Interview Transcript

Nick, I just want to take a step back to when you first joined Majestic. What really attracted you to the business?

It was just over five years ago; I joined three weeks before my wedding, so I can remember the date pretty well. I think, really what attracted me at first, was Rowan, the founder of Naked. The way I got involved with the Majestic group was that, in my previous job I was a retail strategy consultant and I had actually just led a strategic review, in 2014, of the Majestic Wines business. One of the things that came out of that review was some recommendations around the management team at Majestic, at the time, and also around the broader strategy. In particular, they had a business, back in 2014, that was seeing negative volume movement in their online business which, at that time was quite an achievement. There were some clear themes they needed to work on.

The chairman, at the time, saw the opportunity for a combination with Naked and saw and an opportunity to address both of those things; to bring in a very different, visionary management team, led by Rowan and also to infuse the business with digital capability.

Wind forward a little bit and, as Rowan was doing his due diligence, I got a chance to meet him. I remember, vividly, having a meeting with him in London and I also met with James Crawford who now runs our UK business. I thought, these are a couple of people who have got a really interesting perspective on an industry that is, in general, quite tired. This is a combination of a couple of brands which are really interesting and, I think, could do a lot more. It was a story I knew I wanted to follow. I dropped Rowan a note after the deal closed, and said congratulations; it was a pleasure meeting you. I don’t suppose there is anything interesting that I might be able to get involved with? He sent me a nice note back saying, I was actually thinking about giving you a call. We had a half hour chat, over coffee and I surprised my wife when I went home and said, I’ve taken a new job.

What did you learn, in those early days?

It was a really interesting time. For me, it was a combination of what we learned as a business and what I learned, personally. On a personal level, it was a great chance to work directly with Rowan, for a number of years and get a sense of, not just how the business worked in terms of numbers and mechanics, but the philosophy behind founding it and the ideals and aspirations that we were always trying to get Naked to. I think that was really helpful. If I took one thing away from it, it was the absolute criticality of making sure we construct this business as a win/win business; an ecosystem where winemakers are winning, in partnership with customers. A logical, inevitable consequence of getting those two things right will be that, internally, we’ll do fine and shareholders will do well.

In terms of the business, I think it was a time where we really started to professionalize and made great strides, in terms of how we interrogated our performance and, in particular, our investment performance. A lot of my role, at the time, was helping us go from having a good theoretical understanding of a return on investment, but still being a little bit abstract. We maybe knew and measured the return on a channel, in a market, but the reality is, within that channel, you are investing with seven or 10 different people and some of them could be great and some of them could be bad. If I learned one thing, it’s that in particular, in investment, averages can hide a multitude of sins. Disaggregating that down to a specific level of detail is critical, if you really want to be credible when you say that you take capital allocation seriously.

Can we just walk through how Naked works, with winemakers? Let’s say, I’m a winemaker and you, at Naked, approach me. What exactly is the process for us to work together?

The nice thing is now, probably what would happen, Will, is that you would come and approach me. We’re in the nice position of being courted, as opposed to having to do so much courting. The first thing we will always do is start with a conversation around you and your passion, your motivation and your desire. What are you looking to achieve and how can we, with the assets and capabilities we’ve got at Naked, help you to deliver that? Is there a fit? Does that match what we are trying to do, as a business?

Here are some of the things that are on our winemaker checklist. First off, you’ve got to be an amazing winemaker that makes great wine. That’s a given. Almost think of that as a hygiene factor. There are lots of great winemakers out there – it’s a great skill and a great calling – and there are lots of people who can make really good bottles of wine. The next thing we spend a lot of time asking people questions about and understanding, is their intrinsic motivation; what makes them tick? There are some people who are fantastic winemakers but their motivation is all around status or making wines that really give them gratification because a sommelier, in a fancy restaurant, on the West Coast, really likes it. Or because some of their friends think it’s really interesting and esoteric. Those type of people don’t tend to fit very well with Naked.

The type of people who work really well with Naked take passion in producing something of really high quality that can be enjoyed by lots of people. They love the idea that they would be able to directly interact with millions of people who have actually consumed their wine and hear what those real people think. They tend to have a real sense of pride in over-delivering. The idea that you can make something that tastes like a $40 bottle of wine and sell it for $20, really appeals.

On the flip side, there are still some people out there who say, if it’s not going to sell for $200, I don’t want to do it. Those people are never going to be a great fit for what we are trying to achieve.

What exactly do you offer me, as a winemaker?

Let’s get to the point where we’ve worked out that, attitudinally, if feels as if you fit. You’ve got a point of view; you’ve got something you are interested in doing. The next thing we will work out is, what do we need to do to support you, to make that wine happen? Let’s take a couple of different examples. It could be that you are a really talented winemaker that is stuck in one of the big corporate wine entities, here in the US, that make about 80% of all wine sold in the USA. But you’ve probably got a good black book of contacts, you’ve got a lot of experience, but what you won’t have is any capital. What we might do, in that instance, is to say, hey, let’s put a range together. We’ll fund your first couple of vintages, which mean we will go and help you put the fruit contracts in place; you probably already know the growers you want to work with, but we can hold the contracts for you. We can help you work out where you want to crush that wine and we can buy you barrels, set you up with those projects and get you ready to go.

Obviously, we’ll also help you with thinking about how you interact on our community, set up your profile and build your brand, within Naked. We’re giving you absolute clarity, in terms of the volume of wine that you are producing and an iron-clad commitment to take all of that wine. You have got a totally de-risked scenario to go and launch your own brand.

On the flip side, it could be that you are a small producer that has already got a facility and is already making wine. It may be that the only thing we need to help you with, to scale your business and make your business more efficient and reduce your costs is to say, we love your wines and we would like to help you make many more of them. Maybe you are selling excess fruit, at the moment, and you’d like to actually turn that fruit into wine yourself. In that instance, maybe all we need to help you is to give you a long-term commitment, with certainty around volume.

There is no one size fits all solution. It’s a question of thinking, we have some assets; we have a stream of cash flow, about $280 million a year, if you now multiply out the 800,000 members we have globally, coming in, to help us fund projects. We have a predictable and scaling business, which means we can give commitments with certainty. Frankly, we’ve got an ethos that we think that is just the right way to do business, which is not shared by everyone, but that’s important too. Then we have this distribution network and capability. That means that you don’t need to worry about marketing, you don’t need to worry about selling. That’s the other big thing for a winemaker. We’re able to eliminate a lot of costs that just don’t go to the taste of the product at all.

Let’s say you are running a 5,000-case winery, in Paso Robles, California; you are probably going to be spending as much money on things that aren’t making wine as you do on making wine. Those kind of things are going be that you probably operate a tasting room, with a tasting room manager and a couple of staff working there. You will have a small direct-to-consumer business, which needs a D2C manager. You’ve probably got someone doing shipments and you will have a couple of people working on your distribution network, trying to sell to 42 different distributors, to cover the whole USA. We can make all of those costs disappear and, you know what, the wine doesn’t taste any different.

What is the split, in your winemakers, between those smaller producers that already have the facilities versus individual winemakers that have to go and work with the growers and then come to you, as an individual?

I would identify three big groups of producers we work with. The first one is incredibly talented winemakers, coming out of a corporate background and we’re helping set them up in their business. They are a big group of winemakers we have. They tend, individually, to be slightly lower-volume projects, so probably a third of winemakers – maybe less than that – in volume. I’m doing this roughly, off the top of my head; I haven’t got any numbers in front of me.

