Furniture and homewares retailers are getting crushed right now.
Made.com, the UK’s publicly listed furniture store, stopped taking orders last month, citing solvency issues.
Interiordefine, a custom online furniture retailer in the US, entered voluntary administration last month.
And Brosa, the Australian online furniture retailer, entered voluntary administration last month, and was acquired by Kogan.
WTF is happening?
After a surge in growth in 2020/21 as a result of COVID lockdowns and Government stimmy checks, merchants bet that the spending wave would continue into the future.
Large purchase orders were committed to. Headcount increased in warehousing and logistics. Businesses reinvested to handle the growth.
But everything came to a screaming halt in early 2022.
Demand in the category drastically declined.
Rising interest rates and fears of a recession have resulted in consumers re-thinking their need to buy that $3,000 sofa.
Everything that could go wrong, is going wrong.
- Slowing sales
- Refunds spiking due to delays/affordability
- Warehouses that are overflowing with excess inventory
- Suppliers that are demanding payment for committed purchase orders
- Excess headcount
Combined with a continued unreliable supply chain, as well as increased freight and delivery costs due to rising petrol prices.
It’s a recipe for disaster.
Never waste a crisis
Yes, trading conditions are tough for all merchants – but what can we learn from this?
As Charlie Munger famously said: “All I want to know is where I’m going to die so I’ll never go there.”
In this financial teardown, I’ll be dissecting the finances of Brosa.
I’ll share how easily a few factors can send a rocket ship that was growing 100% year on year crashing into insolvency in a matter of months.
The aim is to unpack some insights that you can take away – so you don’t go there.
What is Brosa?
Founded in 2014, Brosa was one of Australia’s first pure-play direct-to-consumer (DTC) brands. It was founded at a time when DTC startups were hot and attracted venture capital – the era of Allbirds, Casper and WarbyParker.
Over the years, Brosa raised $12M, including substantial rounds from Australian VCs AirTree Ventures and Bailador Technologies.
In the environment of cheap capital and low acquisition costs, DTC brands were hot. Due to their supposedly ‘SaaS-like’ scalability, many were being priced at software company valuations.
Flush with funding and facing a lack of tools in the market, many brands built their own proprietary software.
In the furniture category, Wayfair had a custom marketplace software. Zanui (the Rocket Internet version of Wayfair) did the same. Brosa was no different – building a sales platform (instead of using Shopify/BigCommerce), an ERP to manage inventory, and a customer loyalty tool, amongst others.
Nowadays, building a proprietary eCommerce software stack is a fatal error. You can spin up Shopify in less than a day.
I can only speculate that the desire to build proprietary software came down to two things:
1) A perceived competitive advantage. Shopify was a different beast in 2014 to what it is today. The app ecosystem was as well. Many of the tools Brosa were building were presumably not available to third-party vendors at the time. Being first to market to build bespoke tools would have been considered a competitive advantage.
2) A narrative trap. If you pitch yourself as a technology business, you need to live up to that story – the story that Brosa was not just a furniture retailer that sells direct to consumer, but rather a technology company. Alas, it’s not easy to be great at both.
What went wrong?
Fast forward several years to 2020. Brosa was considered Australia’s DTC darling in the furniture and homewares category, chasing the heels of listed giant Temple & Webster.
This was one of the categories that greatly benefited from the COVID boom. Folks were locked down and spending big sums of money to improve their home. Despite this massive tailwind, the business couldn’t continue as a going concern.
Let’s take a look at the financials to investigate what occurred.
Here are a few key observations. Images of financials have been removed as request by Brosa.
Gross Sales grew 5x over the FY19 to FY22 period, from $19M in FY19 to $95M in FY22. This was no doubt COVID-induced, benefiting from a shift in spending towards the home and at accelerated online penetration rates.
As the economy gradually re-opened, order volumes declined to 25-30% in Mid-21, dramatically down from over 100% in 2020.
Product Margin remained steady at ~55% – a remarkable result given the volatile shipping costs over the period.
Brosa increased prices to maintain product margin, but not enough to offset the heavy promotions or discounting.
Last Mile Delivery Costs significantly increased due to :
- Deliveries interstate from Melbourne Distribution Centre (DC) to NSW and QLD
- Demurrage and port penalties due to congestion in internal supply chain network and capacity constraints at DC
- Increase in customer returns, increasing reverse logistics costs
The overall delivered margin was 34% – which is on the lower end of a DTC brand (target is ~45% to 50%).
The key issue, in my opinion, was the heavy promotional activity by the brand.
Discounts averaged 20% of revenue, in addition to the marketing expenses at 16% – 18% of revenue.
