Etsy is a company out to do good in the world. The e-commerce retailer of handcrafted goods is so serious about its social mission that it voluntarily discloses its carbon footprint and even uses compostable plates for staff lunches, with the compost later delivered by bike to a local farm to be turned back into soil. Etsy said it measures job performance based not merely on traditional business metrics, such as showing up on time, but also an employee’s social and environmental goals. And it is consciously trying to make the workplace more balanced in terms of gender, with 46% of its managers being women.
But now the retailer is embarking on a path that artisanal purists fear could lead to ruin: going public. Will the influx of money and pressure from Wall Street to prioritize growth and profitability make Etsy stray from its purpose of enriching local communities by connecting small makers of handmade products with global buyers? There were tremors in October 2013 when Etsy first allowed sellers to use small-batch manufacturers; users feared it would lead to mass merchandising. Then last year, Etsy invited three national retail chains — Nordstrom, West Elm and Whole Foods — to join its wholesale program to find artisanal products for their stores. The initial public offering could be the last straw for worried users.
Mindful of concerns that Etsy was selling out, CEO Chad Dickerson said the IPO would give the firm the capital and long-term structure to endure for generations, according to a letter included in the company’s registration statement filed on March 4 with the U.S. Securities and Exchange Commission. He believes that Etsy can “truly change the world” by reinventing commerce. “For decades now, the conventional and dominant retail model has relentlessly focused on delivering goods at the lowest price, valuing products and profit over community,” he wrote. “I do not believe that this race to the bottom is a sustainable, successful model.” Dickerson thinks that Etsy can holistically integrate the concerns of people and the planet while still making money. “If we succeed, then other companies might replicate our model. We think the world will be a better place for it.”
Etsy represents that rare, high-profile test case of whether a company whose social mission is central to its existence can successfully please shareholders as a publicly held entity. The retailer is certified as a B Corp., a designation given to companies that meet the rigorous social and environmental standards set by B Lab, a nonprofit that aims to make business a force for good in the world. Patagonia, Warby Parker and Seventh Generation have the same designation. However, Etsy did not take the bigger step of incorporating as a benefit corporation, a legal structure now allowed in two dozen states that requires regular disclosures of a company’s social and environmental impact, among other mandates.
“They are going to have some very big strategic decisions to make. To keep the artisan, handcrafted image is going to be difficult as they grow.” –David Reibstein
Even so, Etsy will face some tough choices ahead. “They are going to have some very big strategic decisions to make,” says David Reibstein, Wharton marketing professor. “To keep the artisan, handcrafted image is going to be difficult as they grow.” With the influx of money from the IPO, there is a temptation to expand quickly and perhaps risk losing its cache as the premier destination for handcrafted goods. Indeed, Etsy’s task of pleasing artisans as well as Wall Street analysts and shareholders will be a challenge. Louis Thomas, Wharton management professor, notes that Wall Street analysts and investors want Etsy to be the “Amazon of crafts,” but the problem is “crafts guys don’t want Amazon.”
Inside the IPO
Born in 2005 in Brooklyn, N.Y., Etsy was founded as an e-commerce platform that lets arts and crafts makers — folks who typically grace fairs and farmer’s markets — sell their goods at a central location online. Its social mission was the empowerment of artisans by allowing buyers to purchase the unique goods they make, from Ukrainian shawls and stained-glass art to expensive, one-of-a-kind jewelry and distinctive clothing. “Handmade goods are the foundation of our marketplace,” Etsy proudly declared in its securities filing. This marketplace of handcrafted products is what the company calls the “Etsy economy.” Etsy wants to raise $100 million from the IPO to invest in its expansion, as well as for working capital and general corporate purposes.
At the end of 2014, Etsy said it served 1.4 million active sellers and 19.8 million active buyers. The total value of goods transacted on Etsy was $1.93 billion, with a third of the business coming from overseas. Etsy posted revenue of $196 million in 2014, up 56.4% from the prior year. Around $109 million of last year’s revenue came from its marketplace, while $82 million came from services Etsy provided sellers for a fee, such as payment processing, highlighting listings and provision of shipping labels, among others. Sellers pay 20 cents per listing on Etsy every four months; the retailer also takes a 3% to 4% commission on sales plus a flat fee per order, among other charges. From 2011 to 2014, the company’s workforce grew from 251 to 685, an increase of 173%.
Lawrence Hrebiniak, Wharton emeritus management professor, believes that Etsy is in the process of changing its business model as it strives to expand. He points out that for most of its 10-year existence, it was a “nice little business” as a purveyor of unique products. But two years ago, it allowed mass production, albeit on a small scale. “This is a change. Why? We have to look at it strategically. Did they worry about the maturity of the company? That growth was slowing?” he asks. Perhaps it was to test the reaction of users to manufacturers. In any case, he sees signs of potential trouble.
Hrebiniak notes that growth in the number of users joining Etsy is slowing: active sellers, those that incurred at least one charge in the past 12 months, increased by 26% in 2014, down from 29% in 2013. Active buyers grew 41% last year, but that figure was down from 51% in 2013. “So there’s a slight down trend,” he says. Also, Etsy’s revenue mix has changed. Seller services are taking up a growing portion of revenues. Hrebiniak notes that seller services comprised 21% of revenue in 2012, but it rose to 34% in 2013 and jumped again to 42% in 2014. “They’re taxing sellers,” he says. “They’re charging sellers more for the privilege of selling their things…. Someday, sellers will rebel at the high cost.”
