Weekly Update: Naked Wines Trading Update & New Customer Growth

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1. Investor Dialogue: Naked Wines

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4. Electrocomponents: Industrial Procurement & Supplier Development

Naked Wines Trading Update & New Customer Growth

Last month, Naked Wines (WINE) reported a trading update for the fiscal year 2022, the 12 months ending in March 2022. We’ve covered Naked Wines from various angles over the last 18 months:

1. IP Interview with Rowan Gormley, Naked Wine’s founder

2. IP Interview with WINE’s Current CEO

3. IP Interview with WINE’s Former International CEO

4. IP Interview with Vivino’s Chief Growth Officer

5. IP Analysis of US Alcohol Distribution

6. IP Interview with Former CEO of a large US Wine & Spirits Distributor

We also recently hosted an IP investor dialogue to explore the update and discuss WINE’s opportunities and challenges post-covid.

There were two positive data points from the update:

1. Sales retention was 80% vs mid-70% guidance

2. Repeat sales increased 13% year-on-year at constant FX

In FY21, the 12 months during COVID to March 2021, WINE’s revenue grew 68%. In FY22, with 50% more subscribers and during the large, global reversal in e-commerce sales volumes, an 80% sales retention is impressive.

WINE’s philosophy is to add significant value to its subscribers and winemakers before sharing in the economics. The company aims for a 5-year LTV / CAC of only ~2x, typically much lower than other ecommerce models. However, the retention of contribution profit suggests the service adds significant value to a core group of angels.

The table below shows the contribution profit retention by cohort: on average, 78% of contribution profit is retained after 2 years and 47.5% after 5 years. Beyond 5 years, the cohorts stabilize and retention is near-100%. For example, the 2013 cohort enjoyed 95% and 97% profit retention in 2020 and 2021 respectively. The other cohorts follow a similar trajectory.

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As with most subscription businesses at scale, the rolling contribution profit retention by cohort is slowly deteriorating. This is expected as the early-adopters of the service are typically the best customers. WINE's 5-year retention has declined from 57.5% in the FY13 cohort to 46.7% for the FY16 cohort.

As we learned from studying Blue Apron, the big risk for DTC subscription businesses is to extrapolate LTV / CAC metrics from early adopters to later customers. Blue Apron used its LTV / CAC figure from early customers as a basis to significantly increase growth capex, expecting to earn the same unit economics.

This thinking proved to be flawed as the early customers are typically the most profitable for DTC companies. Blue Apron burned through its marketing expenditure acquiring unprofitable customers and its equity today is 98% below its IPO price.

It seems like WINE and other DTC companies learned from this mistake and now use LTV / CAC as an input, not an output. This was an interesting comment during our dialogue:

One of the misconceptions, to me, is that a lot of people think the LTV to CAC is an output; they invest and they get to two point whatever X. I actually think that figure is actually an input, where they have some rough idea about the LTV for a projected cohort is and they spend up to a CAC that allows them to get that 2X. The higher that CAC is, the harder it is for them to actually put spend into growth. - In Practise Investor Dialogue

Wayfair also seem to follow a similar strategy:

Let me just recap how we think about advertising because I think the way we’ve managed it historically has proven to be a great benefit, which is simply we don’t preset a budget. But rather, we effectively tell our marketing organization they have an infinite budget. However, we’re very inflexible and have a tight framework on measuring paybacks. They have to keep within that payback framework..this is what we don’t find ourselves having overspent on cohorts that will never pay back - Niraj Shah, Wayfair CEO, 2017

Naked is plugging a 5-year 2x LTV / CAC target into its marketing engine and acquiring customers. Although this may well be disciplined, one of the most alarming data points from the trading update is the new customer growth. In FY 22, the number of subscribers grew 9% year-on-year to 964k, but in H2 22, WINE only acquired 17,000 new customers.

There are many potential reasons for the slow growth.

The first is product availability. Vertically integrated ecommerce models like WINE are far more difficult to run than expected; it’s manufacturing + distribution + retailing all in one.

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Just as Carvana sources, reconditions, and merchandises vehicles, WINE sources fruit, finances winemakers, and distributes product directly to customers. Arguably, these companies are just as much manufacturers as retailers.

