Why “Demolition Man”, Fab.com’s former CEO should have studied TOM (at GSB) before running his company into the ground

Fab.com's failure due to operational inefficiency and too high growth targets.

 

Fab.com was launched in June 2011, when its founders Jason Goldberg and Bradford Shellhammer pivoted it from a social networking site for gay men into an invite-only flash sale website. The website featured and sold unique third party items from designers around the world. In only 4 months after its launch, Fab.com grew its sales to $100,000 per day, and its visitor number to over 700,000.[1] After a number of successful funding rounds and an expansion into Europe, Fab.com was valued at $900,000 in June 2013. In October the same year, Goldberg had to fire more than two thirds of his employees. The company was later acquired for est. $10-15M by PCH.[2]

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The key reasons why Fab.com will be remembered as one of the greatest failures in startup history can be synthesized by Goldberg’s inability to align his operating model with his business model. The company expanded its operations into Europe too quickly, before having a proven business model in the United States.  Then it changed its business model into an e-commerce website and abandoned its flash-sale business model. High inventory and marketing costs,  and no good insights of customer preferences made it burn $200M in only two years, without in the end having a proven business or operating model.

 

 

 

 

Fab’s operating model

Initial operating model – no inventory, few employees, flexible operations: Initially,Fab used a flash-sales model, allowing e-commerce companies to sell a limited amount of inventory quickly at a discounted price on its website.1 This allowed the company to be flexible in its choice of designers and have low initial costs, because it did not have to hold inventory. The availability of unique products over a short amount of time made the company grow exponentially. Shellhammer curated the flash sales himself, allowing for low labor costs and immediate customer response.

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First operational mistake – scaling too quickly: Due to Fab’s success, Rocket internet launched a similar website in Germany. Feeling threatened, Goldberg decided to quickly expand in Europe by acquiring three startups and hiring around 100 employees. While the acquisition costs were not disclosed, Fab entered a long-term lease and hired ~100 employees in Europe. Goldberg quickly ran into huge problems in streamlining the businesses worldwide, and clear operating processes were never set up. The company experienced shipping delays, as well as dissatisfied customers. The European employees were never aligned with the U.S. headquarters and the European branch never became profitable.

Next mistake – exponentially increasing the company’s scope through increased inventory and shift in the operating model: At home, Goldberg decided that the path to growth lies in increasing customer satisfaction by decreasing the shipping time from ~16 days to ~6 days. This was only possible by holding inventory and not relying on designers any more.[3] It purchased a warehouse and increased its number of SKUs from 1,000 to 11,000 in only a few months in 2011.[1]  The company quickly ran into problems, because now it had to buy products it thought consumers would buy without solid consumer data.[4] This increased inventory costs and unsold inventory, without a corresponding increase in sales. Employees remember that “piles of inventory remained in the warehouses.”[3]  Fab now had to feature outdated products on its website. At the same time, Goldberg hired over 600 employees, dealing with inefficiencies and confusion in day-to-day operations. By changing the operating model, Goldberg changed the user experience and alienated its customers.

 

Fab’s business model

Initial business model – designer focus: After its failure, many critics said that Fab’s business model did not hold. I believe it did, but it wasn’t scalable at the pace at which Goldberg wanted it to be.  Fab was in the business of connecting unique designers to consumers in the form of flash sales. Fab’s initial revenues came from commissions from the designers. The company was focused on mobile sales (with 35% of sales coming from mobile devices) and on selling unique products, with 90% of its products not found on Amazon. It had 10 million members and $100M sales by 2012.2     

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The fatal move into becoming the new Amazon: Fab’s initial growth and its valuation to $900M determined Goldberg to pursue ambitious sales goals of $250M in 2012, which could not be achieved by the flash sale business model alone. Despite the initial alarm bells regarding his decision to carry inventory, Goldberg decided he wanted Fab to become the next Amazon and shift away from its initial business model of flash sales, in order to grow quicker. This did not correspond to his business model, and consumers started not recognizing Fab’s initial value proposition any more, since Fab now sold products that they could purchase cheaper and get delivered faster on sites such as Amazon. Thus, Fab had to increase its marketing spend dramatically to keep growing its user base. Fab had to spend $40 million on marketing in 2012[5] to fuel its consumer growth and transition into e-commerce. When they ran into financial problems and couldn’t justify the spending any more, the consumer numbers dropped radically.[6]

