Good day and welcome to the Zalando SE publication of the Q2 2022 Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the call over to Patrick Kofler. Please go ahead.
Good morning, ladies and gentlemen, and welcome to our Q2 2022 earnings call. I'm joined by our Co-CEO and Founder, Robert Gentz, and our CFO, Sandra Dembeck. Robert will kick us off with a holistic update on the current performance and an update on the progress we've made against our strategic objectives. Sandra will then walk you through the financials of the quarter, and Robert will discuss our outlook. Robert and Sandra are available for questions afterwards. As usual, the call is being recorded and webcast live on our investor relations website, and a replay of the call will be available later today. Robert, I will now hand it over to you. Please go ahead.
Thank you, Patrick, and yeah, good morning, everyone. Thanks for joining. Since we last met in May, the market environment has further deteriorated. Consumer confidence continues to decline, and we continue to face supply shortages. We also had another quarter of extraordinarily strong growth in 2021. As a result, Q2 came in weaker than expected, and we recorded another quarter of flat growth. While this result stems from the circumstances affecting our business, I want to clearly emphasize that our strategic goals and ambitions are on track. We're already seeing initial results of the efficiency measures we are taking. Despite the volatile market environment, we're able to grow our active customer base on a trailing three-month basis by almost 4%.
Our loyalty program, Zalando Plus, grew 164% year-on-year, which now with more than 1.5 million members. This showcases our progress in deepening customer relationships. We see as well that customer spend contracted as consumer wallets remains under pressure. Drivers and challenges for our performance in the second quarter are very similar to Q1. We face the volatile market environment in the second quarter. On the consumer side, the EU Consumer Confidence Index dropped further due to the cost of living increases triggered by supply shortages and the ongoing war in Ukraine. On the sourcing side, supply chain disruptions continued and driven by prolonged COVID-related disruptions in China. As expected, we saw a further normalization of customer growth and spending.
The last year, these two key drivers of growth experienced an extraordinary strong momentum given the pandemic situation, which resulted in our strong GMV growth back then. Now, let's have a look at our guidance, which we revised on June 23rd in light of the deteriorating macroeconomic conditions and the weak Q2 performance. In early May, we pointed to the lower end of full year guidance based on challenges, but also early signs of a potential recovery. We now expect macroeconomic challenges to be longer lasting and more intense than we previously anticipated. Looking at our GMV growth performance since the beginning of the pandemic, we now expect a return to growth and an improvement in profitability in the second half of 2022.
These expectations are based on actions we are taking to adjust our business to the shift in demand and reduce our cost to mitigate the challenges. We're fully focused now on executing our action plan for 2022, which brings me to the next slide. As I presented to you last time, we are successfully adapting our business to the new environment and took several actions to improve profitability in the second half of the year. We adjusted our offer to better meet consumer demand in light of the shifting demand spending patterns. We implemented measures to improve our order economics to overcome the challenge of the increasing fulfillment costs. We're driving cost efficiencies across the business by reducing our marketing expenditure and pacing our overhead cost growth.
Let me now present some of the key measures that we implemented in the second quarter. First, we adjusted our wholesale order volume for the upcoming fall/winter season to reflect revised growth expectations for the second half of the year and reduce inventory risk. While the majority of our pre-order volume has been already locked in by the end of Q1, we leveraged the remaining flexibility to adapt our assortment to consumer preferences. We'll continue to leverage in-season management levers and our platform business model to further optimize our offer going forward. These measures will help us to stabilize our gross margins in the second half of the year and with further improvement expected in the spring/summer season of 2023. Second, we introduced a minimum order value now in 15 additional markets in June.
This means that we now charge for delivery below a certain minimum basket size across all Zalando markets. Just like when we introduced minimum order value in 9 markets back in 2019. We are seeing positive results as customers migrate to higher baskets and remaining small baskets profitability increases. The positive impact from the minimum order value and some other efficiency measures that we're taking across our European logistics network, I expect it to offset the cost inflation that we're seeing in carrier costs and packaging costs that continue to impact our fulfillment cost line. Third, we focused on driving cost efficiencies across our business and performance and brand marketing to ensure the return on investment in the current environment.
We reduced the maximum payback period for performance marketing investments from 720- 360 days to achieve an earlier break-even. In addition, we continue to pace our overhead investments across the group and target now a flat headcount development until the end of the year. To sum it up, over the last six months, we have seen multiple challenging developments in the broader macroeconomic environment. While some of these developments may last longer and be more intense than previously expected, they do not change our view on the long-term opportunities ahead of us, and that is why we continue to believe in our strategy. We keep our clear focus and selectively invest in three core dimensions of our strategy.
First, we focus and invest in deep customer relationships at scale to play an important role in our customers' lives. Examples of these investments are Plus, Beauty, Designer, also Highsnobiety that I will touch upon a bit later. Second, we are focused on our transition to a true platform business, bringing together customers and partners in a way that creates unique experiences and benefits. Some examples of this are the partner program, Connected Retail, enabling the Zalando Fulfillment Solutions or Zalando Marketing Services, and as well the doubling down on that we do on the multi-channel fulfillment. Last but not least, we're building a more sustainable platform and driving positive impacts for people and planet, which we believe is in line with the long-term interests of our customers and partners. The examples of this are more sustainable assortment and packaging.
