In this week's episode of Industry Focus: Consumer Goods, Emily Flippen talks with The Motley Fool's Tim Beyers about how mass customization has quietly shaped the retail industry in the last few decades.

Learn how companies like Etsy (NASDAQ:ETSY) and Shopify (NYSE:SHOP) are driving the customization boom without cannibalizing their customers, how digital-first companies like Pandora got into the space, and how players like Stitch Fix (NASDAQ:SFIX) are using data to bring customization to physical goods. We'll also explore how the unit economics of mass customization could ever be profitable, why some companies don't need to mass customize, how it might even hurt their brand if they did, how this trend could grow even farther, and more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Jan. 14, 2020.

Emily Flippen: It's Tuesday, January 14th, and I'm your host, Emily Flippen. Today, we're taking a look at one of the biggest trends we've seen over the past decade in consumer goods -- that's personalization. Joining me today is Motley Fool advisor Tim Beyers. Hey, Tim!

Tim Beyers: Hey, Emily, how you doing?

Flippen: I'm all right. It's kind of a special day here for me, because normally you're in Colorado, but today I get to have you in studio.

Beyers: That is true. I'm back at HQ for the week. It's good to be here.

Flippen: What brings you around?

Beyers: We have a special project that we're working on that members will hear about a bit more next week. I'm sorry to be a little bit cagey about it. It's tech focused, since I focus on a lot of tech. We'll have more to announce next week. So, look for that.

Flippen: Not cagey at all, it's very exciting. For listeners, that might sound a little bit disconnected, I guess, to the trend that we're going to talk about today. The big question: What would tech and consumer goods have in common? But I actually think that the trend that we've seen toward personalization of consumer goods has a lot to do with tech, and that's largely going over investors' heads. For a long time now, consumer goods companies have been using technology to personalize the buying process. A Deloitte report has called this trend the rise of mass personalization. That's a little bit of an oxymoron there. But I think the idea being that, yeah, in more and more consumer goods categories, people want to buy a product that's tailored to them.

Beyers: Right. There was a book back -- I'm dating myself a little bit here with this. The Motley Fool was founded in 1993. That same year, two consultants, Martha Rogers and Don Peppers, published a book called The One to One Future. It was a fascinating book. I actually love this book. I wish I still had my copy of it. But the idea was that in the future, technology would enable markets of one. And this is similar to a book that the former publisher of Wired published called The Long Tail. But the idea was that the more technology invades our lives and gets more pervasive and allows us to be very specific in how we use data, we can create markets of one. So there can be a market for Emily Flippen that markets exactly to your taste --

Flippen: The dream.

Beyers: The dream, yes. It's potentially a little spooky, maybe a little creepy, but also amazing, just this idea of, whatever your tastes are and what you permit a company to know about you, and then in return, that you will get back a fully tailored product that meets your desires, it's very valuable. It also theoretically would dramatically improve margins, because you'd be willing to pay more for that kind of service. Let's just talk about retail. This does feel like a little bit of retail nirvana, in an era where malls are closing in mass scale and where Amazon has taken the idea of having a superstore, putting it online. And so you don't need a superstore anywhere else. The opposite of that is, well, Amazon maybe a superstore, but I'll fight that by being very specific and being able to cater to people on a personalized level.

Flippen: You mentioned dating yourself. I'm about to go even further back here. Well, when you talk about this trend, I can't help but go back to what caused mass production. Before the Industrial Revolution, everything was specifically tailored for you, for the most part.

Beyers: That's true, yeah.

Flippen: And a lot of things were a lot more unaffordable than they are now. People didn't have as many clothes in their closet. In my experience, not as many pairs of shoes as I may own now. And industrialization allowed a lot of people to get access to a lot more stuff for a lot cheaper. We talked about using data to go back to the time before mass industrialization. Is everything just going to be crazy expensive? If I want that Emily pair of shoes, is there any way for this to be mass personalization? Or is it a very expensive pair of shoes?

Beyers: That's a really interesting question. Do we ever get past the Henry Ford quote of you can have any color you want, as long as it's black, for the Model T? It's a very interesting question, and it requires some real innovation, I think, around this idea of being able to make a base set of products that can be easily customized at the end. And so, we've seen this before. For example, we've seen this largely in tech-driven models, where it's much easier to take a piece of software and tweak it -- theoretically, at least -- because you're not dealing with a hard product. Pandora was like this. It was built off of the Music Genome Project. And you would be able to listen to music that was uniquely tailored to you because Pandora would get to know what your tastes are. Being able to deliver that on a mass-personalized scale in retail stores, like in physical stores, I think is really hard, because in order to fill out a store, you do have to have some preselected product. And last I checked, you cannot predict as a store owner who's going to walk through the door. So you have to have some kind of representation of what the average is. You have to design for the mean. So it's really hard to be mass personalized in that.