The second group would be those producers who we are helping scale their own business. Some great examples of would be someone like a Sam Plunkett, an amazing winemaker for us, out in Victoria, Australia. Or Scott Kelley, who runs a fantastic operation in the town of Roseburg, in the Umpqua Valley, in Oregon.

Then the third group would be larger wineries that have often got a background and heritage in grape growing that we use as core partners for some of our more affordable wines. If you want to make high quality, affordable wine, what do you need to do? You need to work with people who have got access to the core supply. A great example of that would be a long-term partnership we have with LangeTwins, in Lodi, California. Two of our winemakers work, full-time, on site there – David Akiyoshi and Karen Birmingham – and they are a fantastic family business; they have been farming in Lodi for five generations and we really enjoy working with them.

They would be three different types of relationships we’d have and you could see multiple examples of lots of those. Ultimately, I think we’re really not precious about the structure of the relationship. I think, in this business, you have got to be willing to be flexible and come up with a bespoke arrangement that responds both to what someone needs and, therefore, what you can offer them. What we’re always passionate about is, it’s got to be a great winemaker; they’ve got to have that desire to make great wine for our Angels. It’s always going to be a product that’s absolutely exclusive to Naked Wines customers, so when people become loyal to it, Naked is the only place that they can get it. And it’s got to be a wine that’s delivering so that people buy it and, obviously, the margin structure needs to work; we’re a business, not a charity. As long as those three things are true, then we are happy with lots of different types of arrangements.

How does the economic arrangement differ between those different categories?

Again, the economics of each partnership are somewhat specific. In general, when winemakers come to work for Naked, it’s worth saying that money isn’t normally the biggest driving factor. For a lot of people, there are two primary things. Firstly, getting away from a career that’s accidentally turned into an office job. You started out being a winemaker because you were passionate about wine but, all of a sudden, you’ve been promoted at Treasury or Constellation and you’re responsible for running the budget of three facilities and dealing with HR issues and all the other fun things that I get to do in my job.

So the winemakers have to go and find the growers then, if they leave one of those big brands?

You will normally find the winemakers who have been involved with any of those will have a very good black book of growers. They normally have growers they prefer to work with. We will often negotiate and hold the grape contracts but they will often help us work out who has got the best fruit. We try to divide and conquer. So it’s getting back to making wine and spending time in the cellar and the vineyard. Then the second factor is that it’s about creating a brand that’s personally theirs and that enables them to make products that they are passionate about, as opposed to producing a portfolio that they are told to make. They tend to be the number one and number two reasons people come to Naked.

The great thing is, as the business has scaled, we’ve also got a lot of independent winemakers who are making a really good living and we’re proud of that. As we grow, we’re seeing the average winemaker compensation, year over year, continue to increase and I think it will continue to do so.

In terms of how the working capital works, from your end, do you pay them a portion upfront? What are the installments that you pay, typically, for a 5,000-case winemaker for example?

Again, it will vary a little bit. Let’s say we are funding a project, we will then, typically, be purchasing the fruit so, effectively, the cost of goods we’re paying for upfront. Most of those winemakers will be working on a salary-type model, where we’re paying them per project they are doing for us and we move out their cash flow and put it into a lovely, nice, smooth monthly amount which, again, is very different from how most people in the wine industry are able to do it, in terms of cash flow, and people appreciate that.

If someone is at a point where their business has scaled a little bit more – and maybe that’s because they’ve worked with us for a number of years – we might move to a different model where we are paying and we will have a schedule of payment terms. Our terms will still tend to be much more favorable to working with one of the big guys but, ultimately, over time, we don’t need to use our balance sheet to support everyone because you get to a point where you’ve built your business up. Some of our winemakers are now 50,000, 60,000-case operations. At that scale, they are able to fund, certainly their existing business. It may be that we then do a new project with them and you can look at that differently and say, hey, we need to help you fund your further growth.

In terms of the way you pay them, obviously, you pay the COGS upfront, effectively, pay them a salary and then, potentially, as they scale, that could change the dynamic of the relationship, depending on how much capital they have?

Exactly. Again, it’s all back to, how can we most efficiently use our assets, in order to enable the winemakers to produce great wine, at the lowest cost possible, which means we can share that low-cost of production between the winemaker ourselves and the customer, who gets the outstanding value, at the end of the day. We’re not precious about how that works; we’re always looking at individual circumstances and the most efficient way to do that.

How do you look at analyzing the return on that investment when financing the grape upfront?

We’ve done quite a lot of work on this. The glib answer is, time value of money. In the same way that a traditional, corporate finance team would look at the balance between taking an early settlement discount and paying on the longest possible terms, you can look at the difference between funding a product upfront and paying for it on terms. The slightly less glib answer, which I think is probably the one that you are looking for, is that we look at the performance of the products and we look to see one of two things, if we’re going to fund something upfront.

Number one, that we see an exceptional performance and for us that’s either that we’re driving a higher margin, but normally what we’re looking for is that we’re creating a product that drives higher customer satisfaction. We measure that, primarily, through two things. One thing, you see on our website, which is a buy it again rating. The customers saying, hey, I love this wine and I’d buy it again. The other thing is us taking more of a data science point of view, which is the repurchase rate. While buy it again is the explicit answer from customers, repurchase rate is the derived metric; for all the people who could have bought this wine again, did they? We look at both of those.

The second thing is, there are just some projects that can only come to fruition with funding. It is just core to what we want to do; we want to make those type of projects possible. Let me give you a good example. Wayne Donaldson makes beautiful sparkling wines for us, here in California. Wayne was working at Domaine Chandon, beforehand; he’s got a ton of experience, around the world, making amazing sparkling wine. It takes about three years to bring a bottle-conditioned sparkling wine to market. You need to work with a specialist facility that has got all the tirage equipment. It’s very, very expensive and very capital intensive. The only way Naked could have an independent sparkling wine brand would be through funding that upfront.

So some of those things we just say, hey, we’re in the business of curating a range of wines, from the world’s best winemakers, for our Angels. For some of those, it’s just always going to require us to put our balance sheet to work. That’s just what we do; it’s the business we’ve got.

Obviously, you need to look at how many bottles or cases I’m going to get from this investment and, effectively, what is the price per bottle that I think that I can get, to look at a potential return? Plus the data you have from the website?

Absolutely. The beauty here is, the extent to which the way we work drives down the cost of production for our winemakers. I think that’s the thing that, sometimes, people don’t appreciate fully. When you can help someone produce the same quality product, for less money, that’s great all round. That gives you a real sustainable basis of competitive advantage and that’s why we work so closely with our producers. It’s why we do long-term contracts and commitments. It’s why we’re closely integrated with our supply chain. If you have that basis, as I say, predictability in any kind of production environment – and winemaking is a very romantic production environment – is the secret to driving down cost. Our winemakers are able to enter long-term great contracts, backed with the security of a public listed company.

All of that means that you are sourcing fruit for less money, you’re getting scale in terms of sourcing dry goods, such as barrels and things like that. Then you drive greater volume per SKU; we’re a very big business when you think about the volume we put through on an individual wine level. That means you go from maybe making 2,000 bottles of a wine to 2,000 cases of wine; you’re making 12 times as much. That has a whole bunch of other benefits for your production costs and economics. Your crush costs per ton go down. You are able to utilize bigger tanks. You get the same quality of product, but you get more production efficiency. Then you amortize costs much more effectively.

