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Fast fashion accelerated in 2023. Following in the footsteps of e-commerce giant and market leader Shein, a group of challengers have upended the competitive landscape by producing fashion faster and cheaper than before. First-generation fast-fashion giants such as H&M and Zara, who introduced the concept of trendy runway-inspired fashion at affordable prices, have been challenged before by second-generation digital-first fast-fashion companies such as Asos and Boohoo. Now, third-generation companies are emerging. Among the rising players is Temu, a marketplace owned by China-based PDD Holdings. Just a few months after launch, the company overtook Amazon as the most downloaded shopping app in the U.S. and most of the other 16 markets it operates in. Turkey-based Trendyol is a marketplace backed by Chinese internet giant Alibaba. Cider is a U.S. retailer targeting Gen Z with a third-generation fast-fashion business model.
These companies are catching the attention of consumers in Western markets with their ultra-low prices and fast turnaround of trendy styles. Two companies stand out in this regard: Shein and Temu (the focus of this analysis). According to the BoF-McKinsey State of Fashion 2024 Consumer Survey, 40% of US consumers have shopped with Shein or Temu in the past 12 months, and in the UK, a newer market for the retailer, the figure is 26%. Meanwhile, consumers have indicated they are looking to increase their spending with these players, with future net purchase intentions for Shein and Temu being, on average, 18 percentage points higher than their first-generation competitors.
Ultra-low prices are a key component of the business model’s success: Shein’s average SKU price is $14, significantly lower than H&M’s $26 and Zara’s $34. The turnaround time between capturing a trend and having the product available is also faster: Shein aims for 10 days, less than half the 21 days offered by competitors. However, this speed is not always reflected in delivery times: customers, eager for trendy designs and low prices, often wait weeks for their packages to arrive. Customer loyalty is not built on price or speed alone: Gen 3 players are also transforming the customer experience through gamification, micro-incentives, and social media communities.
Updating a Model
The third generation is based on several operating model innovations.
Agile and scalable manufacturer-to-consumer supply chain: Some 3rd generation companies have built large networks of suppliers who exclusively manufacture for them. Initially built on a first-party, in-house inventory model, Shein (before introducing a third-party cross-category marketplace in 2023) relied on strict supplier performance management to increase reliability and allowed for rapid expansion with reduced inventory risk through direct-to-consumer shipping from China. Temu, on the other hand, operates purely as a marketplace, finding manufacturers with excess capacity to sell off-branded goods directly to consumers in a low-cost “B2B2C” model. Temu’s prices are often 10-40% lower than Shein’s, but retailers face challenges around quality control and reliability.
Data-driven product design and testing: Shein designs or selects products using demand-driven trend modeling, which includes a variety of data inputs, from current trends to hot products to consumer perceptions. Shein adds 2,000 to 10,000 items to the app daily and produces them in small batches. To keep tight control over inventory, hit rates are evaluated in real time, comparing product page visits to sales. Temu’s approach also evaluates hit rates to provide feedback to sellers about product trends and demand levels.
Loyal and growing customer base: Third-generation retailers have focused on building a large, deeply engaged, loyal community. Shein’s multi-tiered affiliate marketing influencer program, coupled with organic social community building, has driven viral user growth and low customer acquisition costs. Temu has invested in marketing to rapidly scale, running more than twice as many Facebook ads in the U.S. as Shein and four times as many as Amazon. The company reportedly spent $14 million on two 30-second ad slots during the 2023 Super Bowl, with market analysis putting quarterly marketing investment at nearly $500 million.
High app adoption and engagement strategy: Shein uses extensive in-app gamification to allow customers to earn loyalty points by completing various steps such as setting up an account, uploading reviews, watching livestreams, participating in outfit challenges, etc. Temu similarly keeps users engaged with in-app games, offering rewards to customers who invite their friends to join. Temu has a high conversion rate of 10%, well above the industry average of 2%, and its retention rate is comparable to Amazon, Shein, and Walmart.
Push back
They may have built a loyal customer base, but these third-generation fast fashion companies are also coming under public and regulatory scrutiny. Consumers are increasingly aware of fast fashion’s negative impact on the environment across the industry, and policymakers in key markets, notably the U.S. and the EU, are considering new legislation to address the fast fashion industry’s alleged role in a culture of overconsumption and waste.
Against this backdrop, some of the core tenets of the third generation fast fashion business model are losing appeal. Some companies have positioned low-volume, reactive production as part of a “zero waste” sustainability narrative. However, this type of production is also associated with rapid trend cycles, often resulting in very cheap products that are quickly discarded. Some third generation companies have tried to promote their more sustainable and ethical side through marketing campaigns, but not always with success. Shein recently invited a group of influencers to its Shein Innovation Center to refresh its supply chain ethics, but this was seen as an attempt to cover up the company’s association with unethical practices.
Many trade and tax agencies are considering new standards to address the way some third generation fast fashion companies have dealt with “de minimis” trade laws in jurisdictions such as the United States, where import taxes are lower if they ship individual orders directly to customers from overseas factories rather than in bulk, a common practice among third generation fast fashion companies. The U.S. Congress is currently considering two bipartisan bills related to the de minimis exception and customs and border inspections, but in their current form, exporters from countries such as China (including major third generation fast fashion companies) would no longer be subject to the de minimis exception and could instead face enhanced customs and border inspections.
The long-term prospects for third-generation business models may face some challenges as players mature. For example, Temu has historically grown through large performance marketing spend and discounts, but it remains to be seen whether it can sustain its current strategy, which requires heavy investments in customer acquisition and astute logistics.
The need to adapt
The industry is poised for further disruption: Faced with new regulations, increased public scrutiny, and falling valuations (Shane’s reported $100 billion valuation in 2022 has fallen to $66 billion in 2023), third-generation players are yet to settle on their business models and may need to adapt again.
To maintain its leading position, SHEIN is diversifying its strategy. The company is experimenting with offline retail, including pop-ups and shop-in-shops. To expand its offline presence in the U.S., it formed a joint venture with Forever 21 and recently acquired the Missguided brand in the U.K. And to address import tax restrictions, SHEIN is expanding its supply chain beyond its network of manufacturers in China, building warehouses in Europe, the U.S. and Canada, and building a factory in Brazil.
As Shein adapts its model to meet new challenges — from a network of low-cost manufacturers primarily in China to new suppliers in other parts of the world, and from a direct-to-consumer online model to offline or omnichannel retail — its previous competitive advantages could fade and threaten the stickiness of its core customer base.
The “one-stop shop” marketplace model could be key for players to succeed: Shein is piloting the model in the U.S. and Brazil, with potential expansion in 2024. The company has also started to branch out into luxury fashion, with some products from luxury brands posted by third-party sellers appearing on its marketplace (although the authenticity of these products has yet to be verified).
In 2024, market disruption will likely accelerate as third-generation fast fashion companies focus on marketplaces to expand across categories, price points, and consumer segments. Customer engagement is likely to remain a key differentiator as third-generation players use strong community and gamification strategies to increase average basket size, boost profits, and protect a viable business model in the future. The entire industry is likely to feel the impact of these third-generation players. Companies may need to take note of the most successful strategies for capturing the attention of modern consumers.
This article first appeared in “The State of Fashion 2024,” an in-depth report on the global fashion industry, jointly published by BoF and McKinsey & Company.