Our online learning platform we recently launched to support brand partners in setting their own climate targets aligned with science, the circularity criteria and our investments in recommerce. Now, we can talk about Highsnobiety. In June, we acquired a majority stake in Highsnobiety, which is one of the most influential fashion and lifestyle media companies in the world. They have an audience of 7 million Instagram followers who serve as culture pioneers for a new generation of consumers. This acquisition gives us access to creators and marketing partners and building upon our already very strong brand relationships and offers us now industry-leading trend analysis and insights. The combined network will allow now Zalando to deliver curated content, exclusive assortment, and fashion-driven editorials.
We also acquire, by the way, a business with healthy financial margins and some of the best creative minds shaping fashion today. Being the starting point for fashion means building an engaging and inspiring experience for our customers and brands. This acquisition will certainly help us to accelerate on our evolution. We are looking forward to driving our strategy now together with Highsnobiety, and we're very excited to share more with you soon. I will now hand over to Sandra, who will provide you with some more details around our Q2 performance.
Thanks, Robert. Let's start with a more detailed look at our top-line performance. The second quarter came in weaker than we expected in light of the further deteriorating consumer sentiment and the macroeconomic outlook. We had a second quarter of flat GMV growth. Revenue declined by 4% to EUR 2.6 billion. Let's look at the performance of each of our segments. First of all, the Fashion Store, our core sales channel. Here we saw GMV decline by 0.2%. GMV in the DACH region decreased by 2.1% on the back of strong growth last year. As a reminder, last year's lockdowns started to get lifted mid-April, but the strict safety measures remained in place, impacting offline retail sales. Rest of Europe delivered 1.6% GMV growth. Here, during Q2, we launched two new markets, Hungary and Romania.
Coming to our off-price segment. Here we saw a slight increase in GMV and revenue of 4.9% and 4.3% respectively. While this development represents an improvement against last quarter, the demand and supply situation for the Zalando Lounge business remains challenging. Lastly, Zalando Marketing Services. Here we had another strong quarter and delivered year-on-year growth of around 40%. We're very pleased with this strong growth of Zalando Marketing Services. Now turning to our customer metrics. In Q2, we grew our active customer base to 49.3 million. However, we recently started to observe changes in our customers' behavior, which are reflected in our trailing three months customer metrics. There are three key takeaways here. First, our active customer growth is slowing down.
Second, customer retention rates show signs of normalization post the pandemic peaks, and this is more pronounced for the lockdown cohorts. It is important to note that they are still above pre-pandemic levels, which indicates that our deep relationships with new and existing customers remain strong. Third, our cohorts are very engaged, but we need to focus even more on profitable order economics given the overall decline in spend per customer. Let's now turn to profitability. For the second quarter, we recorded an adjusted EBIT of EUR 77.4 million, representing a margin of 3%. Our profitability was impacted by slower growth and the continued pressure on unit economics. Coming to our segments, our core segment, Fashion Store, delivered adjusted EBIT of EUR 61 million.
Margins declined more strongly in DACH than in the rest of Europe region, as we saw a more pronounced slowdown in growth there. The decrease in profit in both regions was mainly driven by higher promotional activities to help reduce the high stock levels as well as increased fulfillment costs. This was partly offset by lower marketing spend. Our off-price business and other businesses delivered a profit of EUR 9.5 million and EUR 7.6 million respectively. Let's now move on to the P&L, and let's dive into more detail on this slide. Our gross profit margin declined year-on-year by 3.2 percentage points. This was because we prolonged the sales period and increased our price investment to reduce the stock levels. Our partner business and value-adding B2B services showed strong performance and making a slight positive contribution to our gross profit margin.
The fulfillment cost ratio increased by 1.8 percentage points due to the unfavorable order economics, cost deleverage, and investment inconvenience. During Q2, we introduced minimum order values in 15 additional countries, as Robert already alluded to. We also introduced a temporary fuel surcharge for our ZFS partners. Both of those measures will support the fulfillment cost ratio in the quarters to come. Our marketing costs improved by 1.8 percentage points as we adjusted our marketing expenditure in both performance and brand-related spend to respond to the lower demand that we saw in the market. Lastly, our administrative costs increased by 1.3 percentage points given the flat top-line development. While we reduced the third-party spend and slowed down our hiring pace, we continued to selectively invest to attract and develop and retain great talent. Lastly, let's turn to cash-related items.
We recorded an increased net working capital year-over-year, primarily as a result of higher inventory levels. The two main drivers here are, first of all, an increased inventory commitment back in autumn 2021 to mitigate potential supply chain risks. Secondly, the significant slowdown in demand we saw in Q1 and Q2 against more aggressive growth assumptions we had originally. CapEx spend was EUR 74.5 million in Q2, primarily driven by investments in our logistics infrastructure relating to the fulfillment centers in Poland as well as in the Netherlands. In addition, we had some capital expenditures on internally developed software. On the next page, we see our cash balance. Our cash balance remains strong at EUR 1.6 billion. In the second quarter, we also recorded a positive free cash flow of EUR +56 million. That concludes the financial part.
