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Will Etsy Manufacturing Boost Its Bottom Line Or Compromise Its Artisanal Integrity?

Updated from 10 a.m. with comments from Wedbush analyst Gil Luria.

NEW YORK ( TheStreet ) -- Since Etsy ETSY Get Report ) went public last April, its stock price has nearly fallen off a cliff , losing as much as two-thirds its value and making it the worst-performing IPO this year.

Plagued by the rising value of the dollar, swelling marketing costs and declining revenue from product sales, Etsy reported a net loss for the first six months of 2015 of $42.9 million, an increase of 1,088% from the same period of 2014.

To generate morerevenue from product sales, on Monday the company officially launched Etsy Manufacturing, a departure from its policy of featuring "handmade" products. The service pairs Etsy sellers with Etsy-vetted manufacturers in an effort to assist crafters in growing their businesses while still adhering to Etsy's guiding principles of endorsing "authorship, responsibility and transparency." The decision to allow manufactureditems puts Etsy in an unenviable position as it tries to maintain a very fine line between maintaining its artisanal integrity and providing the revenue growth that will satisfy shareholders. At the same time, Etsy needs to fend off competition from Amazon AMZN ) , which plans to launch Handmade at Amazon , a new store where invited artisans can sell their handcrafted items.

By adapting to the changing marketplace, Etsy hopes to stay in the e-commerce game, rather than risk becoming just another kitschy Web site that sells stuffed-squirrel wedding cake toppers.

Two years ago, Etsy began to allow collaboration between sellers and manufacturers on a case-by-case basis, which has resulted in 7,853 partnerships so far, according to Etsy. The success of these partnerships encouraged the company to expand to a more formal program.

Hoping to quiet any criticism of outsourcing to cheap labor markets overseas, it notes that 85% of those product manufacturers are located in the same country as their product's designer.

"This [has] diluted their brand, especially with their members, but helped the company grow over the past several years," said Wedbush analyst Gil Luria.

But the program is not without its detractors, nearly all of whom come from within the Etsy community.

Founded in 2005 on the principle of selling only handmade goods and eschewing faceless manufacturing, Etsy has grown to 1.5 million members who hawk 32 million different products ranging from handmade jewelry to vintage suspenders. But by allowing sellers to mass produce, some Etsy members fear that not only will the site lose its "farmer's market" appeal, but that cheaper, mass-produced items will outsell comparable handmade products.

To assure members that the company will not lose its artisanal uniqueness, Etsy says the program is intended to help small businesses "start, grow and enjoy their creative business on their own terms" while at the same time provide opportunities for small manufacturers that have been hurt by production moving overseas.

Etsy must also approve any manufacturing collaboration initiated by members, ensuring that the partnership meets its "ethical expectations" that include such standards as humane working conditions, minimal environment impact, and willingness to be transparent about production processes. The companysays it rejects about 40% of seller applications for manufacturing partnerships that don't meet its standards.

To get the process started, Etsy hosted a Re-Imagine Manufacturing summit last October that brought small-scale manufacturers, policy makers and Etsy members together to "envision a new model of responsible manufacturing for Etsy sellers." To that end, Etsy tried to take away some of the negative stigma associated with the usage of manufacturersby reminding members that many manufacturers are nothing more than local businesses better equipped to streamline certain segments of production, from cut-and-sew-shops to printers to jewelry casters.

Feel-good sales pitch aside, the introduction of manufacturers seems more like anattempt byEtsy to boost its bottom line by beefing up the weakest link of its income statement -- marketplace revenue, or Etsy's share of sellers' revenues. While potentially good news for investors, this strategy risks alienating the members that are at the core of its business.

"This could ultimately be Etsy's downfall," said Luria. "While it may help growth for a quarter or two, ultimately sellers will get tired of Etsy, especially with the choice of Handmade at Amazon, which will sell only handmade items without competition from manufacturers. It's a very short-term oriented strategy that will sacrifice the brand they have of being an outlet for handmade goods." For the quarter that ended June 30, 2015, Etsy's marketplace revenue increased just 23% to $30.5 million from the same quarter of 2014, while revenue from seller services (extra fees for promoted listings, payment processing and purchases of shipping labels) soared 79% from the second quarter of 2014 to $30.0 million.

While the growth in seller services revenue looks good on paper, it's hard to see how Etsy can sustain itif itsmembers' products aren't selling. So by allowing the use of manufacturers, Etsy can grow its marketplace revenue by simply increasing the volume of sales. (Etsy gets a 3.5% cut of the sales made by members.) So to keep shareholders and members appeased, Etsy is taking a cautious step towards generating revenue while stillattempting to maintain its unique culture. It's a gamble the company cannot afford to lose.

Will Etsy Manufacturing Boost Its Bottom Line Or Compromise Its Artisanal Integrity? 1

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