#140 - Imperfect Misfits

Online Grocery Delivery Consolidation

Hi 👋 - It’s always a good idea to have some dry powder. The Covid demand whipsaw coupled with souring investor sentiment is creating new opportunities for firms with financial flexibility. Today, a look at Misfits Market’s acquisition of competitor Imperfect Foods. Thanks for reading. 

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Betting Big on Blemished Bananas 

Misfits Market is betting that blemished bananas will become a big business. The online grocer, which works directly with farmers and producers to source food that would otherwise be destined for the scrap heap, acquired competitor Imperfect Foods in an all-stock deal earlier this month. The combined entity is expected to have half a million subscribers and 3,000 employees¹. Terms weren’t disclosed, but are likely favorable to Misfits Market, which has raised over $500 million of venture capital and was last valued at roughly $2 billion, in a September 2021 Series C led by SoftBank².  

The company was founded in 2018 by Abhi Ramesh. Before becoming an entrepreneur, Ramesh worked on an opportunistic investment team at Apollo. His experience there likely helped with the Imperfect Foods acquisition. Like its produce, the business has a few bumps and bruises. 

While Imperfect Food’s financials aren’t readily available, what is public suggests a business in distress. The company has recently been plagued by high executive turnover. Current CEO Dan Park joined in January 2022. His predecessor, Philip Behn, was pushed out by the board in 2021 following layoffs and poor financial performance³. In addition to Behn, Imperfect Food’s chief financial officer, chief product and growth officer, and chief merchandising officer all exited in 2021. Additionally, operational issues were rife. One in five orders had a customer service issue, like damaged or moldy food⁴.  

Ugly Produce 101

Imperfect Foods and Misfits Markets are both on a mission to build an affordable online grocery store while reducing food waste. Every year, between 30-40% of food produced ends up in landfills⁵. Some never make it off the farm. Grocery stores have specifications for what they’re willing to sell:  the size of an apple, the color of kale, the shape of a squash. They seek consistency. Grocery supply chains and stores are optimized to sell food that fits the spec. Yet many things can keep an apple out of a grocery store: too big, too small, minor blemishes, odd shapes or imperfections.

Source: Redditt, r/oddlysatifying – The way these apples are stacked at my local grocery store. 

While you can’t build a pyramid out of off spec apples, you can buy them cheap. That insight is at the heart of the business model. By sourcing quirky produce directly from farmers, growers, and food producers, Imperfect Foods and Misfits Market are able to pass along substantial savings to customers. Both firms trumpet prices 30-40% below grocery stores. The food has the same taste, but a different aesthetic. It’s a compelling – and feel good – value proposition: save money and the planet. (Imperfect Foods initial market research was done at the Berkeley Farmers Market, which tracks.)

In addition to the digital user experience, both companies have built a physical supply chain for delivering boxes of groceries directly to a customer's front door. There’s a complex physical operation behind the cutesy marketing. 

Over time, they’ve both expanded their assortment beyond produce into meat, seafood, dairy, snacks, and staples. For example, Impefect Foods procures broken chocolate covered pretzel pieces, olive oil bottles with the labels slightly askew, and Clif Bar odds and ends. During Covid, they purchased popcorn from movie theaters and first-class cheese plates from airlines⁶. Misfits Market launched in 2018 with 30 produce items. Today it has over 550 grocery items⁷. Like Trader Joes, you can do most, but not all, of your grocery shopping there. 

Financial and operational metrics are limited, but Misfits Market has delivered over 14 million orders since launch in 2018⁸. In a February 2020 interview, former Imperfect Food’s CEO Philip Behn said that once customers try the service, they love it and stick with it forever. Though hyperbolic, this suggests healthy retention. Behn also noted that the marketplace is constrained in the demand side, but that there’s plenty of supply⁹. In a July 2020 interview, Ramesh mentioned that the company loses money on its base box, but is profitable when the box reaches a certain size¹⁰, so upsell is critical to making the unit economics work. Like most DTC businesses, customer acquisition costs (CAC) and ratio of CAC to lifetime value will ultimately dictate success.

Photo by Louis Hansel on Unsplash

The Benefits of Scale

The acquisition is expected to double Misfit’s annual revenue to about $700 million¹¹. Imperfect Food’s saw triple-digit growth in 2020 and ended the year with a revenue run-rate of $500 million¹². (This is a frustrating metric – it could mean $125 million during the fourth quarter, $42 million during a month, or $10 million during a week.) Together, these two data points suggest that, like many e-commerce companies, the businesses benefited from Covid, but are now experiencing a slowdown. 

Talks between the two companies started after Imperfect Foods tried raising another round and received a frosty reception¹³. Unprofitable tech firms are out of favor with investors. So is e-commerce. Imperfect Foods is at the center of that venn diagram. Covid-realted dislocations create opportunities for companies with strong balance sheets and dry powder. It looks like Misfits Market opportunistically snatched up a competitor.  

