Tag - stitchfix

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How J.Jill’s IPO Could Help Define E-Commerce Valuations
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Why Amazon Has Consumer Investors Bemused and Confused
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The Middleman Strikes Back

How J.Jill’s IPO Could Help Define E-Commerce Valuations

You’d be forgiven for missing a small cap retail IPO last week in the midst of the global Snapchat mania. Last Thursday, without much fanfare, J.Jill, a nearly sixty year old former mail order catalog company selling women’s apparel, quietly went public at a nearly $900M enterprise value. And surprisingly, for the complex world of digital commerce, J.Jill’s public market reception might actually be an indicator of what all these next gen direct-to-consumer commerce businesses are actually worth.

How a Small Cap IPO Could Help Define2

In past pieces for BreakingVC during 2016, I’ve discussed Amazon’s impact on both e-commerce and retail at length, as well as the three areas I’ve observed for opportunity to penetrate Amazon’s digital commerce force-field: (1+2) In Why Amazon Has Consumer Investors Bemused and Confused I wrote at length about both off-price retail (Marshalls and T.J. Maxx, for example) as well as mid to upper tier brand opportunities that Amazon fundamentally can’t capture and (3) in The Middleman Strikes Back, I described how Amazon’s anemic commerce margins prohibit it from a service heavy assisted/concierge-commerce provider.

But for everyone else – from Warby Parker to Harry’s to Bonobos to Everlane – what are these weird, sorta digital, sorta omni-channel, sorta personalization brands actually worth? And why is a sixty year old women’s apparel business that was previously spun out of a legacy retailer, Talbots, a leading indicator of value?

As usual, the Company’s S1 is a store of insight and surprises:

Personalization and Loyal Customers

If I were reading an untitled prospectus, I would’ve bet my money that the following block of text from the Company’s S1 “Overview” described a millennial-first next gen commerce brand, with a small but growing retail footprint:

We believe we have strong customer and transaction data capabilities, but it is our use of the data that distinguishes us from our competitors. We have developed industry-leading data capture capabilities that allow us to match approximately 97% of transactions to an identifiable customer, which we believe is significantly ahead of the industry standard. We maintain an extensive customer database that tracks customer details from personal identifiers and demographic overlay (e.g. name, address, age, household income) and transaction history (e.g. orders, returns, order value.) We continually leverage this database and apply our insights to operate our business as well as to acquire new customers and then create, build and maintain a relationship with each customer to drive optimum value.

Believe it or not, that is a sixty year old company talking.

The truth is that most retail businesses are really merchandising and logistics businesses more than personalization businesses. Most big box retailers – or at least the many that I speak with – admit that closing the loop between online-to-offline transactions is amongst their largest struggles.

This is a flaw that digital first businesses – even those with a retail footprint – claim they can solve. And all the moreso, a business such as Stitchfix, which is truly a data business at its core, led by Eric Colson, Chief Algorithms Officer. Case in point, a recent Stitchfix blog entitled “Ruminations on Data Driven Fashion Design,” which noted:

For example, can statistical modeling identify when a successful blouse has an attribute that is holding it back? If so, can we suggest a mutation that replaces the underperforming attribute? To illustrate, can we identify when a parent blouse is successful despite its leopard print, and then change it to the floral print that everyone loves this season? We are also examining how we can leverage less structured types of data. For example, can we extract features from images of blouses or the text feedback that clients provide in response to a blouse?

[To be blown away, visit the Stitchfix Algorithms Tour, built by Colson. It is a wow.]

Data is powerful. But it’s goal is to yield a more engaged customer; in J.Jill’s case existing active customers [within the past five years] represent 70% of annual revenues – an awfully consistent customer who sounds pretty darn comparable to all those subscription commerce businesses that have proliferated the market. And very similar to the vision today’s D2C brands are claiming: own a customer’s wardrobe/apparel/bathroom/etc with a non-commoditizing product and they will come back to you year after year.