Variable Acquisition Costs increased, particularly prevalent in the last 5 months of trading as the brand attempted to stimulate slowing customer demand.
As a result, Contribution Margin, calculated as gross profit less marketing spend, ranges between 18% to 24%.
From my experience, this is a low contribution profit for a DTC brand. A financially sustainable DTC brand should be targeting a 30 – 35% contribution margin. One of the core issues, IMHO, is the discounting – a known killer of eCommerce businesses.
The second overarching point is the level of fixed costs in the business.
With tremendous revenue growth, the fixed operating costs base 3x’d from FY19 to FY22.
FTEs grew from ~30 to 65 in 18 months.
The challenge with investing in fixed costs is that they exist, irrespective of your revenue. As sales and contribution profit declined, Brosa’s losses doubled, spiraling to $4.5M in FY22.
For most eCommerce brands, the biggest cash flow killer is inventory levels. It’s not uncommon for brands to hold excess levels of stock, particularly in periods of supply chain uncertainty.
Whilst Brosa holds inventory, they enjoyed a negative cash conversion cycle due to the large amount of customer deposits. A lot of their sales are “Made to Order”, meaning that customers will pay a deposit for the product whilst it gets manufactured by Brosa’s suppliers.
Brosa enjoys this cash float that it can use to spend on growth. The more sales you make, the more cash your business generates – you can read more about the power of a negative cash conversion cycle here.
A negative working capital cycle is typically a good thing. It means that you’re keeping cash in your bank account and delaying the repayments to creditors and accruing customer liabilities.
But it can work against you in an environment where cash receipts are slowing. All you’re doing is pushing back liabilities to a later date. If you don’t have enough new sales to cover old liabilities, you can quickly end up in a cash flow crunch. This is why Brosa failed so suddenly.
In a profitable and well-managed business, a buffer of cash reserves generated by a negative working capital position would be available to pay short-term liabilities. But if you’re unprofitable, a negative cash conversion cycle simply delays when you need another round of equity or debt funding.
Brosa had to raise more money, irrespective of the market conditions. With tightening capital markets, one could argue that Brosa wasn’t a going concern even with the COVID tailwind.
At the end of the day, there’s no escaping the need to be profitable.
Brosa entered voluntary administration on 14 December 2022, just a week before Christmas.
Within a matter of days, listed retail juggernaut Kogan acquired the goodwill, intellectual property and stock for a cheap $1.5M. It didn’t even take any liabilities, except for some unfulfilled customer orders.
Xmas came early for Father Kogan.
Based on the balance sheet leading up to voluntary administration, I’d estimate that Brosa has around $20M of creditors/liabilities that won’t get paid. The majority of these are suppliers – the very makers of the furniture. The $12M of investor capital is gone, too.
The key takeaways
Businesses fail every day.
People make mistakes. Things don’t go to plan. Markets change. Inputs fluctuate which are not often in our control.
What matters is that we are able to objectively assess what went wrong and what we can potentially risk-mitigate for the future.
Here’s my take:
1. I do not believe eCommerce brands should be “burning” money. Fundamentally, you are a retailer. Act like one. Focus on your unit economics and make money! If you’re burning cash, aggressively reduce fixed costs and fix your margins.
2. “Hyper Growth” is not a good thing in eCommerce. eCommerce is not like SaaS, where you have zero marginal cost. Every order requires someone to make the product, send it to your warehouse, dispatch it to the customer and hope it doesn’t get returned. Capacity constraints are real. The margins are completely different as well. If you have the option to choose, go for slower, predictable and profitable growth over hypergrowth. Logistics, supply chain and costs become easier to manage.
3. Another factor is that Brosa’s contribution margin of ~20% is a lot lower than it should have been (the target is 30% – 35%). From my analysis, aggressive discounting and ad spend is the primary factor (representing a combined ~40% of net sales). Revenue quality matters. Quality over quantity.
4. Finally, you have to choose the type of company you want to be. Brosa made the decision to build proprietary software. I think this was a mistake. You need to keep a team of developers on payroll to fix bugs and build features that would otherwise be managed with third-party tools that cost $50 a month. Aside from the tech debt, you also need to train new team members on how to use this specific software, which consumes valuable resources and onboarding time. I think this is a reason why headcount at Brosa grew so rapidly. If you’re a hybrid eCommerce / software business, choose one or the other. Running one business model is hard enough.
2023 will continue to be a challenging year for all businesses.
I’m in the trenches with you.
My advice is simple (but not always easy).
Focus on the fundamentals: make a profit and turn that profit into cash.