There are a number of strategic benefits for Misfits Market. The first is scale, which is important to a business with high fixed costs and low gross margins. Here’s Ramesh ¹⁴:

Scale is what will drive long-term profitability in online grocery and unit economics efficiency,” he said. “Until probably close to a billion dollars in revenue, it is very hard for any online grocery company to be even close to profitable. 

The combined entity is expected to be profitable in 2024. Second, both brands are mission aligned and have complementary customer bases – Misfit Market’s customers skew rural while Imperfect Foods skew urban and suburban. Third, Misfits will start using Imperfect Food’s delivery network, including its fleet of more than 450 delivery vans. This should improve route density, which is critical to making delivery economics work. Back to Ramesh¹⁵:

[Owned delivery] is a very hard mechanism to go out and build and replicate,” Ramesh said. “They’ve built that institutional knowledge over the past few years and as a result of that, they control the last mile experience for the customer. 

Source: Misfits Market.

Whistling Past the Graveyard?

The base rate of success for grocery delivery startups is low. From Buyk to Webvan, the start-up graveyard is full of online grocery delivery startups with broken business models. While the company benefits from low food costs, it needs to maintain a supply chain, a fulfillment network, cover the cost of delivery, and price at a substantial discount to grocery stores (who don’t need to deal with the cost or headache of e-commerce delivery). Success will require scale, extremely efficient operations, and reasonable customer acquisition costs. Not impossible, but no walk in the park. The fact that Amazon, which acquired Whole Foods, hasn’t cracked the code for online grocery delivery is a reason to be skeptical (the counterargument: Amazon’s not wholly focused on the business.)

In a 2019 interview, Ramesh was asked about the challenges of online grocery delivery. His answer was refreshingly honest; not the type of thing you’re going to hear from a large company with a phalanx of lawyers and PR¹⁶:

Grocery is specifically challenging because it’s extremely capital intensive in terms of building out the logistics, operations, and supply chain side of things. Everything has to be refrigerated always. It’s not just about keeping something cold, it's about keeping temperature constant over time, because temperature fluctuations can affect food just as much as hot temperatures by themselves. There’s this huge issue around the capital expenditure required to maintain a cold chain over time. More broadly, the challenge with grocery and food is that it’s by definition a low cost, low margin item to begin with. Then you add on significant upfront capex required to build the operations. Then you need to translate that to value to the end customer…Those three things are hard to do. 

Post-integration, Ramesh hopes to be profitable in 2024 and ultimately IPO. He’s fighting an uphill battle. Unlike the schadenfreude I get from watching instant delivery startups struggle, Misfits Market is a company I’m rooting for. It has a scrappy founder who maxed out his credit cards, packed his Philadelphia apartment to the ceiling with crates of apples and peaches, and hand delivered orders to get the business off the ground. You don’t need to squint too hard to see a workable economic model (unlike instant delivery). Farmers get an additional revenue stream, consumers get a bargain, and food that would otherwise go to waste is used. Let’s hope more curvy carrots and tarnished turnips find a home. 

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More Good Reads and Listens

Kevin Kwok on marketplaces and underutilized fixed assets. Amazon’s sputtering grocery strategy. Business Breakdowns on Hello Fresh. Below the Line on route density. 

Photo by Mordo Bilman on Unsplash

1. Bloomberg, Misfits Market Buying Fellow Odd-Looking-Items Seller Imperfect Foods, September 7, 2022.

2. San-Francisco based Imperfect Foods was last valued at $700 million in January 2021. It was likely acquired for less than this.

3. Grocery Dive, Imperfect Foods taps Amazon, Target vet as new CEO, January 5, 2022.

4. Eat This, Not That, This Popular Grocery Giant Is On a Downward Spiral and Losing Customers, October 13, 2021.

5. The Growth TLDR Podcast, How Misfits Market Raised $100 Million to Reinvent How You Get Groceries, July 2020.

6. Imperfect Foods, Imperfect Foods Series D Commitment Increased To $110MM, February 5, 2021.

7. Inc. Founders Project with Alex von Tobel, How to Meet the Demand Shift with Abhi Ramesh of Misfits Market, February 9, 2022.

8.  Fortune, Online Grocer Misfits Market Announces Plans To Acquire Competitor Imperfect Foods, September 7, 2022.

9. Build Better Tech Podcast, Imperfect Foods CEO Philip Behn, February 2020. 

10. The Growth TLDR Podcast, How Misfits Market Raised $100 Million to Reinvent How You Get Groceries, July 2020.

11. Axios, Misfits Market to acquire rival online grocery service Imperfect Foods, September 7, 2022.

12. Grocery Dive, Imperfect Foods taps Amazon, Target vet as new CEO, January 5, 2022.

13. Techcrunch, Online grocery company Misfits Market to acquire Imperfect Foods, September 7, 2022.

14. Techcrunch, Online grocery company Misfits Market to acquire Imperfect Foods, September 7, 2022.

15. Grocery Dive, Misfits Market to acquire Imperfect Foods, September 7, 2022. 

16. In Good Hands, E4: The online grocery store that just raised $16.5M to save the world’s ugly food - Misfits Market, September 2019.