Warby Parker - The Not so Fast and Furious

Warby Parker is a carefully crafted brand and a pioneer in the DTC market. However, it is yet to prove its ability to grow profitably in a slow-growth & highly competitive market.

Hey,

Today’s post provides an in-depth look into Warby Parker’s world. Warby Parker is a US-based eyewear company that recently filed Form S-1 with the SEC for a direct listing on NYSE. Warby Parker is the OG of Direct To Consumer companies and has advocated sustainable business, contrary to the growth at all costs approach taken by many startups. 

Here’s a deep dive into its business and the tailwinds and headwinds it faces. But first, my hypothesis about Warby Parker. 

The Hypothesis

Warby Parker has a small market share (1-2.5%) in a large, stable market (US$ 35 billion in 2021). A high NPS of 83 provides it with the right brand equity to exploit the headroom for growth in this market. But the eyewear market in the US is expected to grow at 5.95% CAGR between 2021 and 2025, which means Warby Parker will need to capture market share from existing players to grow. Two key levers for Warby Parker to capture market share rapidly and profitably include accelerating the retail store expansion and improving customer retention. Warby Parker has deliberately preferred a slow retail store rollout strategy, which could hurt its ability to reach profitability. I believe the IPO as a financing event will catalyze the retail store expansion and investment in technology to enhance customer retention.

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A thoughtfully crafted brand

Warby Parker was launched in 2010 by four students of Wharton's School of Business: Neil Blumenthal, Andrew Hunt, David Gilboa, and Jeffrey Raider. Over the years, Warby Parker has grown to a valuation of US$ 3 billion, annual revenue of US$ 490 million (TTM 2021), and 145 retail stores in the US and Canada. Founders Neil Blumenthal and David Gilboa currently serve as co-CEOs.

I like the brand ‘Warby Parker’. It comes across as a thoughtful brand created by deliberate actions and not just another another eyewear company. Its mission statement is not just fancy corporate-speak but something that Warby Parker has put to action: “To inspire and impact the world with vision, purpose, and style.”

Several actions taken by Warby Parker reflect the spirit of its mission statement, such as:

  • Warby Parker runs one of the largest Buy a Pair, Give a Pair programs in the world under which it distributes a pair of eyeglasses to someone in need for every pair of eyeglasses sold. Over the years, Warby Parker has distributed over eight million pairs of eyeglasses across the world. 

  • Warby Parker recently changed its status to a public benefit corporation, which means that it has to balance the interest of their stockholders with the interest of stakeholders and communities impacted by its business.

  • Its top executives do not draw obnoxious salaries, own corporate jets, or undertake suspicious related party transactions (like WeWork buying the trademark for We from Adam Neumann for US$ 5.9 million), which is a breath of fresh air.

  • Its stores are carefully designed, with murals by local artists, and look refreshingly different from other eyewear stores.

Strategy, invention, and quest for power

I usually refer to the scholarship of Hamilton Helmer to analyze the paths a company can take towards profitability. In his seminal book, ‘7 Powers’, Hamilton Helmer defines strategy as “the route to continuing Power in significant markets” and Power as “a set of conditions that create the potential for persistent differential returns”. He defines seven such powers that allow a firm to achieve higher profitability than its competitors.

Equally importantly, he says that “all powers start with an invention”. An invention means a remarkable change in product, business model, brand, or process. By definition, an invention cannot be something that other firms are already doing. 

Going by this definition, Warby Parker pulled off a valid business model invention in 2010. Its business model had three aspects that were contrarian to the eyewear market in 2010:

  • Vertical integration: Warby Parker did not license any existing brand and decided to create a brand from scratch by owning the value chain right from the design of the eyewear to delivery through its website, inventing the category of DTC or Direct To Consumer companies.

  • Pricing: The average cost of a pair of eyeglasses ranged between US$ 300-400 in 2010 when Warby Parker started offering its glasses at US$ 95. This disruptive price provided Warby Parker the initial momentum to acquire customers.

  • Home try-on program: It provided customers the experience of trying different frames in the comfort of their homes before purchasing through its home try-on program. It sends five frames (selected by the customer on the website) to the customer and lets her purchase the one she likes (or return all five).

Warby Parker’s business model invention fits well with the power of ‘counter-positioning’ that Helmer defines as “A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business.” However, for counter-positioning power to be true, the new player should be in a position to charge higher prices or sell the same product as existing players at a lower cost, leading to sustained profit. 

