Grocery Retail Valuation with Dan McCarthy – Grocery Podcast S4 E10

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Grocery Retail Valuation with Dan McCarthy – Grocery Podcast S4 E10

Sylvain and Mark begin by discussing two big developments in the grocery industry. One is Amazon’s launch of “pay-by-palm” technology at Whole Foods.

The other is the entry into the market of what Mark calls “pure eGrocery” companies — online companies that sell food direct to consumer. The pair look at the example of Misfits Market, which recently raised $200 million in series C funding, speculating on the implications for other industry players as well as how the valuations are derived.

To shed some light on the issue of valuations is this week’s guest: Dan McCarthy from Emory University, whose research interests include customer lifetime value and marketing finance. Dan has popularized a valuation methodology known as “customer-based corporate valuations,” or CBCV.

What is CBCV? In Dan McCarthy’s own words:

“It’s really helpful to know what total revenue is, but it’s even more helpful and more diagnostic to be able to break it down into all of the underlying customer behaviors that brought that revenue about. Customers being acquired, staying with the firm, placing orders, having some spend associated with the order and then having that spend flow through into variable profits.”

Dan’s research suggests that by assessing revenue durability this approach can uncover value that’s not always evident from traditional financials — or conversely, identify overvaluation. To illustrate how this plays out, he compares two online marketplaces, luxury goods retailer Fartech and ridesharing company Lyft.

Dan McCarthy also notes that this approach is starting to gain traction, with more analysts and including customer disclosures in some form in their reports. Sylvain wonders whether there are barriers to using this model. Dan replies that data availability is a potential barrier for grocers.

The conversation then turns back to those food retailers with very large valuations. Sylvain asks what’s driving these valuations. Dan McCarthy says it’s in part a function of the nature of grocery:

“The market size that we’re talking about here is going to be tremendous because we are talking about people buying food and obviously people spend not only a lot of money on food, but it’s also a very regular purchase.”

When customer lifetime value is large, and the model scales well, these companies can use the concept of network effects to sell their story, and a virtuous cycle sets in.

Discover how regional grocers can use CBCV, even if they don’t have full customer data, by tuning into the podcast.

 

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Daniel McCarthy, Assistant Professor of Marketing, Emory University, Goizueta School of Business

Daniel’s research specialty is the application of leading-edge statistical methodology to contemporary empirical marketing problems. His research interests include customer lifetime value, limited data problems, and the marketing/finance interface.

He popularized “customer-based corporate valuation” (CBCV), a methodology that drives any traditional valuation model off of the underlying behaviors of the target company’s customers. His work has been featured in major media outlets such as the Harvard Business Review, Wall Street Journal, FT, Fortune, Barron’s, Inc Magazine, the Economist, and CNBC. His research has been accepted and published in top-tier academic journals and has won numerous research awards.

In addition to his roles and responsibilities at Emory, Dan co-founded and was Chief Statistician for Zodiac, a predictive customer analytics SaaS firm. Nike acquired Zodiac in March 2018. Dan has since co-founded Theta Equity Partners to revolutionize how firms (e.g., private equity, venture capital, and operating companies directly) value companies through CBCV.

Photo of Daniel McCarthy

Sylvain Perrier :
Ladies and gentlemen, welcome to Digital Grocer. Mercatus’ very own podcast. Season four, episode 10. It is amazing to have you joining us here again. I’m your host, Sylvain Perrier. President and CEO of Mercatus. And joining me as always is Mark Fairhurst, our VP of marketing.
Mark Fairhurst:
Hey, folks.
Sylvain Perrier:
Mark, you are wearing some new headphones. I’m just really jealous.
Mark Fairhurst:
Well, I think for four seasons, I had headphone envy. So I figured I’d one you up.
Sylvain Perrier:
Well, you’ve one upped the industry, maybe with those new Apple headphones, so that’s awesome. That’s great.
Mark Fairhurst:
Just don’t tell my wife.
Sylvain Perrier:
I will not tell your wife. We’ll have to do some sort of product review show, I think at some point.
Mark Fairhurst:
Absolutely. She doesn’t watch the show, so I’m pretty safe.
Sylvain Perrier :
You’re safe, you’re safe. That’s great.
Mark Fairhurst:
Okay.

