Insights from Rent the Runway’s S-1: Breaking Down the Company’s eCommerce Strategy
Rent the Runway (known as RTR, ticker RENT) is a super interesting company. I love the insights behind the business and market, the laser focus on the company’s core customer, the innovative business model, the potential to change how we consume apparel and fashion, and the impressive technology RTR built to support the vision. It’s a complicated business and a company that has potential, but is currently losing tons of money.
Below, I give a brief overview of the company, outline what I like and don’t like about its eCommerce strategy, and propose what I think the company can do to become profitable. Most of this is based on data and statements in their S-1 (Amendment No. 2).
Founded in 2009 by Jennifer Hyman, Rent the Runway raised $357M in an IPO on October 27, 2021 under the ticker RENT. RTR buys clothes directly from designers (46% of their items in 2020), enters into revenue shares with designers (36%), and designs and contracts manufacturers’ items for rental (18%).
RTR acquires customers who then mostly rent (and occasionally buy) the clothes. Customers can choose from a variety of monthly subscription plans which are tiered by frequency and quantity. Customers can also reserve items for big events in advance (e.g. a wedding) and can buy items they especially love. Plans range from $89/mo for 4 items/mo up to $199/mo for 16 items/mo. There are multiple add ons and everything is handled through the RTR app and site.
The logistics behind this business are daunting. Once items are selected, they have to be picked and shipped to the customer. The customer then has to return the items after they wear them and RTR needs to bring those items back into inventory, clean and repair them, and then make them available for rental again. This is an especially complex process when you think about the context of forecasting inventory and trends across likely tens, if not hundreds, of thousands of SKUs from 750+ designers. Like other DTC brands, RTR also has to master customer acquisition, marketing, supply chain management, and finance.
Rent the Runway’s eCommerce Strategy
RTR’s first superpower is raising money. They have raised ~$700M over 10 rounds (through Series G) with their last pre-IPO post-money valuation of $870M (Market Cap close Friday, November 5 of $1.05B). They also know how to get big debt facilities from Ares and Temasek.
RTR’s second superpower is losing money. RTR lost $84.7M in the first 6 months of 2021 off revenue of $80.2M (that’s a loss of 106% of revenue). In 2020 they lost $183M and in 2019 they lost $154M.
Based on these numbers, I am assuming RTR’s strategy is to make money sometime in the next three years — so everything below is predicated on that goal. RTR may have another goal, which is to continue building out their infrastructure indefinitely and use their fundraising superpower to fund those losses a la Jeff Bezos. I didn’t hear their roadshow pitch, so I don’t know. If that’s their plan, you can stop reading now.
☝️ Before we get into our analysis, let’s take a step back. We need to think of a DTC company as a stream of forward cash flows from individual customers. Each customer represents a potential forward cash flow as they come back and make more purchases. The repeat purchase mechanics and margin structure are what determine the “interest rate” in this analogy. Better repeat purchase rates means more of that investment is earning a return. More frequent purchases, and you compound your returns faster. Improve the margin structure and you improve your interest rate, too. Customer acquisition then is like a principal investment. As you add customers, your investment in marketing hopefully adds more forward cash flows.
Your goal as a founder is to maximize the returns on your investments. You want to acquire customers as cheaply as possible, then monetize them as effectively as possible for as long as possible. Sounds simple, right?
Let's look at how each of them could be applied to RTR.
Analysis of Rent the Runway’s Business
⚠️ Disclaimer: the analyses I am going to run through are NOT how we model and run analyses at Bainbridge. We use real data, detailed cohorts, and powerful financial models. Practically speaking, these quick and dirty analyses are what you might do to screen investment opportunities or if you are a founder who needs to make a quick decision, but doesn’t have good models and tools at your disposal.
Insight #1: RTR’s Repeat Purchase Mechanics Are Okay
RTR’s cohort monetization seems good. It’s awesome to see RTR provide some cohort analysis in its S-1. I hope they continue to beef up this dataset and to talk about it more. The company’s repeat purchase mechanics are what drive this business! Specifically, RTR appears to be on track to monetize new cohorts of customers better than previous cohorts. It’s impossible to see the whole picture without the full data set, but the newest cohorts (e.g. the H2 2020 and H1 2021 cohorts) appear to be able to get to ~$725 in cumulative first 12 months revenue per customer and ~$1,100 in first 24 months revenue. At a 30% contribution margin, the average new customer would be contributing ~$218 in the first 12 months and $330 in the first 24 months
Customer churn is actually very reasonable at 8% annually. Here’s some back of the envelope math:
- The S-1 touts repeatedly that they have had 2.5 million lifetime customers.