Warby Parker is yet to achieve profitability, even after 11 years of operations and its Average Order Value has increased to US$ 184 (almost twice US$ 95). Thus, its business model invention did not lead to the power of counter-positioning because it’s missing a vital piece: Warby Parker’s cost structure is not much better than the existing players in the market. The price of US$ 95 was a signal to the market from a young, disruptive brand rather than the result of cost-effective business operations. Let’s unpack this further.

Warby Parker often mentions Vertical Integration as one of the crucial ways it can offer reduced prices. But, its value chain doesn’t seem to be very different from an established player like EssilorLuxottica (EL) in a way that leads to a better cost structure.

The only place Warby Parker can achieve a significant cost differential is the distribution stage where EssilorLuxottica uses wholesale and franchisee retail stores, which add price mark-up. But beyond that, there’s nothing significant in Warby Parker’s vertical integration that allows it to sell eyewear at a reduced price. 

(As a side note, one apparent difference in the value chain is that Warby Parker doesn’t operate any manufacturing plants or distribution centers. This allows Warby Parker to keep almost all production-related costs variable rather than getting stuck with the high fixed cost of establishing these facilities).


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The market opportunity

The eyewear market in North America is estimated to be worth US$ 35 billion in 2020, with $7 billion from contact lenses, $24 billion from eyeglasses, and $4 billion from sunglasses. The eyewear market has a relatively low rate of digital penetration (13% in 2020) compared to other categories like apparel & footwear (36% digital penetration). 

In the US, ~200 million adults use some form of vision correction out of which 42 million use disposable contact lenses. As per industry estimates, glass wearers replace their glasses every two to two and a half years. Thus, every year ~70 million adults are in the market looking for vision correction eyeglasses.  

This is significant as 85% of Warby Parker’s revenue in 2020 came from vision correction eyeglasses. Assuming that this also applies to the number of orders, Warby Parker fulfilled ~1.8 million orders for vision correction eyeglasses in 2020. So Warby Parker catered to ~2.5% of the market in 2020, reflecting a substantial headroom for growth.

Another way to look at the market is to split it into eyeglasses, sunglasses, and contact lenses. As the table below shows, Warby Parker has less than 2% market share by value in all these segments, signaling a significant growth headroom. 

Before getting bullish on the market opportunity, it is essential to look at how Warby Parker has fared in the market thus far to put the market opportunity in perspective.

Warby Parker entered the market with a business model invention that could have led to power (sustained profit), but it didn’t. One of the ways to look at any business model invention is that businesses that make it easier and/or cheaper to buy a product typically expand the market by improving affordability/accessibility. However, this is not the case with the eyewear market that grew at a moderate CAGR of 2.5% from 2008-2019.

Eyeglasses and contact lenses comprise 90% of the North American eyewear market. These are typical healthcare expenses, and anyone who needs a prescription eyeglass or contact lenses finds a way to buy it at whatever is the least price they can afford. This constrains demand as the purchase is triggered by a health event and not because the product is available at a lesser price. And there’s no way in which suddenly many people will have vision issues, leading to a rapid rise in the market size.

As the market is demand-constrained, Warby Parker’s business model invention cannot expand the market. Thus to grow, it has to capture market share from existing players. Thus, while the market opportunity is significant, without a route to Power (profitable revenue), long-term growth will be tough for Warby Parker. Warby Parker needs to identify a route to Power, sooner than later.

The numbers game

Warby Parker’s S-1 provides a very shallow look at its financials. The lack of data is very annoying, but I have tried to piece together different components from its S-1 to build a comprehensive view of the business (with some assumptions). 

Warby Parker pioneered the online DTC movement when it started selling eyewear on its website. However, now more than 60% of sales come from retail stores (all company-owned). In 2020 this mix changed briefly due to Covid as the retail stores were closed, but Warby Parker believes its retail stores will drive its growth in the future1.

Warby Parker’s sales grew at a reasonable rate in 2019 (35.74%). However, sales were flat in 2020 due to Covid. Sales seem to be returning to the pre-Covid level with a more than 50% increase in H1,  2021, compared to H1, 2020. Compared to H1, 2019 (to remove the Covid impact), the sales in H1, 2021 grew 48%, signaling a definite rebound in customer demand. Assuming that ~50% revenue growth rate will continue for the whole year, Warby Parker can finish 2021 with revenue of ~US$ 550 million.

In the last three years, Warby Parker has lost money at the operating and net profit levels. Warby Parker showcases in its S-1 that it is profitable at the customer level, with contribution per customer staying at more than 20% for the last three years. It also shares that COGS as a percentage of Average Revenue Per Customer is constant over the previous three years.

