in the market. Let us dive into a number of the above levers.

Take-back: Securing the right inventory by incentivising the right behaviours

A continual refrain from both brands and independent resale platforms is that it is increasingly difficult to secure high quality inventory for resale. It seems that the interest to buy second hand is larger than the interest to sell preloved items. With more and more platforms and brands entering this space, securing (the right) inventory might become the biggest bottleneck for scaling. Attracting and engaging resellers with the offering is therefore an essential strategy to establish a resale model at scale.

However, in order to engage resellers—and therefore improve the business case— the message and value proposition must strike a chord with existing customers, and entice them to act in a particular set of ways. Preferably, brands would like customers to give back multiple garments at once, since volume drives efficiencies of scale. They would prefer that customers send in or drop off multiple items at a time, as this would lower the take back cost per item. And they would also prefer that customers supply good quality products, as high quality items in good condition mean lower ‘renewal costs’ and a higher resale value in the market. The customer is a crucial supplier to the system and as we see above, as a brand, you have a lot to ask of them! How will you make it worthwhile for them, and reward them for their compliance? Finding the right incentive or reseller reward is key—one that effectively attracts customers to participate but doesn’t hurt the business case. In order to determine the most suitable reward scheme direction, brands must understand what drives your customer. Is the customer triggered by a financial incentive or is the ‘good feeling’ of giving back a bigger motivator? Are they discerning resellers already, who are interested to maximise the value they get for the used garment, or are they primarily looking for a convenient, hassle-free way to clear out their closet? Questions such as these will help you to decide whether to offer, for instance, a fixed reward for all items returned versus a variable reward for certain items and/or qualities. Lindex tested their concept in the Autumn 2020, and to their surprise, found that the participation of resellers was much lower than expected. They had assumed a higher level of engagement, since their take-back concept benefits parents whose kids are constantly growing out of their clothing. From the prototype they learned that they need to further attune their messaging to capture the attention of their target group, but also to make the take back process very clear and simple, to avoid losing parents in the conversion stage. It is important to note that the test was executed in a few short weeks, and in the midst of a global pandemic, therefore the in-store take back was a challenging option to begin with. This will naturally improve for the pilot, due to launch in Spring 2021, when these constraints no longer apply. And while participation was surprisingly low, the quality of goods coming back was surprisingly high, giving Lindex confidence that the garments can generate significant revenue in resale.

Processing: To outsource or not to outsource?

Collected garments will need to undergo a number of processing steps (sorting, cleaning, repairing, tagging and re-merchandising, for example) in order to prepare them for resale. Working with a solution provider to outsource all or a part of the operations can be a good way to reduce costs and to improve the business case. These players, such as The Renewal Workshop, or Trove, can achieve efficiencies of scale and are specialised in the process of handling garments for repair, renewal and remerchandising, which are manual and time-intensive processes. Setting all of this up in-house would significantly increase your fixed costs—whether training or hiring personnel or investing in the logistics needed to smoothly operate this new end-of-use supply chain. However, finding a suitable partner is not always easy either: this market is still developing and these players and their solutions are not yet widely available, or may not be available at the scale needed. Lindex, for example, decided to keep their pilot in-house. The prototype test they ran in the Autumn of 2020 made them realise that many valuable insights are generated when you handle the process yourself and they want to continue capturing this value during the pilot. In time, when they fully understand which steps they want to outsource and when a certain scale is achieved, they will consider engaging with partners.

Resale: What’s it worth a second time around?

Once renewed, your garment is ready to be resold. Pre-loved items are generally priced at a percentage of their original price, which can be anywhere from 25 percent -65 percent. As outlined in the Circular Fashion report 2020 — Year Zero, there are multiple renewal options in which the pre-loved items can be resold, such as repair, upcycle, recycle (e.g. vintage or limited edition second hand garments). Depending on the renewal choice, garments can cost much more than the original sales price, due to their uniqueness and/or the craftsmanship employed during the renewal process.

In every case, it is important to consider how the pricing of your secondhand offering compares to your firsthand offering and how the customer will view both in relation to each other, instore and online. Earlier this year, Patagonia made headlines with their decision to sell used clothing alongside new, online and instore. This step, although seemingly small, is in actual fact quite radical. The true power of resale lies in its ability to A) increase garment utilisation and B) displace the consumption of new items with used items. Unfortunately, B) is a still a bitter pill for much of the industry to swallow and fears of ‘cannibalisation’ of first hand sales abound. But cannibalisation is not the threat of resale—it is the point of resale. Furthermore, the cannibalisation of primary/linear business models by circular models does not mean brands will see their total revenue decrease. On the contrary, it shows a great opportunity for higher revenues without producing new garments, or, in other words, for decoupling economic growth from environmental harm.

As Annette Tenstam from Lindex stated ‘we can see that this resale is happening, whether or not we are engaged. So we might as well understand it and be part of it.’ For Lindex, it is particularly important to consider the standard discounting strategy for their new products and whether this will hamper their new business model—in other words, will first hand sale prices undercut the second hand offering? This can be a question of timing, but it can also cap the pricing of your resale items to the level of discount given on new items.

This is part 1 of a 2-part blog - stay tuned for a deep dive on building the business case for a full-service rental model.

This 2-part article was written by Hélène Smits and Gwen Cunningham for FashionUnited, with the support of Jennifer Nelen of PwC, who supported the Switching Gear project at Circle Economy as part of their Corporate Sustainability Programme. This article is part of a series of articles published on the topic of resale and rental business models. Hélène and Gwen lead the Switching Gear project at Circle Economy.

Images: Top image: Lena library, Huib van Wersch. Second image: Bo van Veen.