J.Jill also looks a lot more like a direct to consumer business than your traditional retailer, with 42% of 2016 sales (growing to 50% in 2017) coming from direct channels.

How a Small Cap IPO Could Help Define E

What about its retail footprint? As discussed in the past, many of the next gen millennial brands are launching brick and mortar stores to prove a new customer acquisition channel against an overly saturated (and unprofitable) digital marketing environment. But with a footprint of only 275 retail stores, its brick and mortar presence is at least relatively comparable to the type of presence today’s next gen retailers are aiming for (as of today Warby has 44 B&M locations, Bonobos has 11, etc.) And these stores, like the millennial brands are conceptually customer acquisition drivers, as the S1 notes: While 64% of new to brand customers first engage with J.Jill through our retail stores, we have a strong track record of migrating customers from a single-channel customer to a more valuable, omni-channel customer.”

At the end of the day, J.Jill, this under the radar retailer looks surprisingly similar to today’s D2C commerce businesses:

  • Data-first approach (97% of transactions properly attributed to customer profile)
  • Heavy direct sales focus, with stores used merely as customer acqusion tool (42%, growing to 50%).
  • Not overbearing retail footprint
  • Brand quality margins (65.9% gross margins), as compared to 42% for Macy’s, 35% for Nordstrom or 40% for Gap – effectively double the margin basis as a traditional retailer.

What’s It Worth

I like J.Jill as a comp for many of today’s e-commerce companies for two reasons. First, as proven in the prior section, I think it looks much more similar than a casual observer might guess to those businesses. But secondly, at ~$500M in annual revenues, J.Jill is surprisingly small for a public retailer. Gap posted nearly $16B in revenue in 2015, Williams Sonoma is on the small side with $4B in revenues – even Lululemon has trailing revenues greater than $2B. This looks similar to emerging commerce brands which are typically much smaller than their relative press coverage would imply: Dollar Shave Club was on a $250M revenue run rate when acquired by Unilever, Warby Parker booked an estimated ~$200M revenue in 2016, and Trunk Club was on a reported $100M revenue run rate when acquired by Nordstrom. Most of today’s emerging brands, even at triple their current size, would look substantially similar to a small cap IPO.

The first piece of very good news for emerging brands is that there was a market appetite for a small cap offering of this nature whatsoever. Although the Company ultimately priced at $13/share, just below its suggested range of $14-16/share, the good news – again – is that market interest was strong enough not to justify pulling the offering entirely.

But that’s mostly where the good news stops. J.Jill’s IPO (even based on an estimated $15/share offering) would have it placed towards the bottom of a peer set on a valuation basis. The following graphs on valuation comps were initially published on Seeking Alpha:

How a Small Cap IPO Could Help Define 4 How a Small Cap IPO Could Help Define 3

Those are sobering multiples (and, the company actually priced 10% below these estimated multiples) for a company that stacks up extremely well on most operational metrics – for example, they boast higher product gross margin that brands such as Tiffany’s, Michael Kors, Ralph Lauren or even Abercrombie. They boast a higher direct to consumer sales percentage than most of their peers. They have an exceedingly loyal customer.

The biggest knock on the company is their growth rate: 10-15%/year – and one of their biggest divergences against today’s emerging brands who are mostly growing at 50-200% annually.

Given these multiples, e-commerce brands need to bank on the following two factors to earn a premium valuation in the market: maintain strong growth rates and maintain high visibility, momentum brands. J.Jill is a fundamentally strong company – and it has stolen much of the playbook from the online brands – but it lacks both velocity of growth nor excitement around its brand proposition.

Why Amazon Has Consumer Investors Bemused and Confused

Amazon’s recent entries into home servicesfood deliveryprivate label clothes & shoes, as well as a wide range of private label home items represent its most brazen efforts ever to attack the entire retail stack as well as penetrate seemingly defensible network effect businesses.