Where technology gets interesting is when you have data. And so where this world I think is starting to come into play, just to use a simple example, would be if you have a Kohl's account. Kohl's is a big consumer goods retailer. Mass provider of clothes and regular consumer goods. But if you have that account and you have a shopping list, and you have shopping patterns, and that data is available, then Kohl's can make it easier to optimize its merchandising in local stores to fit roughly -- like, if it took the data in a map -- and be able to fill its stores with merchandise that's much more likely to appeal to the demographics of its members in that specific region near that store. And it does have in-store pickup, so it's certainly possible. I don't think it becomes where everything is a premium.

But where we've seen the most success with this, I think, is models like Stitch Fix. I know you and I have gone back and forth on Stitch Fix many times. But this is kind of the model we're going to, which gets to the, if you're willing to pay a premium, we will be willing to put real resources into. For those who don't know, Stitch Fix is a personal styling service. You put in a lot of data, they get your tastes, they get your measurements, they get ideas about where you are in life, what your attitudes are, what you really, really like. Then they try to style you accordingly and not only surprise and delight you but also meet your very specific personal needs. And you're going to pay a premium for that. So there's a little bit of both.

I think we haven't seen a model that works with mass personalization, where it's just like, this is the model, this is how it'll be. It's much more likely, especially in retail, I think where there's going to be a low end of the market. And maybe that's this Kohl's trying to optimize model. And then, a higher end of the market, where Stitch Fix is giving you a very tailored experience, the Emily Flippen shoes.

Flippen: Yeah, I hear both sides of the arguments. There's maybe some potential here for personalization to save what has been an increasingly dying traditional retail environment while also offering the opportunity for more lean operations to meet specific needs. But what I keep going back to is brand, I guess. Because brands have, for so many companies, been the driving force of purchasing. One that just comes to the top of my head is maybe Lululemon, which has done a great job in building out its own brand in a very traditional retail environment. They have an online presence, of course, but they still keep their physical stores. And it's not a product that can be tailored to any specific need, but they still continue to perform really well.

Beyers: Right. And so in a situation like that, then there's the question of, if you want to mass personalize, how many SKUs do you have? The SKU, which is the retail term for a specific line of product. And so, the more you try to tailor to individual tastes, the more SKUs you have. How many SKUs is too many SKUs, and then you have too much data to manage? So it's really interesting. And you're right, brands do matter. The reverse end of the spectrum is where the brand is desirable and the investment is in the brand; you're less interested, I think, in having it be very personalized. The personalization, the relatability, is to the brand itself. Like, I'm a Nike guy, or I'm an Apple guy. Like, I have identified myself as an Apple guy for a really long time, so I have a personal and emotional connection with the brand. So I get the computer or the equipment that roughly fits what I want from Apple, but Apple dictates entirely what its product line is going to be. There is no such thing as a Tim Beyers Mac, and there never will be. And I don't think there should be. So, to your point, which is a good one, there is this segment of, where does mass personalization get in the way? Or, where can it create conflict with companies that are selling based on brand?

Flippen: Yeah. And part of what makes me ask that question, going back to Stitch Fix, is the fact that Stitch Fix doesn't sell brands, right? If you're subscribed to Stitch Fix, you're not doing it to get a specific brand of jeans. You're not doing it to get a specific brand of purse, shoes, or shirt. You're there for the personalization aspect. And if it's a specific brand as a result, then all the better.

Beyers: I think that's largely true. Where that may be changing is that Stitch Fix has recently unveiled its instant buying option. Stitch Fix is misunderstood in a number of ways. One of the ways I think it's misunderstood is, it is classified as a subscription box company, and that's not where they make most of their money. They're not necessarily depending on you to buy a box every single month. There are some customers that do that. It's more likely twice a year, four times a year, and they have you in the system, and so when you come back, you can expect a personalized experience. But you come back on your own terms.

