Analyzing Chegg Inc.’s Competitive Advantages

Chegg Inc (CHGG 0.15%) is a technology-driven educational-services company that aims to be a "student-first" platform. In this segment of our Industry Focus podcast, we learn how Chegg employs a content model similar to TripAdvisor Inc (TRIP 2.19%) to keep students engaged, while using detailed data it collects to enhance its tutoring and academic support services.

A full transcript follows the video.

This video was recorded on Sept. 19, 2017.

Vincent Shen: So the growth for this services part of Chegg's business is pretty spectacular and very impressive to this point. A big thing that I was really impressed by, that you also mentioned, Asit, as well, before the show, is how the company uses its tech and also its data to create a competitive advantage for itself as it scales up. Can you tell us a little bit more about that?

Asit Sharma: Traditional education is delivered by huge infrastructure. If you visualize in your mind a university, it has dormitories, classrooms, salaries of deans to pay, benefits to all the faculty. It's a really low-margin business, even if you're a nonprofit traditional college. And what Chegg is doing is, I feel, the TripAdvisor model. Some of our listeners are familiar with TripAdvisor. Their service as a reseller of travel through online portals is supplemented by this knowledge base that's there. TripAdvisor reviews are a content that subscribers can access and non-subscribers, people who don't subscribe to other TripAdvisor services can get hooked into by reading reviews of travel destinations.

And this is the same as what Chegg is doing. By using low capital technology that can be used over and over again, and delivered through multiple formats, they can increase their margins over time and make students more loyal to them. One stat that stuck out at me is, they have 1.2 million subscribers to Chegg services as of Q2 2017. So in the second quarter of this year, they have 1.2 million subscribers, and that's up 54% versus the prior year. And what that tells me is, this light model, which is providing services digitally, is very sticky. A student who's used the experts to get a question answered, or maybe spent an hour with a tutor, or even used their writing services, which take a paper and format it in MLA format or one of the scientific formats for notation. Once you've used these services, you're much more likely to use this and pay for a subscription in the future. So through a subscription model for many of these services, they have a recurring revenue base that's building. And that's why I think that, although they're operating at a loss, the move to services was smart, because over time, recurring revenue is a stable predictable source of sales for a company, and they can gradually overcome that.

I want to flip it back to you, Vince, really quickly. We can discuss what might be a little bit of an Achilles' heel. Whenever you look at these companies that are fast growing but are losing money, always look, listeners, to find the biggest item on the income statement, where they're really spending the most money incurring that loss. Oftentimes, it's compensation expenses tied to stock. I usually ignore that for a while. I want to see what real life expenditures are going on. For this company, it's technology and development. In the first half of 2017, roughly a third of total revenue, $39 million was devoted to technology and development. That shows you both of the opportunity and the hurdle for Chegg. It has to constantly invest to grow its subscriber base and provide these value-added services to students. What are your thoughts on that, Vince?

Shen: I think ultimately, in the beginning for a company growing this quickly, that's an acceptable risk, for it to be even that large a part of the income statement, as you said, because of the fact that, when it comes down to it, management has said that Chegg Study, which offers some of their textbooks, informational guides, and some of the tutoring services, and writing tools, which you mentioned in terms of the citations, those parts of the business have a relatively fixed cost structure. So once the investment is made, they have those strong profit margins to match them as they scale their businesses over time.

Keep in mind the ways that Chegg can expand. They can add subjects, they can add courses, as they add more questions to that Q&A network, that adds more students, the more students they have, the more cross-selling they can do. They mentioned, for example, that their Chegg tutoring customers, half of them come from other existing services. These are customers of other existing Chegg services. So it's that cross-selling nature.

And a big part of that is this data that they have, they call it the "student graph". I think it's a really powerful example of how the customers and their usage of this site is being leveraged more and more to strengthen the relationship with the company and increase the customer's value for the business. The company can take basically everything that it knows about you -- the textbooks that you rent, will give you an idea of the classes you take, and then the tutoring services that you need will also give the company an idea of what you're interested in and what you might need help with, for example, and create a very personalized experience for you. It's actually pretty shocking. There's a quote from the latest earnings call and Q&A section that I think really highlights just how much information the company can pull from in regards to the students who use their services. Here's the quote:

We collect data either because people provide it directly, or because we're able to track their behavior. If you rent a textbook, we know your college, we know your address, we know your class, we can estimate what your major is as a result of it, depending on your year and other books that you get, and we know your address, and of course, we have your credit card. When you use Chegg Study, we have a lot of that. But in addition to that, we know when you're studying, we know what time of day, we know what time of night that you study, we know which subjects are harder for you and easier for you, we know your preference in terms of whether or not you'd rather ask questions or watch a video, or whether or not you do step-by-step solutions. And of course, as mobile continues to naturally increase, we have geography information. So, it just keeps expanding every time we offer services. In the case of writing, we are increasingly now able to tell whether you're in high school or college. We can start to determine what your classes are based on the paper that you're writing. So this is all information that we're starting to get now that we didn't get before.

So I know it's a long quote, but you can get an idea of the CEO there listing out all the information they're able to pull from to target their services to the students, and exactly for the classes they might need, for their major, for their class level, whatever it may be. And I think that's very powerful as they invest in the technology behind that.