Over the past couple of years, Chicago Ventures has made a number of investments in service-enabled (concierge) commerce businesses believing that their service layer provides a real defensibility against Amazon’s low (no) margin approach. Writing in TechCrunch this past December in “The Middleman Strikes Back,” I noted then:

“If you sell practically any physical good online, Amazon, the Internet’s most powerful retailer, is a perpetual threat. With their distribution, leverage and logistics expertise, they have the wherewithal to undercut on price, and process and deliver products faster than practically any startup — not to mention, they can operate at a loss if necessary.

So where is Amazon exposed? On a services level.

Amazon’s operating margins — already tight at 1.3 percent — don’t allow for much room to train and mobilize a large human concierge force. Which means that building a human-focused, relationship-driven personalization platform actually provides for a tangible differentiator against Amazon — one of the few ways to effectively compete against the giant (and, perhaps more importantly, one of the few ways to build defensibility in a commerce segment traditionally dependent on “brand” as its only de facto moat).

One further point: Amazon is predominantly a destination for directed search – either on a specific product or specific category basis. But as purchasing increasingly shifts to mobile, it turns out that it continues to be difficult to search, discover and catalogue individual items. Concierges – especially when leveraged via a mobile interaction point – reduce that friction and enable a new purchasing behavior.”

But outside of these concierge commerce businesses – which by the very nature of their human capital costs will inherently be lower margin businesses[1] – are there still opportunities to build consumer businesses in a world increasingly dominated (or potentially undercut) by Amazon?

At an event today in Chicago, Amazon employees from nearby fulfillment centers packed 2,000 care packages to send to soldiers abroad who are not able to come home for the holidays Friday, December 4, 2015. Since 2010, Amazon has shipped more than 12 million packages to APO and FPO addresses. The Amazon care packages for the troops included holiday chocolates and snacks alongside an Amazon Fire tablet. The care packages for soldiers headed off in an Amazon branded trailer—one of thousands that Amazon has started to roll-out to increase capacity in the supply chain. Amazon’s Vice President of North America Operations Mike Roth said, “I couldn’t be more pleased that our very first Amazon trailer headed out on the road carrying such special packages—thousands of boxes filled with beloved holiday items and Amazon Fire devices to support troops abroad this holiday season.  (Photo by Peter Wynn Thompson/AP Images for Amazon)

Although many investors and operators I’ve asked privately have expressed mostly bemusement or skepticism about Amazon’s recent efforts, I’ll admit that Amazon has me perpetually on edge.

On Brand Authenticity

On a recent swing through the West Coast I asked several experienced e-commerce entrepreneurs (generated hundreds of millions in annual revenue, raised hundreds of millions of dollars from bulge bracket VC firms) the Amazon question.

The responses were similar: that it is fundamentally unlikely for Amazon to win a branding war in many product categories. For example, one founder noted, Proctor & Gamble or Johnson & Johnson, both of whom are seeing many of their product categories be unbundled by startups, lack the credibility to build authentic new brands in today’s social and content based environments.

How can a corporation claim to represent certain values as underpinning its products when its entire history of operations has been largely antithetical to those same values? Consumers, he argued, are simply too well informed now to be tricked by that ruse.

That strikes me as true – in certain categories. Here’s my view on how many product categories break down from a consumer’s perspective on importance. For context, I believe that purchasing decisions primarily hinge on four variables: Recall Impact is the speed at which a name brand is immediately recognized by a consumer, Authenticity Impact is the natural fit between company (or founders) and its product and messaging, while Review Impact refers to the import of 3rd party or peer-to-peer product reviews.

AmazonConfused4

The takeaway is that authenticity matters – but not always. Bargain shoppers are focused less on company values and story and a lot more on trusted brands who will provide a consistent quality of product at a low price point. Whereas mid-tier buyers care a lot less about traditional household brand names and base far more of their purchasing on crowd sourced information and reviews. This trend is more eloquently described by Itamar Simonson, a Professor at Stanford GSB who argues that we’ve reached “the decline of consumer irrationality,” that is, a large segment of consumers are less malleable to high level branding than in the past.