- There are 97.614 active subscribers as of July 31, 2021, which implies 2.4 million have churned. That amounts to 96% over 12 years, which is 8% annually.
- COVID sparked a churn disaster, but RTR has recovered customers nicely since then by adding 43,386 customers, which is 80% YoY growth.
- While it’s not an apples to apples comparison, putting RTR’s churn in context of a SaaS software company shows that 8% is good. The 2021 Key Bank SaaS survey, which is the gold standard of private SaaS data, has the median logo churn at 13.4%
Tinkering with Customer Counts and Organic Growth Rates
Let’s get a sense of how many customers RTR needs to make the business work. This is a circular analysis — you need money to add customers, which increases the number of customers you need to break even, which increases the number of customers you need and so on. To really answer this question, you need a more detailed model. But we can get a sense of the scale by asking how many new customers it would take to erase RTR’s total 2021 loss. In other words, if RTR could instantly add customers for free, how many would they need to break even?
781,720 is a daunting number, as it’s an 8X increase over the company’s current subscriber base. There are approximately 62 million women between 18 and 44 in the US, so 900,000 subscribers (~100,000 active subscribers + ~800,000 needed = 900,000) is 1.5% of that total addressable market (TAM). That seems reasonable. Even 4X that number is 5.8% which still feels reasonable. I would say that 10% of all women in that age bracket — which equals 6.2 million and 62X the current customer count — seems out of reach. All that in mind, the market appears big enough to support the numbers they need, but there’s a definite ceiling.
🤫 The question RTR then needs to ask is, “Can we add those customers quickly enough and will we have enough money to do so?” RTR seems to prefer organic growth over paid. The S-1 states multiple times that 88% of their customer base has been acquired organically. Organic growth is awesome. But it’s the super rare consumer brand that can achieve the growth RTR needs solely from organic growth.
To see if this is achievable, we need to look at what organic growth rate the company would need to achieve in order to reach profitability. Maybe RTR is one of those super rare brands that can get the growth they need from organic. In the following napkin analysis I make assumptions about forward losses and their ability to increase contribution dollars over time. Giving RTR the benefit of dramatically reducing losses and increasing contribution dollars (see below), RTR would need an organic customer acquisition growth rate of 170% annually to break even in each of the next three years. Of course this is no substitute for a real model and it assumes unrealistically that they can’t fund losses.
Insight #2: RTR’s Budget for Paid Customer Growth Isn’t High Enough
Maybe RTR has the secret sauce for organic growth at that level off a big base and this far into their lifecycle. As an investor, I wouldn’t bet on it. I would want a serious paid effort coupled with organic to add those needed customers. When I look at RTR’s annual marketing budget, I immediately think that $15 million ($7.4M * 2) isn’t going to get them there. The S-1 states their CAC is $55 which implies 269,000 customers acquired, which is about a third of what they need for break even.
Additionally, as every performance advertiser has experienced, dramatically ramping up ad spend means increasing CACs. As you saturate, it gets harder to convert and you spend more for each conversion. The S-1 doesn’t specify what goes into the $55 CAC number so we don’t know if it represents just paid CAC or a blend of organic and paid. If it’s a blend, and the blend is 88% organic, then a $55 CAC implies a $450 paid CAC ($55 / (1 - 12%)) which seems absurdly high. If their paid CAC were that high, it’s hard to know where they can increase it from there. And it also would mean that acquiring 781,720 customers through paid acquisition would cost them $358M.
I am going to assume the $55 CAC is their paid CAC number.
Tinkering with RTR’s Paid CAC
Let’s look at how high RTR’s paid CAC can go. At Bainbridge, we believe that your CAC range should be determined by looking at your payback period and your time-defined lifetime value customer acquisition cost (LTV:CAC) ratio. Payback period is a critical metric for paid acquisition. It describes the amount of time it takes to break even from each customer acquired. Payback period can be calculated in multiple ways (off sales, gross margin, contribution margin, and by paid CAC or fully loaded CAC). We believe the best way is using contribution dollars and fully loaded paid CAC (cost of media plus the cost to run / manage that media).