Let me now hand this back over to Robert to conclude the presentation by looking at our full year 2022 outlook.
Yeah. Thank you, Sandra. Now let's come to our outlook. At the beginning of May, we pointed to the lower end of full-year guidance based on anticipated challenges, but also early signs of a potential recovery. Since then, consumer confidence has dropped further and inflation has increased. As a result, we recorded a weaker performance in the second quarter and incorporated the high intensity and the longer duration of these external developments into our assumptions for the second half of the year. This consequently led us to announce a revised outlook for the full year. We now expect the GMV to grow 3%-7% for the financial year 2022. Revenue is expected to grow 0%-3% with an adjusted EBIT of EUR 180 million-EUR 260 million in the same period.
The CapEx is expected to be in the range of EUR 350 million-EUR 400 million. At the midpoint, this represents a reduction of EUR 75 million, which was driven by an adjustment of our l ogistics infrastructure investments to drive utilization.
We now expect neutral net working capital driven by increased inventory levels. Let me close by reiterating that we expect a return to growth and improved profitability for the second half of the year. Here, we're no longer lapping pandemic peaks, and our efficiency measures will show their full impact. This outcome is a direct result of our action plan, which we keep executing on to adapt our business to the new reality to improve performance going forward. Our vision remains consistent and relevant to be the starting point for fashion. We have a clear strategy and a clear direction, and we continue to invest through cycle to drive long-term value for our customers, partners, and shareholders in the long term. Thank you very much.
That concludes our presentation, and now we're looking forward to your questions.
Thank you. In order to give time to everyone, please ask only one or two question. If you have follow-up question, please queue. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. We will pause for just a moment to allow everyone an opportunity to signal for question. We will take our first question. Miriam Josiah from Morgan Stanley, your line is open. Please go ahead.
Good morning, everyone. Thanks for taking my question. First one is just on margins. Just picking up on the comment that you said that you expect the efficiency measures to offset fulfillment cost inflation. It sounds like you have better visibility on cost. How are you thinking about fulfillment cost for the rest of the year? And perhaps if you could give us a sense of where within your guidance range you'd now expect to come. Do you feel like you have more flexibility to adapt if we do see further deterioration in the macro, or do you think you've done as much as you can? Second question, just on the RCF. I just see that you've doubled the size of the RCF.
Just if you could give some color on the thinking behind that and what the M&A environment looks like at the moment. You know, do you have more appetite to do that in the current environment? Thanks.
Thank you, Miriam. In regards to your first question around the margin and the fulfillment cost for the rest of the year. I think throughout Q2, we have been very much focused on identifying cost saving and efficiency measures, particularly in the area of logistics or the fulfillment cost line. As a reminder, where we are today is the fulfillment costs are impacted by unfavorable order economics, a certain degree of cost leverage, as well as our investment in convenience. What we are saying here is that with the measures we have taken, we can offset any inflationary pressures. Which means that basically the first impact, which is around the unfavorable order economics, we can almost eliminate.
However, there'll still be a remainder left around our lower utilization and therefore cost deleverage from the lower growth that we have seen, as well as our investment in convenience. Yeah. We will not fully close the gap towards the year-end on fulfillment costs. In regards to your question around flexibility, I think the actions that we have identified and to a large extent already implemented have injected flexibility and resilience. We are at the moment protecting the downside. I think there is a question, of course, who knows what the winter will be like. But a certain degree we have of course factored into our guidance. On the RCF, this happened in the due course of the business. Actually, those conversations already started ahead of 2022.
as we are growing our business, we are also growing our RCF. As a reminder, the RCF is there to, on the one hand be a risk buffer, on the other hand be there for any future investments we may want to undertake.
That's helpful. Thank you. Just to follow up in terms of, you know, where within your guidance range you're sort of currently tracking towards?
A volatile environment and therefore for that reason, we gave a very broad range. We're only a few weeks into this half year, and so therefore, we don't want to narrow the guidance at this moment in time.
Great. Thank you.
We will take our next question. Charlie Muir-Sands from BNP Paribas. Your line is open. Please go ahead.
Yes. Good morning, guys. Thank you very much for taking my questions. I've got a couple, please. Firstly, what is it that gives you confidence that you will see an acceleration in sales in the second half? I also acknowledge that the comparative base perhaps eases, but of course the macro seems to be getting tougher and tougher. You know, is it based upon anything you've seen in the last six weeks since the trading update, for example? Then secondly, you've obviously reduced your CapEx guidance a bit for this year. I understand that's about postponing the start of new projects rather than pausing anything that's ongoing. I just wondered, are you still sort of committed to building the capacity out to handle, you know, your 2025 targets still?
Maybe, you know, is it possible that some of those 7 DCs that you'd identified you would need to build get built a little bit later in the future? Thank you.
Maybe I take the first one. Where does the confidence in the growth come from? Yeah, we do believe that we are at the inflection point at this moment in time. As you rightly pointed out, there is of course a baseline effect. Yeah, we have a much softer baseline, much easier comps. If you do the math, basically the second half is an extrapolation of what we have seen in the second quarter. There is another reason why we believe despite the current tougher macroeconomic environment, we can deliver that, and that is due to the initiatives we have taken around the assortment. We alluded to in the Q1 call, where we said we see specific trends within the customer segments trending towards also categories like Designer.