Amazon’s platform allows it to potentially excel within reviews, recall and price. Reviews, because it has habituated its customers to checking peer reviews before purchasing (and if its products warrant positive reviews, consumers will take note), and Recall, because the Amazon name is effectively ubiquitous with quality and convenience.

What this means is that Amazon has a very credible case to steal market share from bargain brands and mid-tier brands, but will face resistance as it moves into categories where authenticity matters a lot or if its product is subpar, irrespective of price. This is likely why its AmazonBasics line has fared well (low cost, commodity products, mostly electronics), whereas its initial line of diapers was pulled from the market. I am personally suspect that its forthcoming “Mama Bear” line of baby products and organics will be successful

On Irrationality and Execution

As an investor, my job is to pick and help businesses that I believe can execute on models that are defensible and sustainable. But Amazon has shown an unwillingness to accept any network effect as impenetrable and a preference for building, rather than acquiring.

That said, the questions I wanted to unpack are: (a) Is Amazon likely to out-execute a focused, fast growing startup and (b) Are they rational?

Let’s start with (b) – are they rational? I asked a respected consultant to the Fortune500 on strategy and corporate development with deep experience in retail. His thoughts:

“Amazon has always had a very unusual way to do strategy, breaking many of our rules.  But along the way, they have also proved that it is a very bad idea to do that.  How do I know that?  Look at the profit margin per sales dollar, the profit margin per employee, and simply the lack of net profit over the many years.  They are masters at “trading dollars” rather than making money.  Until very recently, profits have been essentially zero.  Never before in history has a major retailer grown without making buckets of money all along the way.

Along the way, to provide the appearance of dynamic growth, they have aggressively been crashing into markets and selling things at or below their real cost (including all true costs of operations).  How do I know that?  They make no money in the end, and that shows me their true costs, which they work very hard to hide in the individual business sectors.

Amazon does appear to act irrationally, and it is only the superior irrationality of the stock market that allows them to have the capital to do that.  Can the profit from AWS actually support the entire enterprise?  I have no idea.  But I would not want to compete with Amazon in any product space.”

Irrespective of whether one is an Amazon bull or bear (and I think it’s important to learn Chamath Palihapitiya’s take on the bull case) it does appear that their actions in any given business unit are highly experimental, to the point of appearing irrational (though employees will tell you Amazon is extraordinarily data driven). As an operating business, they are either fools or geniuses – both of which are reasonable perspectives – but many of their business launches do appear irrational. For example, Handmade, a direct Etsy competitor announced more than a year ago, has yet to launch and seems an odd market to attack given that Etsy’s market cap at $1.1B, or 33bps of Amazon’s, is downright immaterial.

The second question worth exploring is whether Amazon is likely to out-execute a more nimble startup. Amazon’s past is riddled with failures such as the Fire phone, Amazon Local (its investment in Living Social was also unsuccessful), and others. Whereas its successes, led by Amazon Web Services, Prime, and Echo are undeniably game changing. The reality, like most of life is likely grey – that Amazon’s outliers are outnumbered by its hundreds of somewhat successful experiments

Insights From Public Markets

To date, Amazon’s aggressive low cost pricing and capex-intensive logistic arsenal has most visibly punished traditional brick & mortar retailers. Sears, Macy’s, Nordstrom, Williams-Sonoma, Kohl’s and others have all lagged the S&P 500, often precipitously, for more than five years. In the following two graphs, the S&P 500 is the blue line.

AmazonConfused6

AmazonConfused5

But there’s one glaring exception (in the second graph). Off-price retailers, led by TJ Maxx & Ross Stores have surged, doubling the return of the S&P500 over the same period, and trading at multiples double to triple those of traditional retailers:

AmazonConfused7

In fact, the three brick & mortar retailers with the highest multiples: TJ Maxx, Ross Stores and Michael’s share one unique characteristic: they have effectively zero e-commerce. In fact, the retailer with the next highest multiple is Costco – who do not rank in SEO and whose e-commerce gated and exclusive to annual members.

