Stitch Fix: A profitable $250 million retail disruptor

Image: Jamel Toppin for Forbes

Katrina Lake strains while rocking back and forth, heel to toe, in the middle of a professional football stadium. It’s a Monday night in Santa Clara, California, and the CEO of the high-flying online retailer Stitch Fix stares up at a seven-storey screen projecting a Godzilla-size image of Beyoncé. The singer is ­performing a mere 50 yards in front of her field-level seats, but at 5 foot 5 in heels, Lake can’t see much on the stage and, instead, holds her iPhone high above her head with the hope of capturing the diva in all her glory.

After 15 seconds, Lake relaxes her posture, drops her arms and shimmies her shoulders, dancing a bit more conservatively than many of the 45,000 others in the “Beyhive”. It’s been a hectic week that included stops in Chicago and New York, ahead of a flight to Las Vegas the next morning—and she’s five months pregnant.

“Who run the world? Girls,” Beyoncé sings. “Who run this motha? Girls.” For one of the too few woman CEOs in Silicon Valley, it rings true. Stitch Fix markets itself to busy working women—and Lake walks the walk. In less than six years her San Francisco-based startup has developed a service that shops for women, matching clients with boutique-brand clothes, shoes and accessories on recommendations powered by a combination of data science and human stylists.

For a woman with little time to shop, Stitch Fix can find that blazer for an interview or that blouse for a first date. Customers pay a $20 “styling fee” to receive a box of five personally curated items either on demand or by subscription. They try on the clothes, keep what they want and return what they don’t. Clients pay the full retail price of any clothes they hold on to, less the $20 fee, which is applied as a credit.

 “The concept has always been personalisation,” says the 33-year-old Lake. “There are millions and millions of products out there. You can look at eBay and Amazon. You can look at every product on the planet, but trying to figure out which one is best for you is really the challenge.”

Online personal shopping has become a highly valuable and rapidly growing business proposition. Forbes estimates that Stitch Fix brought in $250 million of revenue in 2015; that number is predicted to jump by 50 percent this year. To accommodate this scale, Stitch Fix has nearly tripled its head count over the past two years and now has 2,800 mostly part-time stylists, many working from home, and more than 1,000 warehouse workers across five locations. This isn’t heedless growth. While the private company keeps its finances close to the vest, two insiders say it’s profitable. They also point to the fact that in its lifetime Stitch Fix has raised less than $50 million in an industry where fellow startups have burned through hundreds of millions on poor inventory decisions and unsustainable promotions. (In Stitch Fix’s field, former unicorns Fab and Gilt Groupe fell into this trap.)

With the company presumably cash-flow-positive, Lake is in a position to expand it organically. And not take any more dilution. Her last round of funding—more than $25 million in mid-2014 from Benchmark, Lightspeed Venture Partners and Baseline Ventures—valued the company at around $300 million, according to VC Experts. At least one investor has already marked that up to $730 million. ­Depending on which valuation you accept, Lake is worth between $50 million and $120 million, making her an up-and-comer poised to crack Forbes’s list of richest self-made women.

Lake tries to shrug off the wealth she’s creating, perhaps because she’s seen other meteors crash to Earth after missing the basics of her field. “There are a lot of people who have thought of themselves as a tech company or thought of themselves as an ecommerce company and thought they were different from a traditional retailer,” Lake says. “Many people at Stitch Fix came from retail, and many people at Stitch Fix know what drives a great retail business.”

That declaration comes with a caveat: “There are some things from a traditional retailer you can throw out the window,” she says. As stalwarts like Nordstrom and Gap continue to lay off employees and shutter stores in the face of increased competition from online players, Stitch Fix, whose name refers to the supposedly addictive quality of its deliveries, may now be a double entendre. If you are to believe Lake, fashion retail is broken, and the fix lies in data science.
 
Stitch Fix’s office in San Francisco’s Financial District is only a five-minute walk from Union Square, the city’s shopping hub. There, retailers like Banana Republic and Macy’s see hundreds of customers walk through their doors each day and never learn much about them. Without sales associates to interact with customers, those businesses won’t know a person’s pants size, her purchase history or what she’s looking to buy. “Let’s say out of every 100 customers that come in, 25 buy something,” says Marka Hansen, the former president of Gap North America, who sits on Stitch Fix’s board. “So 75 had intent to buy, but we don’t have any idea why we didn’t satisfy them.”

In contrast, Stitch Fix knows that anyone paying the $20 styling fee wants to buy something and is willing to fork over personal data to ensure that her experience is as good as possible. She happily gives her weight, bra size and a link to her Pinterest profile, all part of the more than 50 pieces of information the startup collects from its users. For any given item from the more than 200 brands it carries, Stitch Fix logs 100 to 150 data points, ranging from sleeve length to color.

