Zozo: A Shooting Star Shooting Itself in the Foot

This Insight has been produced jointly by Michael Causton at JapanConsuming and Mio Kato, CFA at LightStream Research.

A. Conclusions Up Front

Zozo’s valuation is based on:

• The core Zozotown mall business
• The potential of its new private brand
• The quality and reliability of its management
• Zozo’s two key assets: its brand and its database of 7 million fashion consumers.

This report examines each of these with the following conclusions:

1. The Existing Zozotown business faces slowing growth profile

We expect Zozotown to continue to grow transaction values (TVs) and revenues but expect growth rates to differ sharply from Zozo’s projections:

• The mall business will continue to add volume in line with expansion of the online fashion market overall but not much higher and margins may suffer from pressure on take rates and declining average prices:
  • Demographic breakdowns suggest that Zozo will have to work much harder to add new customers, especially women in their 20s. To continue growing membership rapidly, penetration of older demographics could be necessary and Zozo has not demonstrated this ability so far.
  • Commission rates could come under pressure as merchant discontent increases due to reduced visibility and the brand dilutive proliferation of lower-priced clothing. The recent departure of Onward could be a sign that brands are increasingly capable of going it alone online.
  • Revenue per user significantly outpaces global competitors such as Asos, Zalando and even Boohoo. After increased purchase frequency drove a temporary small increase, the same purchase frequency is falling back towards trend, as is average revenue per user.

2. Private brand targets look extremely aggressive

The private brand will not reach anywhere near the targets set by Zozo given the difficulty in building a business of such scale in a short time:

• ¥200bn in revenue within three years would represent a pace of growth 3-5x as fast as some of Japan’s biggest names in fashion and the numerous execution errors point to a rushed launch.
• Marginal profit ratios aren’t that high for apparel firms and retailers with most names achieving 6-10% marginal operating profit. While Zozo is likely to hit the top of this range, it will dilute the Zozotown mall's high operating margins.
• The target of 30% of private brand sales coming from overseas in 2020 is a fantasy. Zozo has almost no presence overseas currently and no amount of moon-trip press will deliver sufficient market coverage to drive sales to this target.

3. Other Business has some potential

• Zozo has potential to grow advertising revenues and further leverage its Wear app to do this.
• Adding advertising to Zozotown and Wear requires little capex or additional operational overhead so should be quite profitable – but could annoy some users.

4. Evidence of poor/rushed planning is piling up

While the Zozo business is solid, recent management behaviour and policy implementation suggest management is struggling:

• CEO Maekawa’s public profile is increasingly difficult to reconcile with someone intent on driving their existing business to unprecedented highs.
• Questions regarding the amount of time he spends at work and the moon trip announced with Elon Musk don’t sustain a reputation of solid dedication to the business.
• After consistently producing conservative guidance throughout much of its history, Zozo’s recent medium-term plans appear to be based on bluest-of-sky forecasts.
• At the same time, failed execution on the first Zozosuit, haphazard strategic changes and hopes presented as solid targets for entirely new businesses where the company has not accumulated expertise, suggest a lack of rigour and discipline.
• This all points to management trying to execute to a target that has been determined, not for the purpose of building long term enterprise value, but rather to generate significant positive and temporary buzz… or a higher short-term share price. Either way, signs are that all is not well with the company short-to-medium term.

5. Long-term potential still very much there

While the short-to-medium term outlook looks unstable, Zozo has significant momentum longer-term:

• A valuable database of some 7 million fashion consumers with their purchase histories, likes and dislikes, profiles on Wear, sizing, and relationships with other Wear users. In our view this database is Zozo’s primary asset and not one to be underestimated – it is far and away the biggest and most comprehensive database on fashion preferences among Japan’s most fashion-avid consumers. No competitor has anything like it.
• The Zozo brand remains very valuable despite the recent blemishes caused by the botched launch of the private brand.
• These two assets are an excellent foundation for building a major new apparel brand.
• While no fashion/apparel retailer has reached ¥200 billion in three years, and it is highly unlikely Zozo can, it is equally true that no fashion retailer has started out with a database of all the preferences of 7 million fashion-loving consumers and one of the most famous brands in the sector.
• If management can stabilise and follow long-term planning and a more considered execution of strategy, the potential for the emergence of a Zozo brand to rival Uniqlo and others is real.

However, development of such a business is a five to ten-year project.