So what’s the logic? Has Wall Street simply lost its mind & just hates online shoppers?

No. Each of the retailers in the high multiple bucket shares a commonality: a perception of being Amazon-proof. Off-price retailers have a particularly complex business model: frequently changing merchandise, material inventory differences on a store-by-store and geographic basis [3], and opaque relationships with the brands themselves. Those are complexities that are difficult to productize online because of the fast changing nature of the inventory – and for the time being the street assigns a premium to that non-commoditized revenue. [4]

The same is true of both Costco and Michaels. Costco, historically, has enjoyed a structural moat against other retailers because of its membership club and unique approach to high volume/bulk items. That, of course, may be changing – sales were flat for the first time in six years in the last quarter – and it’s possible that slowdown is related to Amazon’s Subscribe & Save. Michael’s stores, the behemoth craft superstore also trades at a material premium to most retailers, presumably because of a combination of (a) its custom framing business, a major revenue driver, has been reluctant to transition online and (b) over 50% of the store’s product revenue comes from private label brands, insulating itself from selling purely commoditized supplies.

High level – these are the insights investors and entrepreneurs should be focusing on when innovating in direct to consumer businesses. With an effectively infinite war-chest and a fearless leader, Amazon’s willingness to compete, even with mid-cap companies such as Etsy and Grubhub is unprecedented and its potential impact, significant. Those insights suggest a focus on building deeply authentic products, innovating in product mixes that are not naturally leveraged by Amazon’s existing logistics, and/or focusing on defensible transactional network effects businesses[5] – while avoiding mid-tier, commoditized product tiers or businesses that compete on logistics.

[1] There may be exceptions. There’s a reason Stitchfix has been investing heavily in data science, reportedly employing 60 FT data scientists. Data, even if only partially automated, is they key to reducing these concierge related overhead costs.[2]

[2] The paradoxical element of it all is that if a concierge commerce business (such as Stitchfix) becomes a purely data/AI personalized retailer, then they have unknowingly just played into some of Amazon’s greatest strengths: data leveraged personalization. It would seem there is a balance to be struck in this cycle.

[3] As an aside, one of the amusing nuances of the off-price retailers is that because of their changing inventory, and store-to-store inventory differences, each visit provides a sense of surprise and often delight – that same “surprise” many of the e-commerce based curators have tried to recreate online with mixed success. Turns out you could’ve just walked into an off-price store all this time!

[4] This is also why I am personally intrigued by the online consignment players. TheRealReal for example has enormous operational complexity because of the one off nature of its inventory – and forced to streamline processing costs (photography, content, authenticity verification, tagging) to the point of being profitable even on $100 items. Our investment in Luxury Garage Sale takes this complexity even further: moving thousands of truly unique SKUs across the country to its different retail stores, and even further re-leveraging the consigned items by putting them in try on at home and return boxes, called Luxbox

[5] Grubhub’s network effects, though strong from a technical perspective, are arguably weaker as consumer behavior shifts towards expecting a holistic delivery experience. This is because the company at present does not fully control that experience. Amazon, by virtue of its logistical prowess, can begin to recast the network in its favor, especially if it is willing to undercut on price and subsidize the costs of speed. Whether that is cost effective for them is irrelevant – Amazon is not concerned with short term profits.

 

The Middleman Strikes Back

The following article was originally published on TechCrunch on December 30, 2015

One of the great promises of the internet – a democratic, transparent, open network that would dis-intermediate entrenched industries, remove fee-taking middlemen, and thereby lower the costs of goods – has seemingly been realized. The OTAs such as Priceline and Expedia mostly killed travel agents, Prosper and Avant are fast disrupting bank loan officers, and the car salesman has been diminished in favor of eBay, Autotrader or Craigslist.