A talented winemaker has got a going rate and when you are doing that across only a couple of thousand bottles, it can easily end up being $5 a bottle. When you do that across a commercial sized production run, all of a sudden, you are dropping under $1 in terms of winemaker costs. Again, you are stripping a whole bunch of costs out.

Then you take out all of those selling and marketing costs and that’s how we get to a point where we can probably take a wine that is at a 2,000-bottle scale, in Napa, and is costing $15 to make and another $15 to sell; $30 in total, and can make that wine for $10 or $11 and then we don’t have any of those selling costs. I’m sure that at some point we’ll talk about the fact that we go direct to the consumer, and then you get to miss out the distributor and the retailer. That’s the beauty of the model; that’s why the economics stack up. I’m a simple person and, ultimately, that’s why the customers like the business. It’s because we’ve got a way of sustainably creating better quality wine for your money.

How do you plan on continuing to extend the scale economies you achieve? Maybe extending the contract length or keep on improving and reducing that unit cost?

I think you are spot on. We’re always looking to deepen those relationships. With people we’ve got a good track record with and it’s clear the product works, we’re looking at extending contract duration. We’ve already signed a number of five-year contracts which is pushing things out for us. I’m sure, at some point, in key regions, we’ll look at securing sourcing over a 10-year window. That’s good for two reasons. Firstly, it just makes you a preferred buyer so you are able to lock in the best fruit. And it gives you pricing stability which is, obviously, very helpful. The competitors we have out there, who are trying to replicate part of our business – the marketing, direct to consumer angle; so regulate the business as a winery, disintermediate the distributor and retailer – are not working nearly so closely on the supply production side. That means that they are treating the wine a little bit more as a commodity. They’ll buy whatever is available, in a given year, on the spot market.

I want to be very fair. You can buy good wine on the bulk buying market. There doesn’t have to be anything wrong with it. Even a big company, a Kendall-Jackson, will still buy bulk wine; it’s something that most people do. But it exposes you to a lot of cost volatility and you get to a position where people get faced with making a hard decision. Do I compromise my margin structure or do I compromise my quality? I’ll leave it up to people to do some mystery shopping and decide what some people sometimes do.

How does the winemaker’s approach to the economics change, as they do scale? Let’s say you are driving more volume per SKU for them; do they want to take a higher fee? How do you make sure it’s a win/win for them, as you scale?

Imagine the economics of a traditional, smaller winemaker, an independent brand. If you can visualize a nice wave chart, like a radio wave frequency, that’s effectively what the returns look like, for most small wineries. You’ve got some years where things are great; market conditions are good and you can make good profits. For example, if the supply of grapes is plentiful, the price goes down and your profitability goes up. Then there could be years when things happen. For example, it might be 2020 and your production might be disrupted by fire. You might actually not be able to produce that year. Or market conditions can be tough; there could be a glut of wine coming onto the market which undermines your pricing. That’s what it traditionally looks like. It’s a very high risk, very volatile environment.

Now imagine a shallowly growing line. It’s growing at a 15% gradient; that’s what Naked does. It gives you predictability and it gives you a clear path to growth. What is the best way to share in that? Actually, we think, as winemakers grow, on a per bottle basis, they’re probably making a little bit less money. That means, as their brands grow, we’re driving down some of the intrinsic costs and are able to share that value with consumers. But their aggregate rewards are growing and they’ve got this extreme predictability. They’re not having to take risks and leverage, in order to drive growth. Typically, that’s how it works on the winemaker side.

How do you see the contribution margin evolving as you change that mix of winemakers?

I think the long-term margin structure of the business has got a lot of opportunities to increase. The first is that there is a favorable contribution margin dynamic, as we see more and more of our business being in the United States. The structure of the market is such that we are able to over-deliver on quality for value and still generate a higher margin than we are in the UK or Australia. That is one thing, for a group, where we’ll continue to be supportive.

I’ve got to tell you one story that encapsulates this. When I first moved to the USA, I remember going out and doing my first wine tasting, down the Valley. One of the first things we do when someone starts is give them a physical business card; we’re probably the only place left that still does that. You do it so you can go to the different wineries and you ask for industry benefits. Basically, you get treated like royalty and get a discount off everything you buy. I had a lovely tasting and it was at one of the big names; it might have been Frog’s Leap; it might have been Stag’s Leap; it was one of those two. The etiquette, at the end, is that you buy a bottle or two and you get a 30% discount. I bought a couple of bottles of Napa Cab and the thing that blew me away was that they were more expensive, from the winery, yards from where they were produced, with a 30% industry discount, than they were in my local wine shop, in Islington, back in London, where I’d moved from. That just highlights the inefficiency in the US market and the lack of value that the consumer is getting.

For me, that was the a-ha moment. If we get things right here, with this business, there’s an enormous opportunity. Yes, there is plenty of headroom, in terms of contribution margin. The philosophical answer is, we are a business that believes the greatest opportunity for us to drive long-term profitability – the EBITDA margin for the business – is driving retention. If you think about what drives your EBITDA margin, you’ve got your contribution margin and, thinking about a business at maturity, you’ve got fixed costs, which you will leverage and leverage and leverage and they’ll go down. Then you’ve got a cost of replenishing the customers you are losing. The most effective way to drive EBITDA margin is not to make your contribution margin go up a couple of points; it’s to improve your retention. You then get this compounding effect where your cost of replenishment can fall dramatically.

Philosophically, I’m always more interested in ways to make production more efficient and share that value back with consumers and build a higher retention business that is harder to replicate and has a deeper competitive moat, than taking the short-term opportunity to put it into a higher contribution margin.

Given the US perception of wine is clearly different from in the UK and the average price per bottle is much higher, how do you look at Naked aligning your offering with the US perception of wine?

I think this is a really important conversation, so let’s break it into two parts. We should talk about the perceptions and the Napa cult and the high-end part of the American wine industry. But I think it’s important to bust a couple of myths. The first one is, the reason that the price of a bottle of wine in America is higher than it is anywhere else is entirely a function of the three-tier distribution system inflating cost. It’s not that most Americans are substantially more discerning or drinking wines of a higher quality level than they are in other places.

The second thing is, if you think about our addressable market, we believe we address $20 billion of spend, of retail value, in the USA. That is wine sold, at retail, for greater than $10 a bottle, to people who drink wine and buy wine multiple times a month, who are interested in the product – they don’t just see it as a commoditized thing – and are in the 43 states we are able to ship to. That’s a $20 billion market. Of that spend, depending on exactly whose report you believe, $16 billion to $17 billion of that sells at retail, for $30 or less. $3 billion to $4 billion sells for $30 or more, at retail.

If you think about our model, because we’re able to make better wine for less, a $30 bottle at retail is about $16 to $17 on Naked. I think it’s important to start with that anchor and say, the vast opportunity, the biggest opportunity for Naked, is taking more share of that everyday quality wine, for millions of Americans; it’s the biggest opportunity we’ve got.

We get a lot of questions and I’m sure you’ve had a lot of questions when asking what we should talk about, around the $3.5 billion. I’m happy to talk about that, but I think you’ve got to set it in context of the overall opportunity. It is true that, to an extent, the US market is maybe a little less mature in tastes and there is still a little more of a belief that there is a real relationship between price and quality. Part of that is that Napa, as a region, has done an amazing job. It’s done a really good job of branding itself and it’s done a good job of classic price discipline; keeping prices high. Therefore, it’s done a good job of convincing people of this nice, simple logic of great wine, equals Napa Cabernet, equals expensive. It has reinforced that through an incredible experience.

