Interesting analysis, thanks for sharing. I don't have an insurance background, but I do come from the SaaS marketing world.
From that perspective, your modeling makes sense, but it leaves me questioning the core assumption behind your conclusion:
> "Lemonade has a great product. I personally enjoy using their app - its smooth, incredibly user friendly, and turns a chore into a pleasant task. Lemonade’s revenue growth has been incredible thus far. Despite the tear-down above, I think there is strong product market fit and the target market appreciates the value proposition. Unfortunately, at this stage of a company’s life and the current environment, public investors will not view widening losses in a positive light."
Given the uncertain environment, is possible that investors are taking a longer-term view of what is needed to establish a new leader in the saturated insurance vertical? You acknowledge the strength of their UX, and it seems they've been investing in building their brand and not just focused on performance marketing. Done effectively, this would continue to deliver efficiency improvements to CAC in the years to come if they can cement themselves as a household name that is a good alternative to State Farm and the like.
Based on that, I'm curious what CAC trajectory they would need to have (and by extension how realistic that looks for their channel-level marketing performance) to get investors excited.
I haven't read the S1, but I'm also curious how their fundamentals compare to other insurers. Is this a company that wants to be valued like a tech company and deserves it? Or should they be valued like a more traditional insurance company?
Does their approach give them a unique avenue to sell in higher-margin products and services that will flip the current assumptions on their head?
The institutional investors whom Lemonade's exec team will be pitching to on the road show in a few weeks will be long-term focused. The bankers are likely pitching to insurance-focused and technology-focused funds. The investors will ask questions about normalized loss ratios, margins, etc. to determine the run-rate cash flow and ultimately the end-state profitability of Lemonade.
The problem is investors will certainly appreciate an emerging leader in a traditional space with a good product & brand presence. However, I think at the end of the day this feels eerily similar to some aspects of WeWork's story. The insurance (WeWork - real estate) investors will negatively view the near-term cash hemorrhage, and the tech investors will puke at the normalized, future margin profile.
You come from the SaaS world, so you appreciate the low marginal cost of distributing a SaaS product (Ben Thompson fan, anyone?). This means high gross margins and initially large Sales & Marketing spend to acquire customers, but then decreases as percentage of revenue as 1) customers are locked into your platform and their business processes rely on the product) and 2) cash generated from high margin business can fund future growth.
This is not the story at Lemonade. Much like WeWork, there is a ceiling on their gross margins. They are at ~17% right now gross margins, driven by a ~70% loss ratio. This loss ratio is near-industry historicals, and unlikely to materially change. This is similar to WeWork, Rent + Operating Expenses of buildings were ~70-80% of revenue. Compare both to a SaaS company gross margins of 80%. I just can't see investors being excited about this, even if they do inexpensively grow market share. Lemonade's loss profile is similar to competitors, but they have nowhere near the spending power on advertising & customer acquisition needed to make the insurance model work.
Regarding your thoughts on CAC, I think Lemonade is working hard on improving their S&M channel efficiency, and this is evident in Q1. However, my problem is insurance is inherently a high-need, low-value industry. The need for insurance is acute, but the general population places very little value in the activity of seeking out the best insurance experience. You purchase insurance and hope you never interact with the insurance company again. Does brand really matter past the initial, fervent adopters? Furthermore, the value proposition not only has to be clear, but also meaningful to capture people's attentions and make the switch.
I believe CAC will continue to increase if Lemonade intends to grow at their historical pace. For the past 3 years, Lemonade has attempted to market themselves as an anti-insurer, which is great, but the reality is the U.S. market is broker and traditional marketing channel dominated. Insurance lacks organic growth because its inherently a low value activity compared to Facebook, Uber, etc. If they don't spend to capture mindshare, its challenging to see people promoting their product naturally. To get investors excited, Lemonade needs to 1) capture market share inexpensively, 2) through ML/AI, decrease their loss ratio vs. industry average, and 3) allocate capital more efficiently as they are giving away 75% of their premiums under a new deal starting June 2020.
I'm not entirely sure what the answer to a higher-margin insurance product is for them. Lemonade mentions getting into pet, auto, etc. Sure, customer upsell seems easy, but still a very different product, and like I mentioned above, loss ratios are loss ratios. Shit breaks or things go wrong eventually and no amount of pricing risk correctly is going to make that decrease unless you reject higher-risk customers.
Traditional insurers trade on Price / Book, and also Price / Earnings. Allstate trades at ~10x price to earnings, and Progressive trades at ~13x.
Really insightful--thanks for the thoughtful response.
Are there certain new product avenues they could explore that larger traditional insurers may not be well-positioned to because it just isn't in their organizational DNA? Or is the answer to that "money" and the existing insurers choosing not to pursue ideas because it doesn't make enough for them to care?
Yup, Lemonade is certainly has the advantage of being more flexible and nimble. I've spoken / worked with larger insurers and they are hampered by the amount of manual processes and bureaucracy that are typical for +50 year old corporations.
Lemonade's competitors also do most types of insurance, there aren't very many large private or public insurance companies that only focus on renters, homeowners, etc. The power is in the bundle and upselling a suite of insurance products to the customer you've already spent the CAC to acquire. With this comes more data to better underwrite deals, and the cycles goes on.
Lemonade has mentioned looking into niche products like pet, phone, etc. Sure, they can carve out a nice space for itself, but the reality of those products is its low premium, low addressable market stuff so its not the most efficient use of capital for large insurers.
One major piece Lemonade is also missing is the traditional float an insurance company has. Even if loss ratios + expenses are 100% of premiums, insurance companies can still generate returns on the massive amount of float these premiums generate every year.
From that perspective, your modeling makes sense, but it leaves me questioning the core assumption behind your conclusion:
> "Lemonade has a great product. I personally enjoy using their app - its smooth, incredibly user friendly, and turns a chore into a pleasant task. Lemonade’s revenue growth has been incredible thus far. Despite the tear-down above, I think there is strong product market fit and the target market appreciates the value proposition. Unfortunately, at this stage of a company’s life and the current environment, public investors will not view widening losses in a positive light."
Given the uncertain environment, is possible that investors are taking a longer-term view of what is needed to establish a new leader in the saturated insurance vertical? You acknowledge the strength of their UX, and it seems they've been investing in building their brand and not just focused on performance marketing. Done effectively, this would continue to deliver efficiency improvements to CAC in the years to come if they can cement themselves as a household name that is a good alternative to State Farm and the like.
Based on that, I'm curious what CAC trajectory they would need to have (and by extension how realistic that looks for their channel-level marketing performance) to get investors excited.
I haven't read the S1, but I'm also curious how their fundamentals compare to other insurers. Is this a company that wants to be valued like a tech company and deserves it? Or should they be valued like a more traditional insurance company?
Does their approach give them a unique avenue to sell in higher-margin products and services that will flip the current assumptions on their head?