“They’re charging sellers more for the privilege of selling their things…. Someday, sellers will rebel at the high cost.” –Lawrence Hrebiniak
Etsy’s IPO filing also reveals that it has had to restate its financial statements from prior years due to “material weaknesses” in internal controls over financial reporting. David Erickson, a senior fellow in Wharton’s finance department and a former Wall Street investment banker, says such disclosures are not entirely unusual for high-growth companies looking to go public. “Often, they don’t have the comprehensive controls now required” under the Sarbanes-Oxley Act, or Sarbox, he notes. “My guess is Etsy made a lot of investment in the months leading up to an IPO in controls to comply with Sarbox.”
Notably, Etsy is setting aside $300,000 from the IPO proceeds to partially fund Etsy.org, a nonprofit aiming to teach women and under-represented peoples about setting up their own businesses to benefit themselves, their communities and the planet. The nonprofit also received 376,500 Etsy common shares. Erickson said other companies have done the same, so it is not all that unusual for Etsy to carve out part of the proceeds for a nonprofit. On the flip side, Etsy plans to spend $50 million to double the size of its corporate headquarters, which will be LEED-certified for compliance with green standards, despite still posting losses. “They’re spending a lot of money,” Hrebiniak says. “If they want to start showing profitability, they have to cut back.” Investors might not look too kindly on such big expenditures as Etsy seeks to raise money from them.
Avoiding the eBay Trap
Getting access to capital is one thing, but deploying it wisely is another matter. Companies flush with cash often try to expand too quickly, with disastrous results. “That’s happened to a lot of companies. All of a sudden, boom, the dam opens and the cash comes flowing in,” says Gerald Faulhaber, Wharton emeritus professor of business economics and public policy. Without a well-crafted plan, expansions do not work out very well, he notes.
As Etsy grows, it also could be so big as to lose focus. Reibstein points to the experience of eBay, which started out as a website for garage sale items but became so large that it branched out in many directions. That makes eBay vulnerable to smaller niche players that could steal parts of its business. “As you become big, you become vulnerable to those competitors that might come in who are very focused,” he says. Indeed, Etsy did take part of eBay’s business in handcrafted goods. “It would be hard for eBay to have that unique positioning,” according to Reibstein. “This snuck up on them.” Now Etsy risks becoming like eBay, he adds.
“What Etsy really needs to make this work is a very, very strong structure committed to the mindset of small, artisanal craftsmen.” –Louis Thomas
Getting bigger also makes it tough to strike the right balance between profitability and social accountability. To do so, Etsy must have the will to stick to its mission of being a good corporate citizen. “What Etsy really needs to make this work is a very, very strong structure committed to the mindset of small, artisanal craftsmen,” Thomas says. “If they develop a strong organizational culture, it will allow them to scale up in a way that doesn’t disaffect the vendors or change the operating mission…. They have to have a strong sense of who they are.” Jonah Berger, Wharton marketing professor and author of Contagious: Why Things Catch On, agrees that “having a clear mission helps, as does not giving up too much equity.” That means not selling a big chunk of the company to investors who might not share the same social vision.
But by adhering to its social focus, will Etsy and similar companies scare investors away? Not likely, according to an upcoming academic paper, “Institutional Investing When Shareholders Are Not Supreme,” by Christopher Geczy, academic director of the Wharton Wealth Management Initiative; David Musto, a Wharton finance professor; Jessica Jeffers, a Wharton doctoral candidate and Anne Tucker, associate law professor at Georgia State University. The paper, which will be published in the Harvard Business Law Review, examines whether institutional investors such as pension funds and endowments stayed away from investing in benefit corporations and other socially minded firms because they were not purely driven by profit. The authors discovered that “negative pressure on profit maximization did not significantly deter” investments by institutional investors and that the findings are “evidence against fiduciary concerns impeding these firms’ access to public capital.”
Even if Etsy will not deter investments, it still needs to please shareholders. “Firms face more pressure to make their quarterly earnings after going public, and some managers complain that this pressure makes them focus on the short-term at the expense of the long-term,” says Wharton finance professor Luke Taylor. But Etsy’s Dickerson said in the SEC filing that the company will not provide analysts with quarterly or annual earnings guidance because it is “misaligned” with the company’s mission. “The pressure to hit a quarterly financial target could incent us too heavily to seek near-term gains, which could diminish our ability to fulfill our larger mission over the long-term,” he wrote. Instead, Dickerson will provide frequent business updates to investors.
Indeed, Etsy’s CEO does not see a conflict between the retailer’s goals of creating a profitable business that is also good for society and the environment. “People often ask me how I choose between the success of our community and the success of our business,” Dickerson wrote. “My answer is that I don’t have to choose; we have built a business that does well when our community is successful.” The prosperity of Etsy is tied to the success of its members, a relationship Dickerson calls “Etsy’s Empowerment Loop.” Adds Reibstein: “They are bringing in more money so they can better serve the artisans who are currently selling there, and the customers who like buying these types of products. Whatever saintly endeavor they were pursuing, they are going to be able to pursue it better.”