If you will permit me one more story. When I was moving out to the US, I had to go and get a visa to move here. The scary endpoint of that process, for a non-American, is going to the American Embassy. You go past all the security guards and through the barbed wire fence and queue in a pretty bleak looking waiting room, for a long time. Eventually, you are called up to one of the 50 desks and the guy starts grilling you. I’m not going to try and do an American accent or we will have all of our American shareholders sell in disgust. He starts to grill me. Third or fourth question in was, what are you going to do? I let him know that I was going off, at the time, to be marketing director of this wine company, called Naked Wines, out in Napa, California. At which point, he was like, Napa, I’ve always wanted to go there; I’d love to take my wife there; it would be so amazing. He goes on about how much he loves the idea of Napa for about two minutes, by which point he’s processed all of my paperwork and doesn’t ask me another question and I leave.

Napa has just created this aura and, for a lot of people, it colors the expectation of what fine wine is. I think that does present a real choice for us, when we start producing fine wine. On the one hand, you can see from the data, which we publish a lot in our reports and are obsessive about measuring internally, as you get into a higher and higher scoring wine – and one of the ways we measure this, objectively, is to look at the Vivino scores that our wines; ratings of our wines, on a third-party platform, directly comparable to famous brands – the higher the rating, actually, the bigger the gap between the price we can sell them to our members at and the price of similar wines that are available in the market. Why is that? It’s because these high-end wines in Napa are incredibly small production which, by the way, just equals inefficient. There are 700 wineries in Napa, which means you have to spend an awful lot of money marketing and trying to sell them, relative to the small amount of money you spend producing then. Then it’s also the law of scaling numbers. If you start off with a high cost of production and then you scale it through a distributor and a retailer margin, those things just compound.

Actually, our model works extremely well, in terms of producing high-quality wine at great prices. I would describe the challenge as one of accommodation or one of challenge. Do we lean into the perception that, to be a great wine, the bottle has got to be heavy enough to break your arm and the price has to be steep enough to cover a small holiday? Or do we try and challenge that?

I bet it’s tempting. The easy thing to do, I guess, would be to say, okay, the US consumer is used to paying up; even though my price is $16, $17, I can sell it at $40 or $45. But actually, if you can actually train the consumer – which is obviously much more difficult and takes longer – to really believe in Naked and also deliver the quality, you basically win the $17 billion market, effectively?

That’s exactly the question. We’re clear where we sit. We believe it’s a binding commitment, with any priced wine we sell, that we are always going to deliver you measurably better quality for your money. We do believe that there is a reasonable maximum of profit to extract, for the pleasure of giving you something nice to drink. The prize, if you can create that a-ha moment, is that much bigger. That’s a really scaled business, that drives loyalty and advocacy. Whereas the opportunity of just taking some easy margin of money, through selling some expensive wines, is not really changing much.

As you said, the volume matters. Given the scale economies you mentioned in the supply chain and for the winemakers, the volume can make the model that much better. You can always go after the premium section later on?

That’s true. Dollar Shave Club is an interesting business here. The beauty of Dollar Shave Club wasn’t we’re going to sell you cheaper razor blades than you can buy from Gillette, because you can go and buy unbranded razor blades that are cheap in other places. It was having an a-ha moment, convincing customers that we can make the same razor blades, in the same factories, of the same quality and can sell them to you for a lot less money because the cost of producing high-quality razor blades is not very high. That became a business that was really successful.

That’s our challenge, which is to unbundle the customers. What are the real costs of making fine wine, in a region like Napa, and what is a reasonable price to sell it to you for? Part of the reason that the guy who was hired to run the US business, Max Miller, was that in his background, he spent seven years at Craftsy. One of the strengths he’s really got is creating content that brings the stories of makers, artisans and producers to life and helps educate customers, in an entertaining way, about those categories. That is something that we need to do better at Naked. We need to do better at educating customers about what really matters and makes a wine high quality; what does that really cost? How does our model make that more efficient and, therefore, why the myth is a myth? Why you don’t always get what you pay for and why you really can drink a great bottle of Napa Cab for $35.

In the meantime, quick plug; anyone who is in the USA and wants to put us to the test, check out either Matt Parish or Ken Deis, who have got a reserve Napa Cabernet. I can’t tell you the vineyard it’s from, although think about the name of a Hanoverian king. It’s one of the most famous vineyards in the Napa Valley. We don’t put the name on the bottle because, if we did, we’d be obliged to charge $100 for it. It’s $35 a bottle. If you want to answer the question, can Naked make fine wine, go and drink some of that.

Looking at the customer journey in the US, I’m just thinking about the introductory case for the US customers. You talked about retention and it being so important; how do you think about optimizing that first experience that the Naked customer has?

I think it’s probably worth starting with the fact that we done, over the course of our business, an awful lot of testing and optimization on those first cases. I’ll give you a couple of examples of things that have been powerful. One is that we’ve done a lot of work looking, through data science modelling, around the characteristics that drive highest retention in that case. It tells you things like, diversity of winemaker is very important; diversity of wine style is important. There should be both big, bold ripe fruit flavors, but then there should be some slightly more austere wines. In terms of your whites, you want something really crisp – classic Sauvignon Blanc – but you also want something rich, oaky, like Chardonnay.

Is this for all customers? Is it the same factors in the UK, Australia and the US or does it differ?

Similar analysis but the local execution of those styles might be different. For example, in Australia, you’d still have the conclusion that stylistic diversity was really important in the first case; constant. In terms of a local execution, a rich oaky Chardonnay would not be one of the styles you would choose to put in, in Australia. We’ve done a lot of analysis there which has helped us improve the conversion to second purchase.

A second example in the US, specifically, was testing the way we enclosed the wines. We came to the US with a point of view that we quite liked screw caps; they are efficient and a really good closure. If you ask most people in the wine industry, they will tell you they are the best closure out there. But consumers like the ceremony and the experience of being able to use a corkscrew. Fair enough; it’s all part of the experience of drinking a bottle of wine. We AB tested a case of wine, with the same wines enclosed with a screw cap or a cork and we discovered that, actually, that got us something like a five-percentage point improvement in conversion to a second purchase.

I guess, the first thing is, we spend a lot of time testing and refining those case contents and have got to a point where the combination of the journey and that wine works very efficiently. I think, maybe, the question you are getting at is, is there more opportunity to customize that first experience? I think the short answer is, yes, there absolutely is. We’ve got a case that I think is very well-engineered to showcase our business and meet the needs of an awful lot of customers. I guess that’s why we’ve got nearly a million members, around the world. But there are always outliers or people who have differing tastes; we get a lot of questions from outliers who might be back to the luxury Napa Cab end of the spectrum.

To give another example, there are a lot of people whose preference is for a sweeter style of wine, who also might not find the case meeting their needs, because it’s a representation of six styles of dry wine. Yes, there is an opportunity there and one of the things we’ve been testing is ways to easily learn a little bit more about people’s preferences and then curate that first case. I think we can make some good progress on that, in the course of the next 12 months.

I’m just thinking about really getting the merchandise right for different geographies. Is there any challenge there? How do you make sure that you have the right wines, in the right place, for the right customer?

It sounds so simple, doesn’t it? It’s a big challenge. If I was describing Naked and often, when I describe Naked, internally, to candidates, especially people who are joining in the supply chain, planning or finance functions, one of the biggest challenges at Naked – I think it’s a fun challenge, but it’s a hard one – is balancing a production business and a retailing business. Keeping those two things together is difficult. You’ve got a product that’s got anything from maybe a nine month to a 36-month lead time. That’s just from harvest to consumption. Then you actually need to conceive of and commit to a product in advance of that. Then you need to balance that out against a business that is compounding in scale and size and where the growth rate has a degree of uncertainty. Also, people’s tastes and preferences can evolve, during the course of three years, so your mix can change. So it’s not easy.