Goldberg claims that gross margins were 43% and contribution margins were 20% initially [3], but these were quickly eroded by personnel and marketing costs. By the end of  2014, Fab was left with 100 employees. Its European operations had shut down completely and burnt between $60-100M.[7]

Fab failed because it expanded operations too quickly,[8] and decided to carry inventory even if it did not have the capabilities or  customer insights to support this decision. Goldberg was focused on sales growth and did not pay attention to operations. It many ways, Goldberg’s failure could have been avoided if he had paid a bit more attention in (GSB’s version of) TOM.

 

 

[1] Business Insider: http://www.businessinsider.com/how-billion-dollar-startup-fab-died-2015-2

[2] Bloomberg: http://www.bloomberg.com/news/articles/2015-03-03/fab-com-is-sold-in-billion-dollar-darling-s-spectacular-rise-and-fall

[3]Business Insider: http://www.businessinsider.com/rise-and-fall-of-fab-2014-5

[4] Bloomberg: http://www.bloomberg.com/news/articles/2015-03-03/fab-com-is-sold-in-billion-dollar-darling-s-spectacular-rise-and-fall

[5] Fortune: http://fortune.com/2015/01/22/fab-billion-dollar-valuation/

[6] http://www.businessinsider.com/rise-and-fall-of-fab-2014-5

[7] Inc.com: http://www.inc.com/issie-lapowsky/jason-goldberg-what-went-wrong.html

[8] Fast Company: http://www.fastcompany.com/3043123/venture-capital-should-fuel-your-company-not-your-ego-6-critical-lessons-from-the-fall-of-fa

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5 thoughts on “Why “Demolition Man”, Fab.com’s former CEO should have studied TOM (at GSB) before running his company into the ground

  1. I wonder why they made so many mistakes so quickly. Did Goldberg have a different idea of the business model than his customers? That might explain the move to inventory – he thought that having item quickly was a core need of the customer, when customers were more focused on the designer-focus of the business. He was clearly disconnected from the value proposition that the customers believed in.

    1. I think this is the 900 million dollar question … literally. The general opinion is that he shouldn’t have been allowed to change the company’s operating model, and that the VC funds shouldn’t have allowed him to expand so quickly. On the other hand, they are now financing him to create a spin-off from this company. All we know is that Goldberg has driven 3 companies into the ground and burnt over $1 bn, which should raise some red flags.

  2. Interesting read Iulia. It seems like Fab.com tried to follow a “build it and they will come” approach that didn’t work. They tried to build operational capabilities that were not aligned with their initial business model or with their value proposition. I wonder how the European Rocket-Internet sister company ended up doing ? Did they stick with the initial model ?

    1. Great question, Akram! Rocket’s company closed it after 6 months and ended up moving its flash sale-business into Westwing home and living (another Rocket startup) – a home flash sale website. It appears that home products are a much more sustainable business model for this, and actually fab.com was focused on home initially.

  3. Very interesting read, Iulia. And love your title, although not sure if you’re making a dig at the TOM course here at HBS!

    It’s interesting that one of Fab.com’s biggest mistakes was expanding internationally too quickly, as just last night, I was having a conversation with someone who thought that startups should actually be accelerating their international expansion. His argument was that if you have a business model that works, there is nothing to be gained by waiting until the domestic business is well-established before venturing overseas, and that in fact, if you wait too long, you’re leaving the door open for copy cats to establish a dominant position before you enter. I’m curious whether you think Fab.com’s failed international expansion was a failure in strategy or a failure in execution, as it seems to me that some of the issues (e.g. European employees not being aligned w/U.S. headquarters) could have been fixed with better execution.

    – Lan

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