The time-defined LTV:CAC ratio looks at LTV over a specific amount of time, such as 24 months, divided by the fully loaded CAC. In this analysis, I am going to skip this metric because it’s hard to tease out data from the S-1.
Here’s some napkin math of what CACs RTR could support if they were willing to extend payback periods.
The $725 number is not in the S-1. I made an educated guess about that number based on a cohort table and RTR’s H1 2021 revenue per active subscriber.
💡 Based on the analysis above, RTR could support much higher CACs with acceptable payback periods. Of course they would love to continue adding customers at $55 CACs and have a 3-month payback period, but given their fundraising skills, I think they could convince investors that six, nine, or even 12-month paybacks are entirely acceptable.
Let’s say RTR settles for a payback period of just under 6 months and sets a paid CAC target of $100. At that CAC, the company would need an ad budget of $78M to acquire all 782,000 customers needed. Their current marketing budget is about $15M for 2021 ($7.4M*2).
Insight #3: RTR’s Margin Structure is Tight
We have explored repeat purchase mechanics and customer acquisition. What about margin improvement?
First, let’s try to look at RTR like another DTC brand. RTR sets up their internal P&L in a unique way. DTC brands typically think of P&L as: Revenue - COGS = Gross Margin - Fulfillment/Variable = Contribution Profit. RTR’s internal method goes: Revenue - Fulfillment = Fulfillment Profit - Cost of Product - Processing Fees = Contribution Profit
RTR doesn’t have traditional COGS like other DTC brands. Because they are re-renting the same piece of clothing (on average 20 times), RTR depreciates the cost of the item. For revenue share items, RTR shows the payment to the designer of the rental. While technically different, the idea is the same. The company has an item which they monetize and they need to show the cost of that item as they monetize it.
Here is RTR’s internal P&L methodology
And here are the same numbers, restructured as a more standard DTC P&L:
The standard method drops the Other Depreciation and Amortization line item.
I don’t know why RTR chooses their method internally and it’s not really important. The key takeaway from this is that their margin structure is tight. A Contribution Margin of 30% means that in order to make money, they need low operating expenses (OpEx) and marketing budgets. For example, if they wanted a 10% Operating Income margin, then OpEx + marketing would have to be 20% or less. But instead...
Insight #4: RTR’s Overhead is Bananas
RTR’s OpEx is in a league of its own and I would love to know why. General and administrative expenses (G&A) is 48% of revenue and technology costs are 25% of revenue — that is off the charts. Some of this has to be driven by the unique logistics challenges of the company’s renting / returning / preparing / renting cycle. The business is also carrying a big headcount for its revenue. As of July 31, 2021, the company had 893 full-time and 81 part-time employees. Assuming each part timer is half a full time, that’s a headcount of 934 people doing a run rate of $160 million or so in revenue. Annualizing H1 2021 and using 934 people gives us a revenue per employee metric of $172,000. Contrast this with Wayfair, which did $14.1 billion with 16,000 employees for a revenue per employee metric of $875,000. The businesses are obviously at very different scales, but the point is that RTR’s overhead is way ahead of its revenues.
The company’s interest expenses are also very high. As of July 31, 2021, RTR carried $381.8M in long term debt. The interest rates on portions of this are 15% and while they have the ability to defer current payment through PIKs, they have very large interest expenses. For example, interest expense in H1 2021 totaled $29.4M, which was 37% of revenues.
What Should RTR Do Next?
Overall, RTR’s structure and time and expense required to acquire customers means that big losses are inevitable for the company. RTR is a proven master at raising capital, so I wouldn’t bet against them on this front. I would love to see them succeed and fulfill their vision. To do that, I hope we see RTR:
- Dramatically reduce G&A and technology costs. They simply have to get this under control and stop draining money.
- Improve Contribution Margin by at least 10 points through a combination of increased prices, reduced fulfillment costs, and eking out other small wins. A 10% increase in 12 month revenue per customer and a contribution margin of 40% would get them to $27 contribution dollars per month per subscriber. Not only can they then support higher CACs, they would also reduce the number of customers they need to acquire by a third.
- Build their paid acquisition superpower to combine with their impressive organic capabilities.
In other words, RTR must dramatically cut the losses, increase the margins and add more customers faster and at greater efficiency. I will be cheering for them!
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