I think the reality is that it is one of the areas that we have probably improved most at, over the five years I’ve known us as a business. Back in 2016, we almost ran out of wine in our US operation because there was a disconnect between our forecasting and our generation of new customers. We had a classic sales function that loved the idea of over-delivering and didn’t want to promise that they were going to sell anything.

What actually happened? What was the issue there?

Back in 2016, the issue was that we massively overshot our forecasts, in terms of customer acquisition, but didn’t have a good communication process. We ended up with the quality range, for existing members, becoming compromised. That drives excess cancellation and it was a very inefficient way of doing business. In five years, we’ve come an awful long way, but, this year has probably been the hardest year in a while for that. When we made our commitments to vintage 20, we obviously didn’t anticipate what was going to happen in 2020, like everyone else.

There is an extent to which it will take us a little time to get to the absolutely optimized merchandising offer, for new members, for example. If we do have a choice, or a compromise has to be made somewhere, we always want to make sure we maintain a quality and breadth of assortment and range for our existing members. At the end of the day, they are funding the wines so their loyalty and retention is paramount to our long-term success.

You can’t just put all of the great wines in the introductory cases? Firstly, because it would blow out your margin but also, the existing customers wouldn’t have any merchandise.

Obviously, what we try and do is only make great wines. What you describe, if one were being unkind, is the classic wine club business model, that we were very determined not to replicate at Naked. The classic model is, you have some great wines, you invest more in their production, you make sure they really over-deliver, you put them in introductory cases to new members. You then put them onto a recurring shipment plan and you send them high-margin product that is somewhat commoditized and you don’t talk to them and hope they don’t cancel. Essentially, that is the wine club model that was originally conceived.

We always wanted Naked to be different from that and it’s one of the reasons that we chose a payment subscription model as opposed to a product subscription model. One of the things I love about our model is, firstly, the flexibility and empowerment it gives to customers. In March, last year, we were able to write to people and say, hey, times are hard and uncertain; would you like to take the money out of your account because, maybe, you’ve got other things you want to do with it? You couldn’t do that if you’d already charged them for a product. The other thing it does is that it means, every day, we know we need to earn our customer’s business; every order, we need to sell our customers great wine, that over-delivers, in order to earn their continued support and their continued participation. I think that’s exactly how it should be, in any business.

How have you seen the 2020 cohort – the Covid cohort – behave in recent months, as the world starts opening back up?

One of the things that we found interesting is, looking at the three geographies we operate the business in, to give us a real set of comparisons – fortunate is the wrong word; it’s hard to know what the right terms are to use when you are discussing something this severe – but there is, clearly, a very different health outcome situation between Australia, the UK and the US. At different points, the UK and the US have both struggled but have had different cyclicality or different waves of the epidemic. For us, that’s quite helpful. It’s a helpful natural experiment in our data that we can look to.

What we’ve seen everywhere is that customers recruited during this year have had substantially elevated early purchasing; the desire and need to stock up and being stuck at home and some other options having been taken away. What’s been really interesting is that we’ve also seen improved retention characteristics, in both the Covid cohorts – so members recruited in 2020 – and in all of our other cohorts. That retention trend has been very similar in Australia, where things have been much less severe, as it has been in the UK and the US. In Australia, it’s shown continuation through the course of Christmas and beyond. My colleagues, who I follow on Instagram and get updates from, I see them at the beach, having dinner parties and you feel quite profoundly jealous, when you’re stuck at home with two children under the age of three. But what that says to us is, in all markets, there has been a long enough period of time where really deeply engrained habits have formed; I think psychologists say, 90 days to form a habit. I don’t know what this year is going to form; you wonder how it’s changed your children. But certainly, I think it’s had profound changes on people’s shopping behavior.

For us, that stickiness, which I think we attribute to people seeing more intrinsic value in the service, convenience and delivered proposition we offer, feels like something that, increasingly, is enduring and a structural change.

That’s customers using the product more and getting the experience that you deliver, that is driving retention?

It is and like a lot of models, frequency begets quality of the experience. We are a business that prides ourselves on deploying and using data to continually improve the customer experience. Some of the things we’ve seen this year are, not just more customers, but more of those customers engaging with more elements of the Naked proposition. We had 900,000 posts, backwards and forwards, between winemakers and customers in the first half of the year. It was a mind-blowing number and it was up about four times on the year before. Driving more of that richness and quality of interaction, that’s how people go beyond seeing Naked as something transactional, to a relationship they’ve got with a favorite winemaker, and discovering the business or story of someone that they feel personally invested in.

When customers, in the UK, crowdfunded something like $95,000 during the course of a Zoom tasting for Jen Buck, down in the south of France, those people have got much more of an emotional investment than getting something for £5 off 10, in Asda. Ultimately, that’s one of the things that makes this business special. It’s an insight we have always had, which is that far more people are interested in and want to hear about the stories behind wines. It is why we made the winemaker the center of Naked Wines. It’s much easier to understand someone’s passion, the reason why they’ve chosen to make a product, why they’ve chosen to make that wine, in that place, in that style, than it is to have a very technical story about the wine’s tannic structure and ability to age.

I think a lot of the wine industry still hasn’t quite got that and, sometimes, we get people who can take offense at us telling the story differently. Ultimately, as an industry, if we want to engage customers and really help them discover amazing new wines, it’s the best way to do it.

I know you classify people as mature Angels after the second or third case purchase. Do you see frequency change much, per year, for those older cohorts that stick around?

If you dig back a while, in our reporting, we’ve got a couple of different metrics that we disclose. We focused on our sales retention metric, to describe the behavior of our mature customer base. Think about a like-for-like sales metric in retail; of all the customers I had, last year, how much did they spend last year, how much did the same customer spend this year? 100% retention would be the same; 80% retention would be, for £100 of revenue last year, I’ve got £80 of revenue from the same people this year.

We switched that from a customer retention metric, probably about four years ago. The reason for that was that we thought, actually, the sales retention gave you a better proxy for forecasting the business. It’s how a SaaS company thinks about forecasting out its revenue base. There is a difference between those two metrics and, I think, when we ran the numbers last, it tends to be around 10 percentage points as in, we retain sales at a higher rate than we retain customers. That is for two reasons. One, because as customers age, they do tend to purchase a little bit more and, actually, have a slightly higher price per bottle, driving overall annual revenue per member slightly higher. The second reason is that it tends to be that there is a selection bias. The customers who drop out tend to be customers who were spending less anyway and the ones you retain are spending more. That’s broadly the trend we see.

It’s the reason that our UK business has got a sales retention rate that is ahead of our overall group. It’s four and a half years older and, if you think about the weighted average age of customer, it’s older. As we see the overall business starting to trend towards maturity, that average age per customer will go up and that will support higher retention in the business. I think that’s a way off. At the moment, in the acceleration in customer acquisition that we are driving, year over year, we’re actually making the average customer younger because we’re driving so much acquisition. That’s something that will play out over the long term.

How do you look at the long-run retention?

