At the heart of any successful entrepreneur is the ability to identify and meet a market need. In some cases, meeting this need is premised on the introduction of an original, innovative product while in others it is about improving the process by which it is produced and delivered. The latter appears to be the case in the eyewear industry where startup Warby Parker is aiming to provide consumers with “high quality eyewear at a fraction of the price.” Although it’s still early days, the company’s business model seeks to bridge the gap between a social need for affordable quality eyewear and an industry that has succeeded in keeping prices artificially high.
Before discussing Warby Parker in more detail, it’s important to understand the dynamics of the global eyewear industry. When shopping for a pair of glasses, consumers are met with what seems to be an infinite array of options. Upon further investigation, however, it’s apparent that the market is largely an oligopoly. Italian-based Luxottica is the largest, with an estimated 500 million people wearing its products. The magnitude of this number is evident when one considers JP Morgan’s estimate that there are 1.7 billion vision correction wearers globally. Furthermore, Luxottica is vertically integrated across the supply chain, ranging from manufacturing to wholesale and retail distribution to vision insurance. Luxottica’s portfolio consists of several owned brands, such as Ray-Ban and Oakley, as well as licensed luxury brands, such as Bvlgari, Prada, Dolce & Gabbana, and Chanel. It owns retail stores including Lenscrafters, Pearle Vision and Sunglass Hut. Indeed, Luxottica also owns EyeMed Vision Care, one of the largest managed vision care operators in the US. Effectively, a customer could buy a pair of glasses manufactured by Luxottica in a retail store owned by Luxottica with insurance provided by Luxottica. It is this dynamic of being vertically integrated in a concentrated market that is key in allowing Luxottica and a few other large players to be price setters.
But it is this same dynamic that led to the conception of Warby Parker. Frustrated by the high prices of eyewear, the founders built a company that offers a reasonably priced, high quality alternative. Instead of partnering with licensing companies and selling through retail optical shops, Warby Parker designs its own frames and sells directly to consumers. Whereas polycarbonate prescription lenses and anti-reflective lens coating often come at a premium in traditional eyewear shops, Warby Parker incorporates these features at no additional cost. At the end of the day, the average frame plus lenses costs $300 at Lenscrafters (~20x more than it costs to make them), while Warby Parker charges $95 for a comparable product. This price point includes free shipping and a 30-day, no-questions-asked return policy.
In addition to providing the consumer with an attractively priced product, Warby Parker is aiming to make a positive impact with its “Buy a Pair, Give a Pair” program. According to the company, “approximately one billion people don’t have access to affordable glasses…which means that 15% of the world’s population is unable to effectively learn or work because they can’t see clearly.” The company provides funding and/or glasses to non-profit partners for each pair sold, and those non-profit partners provide glasses and training to low-income entrepreneurs in developing countries to start their own businesses selling glasses. Thus far, Warby Parker has donated 500k pairs of glasses to people in need, up from 250k the year prior.
Given the one for one nature of the program, we can conclude that Warby Parker roughly doubled its sales in 2013. While we’d be naïve to suggest that a relatively small startup is an immediate threat to Luxottica and the other industry heavyweights, it’s useful to examine what elements of the business model may be disruptive in the long-run. To be sure, Luxottica’s aforementioned vertically integrated business model and extensive portfolio of owned and licensed brands is a formidable barrier to entry. It is in part what has prevented other competitors, such as Costco and Wal-mart, from disrupting the status quo. Where these players excel in affordability, they lack in brand value and quality (or, at least perceived quality.)
On the other hand, Warby Parker offers a product on par with luxury brands and, perhaps more importantly, is building brand equity. The company’s founders say of all the metrics they track, they monitor the company’s Net Promoter Score most closely. This statistic, created by Bain & Company and Satmetrix, is a measurement of customer satisfaction. Warby Parker has “consistently been in the high 80s or low 90s” (on a scale of -100 to 100). It is this combination of an affordable, high-quality product and a brand that consumers respect that makes Warby Parker stand out.
Naysayers suggest that there will always be an audience willing to pay a significant premium to sport the logo of luxury brand. We agree. But there is also a segment of the population that simply desires a quality pair of glasses at a reasonable price. In 2011, The Vision Council, with the assistance of industry leaders, developed a questionnaire to survey whether eyewear users and buyers value the ‘fashion’ aspect of eyewear or the ‘medical-function’ of eyewear. The survey concluded that: 1) functional factors consistently outrank fashion factors (including brand/designer name); 2) about 6-10% of eyewear buyers explicitly mentioned the brand/designer name as one of the main decision factors in their most recent eyewear purchase; 3) of the surveyed respondents that purchased prescription glasses in the six months leading up to the survey, approximately 76% were more concerned with the ability of the eyeglasses to provide the best vision possible, while 24% were more concerned with the look/style/fashion of the glasses purchased. For Luxottica, this is the customer segment that is most susceptible to competition and potentially poses a risk with respect to lost sales and/or pricing pressure.
Another factor worth considering is the fact that online sales of eyewear is still in its infancy. Until recently, consumers were essentially forced to shop at brick-and-mortar stores to try on glasses. This is evident in the fact that less than 1% of Luxottica’s sales are online. However, with the recent improvements in virtual try-on technology, online sales are posting impressive growth rates. Should this trend continue, Luxottica’s position in the retail sales channel may be not be as robust as it’s currently regarded.
It’s clear that Luxottica has accomplished an impressive feat in dominating the eyewear vertical, and the company’s shareholders have been rewarded handsomely. We recognize that Luxottica isn’t standing still – the company is building out an online presence with virtual try-on technology and could put more effort in developing brands that compete at the Warby Parker price point. But herein lies the potentially disruptive nature of the Warby Parker’s of the eyewear industry. Should these newcomers force incumbents to cede market share or lower prices, what does this mean for pricing, volumes and margins? On consensus estimates, Luxottica is trading at 27x next twelve months P/E, a 30% premium to its peer group average and about 1.5 standard deviations above its historical premium versus the peer group. Given the premium valuation, investors would be keen to contemplate the potential long-term ramifications of an evolving market place. Like a good pair of glasses, investing is often about putting the right points into focus.
Michael Shavel, CFA is the Research & Business Analyst at Cornerstone Capital Inc. and a former Research Analyst on AllianceBernstein’s Global Growth & Thematic team.