And yet, just as surely as we thought they were gone for good, the middlemen have come surging back to life. Only this time rebranded as our best friends: the personal concierge.

Case in point, personal shoppers were once a luxury – a sign of elite class and prestige. No longer: hundreds of thousands of consumers are now communicating with personal stylists (or data-driven human/Artificial Intelligence hybrids) via next gen fashion platforms such as TrunkClub and Stitchfix – two platforms with demonstrative value (Trunk Club was acquired more than a year ago for $450M and few experts would reject Stitch Fix’s $300M recent valuation).

And while fashion is an obvious use case, the concierge economy is thriving –spanning verticals from wellness to design, with a whole host of broad based horizontal concierge services also trying to impress their worth.

Slide1

ET TU, AMAZON?

The logical question is: why? Why, given all the advantages of a fricitionless, democratic playing field, are concierges suddenly surging back to popularity?

I see three likely explanations –

Amazon: If you sell practically any physical good online, Amazon, the internet’s most powerful retailer, is a perpetual threat. With their distribution, leverage, and logistics expertise they have the wherewithal to undercut on price, process and deliver product faster than practically any startup – not to mention, operate at a loss if necessary.

So where is Amazon exposed? On a services level.

Amazon’s operating margins – already tight at 1.3% – don’t allow for much room to train and mobilize a large human concierge force. Which means that building a human-focused, relationship-driven personalization platform actually provides for a tangible differentiator against Amazon – one of the few ways to effectively compete against the giant. And – perhaps more importantly – one of the few ways to build defensibility in a commerce segment traditionally dependent on “brand” as its only de facto moat.

One further point: Amazon is a predominantly a destination for directed search – either on a specific product or specific category basis. But as purchasing increasingly shifts to mobile, it turns out that it continues to be difficult to search, discover and catalogue individual items. Concierges – especially when leveraged via a mobile interaction point – reduce that friction and enable a new purchasing behavior.

Too Many SKUs: We exist in a world of overwhelm. That overwhelm via multi-tasking is affecting how we learn and think, and the overwhelm via optionality and availability of information is also affecting how we process, “shatter[ing] focus,” and deferring decision making as long as possible.

That problem of information overload was initially solved via curation, the mid-point on the spectrum in reduction of cognitive noise:

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But based on the hyper-growth of concierge facilitated platforms, it appears that curation doesn’t go far enough for the emerging set of millennial buyers – that they demand even more assistance and personalization than before.

The question that operators and investors should be asking is not whether consumers are connecting with digital assistants, but if – and at what point – we actually acquire too many concierges, thereby repeating the cycle of cognitive overwhelm, and forcing the next iteration of the operator/customer relationship.

Customer Acquisition: One of the curiosities of the concierge resurgence is that it may have opened the door for the next generation of customer acquisition.

The middlemen – when incentivized via a pay for performance model – actually become de facto customer acquisition agents for the company, serving as outbound salespeople. Trunk Club was one of the innovators of this model and our portfolio company, LGS has leveraged it as well with great success.

It replicates much of the power/incentives of a Multi-level-marketing model without the pyramid-like upfront capital commitments and obligations. MLM is a powerful model (Herbalife is one example of many), but social selling can generate abusive aggressiveness, poor customer relationships, and low return purchase rates. Because the concierge model is instead formulated as an expert/amateur relationship, there is an understood value in paying for guidance and reduce price sensitivity.

A concierge-turned-salesperson model isn’t a customer acquisition fit for all verticals, and it also can’t be as well leveraged by hybrid AI assistants, but it does solve some of the scalability concerns that most consumer businesses experience once traditional digital channels (FB, Google) begin underperforming.