That’s all necessary, Lake says, because the client is relying completely on Stitch Fix. According to her, at Amazon 35 percent of purchases are driven by recommendations while 50 percent  of LinkedIn connections are made through suggested matches. Lake stresses: “One hundred percent of things that are bought on Stitch Fix are recommended.” Even returns are treated as valuable data points, with Stitch Fix’s stylists absorbing the negative feedback in a customer’s comments to better calibrate the customer’s style or an item’s description.

 With a team of 80 data scientists—among them astrophysicists and computational neurologists (with 49 PhDs)—Stitch Fix believes that computers, with the help of humans, can pick your clothes better than you can. The company’s algorithms use a customer’s data to predict how likely she is to keep a given item based on parameters that range from the woman’s style to her occupation to her Zip code (which predicts weather). A stylist then reviews the information, ultimately picking out five items to include in a customer’s “fix”. Gone are the days when a woman has to try on 20 pairs of jeans to find one that she likes, and Stitch Fix believes that if it keeps getting it right, customers will keep coming back.

“It’s about the experience and relevancy, the ‘Huh—they get me, and I keep keeping things they send me,’ ” says Eric Colson, the former vice president of data science at Netflix, who holds a very data-driven C-suite title at Stitch Fix: Chief algorithms officer. “The clothes are not exclusive. We don’t price them better than anyone else. We don’t do fast shipping. We’ve just got to be more relevant.”

Growing up in San Francisco, Lake was “never the kid with the lemonade stand.” Her parents, a teacher of Japanese and a public-university doctor, own a city property on which she says they haven’t raised the rent since 1997. “They’re not supercapitalists, so I never really imagined myself as a businessperson.”

Lake was admittedly not a good student entering high school. As her teen years took hold in the late 1990s, she snuck out of her house to visit the burgeoning, and often illegal, Bay Area warehouse rave scene. Her parents decided to move their three kids to Minneapolis, in part to reverse the trajectory of their eldest child. At 15 Lake found herself in a new town with no friends and no semblance of her old life.

Seeing that college was her only way back to the West Coast, Lake hit the books. In 2001 she got into ­Stanford, intending to become a doctor like her father, but she lost interest and wound up at a consultancy, the Parthenon Group, where she advised restaurants and retailers such as IHOP and Kohl’s. There she saw firsthand how brick-and-mortar businesses lacked or were unable to use data to understand their customers. She decided to go to business school, hoping to use this insight to upend the retail status quo.

“Male programmers and engineers have brought technology to poker, Little League baseball and price comparison shopping engines for electronics, but with historically fewer women having technical backgrounds, traditionally ‘female’ spaces and hobbies have benefited less from technology,” she wrote in an application essay. “My goal is to be CEO of a retail company and lead the industry in technology and innovation.”

While at Harvard Business School, Lake came up with a few business ­concepts to pursue after graduation, including a flash sales site for hunters and fishers she researched by driving across New Hampshire.

The idea for Stitch Fix emerged when Lake began thinking about her bad shopping experiences. Around that same time, Chicago-based Trunk Club had raised funding for an online service that connected men to personal stylists, with the idea that men hated to shop but still wanted to look good. The service sent customers handpicked clothes, and they kept what they liked and returned what they didn’t. There was nothing really like it for women.

Still at business school, Lake joined Erin Morrison Flynn (the wife of an old Stanford classmate and a former merchant at J Crew who worked with its famous CEO, Mickey Drexler) to create what was initially known as Rack Habit. They signed up friends of friends in the Boston area, gathered their style preferences using online survey forms and logged basic style profiles in an Excel spreadsheet. The pair also visited boutiques to buy inventory, constantly maxing out Lake’s $6,000-limit credit card for skirts, blouses and other items that were delivered to customers in boxes. Buying goods at full retail, Rack Habit made no money, but its quick traction was validation. After raising $750,000 in seed funding in 2011 from Baseline Venture’s Steve Anderson—who had been actively combing his network for the “Trunk Club for women”—the company moved west and changed its name.

By the next year Stitch Fix was rapidly outgrowing its office on San Francisco’s Market Street, which was soon overrun with inventory. With the funding, Lake was able to hire Walmart.com COO Mike Smith, who had been looking to join a bare-bones startup, and later Colson, who had been mentored by Net­flix CEO Reed Hastings. Results, however, weren’t always up and to the right. Seeking another round of funding, Lake was rebuffed by some 20 venture firms, including Valley stalwarts Andreessen Horowitz, Sequoia Capital and Accel Partners. Some couldn’t get past her lack of technical background or coding ability, despite her analytical mind and willingness to work with data. Other decisions likely came down to the “implicit biases” of an industry where “94 percent of VCs are male”, Lake says. “As men are deciding what companies to get passionate about, the deck is a little stacked against you when you’re in a business that caters to women.” With the company eight weeks from not making payroll, Anderson bankrolled the business again, leading a $2 million bridge round of financing that kept it afloat.