We have increased our Plus membership, so these are valuable customers. Beauty is performing very well and adding to the growth. Recently entered markets are, yeah. So I think these are the two comments here.
Yes.
CapEx, I hand to Robert.
Happy to. Thank you for the question. On the CapEx, all our recently announced projects of the logistics expansion, like the two in Poland, the one in France and Germany, they're all progressing as we planned. Not only for our own capacity, but as well for enabling the B2B efforts that we talked about in the previous earnings call. The CapEx reduction is actually more coming from postponing a new project that has not yet been started, that we will start at a later point in time.
on current trading, which was another question of yours, so far in July, we have seen an improvement of our performance and that supports our full year guidance. We are now basically focused on building up momentum for a successful start of the fall/winter season.
Many thanks. I don't know if I could just squeeze one follow-up question. In order to clear the surplus inventory of your own stock that you have, are you prioritizing at all on your platform the sale of your own goods above that of partners? Or is there a risk that partners who are in a similar situation might be, you know, pushing a lot through your platform and perhaps crowding you out?
I think there are in general elevated stock levels in the market, yeah. That is on our side, that is on the partner side, so you're absolutely right there. I think we have found the right balance throughout Q2, yeah, where we have seen also partners discounting heavily. I think we are on a good glide path now to clear out the majority of our overstock for the spring/summer season, and so are the partners. I think for the fall/winter season, the situation is slightly different because we were able to adjust our buying budget to the revised growth assumptions. I mean, we couldn't do that through the pre-order volumes because those of course had been locked in since Q1.
We were able to use the flexibility we had created to adjust those volumes. Now we will continue with those effective in-season inventory management tools that we have, leveraging also heavily our off-price business. I think the situation was already there in Q2 with elevated stock levels in the market and of course, I think we find the right balance between our wholesale business and the partner business.
We'll take our next question from Guido Lucarelli from Citi. Your line is open. Please go ahead.
Yes. Good morning, and thank you for taking my questions. I have two, if I may. The first one on the improved performance that you're seeing in July. I was wondering to what extent has the increased level of discount helped this performance? Or put it another way, was this an underlying improvement that you're seeing, or was there a stronger contribution from the higher level of discounts? A second question, in light of the more muted economic projections for FY 2023, which you have fully pointed out in your report, how do you see current consensus, which is seeing I think 13% sales growth for FY 2023?
How comfortable are you with that? Thank you.
Thank you. In regards to July, I mean, July and August are always the clearance months. These are the months where we have end of season sales across all of Europe, so June, July, and into August. Therefore, of course, the level of discounting is high. I hope that addresses a little bit the first question. In regards to the second question around a bit of color on 2023, I think it is definitely a bit too early to comment on 2023 because we are still in this quite volatile environment. We still see a high degree of uncertainty in the market. To be honest, the fall/winter season for us, which is critical every year, hasn't started yet.
The season start really is only in September. I think I wouldn't want to now comment necessarily on top line growth in 2023. I think we will get to that a bit later in the year.
We'll take our next question. Volker Bosse from Baader Bank. Your line is open. Please go ahead.
Yeah. Good morning, Volker Bosse, Baader Bank. Thanks for taking my question. I would like to start with your ordering. You said you order less, of course, but do you also order differently given the changed consumer sentiment, meaning more lower price points, for example? In other words, which product segments are still at relatively healthy demand levels? The first question. Second question would be on Zalando Plus. I think building customer loyalty is a cornerstone of your strategy also going forward. So what are potential add-ons you could think about in order to make the Zalando Plus offer more appealing for customers? And, yeah, what are your first observation? What makes people signing up for Zalando Plus, and how you plan to accelerate that? Thanks.
Maybe I take the first question, and then for the second question, I hand over to Robert. In regards to our fall/winter buy, yes, we reduced it, but we also improved it. We took into considerations the learnings from the changes in the consumer behavior, whereby we saw different tendencies. One was a move, as you mentioned, downwards to lower price points. This segment primarily is being served by our partners. We also saw a move towards actually the higher price segments, and this is what we have reflected in our buys, so the Designer categories, for example. We also saw a move towards more occasion wear. We have also moved away from the comfy loungewear to what's more the occasion wear for our fall/winter assortment.
Yes, we do have, to the degree that was possible, reflected of course the changes in the customer behavior in our buy, but also in togetherness with our partners. Robert, maybe over to you for the Plus program.
Yeah. Yeah. As you rightly point out, I think Zalando Plus is at the core of you know, of what we see as the ultimate key to deep relationships is like when customers actually pay your membership program to get the best out of Zalando. I think that's really the journey that we're on. We're very, very happy that we now have crossed like 1.5 million members and seen like 160% year-on-year growth. It's a good journey we're on. I think that being said, we are still like you know, always experimenting what are actually the right benefits that you know, that we incorporate in there.
What we're seeing is generally that the service benefits, they already are a good argument. even fast delivery, even more convenient, returns now as well. like advice services that we will bundle into the Plus program. what has as well been a great success so far is actually the access now to like very exclusive assortment where we have just very limited merchandise. that our Plus members actually get the access exclusively to these drops. these are as well good arguments for customers to sign up.