THE DEATH OF THE COMMUNITY

Until recently, there was a strong hypothesis that a thriving, active community would unlock an unprecedented ability to facilitate native transactions. Andresseen-Horowitz General Partner Chris Dixon, when announcing his investment in Soylent, noted:

He said he was interested in companies that appear to be focused on selling X but are really online communities that happen to make money selling X. This helps explain why many investors are confused by the sustained success of these companies. One example he cited was GoPro. Many investors decided not to invest in GoPro because they saw it as a camera company, and camera companies generally get quickly commoditized. However, investors who properly understood GoPro saw it primarily as a highly engaged community of sports enthusiasts, something that is very hard for competitors to replicate.

And yet, at least on a macro scale, the presumed value is very much in doubt.

Last month, it was reported that native buy ads on Pinterest during the holiday season did not meet expectations:

The company began inserting Buyable Pins into its iPhone app in late June, and just added the feature to its Android app in early November. The company says more than 10,000 merchants have joined the program, including big retailers and brands like Macy’s, Nordstrom, Neiman Marcus, Cole Haan and Tory Burch, but at least one of these big partners is seeing fewer than 10 purchases a day on Pinterest, according to a person with direct knowledge of the sales figures. This source and another also said that Pinterest insiders have privately admitted to being disappointed with early sales numbers.

According to the same report, results are similarly disappointing at Twitter and Facebook. One time startup darling, community leveraged shopping portal Polyvore was acquired by Yahoo in 2015 for $200M – a healthy price to be sure, but certainly lower than once hoped. Even GoPro, noted by Dixon as a community outlier, has lost nearly 75% of its enterprise value in the public markets over the past 12 months. True, it trades at a premium to commodity manufacturers, but it appears its community purchasing may not be as strong as once imagined.

Nevertheless, transactional communities with more vertical specificity (such as Soylent) do outperform bare bones e-commerce. And is it clearly the very early innings in Pinterest and Twitter’s efforts to sell product directly through its platform. But don’t be surprised to see the larger horizontal community players continue to struggle, and ultimately acquire companies in the concierge space in order to boost their conversions, order sizes, and frequency.

THE ECONOMICS

The upside of human driven assistant/concierge services is that in most scenarios, they add value to an end user experience. The downside is that they add material costs to a company’s P&L.

Take for example any of the listed wellness apps (Rise, Talkspace, Big Health, etc) which, if it operated on a purely software basis would boast 80-90% gross margins. But a human focused component affects that in one of two ways:

  1. Either the company employs (W2’s) any number of wellness professionals who are expected to interface with a given quota of customers. Although that model enables the wellness app to maintain their gross margins, it cuts deeply into their contribution margins because of the additional labor expense.
  2. The other option is to view the wellness professionals more like marketplace suppliers, and connect them to customers on a 1:1 basis, while paying them a percentage of every transaction, say 70%. Though this does have the effect of removing the wellness professional costs from the G&A line, it also changes the nature of the business – from a 90% margin software business to towards a marketplace model with a 30% take-rate.

Given those two options, it’s clear why a hybrid AI/Machine Learning model is the holy grail for several verticals – replicating the level of personalized service while minimizing overhead labor costs and maintaining extraordinary software level gross margins.

That said, it is still unclear if hybrid AI assistants can provide an end-user experience powerful enough to materially affect purchasing, conversion, and frequency.

For the time being, within the fully human powered services, the winning business models will be ones that can hire relatively inexpensive, untrained people, who can then be empowered via software or leveraged workflows to deliver a meaningfully improved end-user experience. This has the added benefit of yielding greater supply/expert-side scalability in that the pool of potential concierges is far larger (if performance does not require deep inherent expertise) and the level of consistency, even across expertise levels, will be more stable.

Startups trying to wedge into the market using a high level of service need to be highly cognizant of, and focused on, controlling costs. Especially as the investor market continues transitioning away from high cash burn models, obsessive attention on how to deliver a high quality experience, deepening long-term scalability, and leveraging lower-cost labor will yield many compelling outcomes.

Special thanks to Rebecca Kaden, James Conlon, and Peter Christman for their assistance on this article.

[For disclosure, Chicago Ventures is an investor in LGS, Mac&Mia, Rise Science, Retrofit, and Havenly.]

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