The Shein “Choke Hold”
I explain what Shein, the Chinese fashion ecom giant, is doing to eventually squeeze out its fashion competition. Not just online but also offline competitors
This is the original version of this article that was published on TechinAsia
A Refresher on who Shein is
Shein is the online fashion company from China that has taken the world by storm and is estimated to be worth more than a $100bn (based on a funding round led by the VC, General Atlantic, earlier in the year. After having first been founded in 2012 they now sell in 200+ countries and do well over $10bn in GMV. The most intriguing thing about Shein in my view is what they are doing on the supply chain side.
As they have traditionally shipped from China to all these markets, their free shipping has been key to the model. And you can see in this data by measurable.ai below just how often it is utilized in some of the major Shein markets.
I know a thing or two about fashion supply chain from my time at Pomelo
When I ran Product and Data in Pomelo Fashion back in 2019-20 we were also designing clothing and producing it in China by working with contract manufacturers. Plus we were also selling to young, female consumers by leveraging affordable price points in a very similar way to the way Shein is.
We also utilized similar technologies as they do in their supply chain in order to scale working with many factories in an efficient way. And we leveraged heavy use of data and personalization tools (eg. Amazon Personalize) in a similar way as Shein does.
In a way… you can think of Pomelo Fashion as the company that dreamed of being Shein… but just didn’t pan out that way. For a variety of reasons.
Fashion companies live and die because of inventory
Think about it from a fashion company’s perspective. You’re selling a product that typically has 70%+ gross margins yet still most fashion companies lose money because inventory is so difficult to manage. If you produce too much then you need to heavily discount or even destroy some of it. If you produce too little you stock out and then by the time you produce more the season has potentially changed.
It is just very hard to figure out consistently and correctly how much to produce. And one bad season of getting it wrong can mean destroying your balance sheet with excess working capital and an eventual writeoff. For this reason, the company that manages inventory the best will win long-term.
Managing inventory well is a function of these 4 components
The four ‘inventory success components’ are:
(1) Assortment: is the variety of what you produce. to produce clothing you need data to figure out what is popular, you need buyers to decide what to make, and you need designers to produce it.
(2) How much to produce: to determine how much to produce you need as good data as you can get about past sales, you need forward-looking data that helps you account for what demand will look like in the future, you need the factories that can produce it, and you need the right levels of raw materials on hand.
(3) Speed of production: this depends on how quickly you can design, source the raw materials, complete production and be ready to ship.
(4) How quick you replenish: This is generally a function of how quickly you can access more materials, how quickly the factory can prioritize it and then produce it, and how quickly you can then ship it out to market. Generally three months is the fastest you will see most fashion brands be able to do this.
Shein is very very good at managing these four components
Let’s look at what they do using the framework I’ve introduced above.
(1) Assortment
It is estimated that Shein launches about 5-8k sku’s daily and about 200 or so new styles. This is just massive and is in a completely different league from the way even the best fashion players like Zara did it earlier. But the key is in how they do it.
First, they don’t rely on their own designers. Rather they seem to be providing the data on what is selling well to their supplier base, which is comprised of:
“Free on board” suppliers: there are about 500 of these and they make designs that they haven’t designed (ie. either Shein or an influencer that Shein uses provided the design.
“Original design” suppliers: there are 20k-30k of these and the way these guys operate is they send pics of the designs to Shein’s internal buyers, which if they’re approved, they then send samples for. And if the sample is approved, they get a production order.
So you see… the brunt of their supply base is actually suppliers that are getting data from Shein and then pitching their own designs and samples based on it. Then if they do get an order, it is typically a very small order that is for like 50-100 pieces, far less than the MOQ that most companies would get from Chinese suppliers.
From memory I believe the MOQ from most Chinese suppliers that Pomelo Fashion was getting was at least 200 pieces. So a global powerhouse that is doing more than 400x in GMV is getting an MOQ that is more than 50% less.
(2) How much to produce
When Shein makes an initial order of just 50-100 pieces this is almost always loss-making for the supplier. So why are suppliers willing to work like this?
Well simple.. Because if the SKU works then they can expect massive followup orders, which will then make it profitable. And Shein shares data with these suppliers that helps them make smarter decisions on everything from raw materials, design capacity, and production.
So the suppliers are essentially getting smarter and smarter about what designs to propose to operate profitably.
(3) Speed of production
It takes just 10 days for a SKU to go from the drawing board to the shipping container. Compare this to Zara who takes more than three weeks and was earlier considered the ‘gold standard’ for supply chain speed. So essentially Shein cut it by more than half and at an unbelievable scale.
When it takes just 10 days to produce a new item you can react to things very quickly. If you see something selling well in a competitor through the data you’re analyzing.. Then you can react and have a copy of it on your site within two weeks. No longer does your success depend on you innovating and figuring out the hot new fashion… rather you just fast copy others that do this for you.
In a way you pull design competency completely out of your success formula, which massively simplifies things.