Its Average Order Value, Average Revenue per User, and Active Customers increased over the last three years.

Warby Parker has raised US$535.5 million from 31 investors. In August 2020, it raised US$ 245 million, which valued it at US$ 3 billion, making its private market value 7.5X of its 2020 revenue (US$ 393 million) and ~5.5X of its estimated 2021 revenue (US$ 550 million). The table below provides the market value to revenue multiple of comparable companies from the eyewear and DTC sectors.

Warby Parker should get a better market value to revenue multiple than EssilorLuxottica, factoring in expected growth. I will be worried if its multiple is at 5X to 6X level, reflecting that investors are worried about its future growth ability.

Unit economics

One of the issues in Warby Parker’s unit economics depiction is that it doesn’t provide a break-up of costs between new customers and returning customers. All costs are blended over all active customers in an year.

In a market with slow growth and long repurchase cycles (2-2.5 years), retaining a customer becomes critical for profitable growth. It is a challenging proposition as the switching cost are low, and the healthcare part of the product is undifferentiated (all retailers and eCommerce stores offer similar lenses).

Thus, it would have been interesting to see how the contribution margin of Warby Parker changes for a returning customer compared to a new customer. Since Warby Parker doesn’t provide it, I have created a unit economics model based on other information from the S-1 and some educated guesses.

Here’s the unit economics break-up as reported by Warby Parker.

Note: COGS includes product costs, fulfillment, optometrists salary, store rent, store depreciation; CAC includes media spend, home try-on program; Selling and service cost includes store salaries, customer experience salaries, credit card processing, store operating expenses.

Let’s add some nuance to it using the data available elsewhere in S-1. Warby Parker mentions the total CAC and media spend for 2019 and 2020 in its S-1. It also provides a break-up of new and returning customers, which is added to the table below. I will drop 2018 from the analysis as the break-up of CAC is not available.

To tease out the contribution per new customer, I assume that COGS and Selling and Service cost remain the same for new and returning customers, but CAC changes. In CAC, the home try-on cost remains the same per customer, but the media spend is loaded only on the new customers, assuming that with a high NPS of 83, there’s no need for advertisements to drive repeat purchases.

This assumption allows us to segregate the unit economics for new customers and returning customers. Let’s look at a new customer first.

The contribution margin of a new customer is significantly lesser than the blended contribution margin seen earlier. In fact, with the increased CAC in 2020, the contribution margin comes to zero.

Continuing with the assumption that the new customers absorb all media spend, the media spend component of CAC for a returning customer is assumed to be zero. This gives us the table below.

In 2019, the contribution margin of a returning customer was 6X of the contribution margin of a new customer, and in 2020, the margin is many multiples higher. One key implication is for Warby Parker to increase the returning customers in its customer mix to the extent possible. However, as noted earlier, Warby Parker needs to capture market share from other players to grow in a slow-growth market. Thus, it will always have a high mix of new customers and needs to find a way to make the new customer economics profitable.

Coming to store economics, Warby Parker’s S-1 doesn’t reveal anything useful. It does tell us is that its average sales per square foot in 2020 is US$ 2900 for stores open for 12 months or more, which puts it at the same level as Tiffany and much ahead of many other retailers2.


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Putting technology to use

Warby Parker’s S-1 interestingly doesn’t provide much information on its technology and data science-based programs. But given that it owns the entire data pipeline from website/app browsing to order placement to order fulfillment, Warby Parker has access to rich first-party data. It has focused on building a robust data-driven culture from its early years as it hired its first head of data science in 2013, just three years into its existence.

Warby Parker may not have the same density of data as Netflix or StitchFix or the same scale of data as Amazon, but owning the data across the purchase journey still allows it to utilize its data in meaningful ways. Here are three ways Warby Parker uses the data (as inferred from its S-1 and media reports), and I am sure there are more.

Store locations

Warby Parker analyzes multiple first-party and third-party data sets to inform its retail store rollout strategy. Its S-1 provides a glimpse into this.

Warby Parker’s e-commerce performance has been the underpinning of our early retail strategy—opening retail stores in locations with rich consumer demand and strong demographic alignment to our target consumer profile. Since those early retail store openings in 2013, Warby Parker has enriched our site-selection approach, blending e-commerce data with our data-driven institutional knowledge about what has produced our highest-performing retail stores; we also keep a pulse on market data and complementary retailers. The keystone to our strategy is ensuring each retail store location—whether on proven, retail-oriented streets or in high-performing shopping centers—communicates the brand in a consistent and engaging manner to all customers, past, current, and potential.

