#19 - Friendly Ghosts Don’t Scare Away Competitors
Why Casper has over 175 competitors
Yesterday mattress-in-a-box company Casper IPOed. One of the great things about an IPO process is that companies are forced to open the kimono. This gives financial journalists and folks on Twitter a lot to analyze. For a time, you’ll see an uptick in the press about that company. On occasion, these articles contain gems like this from CNBC: “there are an estimated 175 mattress-in-a-box companies.”
One. Hundred. And. Seventy. Five.
How can that be?
Competitive Strategy by Michael Porter provides a good framework for answering this question. Barriers to entry are one of Porter’s five forces that ultimately determine a industries return profile.
With 175 competitors, barriers to entry in the mattress-in-a-box industry must be pretty low, but let’s take a closer look.
Product Differentiation
According to Porter:
“product differentiation means that established firms have brand identification and customer loyalties, which stem from past advertising, customer service, product differences, or simply being the first to industry.”
Casper certainly ticks the box when it comes to advertising. The company has spent heavily on acquisition and brand marketing. However, Porter’s advice is to tread carefully here because:
“investments in building a brand name are particularly risky since they have no salvage value if entry fails.”
Turning to product, Casper holds a number of design patents around combining latex and foam. The word “innovative” shows up 30 times in Casper’s S1. So does this:
“Casper Labs innovates throughout the Sleep Economy. Based in San Francisco, Casper Labs has over 25,000 square feet of fabrication and test space, featuring state-of-the-art capabilities to test against a wide range of factors affecting sleep quality. Casper Labs controls every aspect of our product offerings, including design and construction, material performance requirements, manufacturing protocols, supplier selection, packaging specifications, and quality assurance. We believe that no other company in the category has our level of product development talent, resources, or expertise.”
Here’s the rub. Casper lumps product development expenses together with general and administrative expenses. With all the talk of innovation, that seems a little odd. Most companies with large product development or technology organizations break them out separately. Digging deeper, it turns out that from the start of 2017 through the end of September 2019, Casper spent $27.7M on product development, or roughly $0.03 for every $1 in net revenue. Words say one thing, but the numbers suggest otherwise. A New York Post story on the IPO sums it up nicely:
“Even if Casper keeps its designs proprietary, it’s doubtful whether it can build the kind of loyalty that’s enjoyed in other niches like clothing and electronics, says Craig Fruchtman of New York-based mattress retailer Craig’s Beds. “They built their own brand, but people aren’t brand loyal in mattresses,” Fruchtman said. “I don’t get customers coming in saying ‘I’m a Sealy guy, my grandmother was a Sealy guy.’ ”
Verdict? Pure yoga babble.
Economies of Scale
Porter defines these as:
“declines in the unit cost of a product as the absolute volume per period increases.”
During the first nine months of 2018, Casper’s cost of goods sold plus refunds, returns, and discounts amounted to 77% of their net revenue. The equivalent figure for 2019 is 76%. Over that period net revenue grew 20% year-over-year. While their cost of goods sold appears to be improving with scale, their refunds and returns are trending in the opposite direction, canceling out any benefit. If there are benefits to scale, they’re well hidden.
Verdict? No advantage.
Switching Costs
Porter defines these as:
“one-time costs facing the buyer when switching from one suppliers’ product to another’s.”
The very nature of the mattress-in-a-box business reduces switching costs substantially. Mattress-in-a-box companies: (1) sell online, saving you time versus going to a store, (2) deliver a mattress to your front doorstep, with some offering in-home delivery and setup for a fee, and (3) offer free trials of 100 days or more. If you had the inclination, you could spend the next 50 years sampling mattresses and never pay a dime.
Verdict? Move along folks, nothing to see here.
Access to Distribution Channels
Do you have access to unique distribution? Does it matter? Casper’s S1 notes 18 retail partnerships, including Amazon, Costco, and Target. These accounted for 14% of revenue through the first nine months of 2019. However, the real story here is that we’re moving from an analog world of limited shelf-space to a digital world of infinite shelf-space. Searching Amazon — one of Casper’s partners — for “mattress in a box” yields seven results pages and nearly 400 products. Some friend they are.
For online sales, discovery is replacing distribution as a key success factor and online is the dominant sales channel for Casper and other DTC companies. No wonder Casper spends $0.36 on sales and marketing for every $1 of revenue that it generates.
Verdict? Retail partnerships provide some defensibility.
Capital Requirements
This isn’t a business like semiconductor manufacturing where building a fab costs billions of dollars. The minimum requirements to set up a mattress-in-a-box business are a website, a mattress design, and money for marketing. According to the New York Post article, manufacturing is typically outsourced to firms like Carpenter, Future Foam, Innocor Foam Technologies, or Leggett & Platt. Verdict? Nada.
Government Policy
This category includes licensing requirements or limited access to raw materials.
Verdict? Nothing here. But please do keep an eye on Twitter. Sigh.
If you’re interested in digging into the numbers referenced above, here’s some select financial data. If you’re really interested, here’s the S1.
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