Last but not least, I think even like the minimum order value introduction I think makes the Plus even more exciting as well. Because, you know, with customers that don't commit like so much to Zalando, like, and they get like the normal experience. Like the Plus members, they don't have to worry about minimum order values. They don't have to worry about any of these services. I think that's one of as well of the drivers that keeps on committing even more customers to deep relations with Zalando.
Thank you. We'll take our next question. Anne Critchlow from Société Générale. Your line is open. Please go ahead.
Thank you. I've got just one question, relating to the reduced CapEx guidance and postponing some warehouse projects. Do you believe you're still on track for the EUR 30 billion of GMV by 2025? Or does the postponed projects reflect maybe a slower build of GMV?
Yeah. Thank you for your question. I think, you know, we are, you know, we just come from like, you know, two years that were like, you know, our growth was much more than we actually expected, so far. 2022 is now a year where, yeah, I think, you know, we all have not expected, like, I think, like this environment. We have now two quarters where we, yeah, growing less than we actually expected. We are not a company that just like, you know, that talks about long-term goals or changes long-term goals just on the back of like, you know, two good or bad quarters. We are sticking to our goals. We're sticking to EUR 30 billion GMV.
We're sticking to 10% of the fashion market that will be on Zalando. We're sticking to our 20%-60% midterm guidance. All these goals we're sticking to. Obviously, like the trajectory, given like, you know, the volatile market environment, we need to see like how it goes out. The goals remain the same as our strategy does.
Thank you. We'll take our next question. Clement Giner, from Garnier, your line is open. Please go ahead.
Yeah, good morning. I will have two questions from my side. Maybe first one is on the U.S. expansion. Is it still on the table right now? And what would be the cost on all of it behind it? And the second point is on the ZMS. You and all the players in the consumer space are currently increasing marketing spending. Does it mean that ZMS will be lagging behind ratio? Thanks.
Yeah, thank you for your question. First of all, like on the, I've seen this report as well. What can I say about.
I think first of all, like, you know, we are an intermediary company, so we always look for good opportunities like be it like, you know, expansion, what we can do more for our customers within Europe or as well in geographic expansion. Yeah. Like we constantly look out for like new opportunities. I think that being said, I think there's certainly an opportunity as well from Zalando at one point in time, maybe as well outside of Europe. I think the time is not. Yeah, it's not now. It's not the next and for the time being. We are very much focused on the 25 markets that we're in in Europe. There's no organic launch in the U.S. anytime soon.
We're very focused on our opportunities and challenges here in Europe in the 25 markets and the propositions that we're in. Yeah. On the ZMS question. Yeah. As Sandra said, like we've seen actually a very good growth of ZMS with 40%+ . What we're seeing, interestingly in ZMS is that brands as well behave differently. We have actually some brands that actually contract a little bit like their spending from ZMS. But then there's other brands that actually take it more as an opportunity to double down on investment. It's a different behavior by brands, which overall actually leads to an increase of ZMS by 40%.
As we'll see generally in the fashion market, that there are some brands that are more gaining and some brands that are more seeing more contraction. We see the similar pattern as well in ZMS, but at a 40% growth so far.
Thank you. We'll take our next question. Simon Irwin from Credit Suisse, your line is open. Please go ahead.
Morning, all. Two questions from me. The first is, can you just talk a little bit about invoice payments? Do they attract higher return rates? And is there anything you can do to reduce invoice payments and return rates on that part of your business? The second is just thinking longer term about inventory management. Your overall kind of commitments are high. You keep a lot of inventory kind of spread across the network. What can you do to be more reactive and not be in a position like this year, you know, where you read the trends wrong and are overcommitted, which takes a long time to kind of clear through?
You know, is there anything that strategically within the business which where you can either kind of commit later or just hold less stock within the business?
Thanks. I'll take the invoice payments question, and then Robert will take the inventory and management question. On invoice payments, to be honest, it doesn't really attract higher return rates. I think it is learned behavior. Invoice payments has always been strong in Germany ever since the catalog businesses, and therefore it's learned behavior of that in the German environment. You get the product and then the invoice, and only afterwards you pay. We don't really see a material difference in return rates whether it's invoice payments or whether it's PayPal or credit card.
Yeah. Maybe just to add a little bit to that, I think to the invoice. We're not seeing any elevated levels actually of defaults or debt.
I think it's actually part of the service suite of Zalando to actually have which is something we're very proud of that we have an own high performing BNPL service built up that is so much catered for fashion and actually is one of the most favored payment methods. It really is part of the value proposition that we're actually able to offer that. Our investments to you know to reduce returns are actually more I think on the technology side to help customers to have the right choices.
This is more catered to through technology, through better selection, through better description, and maybe in the future as well through augmented reality and many of these investments. That's what we are very, very focused and excited about. On your second question of how we see actually wholesale and partner program going forward, I think you're right. Like, I think, you know, generally, I think our view has, I think, as well evolved over the last couple of years, what is actually the right approach for wholesale and taking on inventory risk and as well, the partner program, where we as well see a lot of like, you know, these benefits where we just more service our infrastructure to the brands.
