Stitch Fix Finds What's Most Important to Measure

Optimizing a business often boils down to knowing the best questions to ask.

Asit Sharma
Asit Sharma
Jun 11, 2019 at 5:51PM
Consumer Goods

Stitch Fix's (NASDAQ:SFIX) fiscal third-quarter earnings report on June 5 initiated what's become a typical double-digit swing in shares following the close of a quarter. This quarter, the arc was positive: As of this writing, stock in the personalized fashion service has risen roughly 25% since the earnings date. Shareholders appreciated Stitch Fix's reported revenue growth of 17%, and lauded the company's increasing user engagement, as average revenue per customer (ARPC) improved by 8% year over year.

While much attention was focused on the rise in ARPC, another metric demonstrates how attuned the company is to acquiring profitable new business, and increasing the lifetime value (LTV) of each customer. This measure relates to Fixes. A "Fix" is Stitch Fix's term for the package a customer receives of hand-selected clothing items. Each Fix is selected by a personal stylist, and informed by the stylist's expertise and knowledge of the customer, supplemented by data science.

During Stitch Fix's earnings conference call, in a discussion of new-client retention, CEO Katrina Lake explained the metric as follows: "One measure we look at is the number of clients who keep at least one item in their Fix and tell us that they're looking forward to their next Fix."

This number improved by 8% against the third quarter of 2018 -- mirroring this quarter's 8% increase in ARPC. The company is often lauded for its use of data analytics to understand the fashions its customers will respond to. But it doesn't get nearly enough credit for management's acumen for asking the right questions to drive its business forward.

Growth companies can get caught in a cycle of spending heavily on sales and marketing to drive key revenue metrics. But knowing what to measure can make customer acquisition spends much more efficient.

Target, optimize, and seek to understand

The metric of "first Fix satisfaction" informs one part of a simple formula that CFO Paul Yee outlined during the earnings call, which management employs to boost retention and longevity: Target those customers who are ideal candidates for Stitch Fix's service, and optimize the outcome of the first Fix.

Yee also emphasized how critical it is to management that the company understand its client base -- both new and recurring. He observed that the ability "to understand our client base and therefore be able to deliver Fixes that are curated for them is translating into higher revenue per client."

Much has been made of the company's algorithmic approach to gaining this understanding. Stitch Fix's data analysis is enriched over time as a customer receives Fixes throughout the year, and the company collects feedback and analyzes purchase patterns. The process of getting into the customer's head has accelerated with the introduction of Style Shuffle, an online app which gamifies the extraction of personal style preferences. Each time a customer plays Style Shuffle, the collected data on style choices, outfit combinations, color preferences and the like sharpens guidance that Stitch Fix's analytics programs can present to the stylist responsible for curating the customer's Fixes.

A young woman removes clothes from a cardboard box.

Image source: Getty Images.

Purposefully constrained ambition

There seems to be an obvious inference we can glean from Stitch Fix's methodical customer acquisition and increasing utility to customers. Namely, the company could probably use its respected data analytics capabilities to rapidly widen its new customer base -- if it were willing to accept a higher customer churn rate and lower annual revenue per client. As my colleague Karen Mikolainis recently pointed out, Stitch Fix instead aims for a self-prescribed growth range, currently locked in at 20%-25% revenue expansion per year.

Within this top-line constraint, the company also apparently targets an operating margin that tends to fluctuate between 2% and 3% in a given quarter, leaving just enough room for it to be consistently profitable on a GAAP basis. In the first nine months of 2019, the company booked net income of $29.7 million on $1.1 billion in sales. During the same period, Stitch Fix generated $75.2 million in operating cash flow, and $50.7 million in free cash flow. The organization has no long-term debt on its books.

These disparate stats from the company's financials paint a picture of an organization that defines itself as a growth company, but manages its growth prudently while self-funding its expansion. Shareholders who appreciate the company's balanced approach undoubtedly await their own "fix" each quarter when Stitch Fix reports earnings.