I think that any person who runs a subscription business and doesn’t have a point of view on their long-term target of retention probably shouldn’t be running the business. We absolutely know that it’s the single biggest way in which we can impact the ultimate profitability and scale of Naked Wines. In terms of where do I think that can get to, I’m not going to guide anyone to a number out here, but we do have a number of hypotheses about ways in which we can drive that retention rate higher. We talked a lot about how we can do it through our wine, our product, so I won’t go back there. But I will say, fundamentally, I’m an old-fashioned retail guy at heart and I think product is king so the wine is incredibly important.

In addition to that, we can continue to make improvements in the quality of our digital experience and the way in which we present that product to customers. There are a couple of things that I am really excited about. One is the opportunity to get much better at adapting the Naked Wines experience to the preferences of different groups of customers. Time and time again, research has shown – and our research shows this very clearly – that there is a split between customers who love shopping for wine and want to be deeply involved and like making their own choices, and customers who love drinking wine but don’t enjoy the process of shopping for it and are looking more for someone to do the hard work of recommendation and helping them identify new favorite products for them.

I think, today, we’re doing a better job for the former group of customers than we are for the latter, but we’ve got all the right attributes. In terms of the data, we’ve got 29 million ratings of our wine, since we started. We have good recommendations, but we haven’t found quite the right experiences to surface those recommendations to customers. One of the things we got in beta testing at the moment is a product we call Wine Genie, which does just that; I’m very excited about that. I think there are also other ways in which we can continue to invest more in just the basics, the fundamentals, of the user experience, with things like our app and our site. It is probably one of the legacies of the business being a little underinvested in, or capital constrained, during the era when we were combined with Majestic, that we’ve not been able to put as much money into that tech development, from 2015 through to 2019, as maybe, ideally, we would have done.

We see ourselves, very much, as in catch-up mode and I think there is some low-hanging fruit there that can make it easier for customers to get to the really special parts of the Naked business, which are the stories of our winemakers, these amazing wines that over-deliver on quality for value, and this fantastic community where they can engage and discover the real people behind real products, as opposed to the commoditized brands that you are seeing on grocery shelves.

I’m just trying to get into your head, day-to-day, Nick. That stand-still EBIT number that you report, as you said, is mainly driven by the sales retention and that repeat contribution margin and then you find the replenishment spend which is based on the one-year payback or, effectively, the CAC. What do you really focus on, specifically, to make sure that you don’t overspend or it becomes a Blue Apron scenario where you get ahead of yourself?

That’s an excellent question. It is probably one of the areas where I’m most proud of the competency we’ve built in the business. It’s worth talking a bit about how we come to a lifetime value estimate for our customers and the process we go through. I don’t want to claim that we have the best lifetime value calculations of anyone out there, because I’m sure there is someone who can beat us. But in terms of a mid-cap company, I think we’re in a really good place in the way that we do it.

Wind back to when I started in the business, five years ago. We were still in that classic world of cohorts and spreadsheets. After a year, we knew whether or not our investments had been good and we had a decent idea where cohorts of customers were going to go. But you know what, a lot happens in a year. There are two things that are really important about lifetime value modelling. Firstly, you need to be accurate in terms of the values you generate. Secondly, you need to do it in a timely and actionable way because the biggest use of lifetime value modelling in our business, is giving real-time feedback to operational teams who are making decisions. The most important group within that, are our growth marketing teams. At an extreme, our digital marketing group are making decisions on allowable bids on Facebook, every day. But every week, our partnerships team are deciding whether or not to renew or sign new partnerships. Should we do another direct mail campaign? You need a decent degree of accuracy, but you also need that early on and what we were doing didn’t work.

We moved to a machine-learning driven valuation of each customer. I’ve got to really credit a guy called Jason Scott who runs our global analytics function, who pioneered this and built it out for us. Probably in about 2017, we went through a long process of interrogating this. We built this framework in a beta test environment and we built the models; I think there are about 150 attributes that go into building 200 different, unique models. Effectively, you are valuing each customer, every day and you are creating, for them, a trajectory of likely orders, likely survival to the next period and then you’re projecting forward a contribution margin. Those three things, when they build up, effectively get you to a lifetime value calculation, over either a one-year, five-year period or whatever horizon you want. We spent a lot of time verifying how accurate these models were and cuffing them in different ways. If I look at the whole American customer base that I recruited, what’s my margin of error, for the one-year horizon, because that was a horizon we could test the models to? Then we cut it into, let’s look at it on an individual partner level because that’s the decision we’re actually trying to make. How accurate are we on those levels?

We actually put some of the extracts from some of those charts into one of our results presentations and what we discovered was, by using a combination of transactional metrics, demographic metrics and engagement metrics, we could get to a plus or minus 10% forecast of customer quality very, very quickly, which is incredibly powerful. If you’ve got a new channel or a new marketing area, it helps you work out if they are average quality customers, extremely high-quality customers or low-quality customers. Everyone thinks the biggest value is in spotting mistakes and identifying when they are a low value customer, and that’s useful. But actually, the biggest application for us has been helping us identify high quality demographics and high-quality customer bases, because that is where you have got real competitive advantage. You’ve got the confidence and certainty to be able to back that investment hard and early, commit more money there and scale investment in those channels and, in aggregate, bring higher quality customers into the business.

We started that in 2017 and I think we fully rolled that out, globally, in about 2018. It is something that is never finished; you’re always working through it and validating and improving it. It really is one of the bits of proprietary technology that has been at the heart of Naked Wines’ success and I’m very proud of it.

The only other thing I’d say to that is, the last nine months have been tricky. Again, if I quote Jason, anyone who tells you that they’ve got a great model that understands we’re having a pandemic is either delusional or a liar. You’ve also got to recognize that there are some limitations. In a time like this is, we do a couple of things. We look at the simple triangulations you can do which let you look at the movement in the valuation that your model is telling you, in customers, and you take it back to fundamentals. You say, okay, I’ve seen this much appreciation in suggested value; I can see a 10% step up in contribution margin and I’m confident that’s enduring, so that supports a portion of it. We’ve seen this change in underlying retention; if it actually compounded out and stuck, all of it, maybe that drives 30% to 40% increase in valuation. Then we’ve got some increased frequency and you say, if I look at the fundamentals, they support a slightly higher increase in values, but then you’re taking a judgement call on how much of them stick.

The final thing you do – or at least, we do, as a team – is say, in a period where there is more uncertainty, you give yourself more cushion. You try and invest a little bit higher above your hurdle rate. Maybe this year we got that not quite right, because our returns at the half year, our lifetime payback metric, we’re about 7.6 versus a long-term target of four. Mentally, we were thinking that five would be a good buffer, so maybe we still weren’t quite aggressive enough. But that’s, philosophically, how we think about that.

How are you thinking about it now? As you said, you’ve got to make a judgement call on the retention, the stickiness of those Covid cohorts, because you have to go and acquire more customers but also, you have the working capital of inventory and serving those new customers, potentially?

Absolutely; they are big decisions. At the end of the day, we have a lot of confidence in the different ways we’re triangulating that number. I guess it also comes back to your belief in your ability to explain positive movements in your business. For us, one of the things we haven’t talked about is the extent to which this period, this pandemic, has fundamentally changed something in terms of consumer openness, to just a category. I think that’s the biggest single change, in terms of the rate at which I think we can grow this business to scale. It was always going to happen, eventually, that Americans in particular were going to start buying wine online, but it had been this strange category. Penetration of wine online, in the USA, was a long way behind other categories in the USA and it was a long way behind wine online penetration in other markets. Why is this? Back in 2019, the guys at Rabobank did a study and I think they found something like 30% to 40% of Americans didn’t even realize that it was legal to buy wine online. I think a lot of this comes back to the patchwork of complicated state-level laws that were put in place at the repeal of Prohibition.