Improving design

In 2019, Warby Parker introduced a series of frames with extended sizes (extra narrow, narrow, medium, wide, and extra-wide), based on collaboration between its product strategy, R&D, and data science teams. These frames cater to different face types and make Warby Parker’s offering more inclusive. While this specific intervention may not provide a significant revenue uptick, it shows Warby Parker’s data and technology capability and how it can expand its core offering. 

Tweaking product mix

In an interview with Data Science Weekly, Carl Andersen, Former Director of Data Science at Warby Parker, provided an interesting example of how Warby Parker utilizes data from purchases to optimize the home try-on basket.

Warby Parker sells a monocle and it has an extremely high conversion rate. Most people who order this in their Home Try-On boxes end up purchasing it. Conversion is so high that we had to tweak our basket analysis algorithm specifically to account for it.

Warby Parker also offers virtual try-on through its app and store try-ons, which together with home try-ons provide a rich data set of customer preferences for frames, feeding into its evolving product mix.

New ways for customer acquisition

Warby Parker launched a telehealth app in May 2017 that allows customers to do a basic vision exam using an iPhone, upload their results instantly for a review by an optometrist, followed by online ordering. Given that 70% of eyeglasses purchases happen at the same time as the eye exam, this app has the potential to significantly reduce friction in Warby Parker’s customer journey. The app hasn’t been rolled out to all states due to state-level regulations and is yet to be cleared by FDA (Warby Parker is working with FDA on it).

The road to profitability

Now the all-important question - What is Warby Parker’s strategy to pursue profitable growth? To answer this question, I again refer to Hamilton Helmer’s work in the 7 Powers.

In his book, Hamilton Helmer talks about Power progression. He believes that not all types of Powers can be achieved at all stages of a company. The Power progression curve looks like this.

Warby Parker is past the origination phase and well into the takeoff or scale-up phase. There are three typical pathways for a company to achieve Power in the scale-up phase. Helmer defines these as:

  • Network Economies: Every new customer adds value to existing customers or suppliers

  • Scale Economies: The incremental cost of production per customer decreases as the number of customers increases

  • Switching Costs: Lack of willingness or ability to change supplier due to prohibitively high friction in switching 

Warby Parker doesn’t operate in an industry that supports Network Effects. Thus let’s look at its path to profitability through the lens of Scale Economies and Switching Costs.

Scale economies and leverage

In his 2002 letter to the shareholders, Jeff Bezos mentioned something that I believe is very relevant for Warby Parker right now (emphasis mine).

Traditional stores face a time-tested tradeoff between offering high-touch customer experience on the one hand and the lowest possible prices on the other. How can Amazon.com be trying to do both? The answer is that we transform much of customer experiences—such as unmatched selection, extensive product information, personalized recommendations, and other new software features—into largely a fixed expense. With customer experience costs largely fixed (more like a publishing model than a retailing model), our costs as a percentage of sales can shrink rapidly as we grow our business. Moreover, customer experience costs that remain variable—such as the variable portion of fulfillment costs—improve in our model as we reduce defects. Eliminating defects improves costs and leads to better customer experience. We believe our ability to lower prices and simultaneously drive customer experience is a big deal, and this past year offers evidence that the strategy is working.

This text highlights three principles behind Amazon’s meteoric rise as a retailer (a) Converting variable costs to fixed cost (b) Scaling up sales rapidly to cover fixed costs and build leverage to improve gross margin (c) Using its scale to further expand margin through economies of scale. I believe these three principles are also fundamental to Warby Parker’s growth post IPO. 

When Warby Parker was primarily driven by eCommerce, its costs were more variable in nature. By opening stores and driving a large part of its revenue from retail stores, Warby Parker is shifting a portion of its COGS to fixed costs. However, this alone cannot provide it leverage. There are several other customer-experience and COGS linked variable costs that could convert to fixed costs.

For instance, it would be interesting to see how Warby Parker’s telehealth vision app progresses. This is the classic case of converting variable costs of an eye exam at each retail store to fixed IT costs of building the app. However, the app is at a very nascent stage right now, with regulatory hurdles in the way of a full-scale rollout. Similar telehealth initiatives can help in shifting the customer experience costs to fixed costs.

Sales growth needs to pick-up

Warby Parker’s sales are not scaling up fast enough to support this transition to a high leverage model. If you look at its quarterly performance, shared in the S-1, its COGS to revenue ratio hovers around 40% in good quarters, but when the sales dipped precipitously in Q2, 2020 due to Covid, its COGS to Revenue ratio jumped to 46%, indicating that its revenue is not yet large enough to cover the fixed costs during such periods of slow business growth.