There may be some instances, because Stitch Fix is starting to work with some of these brands -- here's where it can get very, very interesting. Where can a company like Stitch Fix, which has very detailed and very interesting data on customers, serve a company like a fashion retailer that really does sell on brand? And where can those two come together and create a more personalized but also meaningfully connected experience? So, let's say it's Michael Kors, just for example. And Stitch Fix can say, "We have run the numbers, and we found out that 35% of males 26 to 49 preferred these colors of your type of clothing." That's very valuable for Michael Kors, and it's something they can't get. Or, at least, they typically can't get it. So that gets them a little closer to mass personalization. But that isn't Michael Kors doing that. That's a loose and virtual and largely tech-enabled value chain, where the customer is giving over some data and saying, "Here. Give me some value for my data." And these two brands come together.

But I think you're right, it's challenging for a brand to really make this happen without interesting partnerships. So this push to mass personalization may see some interesting variable partnerships over the next few years.

Flippen: Now, Tim, we've talked a lot about Stitch Fix. And I definitely want to still continue to touch on it. But there are lots of other companies like Stitch Fix that are playing off of this trend toward personalization. And I think one of the things that we're finding with these companies is that sometimes the unit economics can be pretty challenging. I was actually a recent Stitch Fix subscriber. I'm not a huge clothes person, so I did end up canceling my subscription. But I will say, I was impressed with the personalization that I got in my box. I liked everything that they sent me.

But when I left, I got a coupon code. It said, "You get $75 if you refer a friend, and they get $75." And as an investor, the first thing that came to my mind was, "Wow, that's a really high customer acquisition cost." So, is that a testament to the value they get from their customers? Or is personalization just a hard thing to make the unit economics work for?

Beyers: I think it's a testament to the long-term unit economics. Like most businesses that are relationship driven -- I think there's really only one good reason to do mass personalization: that you're trying to drive relationships and long-term value with customers. Like, your unit economics are dependent upon increasing value over time with that customer. And so your up-front customer acquisition costs will be high, because your lifetime value on that customer is worth it.

To throw some numbers out on Stitch Fix, generally, they tend to do about 8% to 10% every quarter year over year in active customer count. I think last quarter was 9%. And the average spend per box goes up somewhere between 15% and 20% every year. So there's some leverage in that. So as they gain customers who become active customers, they do spend more, and they stick for a longer period of time. So it is a meaningful up-front customer acquisition cost. But to the degree -- like, they give you a coupon, and then they ask you to give that coupon to a friend, and they try it. And if they become a customer, the payoff period on that is not nearly as high as it could be if it was a mass market where you're just trying to blast as many people as you can.

The customer value over the lifetime of that customer is pretty high if your capture rate is pretty decent. But Stitch Fix, to its credit, has been profitable for a long time. They tend to turn up the spigot on different levels of marketing. They're cash flow positive. The economics of this business have been very good for a long period of time. But I think this is one where it's the snowball effect. As they continue to grow their customer base, as people tend to stick for a long period of time, and they find they trust Stitch Fix over a course of time, then that's where the biggest value comes and where the cash flow really starts to roll up for them.

Flippen: There's lots of e-commerce companies when I think about, yeah, having the ability to roll up customers and retain them, with less pricing pressure. There's lots of e-commerce companies that do this as well. A company that, obviously, I'm a big fan of, I talk about a lot, is Chewy. They send out personalized notes to all their customers. And while the product that they're selling is obviously not a personalized product, they don't make dog food or cat food specific for you, they personalize the customer buying experience so that you feel some sort of loyalty. I think Etsy possibly is another good example of a company that is playing off of that personalization, too.

Beyers: I 100% agree. Let's go back to your pre-Industrial Revolution example again. This was the model. The idea was, if you are a cobbler, or if you were a blacksmith or a baker, you would have a consistent base of customers, and those were your loyal customers, and you would stay in business and grow over the course of time because you'd be serving these same customers for years and years and years. And so, yes, as those years went on, the acquisition costs of that customer starts netting down to close to zero, but the lifetime value had gone through the roof.

So now, we're taking that model and trying to push it forward and bringing it into the modern era using technology. Chewy is a good example. Etsy is a great example. And frankly, I think any store that's on Shopify. Very similar, Etsy and Shopify. Shopify stores are the same way. Your acquisition cost is going to be the net marketing cost minus the platform cost for being on Etsy or Shopify. And those platform costs are not really high. They're low, they're a subscription, you get a tax write-off for that. So then, really, what you're focusing on is finding your ideal customer. You actually are trying to do some degree of mass personalization there.