I think generally, what we use the wholesale business model more, going forward, for is that we buy those brands that anchor and authenticate our fashion assortment, yeah. That we can actually make sure through our wholesale that we make sure that our customers find the most loved fashion brands in an inspiring multi-brand environment. It will be the favored business model for brands where we see like the risk is very low and the high confidence for the consumer relevance is actually very high. Brands where we see they have a higher risk or the customer relevance is a bit lower, we will continue their transition towards the partner program.
I think that's the right mix that we will use going forward that actually, yeah, brings the best to our customers, but as well caters for the right mix of like risk return in our assortment going forward.
Thank you. We'll take our next question. Anubhav Malhotra from Liberum. Your line is open. Please go ahead.
Hi, team. I've got a couple of questions myself. Firstly, on the return rate, if you can give me an idea on where it is trending at the moment and how does it compare to pre-pandemic levels? If the requirement for minimum order values, have you ever seen any impact on return rate and so once you introduce those requirements? Secondly, on the partner program and just on, in terms of what the reaction of the partners has been when you have increased your ZFS fuel surcharges to them, and you pass them on. Also on the partner program, you talked about the higher risk, lower prominence brands being moved a lot more to the partner program than the main, dominant brand in the market.
Can you give me an idea on whether those lesser prominent brands are making money on the platform at the moment, given that I think a lot of them would be shipping individual shipments, especially those who do not take on the ZFS program with you, and they would be sending single product shipments as part of a bigger order, and it may be quite costly for them. Can you give me an idea of whether they are making money with you guys? Thank you.
Leah, answer that.
Thanks for the questions. Your question about the return rate and where we are trending versus the pre-pandemic levels. We have seen a gradual increase in the return rates, but we are still trending below the pre-COVID levels. We do expect that this trend will continue. That it will normalize at a slightly lower level than pre-pandemic because we are taking a lot of measures to actually help the customer on the size and fit side, to hopefully then choose the right article firsthand and not having to send back the parcel.
The MOV from everything we have seen so far in the new countries, but also from the experience in where we introduced the MOV previously, didn't have an impact on return rates, so no change there. In regards to your question about the ZFS fuel surcharges, whether they were accepted, we generally operate on a cost plus contract with those partners for ZFS. Therefore, the fuel surcharges were somewhat expected. It's pretty much industry standard. Other companies like you may remember Amazon had done it slightly earlier than us, so it's pretty much common market practice. So it was broadly accepted by our partners. I hand over to Robert for the third question.
Yeah. I think your third question, if I kind of understand correctly, is, like, was the question of how does the profitability of the partner program actually looks for an individual partner? Obviously like, you know, I don't know in detail, like, you know, how the P&L for every single brand, how it looks like. But obviously, like, it's only sustainable, long term if like a partner makes good money and we make good money. That's, I think, fundamentally our job that we're on to enable them to make good money.
I think fundamentally, as you see that the partner program is, like, still like so massively, growing and increasing, I think it can only grow as much if, like, you know, if the partners actually make good money with that. Therefore, I think I'm overall very, very confident. I think ZFS is actually a good example of how we then use our services to then enable partners to make even more money out of that and then to invest even more into it. Because with ZFS, they are then able to combine packages with other partners, so split the cost of shipments, split the cost of returns, and make even more money. As well on a standalone basis, I think that is what I said.
Shipping directly from the store, shipping directly from their own e-com as well. This is a piece that is as well continues to grow in our numbers. I assume they're good, there's good money being made, huh?
Thank you. We'll take our next question. Georgina Johanan from J.P. Morgan, your line is open. Please go ahead.
Hi. Three quick questions from me, please. The first one, apologies if I've missed it in all of the materials, but can you sort of share a rough number as to where partner program penetration is sitting now within Fashion Store, please? Second one was just with regards to expansion outside of Europe. I know that you said it's not the right time for organic expansion. If an inorganic opportunity did come up, would you still consider it not to be the right time given the backdrop or would that be something you're open to, please?
Finally, I know you referenced that there's been no increase in defaults on buy now, pay later, but we have seen some gaps in the UK that certainly there are longer delays in payments and people sort of missing first payments and things. Are you seeing anything like that, please? Thank you.
Thanks a lot. I take the first and the third one and then hand over to Robert for the second question. The partner share remains stable, so it's no material change to the partner share versus what we said in what we published in Q1. In regards to the default rate, so far we haven't seen anything. It's rightly as you point out, we're very much very closely now watching, of course, how the consumer behavior is changing or not in that area. That's one that we have very clearly on our radar.
Yeah. On the question, yes. Like as said, our focus is on Europe. Yeah. Our focus is on our business in Europe. There's some challenges that we talked about, but as well, there's a lot of opportunities that will as well come out of this situation. That's our focus and that's really where our mind is. That's really where we're thinking about. Yeah. I think like, you know, will there ever be no business in the US? I don't like at this stage I can't really say even like Highsnobiety has a big business in the US and therefore we indirectly now have some business in the US.
I think our focus and to make it very clear, is on Europe, is on the opportunities and as well the challenges that we see now in Europe. That's yeah that's where our mind is.