What’s happened this year is that you’ve had this massive acceleration in online purchasing because, from education streaming to video conferencing to everything else, people were stuck at home and had to find different ways to solve aspects of their life. Wine was the same thing. People wanted a simple pleasure, to enjoy with their family; they had to find a new way to buy. What they did was ask friends and family and we actually saw a 16-fold increase in customer referral, in May last year versus February, in the US. There is just this moment of awakening. You might not have bought wine online this year but, if you’re a wine lover, chances are either a member of your family or a close friend has. That consideration set is much improved.

When you’re a business like us, a really big advertiser, that believes in acquiring customers and then driving value over the long term, anything that fundamentally changes the portion of the market that are open to your product or service, you’re just going to drive marketing effectiveness. For us, that’s a structural shift we don’t see going back. Even if the actual percentage of wine bought online oscillates around, the openness, the percentage of people who will consider online purchasing, I think has taken a massive step up and that’s not going away.

How do you use the outbound calling sales channel, to be effective at onboarding?

These days, we tend to use our outbound team, primarily, on existing members and we find that there are a cohort of members who just love the human touch and like to hear from someone who is an expert, who gets to taste the range, with our winemakers, in normal times; sadly, not in the last eight months. That’s the primary way that we use that. We do also do some targeted campaigns to reach out to people who we see maybe not engaging with the early emails and we just want to make sure they understand their membership.

I think it’s one of the areas that I’m interested in, longer term. I think there could be an interesting opportunity to integrate that with some of the data-led propositions we have. You can imagine a combination of Wine Genie plus your Wine Concierge or Wine Expert; that could be a powerful combination. That’s an area we are always looking to develop but, primarily, for us at the moment, a way of better serving some of our existing members.

I just have to ask you about vouchering and why vouchering is so effective?

I’m disappointed I haven’t got my wallet or anything with me; I was going to hold up a voucher as a little prop. From even the first day I entered Naked, people were always asking us, when are you guys going to stop doing vouchers? Taking a step back, I really enjoy that the voucher marketing or insert marketing channel is seen as a bit old-fashioned – it’s certainly not a sexy marketing channel – because that means that there is, ultimately, less competition in it. At Naked, we’ve always prided ourselves on doing a few things a little bit differently.

The fundamental driver of that channel, if you think about it, the size of the channel, is driven by the number of e-commerce delivered packages in the market which supported by a secular growth trend, has actually seen the fastest growth ever, this year. The channel is actually in robust health. If you compare that to the trend, in terms of eyeballs available on Facebook, actually, the underpinning growth in inventory, on vouchers, is much more favorable. The secret sauce, for Naked, is that we hold most of our relationships directly. By that I mean, we will have an annual contract with Shutterfly, to insert 12 million vouchers in Shutterfly packages.

Why do we do that? Number one, you get access to better quality of inventory. You’re doing deals with businesses that have good customer bases, that have affinity to yours and you’re getting your insert featured, maybe on its own, or with one or two other inserts. As opposed to people who just dabble in the channel and use a broker; typically, you get that envelope of 10 bits of paper, that often goes straight in the bin. That’s powerful.

I think the second thing is, because we have this proprietary understanding of lifetime value and we’re very confident in our ability, early, to do a small test and understand the quality of a demographic, of a cohort, and measure response, we’re willing to commit in a much bolder way than other people will. We’ll say, great, it looks as if this really works. Let’s do a deal for a year; here’s a cheque for half a billion dollars, or whatever it might me.

Does that fit the consumer perception in the US, if they get vouchers? It seemed like a discount channel, in the UK, to some extent. Do you think that could be damaging to the perception of the brand, in the US?

You always need to strike a balance. Vouchers have got a great role to play; they’re a really good, proven driver of trial and a great way to take someone the last step of a conversion journey. The opportunity we have in front of us is to have a much richer marketing ecosystem and find more ways to communicate Naked’s points of difference; more ways to tell our winemaker’s stories and get them out there. The more we do that, the more powerful vouchers become because they are that perfect final prod or call to action. I’ve been meaning to try that; let’s give it a go; this seems like a great place to start.

You’re right; there is always a little bit of a tension, but I think the power and the way in which they perform and help drive people to that final action we want, of trying the really good stuff, the wine, means they are always going to have a role to play and, I think, a channel that has great long-term fundamentals.

Is there any difference in, just roughly, the cost of acquiring a customer or that discount you have to give the customer in the US versus the UK, to actually buy the first case with Naked?

The reality is, we run in lots of different markets, at different times, different offers. The thing that is constant, in all of them, is that we will be testing the right level of incentive and the thing we are always balancing is, a deeper incentive will leverage your media cost investment more effectively; you will convert more traffic. Make the incentive too deep and you will bring in too many time-wasters, so your aggregate quality goes down and you’re burning stock, money and time on people who have got no interest in being a long-term subscriber.

We’ve just got a bunch of smart people, running calculations and optimizing different channels and different audiences in different markets. It’s much more about the right combination of channel and audience than it is about a country.

How are you approaching building a logistics network in the US?

One of the things that team that we have put in place have done a great job of is building a category-leading network. Our operations director, in the US, is a guy called Brian Peabody who joined us about three years ago. He took what was a solid foundation and has really helped drive the maturity of that network. We work in partnership with a company called Wineshipping and, as we’re a capex-light business, Wineshipping are the warehousing experts; they put down the capex on new sites and they operate sites exclusively for us. The thing that has been great about having Brian on board – his background is in Tom’s of Maine and Colgate – is that he’s done all the jobs as well as running large networks. He knows how to operate warehouses efficiently as well as build a scaled network. I saw his first three-year plan presentation the other day and, pleasingly, the first three years in, we’ve done all of the first three-year plan and a bit more, so he’s done a great job.

Where we are today is a network that can serve 95% of our customers with a product, within two days of order and it does so with increasing cost efficiency, as you can see from our most recent disclosure. That’s very satisfying. I think it is still an area where we see opportunity to invest in improving the customer experience. In particular, in the US, where wine is an adult signature category, we are driving to give people more choice and more certainty around the point at which their package arrives, ultimately hoping to get down to some time windows. That’s a way away, but I think that’s the right long-term aim. That can still be one of the points of pain or failure for our experience and, actually, it’s one of the things that drives long tenure members to cancel and it kills me. The final mile, to an extent, is outside your control, but you’ve always got to be innovating and finding ways to make that easier, more convenient and more flexible for members.

And you use outsourced last-mile carriers that actually deliver the product from the warehouse?

Exactly, yes. The big difference for us, compared to a lot of people is that 95% of our orders ship, with shipping included. That’s very different from the market norm, in the US. I still remember having utter disbelief the first time I tried to order a case of wine from San Francisco and someone wanted to charge me $60 to ship my wine 50 miles, up to Napa. Having built a network, at scale, that is efficient and have the economics to be able to offer that included, is a really big point of differentiation, especially if you go back to the question about what we offer to a smaller winery. If you are small winery, today, making your 2,000 cases of wine, you’re trying to ship it to all your members, nationally, probably from your one location in California, it’s probably costing you $75 to $80 to get a case of wine to the East Coast. Again, it’s just another way in which our model helps strip out unnecessary cost and support better value to the consumer.

There’s no capex that Naked has to put down, to open a new warehouse?