And when you find them, you can grow very big. There are relatively big businesses that have started and grown up on Shopify. I'm confident that the same is true in Etsy, and it will become more true. The platform does not compete with the business itself, which is not true of Amazon. And so it gives them some runway. I like that a lot. I do think, as this goes on, as these businesses start to figure out how to market to their customers specifically, it increases the total value of the platform, and it also increases the value of the business. And it's better for the consumer experience, I think.

Flippen: What I think is really interesting about Shopify -- not to completely derail the conversation -- as a consumer, we're focused on buying products that we like and that we have a good experience buying, whether that be quick delivery, low prices. Obviously, Etsy is playing off of that trend really well, because when people shop for their holidays, they find themselves going on Etsy as opposed to Amazon because you're getting more personalized products on Etsy. Companies like Shopify, and Etsy to an extent, they're not trying to convince consumers to go to their websites. Shopify isn't actively going after consumers and directing them to their customers' platforms, like Amazon is trying to direct right to their platform. They're just trying to create the best experience possible for the businesses that are using the Shopify platform, which theoretically could keep their costs much lower.

Beyers: Right. In this era, what we're coming around to is, depending upon how you use data as a business, how responsible you are with it, and how careful you are in building that relationship with a customer, every business can do some form of mass personalization. It's probably a little bit early. I think the technology is still developing a bit, and the business models are being shaped. But you can be a business like The RealReal, which is another consumer products company. It's online, it's lightly used, vintage, really impressive, high-end fashion items. And it's a spin on consignment. So even The RealReal, they have a certain amount of inventory, and it's impossible to predict who is going to be shopping on that site. And yet, if you're The RealReal, you have account control, you know the data of the customers there, it's more likely that if you're responsible about it, you can make an effort to put the right product in front of the right person at the right time. And in the end, that's kind of what personalization is, at least in its current form. The ultimate idea would be, personalization is, I make an order, then you make it to my specifications, like a tailor would if you were ordering clothes. So there is a difference. We're not quite there yet. But I think data is pushing us in that direction.

Flippen: I have one last question for you, which came to my mind because you said every business can do personalization on some scale. If you are a business out there, if you're a publicly traded company, even a small business, and you're not doing anything for personalization, do you think that business survives five years from now?

Beyers: If you're a small business and you don't have scale, like, you're not Apple and able to have a brand, and you deliver a whole experience, and your brand is desired, and people are shopping for you at the brand level, and they just want to be associated with that brand, yes, I think it's really difficult as a small business if you do not have a brand that creates emotional resonance with that customer. If you're not doing that and you're not personalizing, I think it's very difficult for you to stand out. And in a market like this, where dollars are scarce, businesses are plentiful, and the options for customers to reach out and find options is greater than ever before because of Google, yes, I think it makes it very tough.

Having said that, though, if you are in a market where the options are scarce -- and I'm including either online or physical. If you're in a small town, for example, and you have most of the options that people want, and maybe you have a small web presence -- I've seen this, Shopify stores that are in really tiny towns, and they have one physical location. And so they do some e-commerce. But then they also are in this town, and they're an entirely unique store. And so their brand isn't a beloved mass brand, it's just a small-town brand, like, that store does something unique, and I can go there and get something that I know is unique, and it exists online, and it also sells something unique. Those real micro niches, I think they can survive. But if you're in the middle, I think it's tough.

Flippen: Well, it will definitely be exciting to watch this trend play out, especially for a lot of these bigger publicly traded companies that seem to be succeeding well based on the trend that will likely continue into the near future.

Beyers: It sure seems like it. I mean, to be fair, I do own shares of Shopify. I do really believe in this idea that there are 10 million, 20 million, 50 million small businesses that can exist, can exist largely online with a small physical presence and serve a micro niche extremely well. And I believe that companies like Shopify and Etsy are going to help them do that very successfully over the next 10, 20 years.

Flippen: It's definitely been the case thus far. Tim, thank you again for joining us today. It's not just a treat to have you on, but to actually have you on in person is always special.

Beyers: Yeah. Thanks a lot, Emily! I appreciate it. It's good to be here.

Flippen: Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out and say hey, shoot us an email at industryfocus@fool.com, or tweet us @MFIndustryFocus. If you're looking for more of our stuff, subscribe on iTunes or check out the videos from our podcasts over on YouTube.

As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for against any companies mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass today! For Tim Beyers, I'm Emily Flippen. Thanks for listening, and Fool on!