Thank you. We'll take our next question. Geoffroy de Mendez from Bank of America, your line is open. Please go ahead.
Thank you very much. I have three questions, please. The first one, I wanted to come back on your comments on the acceleration of growth that you are seeing so far in Q3. I think you also said that July and August were driven by clearance in general. I was just wondering how you feel about the month of September when people go back from holidays with, you know, presumably a lower budget, when at the same time you've cut marketing expenses and you've introduced a minimum order value. Yeah, just your thoughts on the month of September. I think it's also in terms of weight in Q3, the largest month. That's question number one.
Question number 2 is, you know, in a scenario where growth is not falling where you hope it will fall for the second half of the year, what's your priority? Would you reinvest in pricing or would you protect the margins? So that's the second question. The last one is on the gross margin that we saw in H1 and in Q2, it was down quite a lot. I was wondering if you could give us a sense of what your expectations are for the second half, if you're expecting to discount as much as you did in H1. Thank you.
Thanks a lot. I hope I got it all, but please, remind me if I'm not, if I missed something. In regards to Q3, as I said, we have seen an improvement in our performance in July that does support so far our full year guidance. As you rightly say, September is the critical month for Q3. Which way the consumer will behave, who knows? Yeah, I think that's up to the consumer. What we have done is we have factored in the behaviors and that consumer sentiment that we saw in over the recent months into our guidance, and that will hopefully then address that. What will then be the priority in the second half, growth or margin?
We are trying to strike a good balance between both of them, because it relates also then to your third question. Of course we have elevated levels of inventory, and we need to churn through those inventories. On the one hand, we need to make sure that there is sufficient growth to get off these inventory positions, while at the same time, of course, we want to protect the downside.
I think in order to protect the downside, we have really been busy over Q2 to identify all of these cost saving measures and efficiency measures, whether that is on the fulfillment cost line, but also within the areas of marketing and overhead to just ensure that we can protect the downside. In regards to your third question around gross margin expectations for the second half, so I think Robert said it in his presentation, the ambition is to stabilize the gross margin. Yeah.
We have been able to amend our buy in a way that gives us the confidence that we have a better buy in terms of categories and price points that we cover, while, of course, at the same time, the cut of the buy came at a later stage, so it does put a risk on inventory, and we will transfer that.
I would actually like to add a little bit, like, of color to the second question you had because of this growth and profitability. Just to make clear, like, what kind of company we are. Fundamentally, we are a growth company, and this is in our DNA, and this is really where all our beliefs actually come from, that I think at the larger scale, there's actually much benefits for the consumers, for the brands. As for all our agenda that we have on sustainability, that we have more impact and have higher, have high return on capital as well at larger scale. Fundamentally, we're a growth company, and that's, I think, like, important as well to always remind ourselves.
I think this current situation that we're now in, so how we approach that. I think, first of all, we see there's so much uncertainty, so the thing that we now think is actually best, the best for Zalando is really focusing now on the profitability at this stage. Focusing on the profitability and focusing on our cost side. I think even culturally, this is as well good and important for us because after two years of riding a high growth wave at Zalando and, like, where a lot of things that we have done is, like, where we just went for the scaling part of it. We just, you know, we prioritized everything that it was capturing on the growth side.
I think for us as a company, it's actually something very good and healthy now to go through a period where we are more faced with scarcity of resources, prioritize more, efficiency measures as the MOV and so on. I think fundamentally it's a step now to go back a little bit in order to be prepared for the best opportunities when they present themselves. I just want to put this as well out there, like, that's our higher level mentality, how we approach now in general the situation.
Thank you. We'll take our next question. Michael Benedict from Berenberg, your line is open. Please go ahead.
Morning, all. Thanks very much for taking my question. Just a couple from me, please. First one, on minimum order values, if you see an improvement in your order economics without any noticeable impact on the top line, why didn't you implement the MOVs in additional markets until now? Then the second question on marketing costs, I think they're 8% in Q2. Is that a sensible level to assume over the course of the year as well? Thanks very much.
Yeah, on the first question, on the minimum order value. Many ways to answer that. I think first of all, just what I just said, like you know when we prioritize our projects that we're doing, like you know for us, the minimum order value was not. In the past it was not, like you know, the highest priority topic because it essentially helps you to generate more profits or to offset costs as we allude to. It doesn't really like you know necessarily first of all increase the customer experience. Therefore, we didn't prioritize in the past.
I think now, given the macro situation, I think those kind of projects that don't help us necessarily on the growth side, but that will help us to, you know, to essentially be, well, a more cash generating business. They are the ones that we now prioritize higher than the other ones. That's the first piece of the answer. The second piece of the answer is obviously with the increased cost inflation that we have seen on the logistics side, it made it even clearer that the minimum order value is now a project to pursue. That we as well are able to continue to offer items below a certain threshold to our customers, especially to Plus customers.
That's why we now did it and not, like, two years ago. Yeah. The second question was on marketing costs.
Yeah.
ratio for the second half of the year.
I think on the marketing cost ratio, maybe we take a step back into last year. Last year, we had elevated levels of marketing as there was strong demand out there in the market, and we wanted to capitalize on that. This year, now that the demand is slower, we have basically returned back to a level that we previously had, and therefore we feel like the 8% as it is around the 8% is roughly what is the right number going forward for the remainder of this year.