 Internally all was not calm either. In late 2012 Lake allegedly forced Morrison out of the company after a dispute over her compensation and ownership stake. Morrison sued Lake and Stitch Fix, alleging that her co-founder was attempting to take her shares away to distribute to new hires. Lake denied this, and the lawsuit was settled for undisclosed terms in February 2014. (Both parties declined to comment to Forbes about the lawsuit.)

By early 2013 Lake was on her own, and Stitch Fix was on its way to shipping its 100,000th fix. The performance caught the attention of Benchmark’s Bill Gurley, who noticed that his assistant, Amie Fineberg, was spending all her discretionary income on Uber and an unknown personal styling service. Curious, he asked for a meeting with Lake, who stunned him by presenting an Excel spreadsheet with a three-year forward cash flow and income statement. “That’s never happened in the history of my venture career,” says Gurley, an Uber investor who says his decision to invest in Stitch Fix was his fastest ever. He spent the next eight months lobbying Lake, who didn’t need money right then, to let him invest. He adds: “I think of it as the moneyballing of women’s fashion.”

Pamela Radgowski (34), a former PR executive who “hates shopping” and has spent more than $500 at Stitch Fix over the past 18 months, falls right into the company’s sweet spot. Its core customer is a woman between 25 and 45, comfortable at prices of $55 and up.

“I’m not a bargain shopper. If I like it, I’m just going to buy it, because my time is worth that,” she says. “There’s also the element of surprise and the fact that you may get something you wouldn’t pick out at a store.”

Lake says there are a lot of Radgowskis out there: She estimates the company’s potential market represents a $40 billion chunk of the annual $371 billion (sales) US footware and apparel market, according to Kantar Retail.

Sceptics doubt Stitch Fix will get anywhere close. Forrester analyst Sucharita Mulpuru places the company in the category of subscription-box services like Birchbox. In a 2015 Forrester survey that polled 4,667 shoppers in the US, only 3 percent had signed up for a subscription programme for clothing, shoes or accessories. Some 59 percent indicated they were not interested at all.

“We know that subscription ser­vices have a significant amount of churn,” Mulpuru says, noting that often it’s heavy discounts or marketing promotions that attract new customers. “People will try something because they’re intrigued … but then realise, ‘This isn’t something I need on a regular basis.’ Then they either opt out entirely or put the account on hold.”

 Tiffany Hogan, an analyst at Kantar Retail, adds that there’s a “natural ceiling” to the business. “The idea of personalisation is hard to mass-produce,” she says.

Points taken. For all her data and algorithms, Lake refuses to share customer numbers, other than vague references to “millions of fixes” that have been shipped across the country. Tellingly, she does talk about how much they can wring out of current customers, 39 percent  of whom, she says, spend more than half their annual apparel budget at Stitch Fix.

This indeed is a key number. With a ceiling on new customers lower than Lake would care to admit, she needs to get current ones to keep coming back. Customers can help by making requests, for instance, for an outfit for a cocktail party. About 80 percent of people who order one box order a second within 90 days. (The company won’t say how many come back for a third.) Lake also must ensure they like what Stitch Fix sends them. To turn a profit, the company needs customers to keep at least two of the five items in each shipment.

 One challenge she’s turning to her advantage is managing inventory while selling so many disparate pieces. Whereas a traditional retailer has to largely guess how many pairs of jeans it’ll sell at the start of a season and place an order, Stitch Fix can be more reactive, limiting inventory risk. The algorithms help in that regard. Stitch Fix, for instance, can make predictions based on how many customers are purchasing pants and tell manufacturers to produce particular styles, colours or patterns when ordering.

The company is also building up its private labels, with six lines that deal primarily with basic goods like a pencil skirt or fitted cardigan that tend to be ordered by large swaths of its customer base. That, too, is being fed by data. Lake says that the data science is so strong that Colson’s team can create mockup designs for items they think will do well but are not on the market.

Stitch Fix also plans to unveil a service for men, taking on its spiritual brother, Trunk Club, now owned by Nordstrom, which entered the women’s category earlier this year. (By Forbes’s count, there are now more than a half-dozen personal styling companies.)

With so much going on, Lake’s been on call nonstop, though that will change when she has her baby in ­September. She plans to take the company’s 16-week ­maternity leave, entrusting most of the operations to former ­Sephora chief marketing officer Julie Bornstein, now the chief operating officer (the company is 70 percent  women, and its executive team is majority female as well).

Lake waited until early May to tell her employees she was pregnant. She treated it as business as usual, burying the details in the regular company-wide Friday email.

One of the first to know outside Lake’s family? Her Stitch Fix stylist. She needed something more fitting for that baby bump.