RealReal (NASDAQ:REAL) is an online marketplace for consigned luxury goods. Sellers can post their pre-owned products on the site, and once the item sells, RealReal takes a cut of the sale price. RealReal also earns revenue from company-owned inventory, and this occurs potentially when buyers return their items. The stock has performed quite well since March lows despite continuous unprofitable quarters.

(RealReal Market Chart – Seeking Alpha, 2020)

We believe that despite being one of the prominent first-movers in the pre-owned luxury goods space, RealReal’s growth is ultimately unsustainable.

From a strategy perspective, RealReal provides no differentiation and competes in a market with easy entry

Despite being one of the only companies that are currently focusing on purely luxury goods, RealReal faces competition from every corner. Some companies that rival RealReal include Facebook, eBay, Poshmark, Grailed, ThredUP, local consignment stores, and the list goes on.

One of the main selling points for RealReal is that they have ‘specialists’ that authenticate every item. The company CEO has even said that there is “no fakes on our site”, yet fakes seem to be among the biggest issues, based on online reviews and popular articles. Other major complaints include damaged items and “dreadful customer service”. Therefore, it seems that their seemingly biggest competitive advantage is working against them. Poshmark provides free authentication services for items that are over $700.

Although the site is catered more towards males, one big advantage that online marketplace Grailed has over RealReal is that not only do they authenticate every item, but each seller has their own profile that includes other listings they have, and feedback from buyers. Therefore, there is much more transparency as sellers will be more cautious about what they are listing and their overall reputation. Again, although RealReal might not have a competitor with the exact same business model, there are many indirect competitors with better features. Facebook Marketplace and Groups are quite unique in the sense that there is a real community among ‘streetwear groups’. Users will often go out of their way to help prospective buyers identify if an item is fake, and sellers are named, shamed, and banned if they are caught deliberately selling a fake item.

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(Vogue Business, 2019)

From a pricing strategy perspective, RealReal’s consignment rates are purely outrageous. RealReal’s overall take rate is 36% (RealReal 10-Q, 2020), which is much higher than direct competitors, and quite high for a general item transaction in the first place. Poshmark, which is a direct competitor, has a commission rate of only 20%. Moreover, Grailed’s rate is under 10%. It won’t be long either before there are more direct competitors, and internal rivalry will continue to push RealReal’s margins down.

RealReal relies on heavy supply from new and existing consignors, and COVID-19 has interrupted the company’s ability to form relationships

RealReal currently spends a lot of money to retain and attract new and existing consignors. RealReal has noted that “a significant number of our new and existing consignors greatly prefer our White Glove consultation method for consigning luxury goods, which involves our sales professionals meeting with our consignors in their homes (RealReal 10-Q, 2020).” Many Americans may be much more comfortable going into public spaces compared to their sentiments in March but allowing sales representatives into one’s own home is a completely different story. COVID-19 has forced RealReal to modify its White Glove method, and it now involves ‘no contact’ meetings.

We believe that this will have a material impact moving forward given that sales representatives are not able to connect with consignors on the same level as if meetings were in person. Moreover, given that this ‘White Glove’ consultation method was considered a competitive advantage before, consignors are now just as likely to list with sites like Poshmark given the lack of in-person connection.

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Although RealReal now has seen one of their unique activities dissipate, the assumption is that they should spend more money elsewhere to make up for the potential loss on all revenues from ‘White Glove’ consultations. However, the company has done the exact opposite, as they have “recently implemented a number of measures to realign our cost structure and preserve liquidity, which included reducing marketing investments and […] discretionary investments (RealReal 10-Q, 2020).”

RealReal relies on frequent purchases from repeat buyers, and those who purchase large value items

We believe that a pending recession will have a material impact on RealReal’s ability to drive revenue growth, as many buyers may be deterred from purchasing items in general. Contrary to popular belief, “luxury is not recession-proof”.

(Vogue Business, 2019)

Therefore, as fewer buyers are looking for luxury goods during an economic crisis, RealReal will not only see a potential decline in revenue for the next few years, but the economic situation may actually deter potential repeat buyers from coming back to the site for the long term.

Buyers may also be driven away from RealReal for many other reasons, one being that luxury retailers themselves are forced into panic-mode because of a pending recession. As a result, price slashing and discounts on brand new retail items forces RealReal to either lose potential customers completely or suggest for consignors to lower prices, which in turn reduces overall revenue.

RealReal is nowhere near profitable, and its operating expenses are mostly variable

(Koyfin, 2020)

The company lost $42.9M in Q2/2020 and has been unprofitable since its IPO in 2019. Keep in mind that this company was founded in 2011, and has had a very hard time scaling efficiently.

(RealReal 10-Q, 2020)

RealReal spent an astounding $36M on operating costs in the most recent quarter due to “overall higher headcount primarily in our authentication, merchandising and technology teams, higher stock compensation expense, and higher occupancy costs in our fulfillment centers and retail stores (RealReal 10-Q, 2020).”

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These ‘operations and technology’ costs will continue to go up, as, in order to support higher revenue figures, the company will need more authenticators and fulfillment centers. The company states that retail store openings “significantly contributed to the increase in operations and technology expense (RealReal 10-Q, 2020),” which alludes to the fact that once RealReal finally opens their Chicago retail store after COVID settles, and goes through with their intent “to open additional retail stores in the future”, ‘operations and technology’ costs will rise even more. SG&A costs should also be considered variable costs that go up with more sales volume, as this cost account is “principally comprised of personnel-related costs for our sales professionals and employees involved in finance and administration (RealReal 10-Q, 2020).”

In summation, if RealReal reduces take rates, gross margins will dwindle and the company will be even more unprofitable. If RealReal increases take rates, this creates more incentive for consignors, especially repeat ones, to move platforms. If RealReal cuts ‘operations and technology costs’, their overall logistics efficiency will be negatively affected, and if RealReal cuts their SG&A costs, fewer consignors will be attracted to the RealReal platform given that sales professionals are an integral part of the business. We fail to see any sort of way out of this situation, especially as the company is scaling inefficiently and has no real competitive advantage.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.