Thank you. We'll take our next question. Andreas Riemann from ODDO, your line is open. Please go ahead.
Yes, good morning. It's Andreas here from ODDO . Two topics. One would be fulfillment costs. Is introducing the minimum order values that you mentioned enough from your perspective? Are you also thinking about charging fees for delivery, for returns to improve the unit economics in order to account for the growing relevance of sustainability? Is that simply no option because that was your initial promise to the customer?
Would be the first topic or question. Then on Connected Retail, that was a big topic last year and I guess the year before. How many of those partners are still there? Is that also from your perspective a meaningful business going forward? Thanks.
Yeah, thank you for this question. First of all, like, as I said in the presentation, the minimum order value and as well other measures that we've done in the logistics infrastructure side actually offset all the costs that we're seeing now from inflation on transportation costs going forward. It kind of netted out. When it comes to additional levels such as charging now for returns, we fundamentally believe that this is not the right approach, yeah. Because our approach is to make it, you know, as convenient and easy for customers to have the merchandise coming to them.
Yeah, there's a lot of like reasons as well why customers then in the moment when they touch it and when they feel it, don't want to have it. This fundamentally making it harder for them to return would fundamentally decrease the customer lifetime value going forward. It won't help in the long term as much. Our investments are very much geared towards making unnecessary returns like, you know, size and fit and like the merchandise not coming as expected to prevent these kind of reasons by investing into technology, investing into data, investing into product presentation. That's for us the right approach going forward and as it always has been.
The second question on Connected Retail. Yes, we've seen some decrease in the volume in Connected Retail and the total volume that we are transmitting to partners, yet we haven't seen any churn in stores, yeah. Why we've not seen any churn in stores is because it's, I think, for the stores, it's very easy to have our software running into their stores and do this business side by side when they as well have customers in the stores. There's literally no churn. I think the more exciting pieces for us going forward is actually how we see that stores actually create locally relevant assortment in the markets that we're in.
We see, for example, in some countries where retailers actually upload merchandise that we don't have on the platform, and this already makes up 30% of the Connected Retail business so far. I think that's one part that we're taking to use the store network even more to create merchandise locally relevant that we don't carry at this stage, yeah.
Thank you. We'll take our next question. Jürgen Kolb from Kepler Cheuvreux. Over to you, your line is open. Please go ahead.
Very good. Thank you. Two questions on my side, still open. One is on Highsnobiety. I was wondering if you could maybe elaborate in some more detail as to what your plans are with them. When will we see the first, say, combined campaign or, you know, what's in it from your perspective with that acquisition? The second one, also, going back to a acquisition you did in the past on the Swiss body scanning company Fision. Was wondering how you have implemented this service already entirely or what is here the current level of expertise that you have gotten into your app and what's the impact that you've witnessed? Thank you.
Yeah, thank you. Of course. First of all, on Highsnobiety. I think, you know, fundamentally as I looked in my presentation to it's like Highsnobiety is much more a fashion authority. It's much more like speaks to the CMO of the brands, while we mostly speak to the chief sales officers or the CEOs of brands. I think this actually is a very good combination because it allows us to have access to brands in a very complementary way to us. And actually allows us to understand more what we can do on the storytelling perspective and what we can do to actually get the most exclusive assortment of these brands going forward. I think this is already happening.
We're already like we have a lot of like joint approaches to brands and actually thinking about and working with some of the brands is how we can actually yeah tell their stories even more and then learn what kind of content can we bring and how we get access to these yeah to these drops that are like everyone is trying to get to. I think that's overall the big piece of what we are for them with Highsnobiety.
A second bigger piece is telling the stories and producing content in such a way that we get even more attention from our customers to tell stories on the fashion in a very inspiring way. Here we will have a release in the course of this year, where we make place on our properties much more for these storytelling perspectives that we're creating now jointly with Highsnobiety. On Fision, on the acquisition.
Since acquisition, I think we were very happy with the team and how we integrate as well their knowledge and their capabilities into our size and fit capabilities. There's no release yet that we have announced that brings it all to market, but it will follow soon and we will let you know once it's released. It's remarkably enough.
Thank you. That concludes today's question and answer session. At this time, I would like to turn the conference back to the company for any additional or closing remarks.
Thank you, thank you all for these great questions. I would like to close by reiterating first of all, that we expect a return to growth now and improved profitability for the second half of the year. Because here we are not no longer lapping pandemic peaks, and our efficiency measures will show their full impact. Just to reiterate, this outcome is a direct result of our action plan, which we keep executing on to adapt our business to the new reality and improve performance now going forward. To close, our vision remains consistent and relevant to be the starting point for fashion.
We have a clear strategy and a clear direction, and we continue to invest through cycles to drive long-term value for our customers, partners, and shareholders in the long term. Yeah, with these words, I just wanted to close up this presentation and thank you once more, one more time for your questions. Yeah, and see you soon.
Patrick.
Thank you.
Thanks a lot. Bye-bye.
This concludes today's call. Thank you for your participation. You may now disconnect.