(4) How quick to replenish Shein is using just 15-20 days of safety stock of inventory. Compare this to an industry that is probably typically 3-6x this (ie. 90+ days).
And as they are testing products out at amazingly low production volumes of 50-100 pieces, this means that if it sells well, it can probably easily sell out in even one day. But if you can have more to ship within 5 days or perhaps even less… then its not such a big deal. And on this next production run you know that it sold well and so instead of producing 100 you instead produce 10,000. Because you have the data to support it.
This also leaves almost no risk of being stuck with bad inventory, which means that they will rarely ever have to destroy clothing. Which is another reason why I think all the environmental flak that the media and other fashion companies give them is actually a bit misplaced…
“Shein recently mentioned that the average unsold inventory level of the industry is between 25%–40%, whereas Shein has reduced its own to a single digit.”
The moat Shein is creating around its supply chain is deep
Let’s define the moat with some specifics… I call these my “Five moat elements”.
1. The supply base
It was estimated that up to half of the entire clothing supplier base in Guangzhou (one of the production capitals of the 400k+ clothing factories in China) is dedicated just to Shein. We are talking thousands upon thousands of factories of all sizes, most of which are then locked out of cooperating with other fashion companies.
And since Shein is so aggressive with measuring performance and culling low performers, you can expect that the ones that still work with Shein are extremely good. Note that Shein stated publicly that it culls the lowest 30% of its factory base.
In February of this year they also announced they are investing a further $2.3bn into their supply chain hub in Guangzhou to equip it with the very latest in tech and processes. Can anyone else compete with this size of investment and scale? I should probably say “Nobody” but i’ll conservatively say… “very very few.”
2. Systems
How do you manage so many factories and the production of so much assortment? Answer: with very good systems. Shein built its own “MES” (Manufacturing Execution System) which records all raw material and factory data, manages the production life cycle, etc.
At Pomelo we’d built our own simple version of this that was called “Henry” and I’ve also implemented a similar 3rd party system called “Suuchi” at a former client so I have a pretty good idea of what they built. And as a software person i can say that you can go pretty deep in customizing such a system.. Which I am sure they have…. So I also consider this software a key moat element.
3. Data
Shein is known for its collection and use of data throughout its customer experience and supply chain, and I would not be surprised if they are one of the global leaders at this. They are known for collecting things like user browse behavior, data they scrape about trending styles on social media, etc. And not only do you need to collect it, but you need to process it and use it to make smarter decisions. Much easier said than done.
This data is also a key reason why so many factories are willing to work with them at such low initial production volumes.
4. Design
Shein is working with an increasingly large number of designers and influencers on developing styles. For example, the Shein X incubator programme, which launched in January 2021, allows creatives and artists from more than 20 countries to design garments, while Shein takes care of the production and marketing and provides them the platform on which to sell. The designers receive 10% commission from the design’s sales and a long-term collaboration contract.
They have essentially taken what is typically a large fixed cost, design… and have turned it into a service that they can pay for as a percentage of sales. Simply brilliant. And very different from how the rest of the industry works.
5. The negotiating power they have
The sheer size of their business and the fact that they are Chinese themselves, makes them by far the most powerful negotiating force in China. And note that China is still by far the clothing supply chain capital of the world.
My friend who ran Supply Chain at Pomelo used to tell me what it takes to work with these Chinese contract manufacturers… but the best way to explain it was when i happened to stumble into a conference room as he was finishing up a meeting with a Chinese supplier. He was yelling into his computer looking all pissed off, then as soon as he ended the call he smiles and says “Hi Ken.. what’s up?”
I’m like… “Damn dude.. What the hell happened?”
And he calmly answers.. “Oh i was just chatting with one of our big suppliers.. It’s China man.. That is how you gotta manage some of these guys. It’s a mindset thing and if you don’t get it.. Then they just eat you up.” He was American but of Chinese heritage and so he could play both worlds.
Why I call it a ‘choke hold’
Now if you think about the fact that fashion lives and dies off how it manages inventory and how Shein is getting very good at managing the key four elements to it… this should already be ringing alarm bells in your head. Kind of like when you notice that… “oh hey wait a minute… this guy is not hugging me, he is in fact choking me.” hahaha
But when you notice that not only is he choking you but he has in fact locked in a ‘full nelson’ this is when you realize… “wait..this person intends to kill me”.
And these five moat elements that i mentioned above are the figurative ‘full nelson’ that I am talking about. Because they will make it increasingly difficult for any fashion company to escape and find a way of surviving.
Do you rely on brand? Well Shein will probably offer lots of brands at some point. Do you rely on better design? Well Shein has in fact created a platform with thousands of the best designers and they are fast copying yours every time you produce something good.
Do you rely on supply chain? Well no because they’re already light years ahead of you.
And so in the end you realize you are doomed and you just throw your hands up and complain about how they’re bad for the environment.
When in reality.. You just lost to someone who saw the end game a lot clearer than you did.