The word ‘retail’ comes from the Middle French verb retailler meaning ‘a piece cut off, shred, scrap’, or put simply, purchased in bulk and sold individually. Companies like Carvana and WINE need to do far more than purchase and re-sell products individually.

For Naked, sourcing grapes, financing winemakers, and accessing winemaking facilities at the same rate as customer acquisition growth is a real challenge. Ensuring enough product is available during periods of rapid growth is difficult. Carvana’s Q1 performance suggests it needs to perfect lean manufacturing processes just as much as the merchandising of autos.

In H1 21, during COVID when LTV / CAC peaked, Naked slowed down customer acquisition because it didn’t have enough product.

If you remember, in peak Covid, they basically stopped taking on new customers, despite the fact that the LTV to CAC was probably the best it ever could have been. CAC was so depressed and the LTV of those cohorts was great because they didn’t have inventory to fulfil and they wanted to fulfil for existing. Inventory has been a real limitation on this business, in the past. - In Practise Investor Dialogue

Although the lack of product availability in H1 21 stumped growth, WINE solved this problem in FY22 as inventory increased from £66m to £143m. This higher product availability likely drove higher order frequency and repeat sales which offsets lower new customer growth.

Higher availability drives repeat sales but doesn’t necessarily solve the problem of acquiring new customers.

WINE acquired 61,000 customers in H1 22 and 17,000 in H2 22. The second potential reason for the slower growth in H2 could be the iOS changes that distorted Facebook’s ROAS. Also, WINE’s major marketing channel is vouchering: inserting discount vouchers inside e-commerce boxes. Not only has competition for inserts inside popular ecommerce retail boxes increased, but the overall volume of boxes shipped online has decreased as the world reopens.

While all these factors have contributed to Naked’s slower new customer growth, there could also be another reason: the market for a wine subscription just isn’t that big.

This could be true, although WINE is a young company. If it was a US business, it would probably be at Series B or C financing. Also, WINE has over 500,000 subscribers in the UK, a population of 70m. In the US, a population of nearly 5x the UK, WINE still has under 400,000 subscribers.

We believe communicating the value proposition is the biggest challenge for WINE scaling in the US. In the UK, a price-driven market dominated by the Big 4 grocers, WINE entered with a ‘cheaper but higher quality’ positioning. This resonated with customers. The US customer is very different; the three-tier distribution structure means alcohol prices are structurally higher and customers associate low prices with low quality.

I think one of the bigger problems, in the US, is that wine here is like a Veblen good and there is a huge association between price and quality. It’s very hard to come in with what you would call cheap quality. - In Practise Investor Dialogue

Building a narrative around WINE’s higher quality products at reasonable pricing is the challenge. The company certainly seems to have the stories and content to give it a shot:

They have so many great stories of winemakers. They have Carmen Stevens, the first African-American female winemaker from South Africa; they have a winemaker who used to be an astronaut. They have all these incredible stories and they used to do a podcast, in Australia, where they would interview winemakers and they don’t do that. There is all this great content they have that they haven’t yet unlocked. To me, the biggest challenge is, can they do that? - In Practise Investor Dialogue

Time will tell whether WINE can find a scalable US marketing channel. However, it seems management is unlikely to go a similar way as Blue Apron given its discipline acquiring customers.

The company reports sales retention and a year 1 payback number that enables us to calculate the ‘replenishment marketing spend’ to acquire the churned profit. Taking the 80% sales retention reported for FY22 and assuming a payback of 78% (which equates to ~60% for H2 and in-line with pre-covid numbers), we can see CAC for net new customers normalised to ~£220, only 5% higher than the pre-covid net CAC.

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Although WINE hasn’t acquired many customers in H2, the discipline is encouraging. We’re looking forward to the FY 22 earnings call next month and will be following US net customer growth closely in FY23.

Please reach out if you have wildly different CAC numbers than ours above. We appreciate that this calculates CAC from net adds, not gross, which we normally use, but it seems the net calculation aligns with the reported paybacks and estimated IRR.

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