No; it actually ends up being a lot like the winemaker equation. The biggest thing that you can offer in a partnership like this is that you are a secure client and you can offer commitment and tenure of relationship. In return, in this instance, the nice thing is that we keep the business capex-light.

You mentioned the disclosure; I think you reported that fulfilment costs, per order, declined around 20%, to $31. Is that of a case that’s $120? What’s the fulfilment cost, roughly, of the case that you are referring to?

That’s a really artful way of you trying to get me to disclose our average order value, in the US, which I’m not going to do.

What I’m trying to get at more is, actually, how low do you think the fulfilment cost per order can really get to at scale?

What we’ve seen this year is a step change and I think it will be a while before we see another step change, so now we will go back into a path of gradual improvement. There are things that can carry on improving; we have a negotiated margin structure with our warehousing operator. As we put more volume through, the margin per bottle decreases, so you will continue seeing benefit there. I think, probably, the next time you might get to a step change will be that, at some point, we will get to sufficient scale for it to make sense for us to work with our partners, to look at investment in automation. Ultimately, the USA, the UK and Australia are three high labor cost geographies and there is quite a lot of labor involved in the pick-pack operation. At some point, that will probably be the next opportunity.

Probably, it will come up first in the UK because that’s our biggest single warehouse operation. By the nature of the UK, you have got a consolidated market where you can serve all our customers from a single point. Whereas in the US, because you make a big saving by getting closer to the customer and reducing your final mile charge, you actually have smaller individual warehouses.

How does the working capital investment from Naked evolve, as the sales grow?

The guidance we give on this – and it’s never absolutely linear, year to year – is roughly, if you increase investment in new customer acquisition by a million, you should expect to see a million investment, through the balance sheet, in working capital. That has been our long-term relationship and so that’s what we guide to. What that tells you is, effectively, existing customers fund all their own stock, so the reason that you might need to fund more stock or see that working capital balance grow, is because you need to provide for the stock for new customers. The change is not the investment, but the change in investment that drives needing more working capital.

Long term, I’m sure there is opportunity for optimization for our working capital. Right now, as we see the transformation in the consumer environment and we see the opportunities for growth are vast, and a chance to accelerate growth, I think the right thing for us to do, strategically, is to be a little bit longer on stock. We may well build inventory well ahead of that, in the six to 12 months to come because you don’t want to find yourself in a position where inventory is a constraint to growth. Wine is a little bit like those signs you get in hairdressers or barber shops which say, you can have something good, you can have it cheap or you can have it quick.

For us, the wine has got to be good so that’s one of our two. At the end of the day, we like be involved in production so we can make it efficient, which is code for cheap, but that means you can’t have it quick. We do need to commit to that quality and authenticity of inventory, to be able to support our growth.

As you are evolving from a UK brick and mortar retailer, previously, now to Naked, a real online D2C, mainly in the US, how aggressive can you get in acquiring customers and really investing through the income statement, for the long run, as Naked becomes more and more a proven model?

What we’re determined to do is grow this business to scale. There is so much about the business that improves, as it scales; not just for us, but for all the other participants we support, with the value we give to customers, the opportunities we can give to winemakers and, I think, the positive change we can impact on the wider wine industry where there are so many people who are crying out for an alternative, for a very consolidated production environment and some different routes to market and distribution. Especially with this year and Covid having accentuated that. The routes to market, for smaller producers, tended to be direct to the consumer, at their tasting room or via quality local restaurants and both of those sectors that have been hammered.

I think the wine industry has never needed a business like Naked more and we need to be much bigger to have the level of impact that is needed so we’re committed to growing. I think we can substantially scale the amount we invest in new customer acquisition. Because we have the positive secular trend of migration of spend online and this awakening of understanding and openness to the category; because we continue to have a lot of headroom to grow awareness of Naked, as a brand, and our points of difference and what we do; and because we’ve got the capability and the technology and the understanding and ability to measure lifetime value, to de-risk that investment, I think that sets us up incredibly well. Frankly, also because there is still a lot of stuff that we should be doing that we are not doing. One of the first things I committed to was us having an R&D fund, to explore new marketing channels because there are still a lot of channels that I see as being proven or companies that I think of as peers, are deploying a lot of capital into that we haven’t, in the past. So I think there are a lot more places you can deploy capital.

Also, when the consumer environment changes, supporting marketing response, and when you scale the business, driving higher lifetime value, that opens up a lot more investment potential in channels you already know and understand. You can revisit partnerships that didn’t work in the past; or on a channel like Facebook, a small improvement in your response rate and your lifetime value, supports an improvement of 15% to 20% in your allowable bid which, actually, can unlock double the volume. Some of these channels can really compound.

I think there is a lot of headroom. I’m not going to make a promise as to where we can get to or at what speed we can get there. I definitely look at businesses that we believe generate comparable or lower lifetime values, that have got to well north of $100 million in investment in customer acquisition in the USA. I certainly think we would be an unambitious team if we didn’t believe Naked should be able to get there, at some point.

Last question; it’s 2030 and Naked is not there. They are not spending $100 million in the US; they’re not the largest player. What do you think the reason could be?

First of all, I very much hope we are still there and I’d still like to be involved. I think the only way I really see this business failing would be if, in driving for growth, you lose sight of the reason the business exists and the point of difference. If Naked went wrong, it would be that you would take a different philosophy and you would forget about building a win/win partnership; if you forget about growth that benefits your suppliers and winemakers and your customers and you focus too much on short-term perspective. If you make it all about trying to drive the investment numbers or all about saying, we’ve got to have a 30% top line growth rate or any of that, if you did that, you could lose the point of the business.

A great piece of advice that one of my colleagues gave me once was, for every one person who turns up at work, interested in how big the revenue line might be or what the share price might be, there are nine people who turn up at work because they want to make an impact on the lives of talented winemakers and give them a platform. We had an email from the guy I mentioned, Sam Plunkett, in Victoria, Australia, the other day and it had everyone in the office in tears. It said, I don’t know if you guys know exactly the amount of impact that you have on the ground and that Naked is making. We were drawing together a budget for this year, with the pandemic starting and trying to work out if we could get by without laying people off, with revenue down 50%. As it is, with the orders coming in from Naked, we’re on track for a record year and that means we’ve been able to employ a bunch more people in the community. Sam set this winery up in a pretty run down town, in rural Victoria and he takes an awful lot of pride in being able to employ people in the local area. He said, we’re just so grateful and it means so much to us to be a part of this. That’s the reason people come to work. I think, if we lost track of that, that would be the reason that the business failed.

Could you move into spirits or craft beer, in the same model?

I think there are a lot of things around, beyond the next three years, regarding where else you could think of for value generation, for Naked? I prefer the economics of spirits to beer. There are a couple of reasons. It’s a non-perishable product; all of the things that are wrong with the wine industry are also wrong with the spirits industry. Extraordinary consolidation of production, marketing budgets vastly greater than the cost of the product itself, no platform for small independents to meaningfully grow volume. I think that could be a really interesting opportunity.

We’ve had a lot of success, in the UK, selling some gin, some vermouth and we’ve just done our first whisky. James, with seven years or so at Diageo, knows the spirits industry inside out. I think that could be a credible, long-term opportunity. The regulatory landscape for direct-to-consumer spirits is a bit more challenging in the US, so probably not.

Ultimately, we’ve got something like one and a bit percent of a £24 billion - £25 billion addressable wine market and I think we’ve got a winning and differentiated proposition, so there’s quite a lot for us to get our teeth into, in the wine.

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.