Thus, Warby Parker needs to accelerate the store expansion to right-size its sales to become more profitable. It mentions in its S-1 that it aims to open 30-35 stores in 2021 and the same number in 2022, which may not provide it with the correct scale to benefit from scale economies or leverage.

Warby Parker doesn’t provide details of its store-level sales, but dividing the annual sales by the number of stores at the end of the year shows that each store on an average generates US$ 2 million annually. This number, in reality, will be much more as stores are opened throughout the year, and full impact cannot be captured with available data. Thus, opening 90-100 stores in a year provides it with additional revenue of US$ 200 million annually. Warby Parker notes in the S-1 that its stores have a payback period of 20 months, indicating that if it opens  ~100 stores between 2021 and 2022, by 2024, it will have at least US$ 200 million additional sales. This will be high margin sales as the scale will cover the pre-production fixed cost of its stores, providing it the leverage to achieve higher profits.

They have the cash on the balance sheet to undertake the expansion. The money raised from IPO can accelerate the opening of new stores as the property rentals remain depressed. Thus, I will be surprised if the store rollout doesn’t get a shot in the arm post IPO.

Enhance customer retention by building switching costs

A customer who once enters the eyewear market (eyeglasses or lenses) doesn’t exit it for many decades unless they take a surgical route. Thus the LTV of a customer for the eyewear company is quite high.

Warby Parker doesn’t disclose the LTV of its customers, but we can estimate it. Warby Parker’s 2020 ARPU is US$ 218. Assuming a risk-free return of 2% (30-year treasury rate), annual inflation of 2.3%, and a purchase frequency of 2.5 years, we can estimate that a customer with 30-years of eyewear use has a lifetime value of ~US$ 3000 (revenue). Even if the contribution margin remains at 25%, it means US$ 750 in lifetime customer contribution. 

The real challenge for Warby Parker is to build switching costs in a traditionally low switching cost market to continue to get a significant chunk of its customers to return. Let’s look at three types of switching costs.

Warby Parker has a strong lever on the financial switching cost. On average, an exam, lenses, and frame in the US cost US$ 541 in non-Warby Parker stores, compared to ~US$ 200 at Warby Parker3.

However, Warby Parker loses out to the more well-entrenched retailers like EssilorLuxottica and National Vision on the experience aspect, simply because of the friction in getting a prescription from an optometrist, uploading it on Warby Parker, and waiting 7-10 days for the eyewear to be delivered.

The only way for Warby Parker to counter this is to offer a remarkably better experience to its customers at the place they want. Warby Parker seems to be already aware of this and hence is focusing on ‘Holistic Vision Offering,’ which means selling the full suite of eye exams, contacts, and glasses to customers instead of just eyeglasses.

This assertion is supported by data from S-1.Warby Parker notes in its S-1 that customers who purchase the holistic vision offering are more valuable and more sticky than customers who only buy eyeglasses. Thus, Warby Parker can combine the Financial and Experience aspects to build high switching costs, boosting the rate of customers retention. 

It is essential to mention that customers who purchase holistic vision offerings currently form less than 1% of Warby Parker’s total customer base. Given that the holistic vision offering begins with an eye exam, the imperative for Warby Parker is to explore more opportunities for customers to get eye exams. This means offering eye exam facilities in all its stores (currently, 54 stores out of 145 do not provide them). It also means that they need to increase the number of stores rapidly to have more opportunities for eye exams. This dovetails with my earlier point on expanding the retail store base at a much faster pace.

To conclude, I will go back to the title of the post - Not so Fast and Furious. Warby Parker has grown its retail stores at a moderate pace over the years. It notes in its S-1 that “We have thoughtfully expanded our retail store footprint over the past five years.” Both the routes to Power for Warby Parker at this stage require it to expand its retail store base at a much higher rate.

I believe the pace of the store rollout is impacting the opportunity for Warby Parker to unlock value and holding back its valuation. The infusion of funds from the IPO may be the catalyst required to accelerate the next phase of growth for Warby Parker. I like the brand and its ethos, and it will be a shame if they end up going the Caspers's way post IPO.


I hope you enjoyed reading Warby Parker’s deep dive profile. The next deep-dive profile is of Toast, a restaurant fintech company, dropping on 2nd October. If you liked reading this and haven’t yet joined the free mailing list, you can join it by clicking the button below.

Till next time

Rohit

2

Source: Wall Street Journal