Why Loehmann's just couldn't compete

Say bye-bye to the Back Room, discount shoppers.

Loehmann's, the nearly 100-year-old seller of discount designer clothing, this week filed for bankruptcy protection for the third time. Claiming $100 million in debt, the Bronx-based retailer said it plans to close all 39 stores, says Fortune, joining Filene's Basement and Syms in discount store heaven.

Loehmann's business model, where it buys cast-offs or unsold clothes from designer brands, then sold them a season later at a fraction of the price, was a gem for much of the 20th century. Designers liquidated their least successful product out of view of their target customer, shoppers who usually couldn't afford brand names got to sport prestigious tags, and Loehmann's profited nicely — a kind of win-win-win for everyone involved.

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So how did this trifecta of off-price-fashion crumble?

Loehmann's cited increased competition as a chief reason for its slide — but this may have several facets.

"[Loehmann's] model has been upended by online flash sales from Gilt Groupe and Rue La La, which gave designers an alternative way to sell their clothes as they pleased," an AlixPartners analyst told Fortune. And true, the discount designer sector has doubled since 2001, led by online startups that tussled up tradition. But many of these retailers, even the big ones, are floundering lately as well.

Gilt launched in 2007 — fortuitous timing for a discount retailer. In 2008 and 2009, the global recession left designer brands, from Rag & Bone to Ralph Lauren, with piles of excess clothing. Yet, the most popular brands, which spent decades nurturing and guarding and exclusive, luxurious brand image, were reluctant to funnel the glut through Century 21 or Loehmann's, stores known for their messy displays and large, neon "sale" tags.

Gilt offered them another option. Rather than fiddling with ugly tags and florescent lighting, Gilt sends emails to members announcing "exclusive" flash sales of high-end items. So from 2007 to 2010, brands shipped their excess to Gilt, liquidating merchandise, while protecting brand image, says Business of Fashion. By 2010, Gilt's revenue reached about $425 million.

But Gilt struggled in 2012. As demand for discount, designer clothing rose, availability sank, partly because of a rush of new online, flash-sale companies copying the model, and partly because brands began adjusting their production orders to match the slump in demand. The result is that now when customers open their Gilt emails, they often don't see designer items at enticing prices — they see unknown brands at discount prices, which was not really the point.

So, where does the Loehmann and Gilt customer, who values designer clothing, but can't pay $900 for a blazer, go? Zulily and La La Rue, competing online discounters, offer one option.

But increasingly, fast fashion labels, particularly Zara, seem to be the other. The Spanish label, owned by Inditex, plainly adapts famous designers' looks straight from the runway, and thanks to an efficient production model, takes only about two weeks to get them on the racks.

So the fashion-forward shopper has two options: She can search for discount designer clothing (that is one season behind or in a color that was too unflattering to sell) on a slew of websites that increasingly have less to offer. Or, she can go to Zara and buy a pretty solid copy of this season's styles — even next season's — at a fraction of the price.

This isn't to say that a name brand tag no longer matters — certain Loehmann's devotees would never be caught dead with a Zara tag. But looking at the numbers, it's hard to imagine that the fashion behemoth isn't sucking in a chunk of those customers.

Inside View estimates Loehmann's yearly revenue is about $386 million, while Gilt, says Bloomberg, sells somewhere in the $550 million range. By comparison, Zara made $11.4 billion in 2011.

These are not apples-to-apples businesses (Zara has about 1,800 stores globally). But there's a reason why in 2001, when Zara had about 425 stores and made closer to $2 billion in revenue, Daniel Piette, at the time Louis Vuitton's fashion director, described the company as "possibly the most innovative and devastating retailer in the world."