Grocery news: Amazon’s palm-scanning and Misfits Market valuation
Sylvain Perrier:
Mark, there’s a lot going on in the industry right now. So kind of two big things. Number one is, I don’t know if you saw this, but this was reported at a progressive grocer. Amazon launched what they call the pay by palm technology and it’s going to be launched at Whole Foods. So if you’re checking out, you magically wave your palm over something. I’ve seen pictures of it and your biometrics are tied to your payment. So this is a rehash of some technology that was originally launched between I believe, ’02 and then the demise of the economy in ’08 by a company called Pay By Touch out of San Francisco. They had raised over, call it 300 million US.
Sylvain Perrier:
I remember seeing the technology firsthand in some of the labs over at Food Lion in Salisbury, North Carolina. I know that Pay By Touch had done a massive launch across Cub Foods and the technology had some challenges and specifically, when it got too cold or too humid outside. This isn’t new for Amazon. I don’t see this as being really refreshing. It’s just a rehash of what we’ve seen in the past, but I’m kind of curious where this is going to go.
Mark Fairhurst:
So is it actually your palm print? You have to register that on … Really?
Sylvain Perrier:
Yeah. And apparently, for security purposes, you can do both.
Mark Fairhurst:
Wow.
Sylvain Perrier:
Yeah.
Mark Fairhurst:
There’s no Logan’s Run chip in the palm, is there?
Sylvain Perrier:
No, not yet.
Mark Fairhurst:
Okay, good. [inaudible].
Sylvain Perrier:
Oh, don’t even go there. I can just imagine what you could do, but it’s crazy.
Mark Fairhurst:
Yep.
Sylvain Perrier:
Now, the one thing that you and I have been talking about, this is the second thing I just wanted to raise before we get into our core subject here is, we’re seeing a lot of what I like to call pure eGrocery entrants coming into the market. So these are companies that are selling food online. It could be perishables, non-perishables. Delivering them to consumers and they are not leveraging the brick and mortar operators, they’re going direct to consumer. And one right now that was just announced Misfits Market. They just revealed that they raised 200 million in series C funding.
Mark Fairhurst:
That’s insane.
Sylvain Perrier:
Yeah. Well, they did over five million deliveries in the last 12 months.
Mark Fairhurst:
Wow.
Sylvain Perrier:
And all in, they’ve raised over 310 million. This puts a lot of pressure on the brick and mortar operators. It puts even more pressure on the companies like Instacart that quite frankly, they’re bridging the gap by leveraging the retailers. It continues to point that they may have to go direct to consumer.
Mark Fairhurst:
We’ve all heard the rumors, the speculation that, that’s the next logical step. And to be honest, I think this is something that we should delve into.
Sylvain Perrier:
Yeah.
Mark Fairhurst:
It’s always interesting to delve into speculation, but you got to think there’s a strategy here and they’re putting the building blocks in place, definitely.
Sylvain Perrier:
Yeah. I would agree with that. The one thing that you can’t deny, as we hear these stories about these organizations that are raising a significant amount of capital, that at some point, they’re going to have to prove a return on the investment to their shareholders. Whether that’s an IPO, whether that’s somebody buying them out, who knows what where that’s going to end up? But the one thing that really continues to baffle me, as this industry continues to unfold. Specifically, around this level of technology, is how are these organizations getting these valuations and out of thin air? These valuations, are they really fundamentally based on revenue durability?
Sylvain Perrier:
Now, I’ve worked with the KPMGs and the PWCs of the world and you give them three years of financial statements, discounted cashflow, and then they come back and say, “Oh, your company’s worth this much.” And you’re like, “Okay, that’s great. That’s fine.” But what about the underlying structure? What about the underlying principles of the business? What about the customers that are being serviced underneath the business and so on? I think there’s a different way of thinking about this. Now, to help us kind of decode this, we’ve decided to invite a very special guest who can really help us understand what’s the impact on the industry. What’s the impact, if you’re an investor and how does this affect our food retailers that are operating brick and mortar?
Sylvain Perrier:
So we’ve asked Daniel McCarthy, Daniel is an assistant professor of marketing at Emory University. His research specialty is the application of leading edge statistical methodology to contemporary empirical marketing problems. His research interests include customer lifetime value, limited data problems and the marketing finance interface. So he’s popularized customer base, corporate valuations also known as CBCV. It’s a methodology that drives any traditional valuation and model off the underlying behaviors of the target company’s customers.
Sylvain Perrier:
His work’s been featured in major media outlets, such as a Harvard Business Review, Wall Street Journal, Fortune, Barons Inc magazine, the Economist and CNBC. His research has been accepted and publish in top tier academic journals and he has won numerous research awards. In addition to his role and responsibilities at Emory, Dan co-founded and was chief statistician for Zodiac, which I love that name by the way. It’s a predictive customers’ and analytics SaaS firm that Nike acquired in March of 2018. And Dan has, since co-founded Theta, and I’m probably not pronouncing this right. Equity Partners to revolutionize how firms value companies through CBCV. Dan, welcome to Digital Grocer.
Dan McCarthy:
Thanks so much for having me. Going back to the names first, Zodiac was not actually our original name. It was actually originally CLVmetrics. And this is kind of obviously a segue into what we’ll be talking about today. Basically, our VC backers said, “That name is way too specific for what you’re looking to do.” So we had to change it. Zodiac was kind of iteration number two and the new firm Theta Equity Partners, like the Greek letter.

Guest Dan McCarthy explains CBCV – customer-based corporate valuations
Sylvain Perrier:
Oh, great. Great. Thank you so much for joining us. For our audience, can you help us understand and can you explain CBCV?
Dan McCarthy:
Yeah. The fundamental premise behind CBCV is, every dollar of revenue has to come from a customer that has been acquired and is making purchases with some spend associated with a purchase. And if, you just kind of sum up all those spends across all the customers that has to give you revenues. And so when you talk about, the KPMGs of the world, looking at traditional financial statements. Basically, what we’re looking at there is just total revenue. And what we’re saying is, “Sure, it’s really helpful to know what total revenue is, but it’s even more helpful and more diagnostic to be able to break it down into all of the underlying customer behaviors that brought that revenue about.” Customers being acquired, staying with the firm, placing orders, having some spend associated with the order and then having that spend flow through into variable profits.
Dan McCarthy:
And when you [inaudible] that way, you can be able to uncover value that may not be quite so evident, if you were just looking at traditional financials. And so you could have companies that are losing a significant amount of money who we would infer would be significantly, very, very valuable because we can understand that say, the underlying customer unit economics are looking good.
Sylvain Perrier:
And Dan, can you give us an example of something off the top of your head that could reflect an example of CBCV?
Dan McCarthy:
Yeah. There’s a handful of analysis, when you talk about marketplaces and we’ve done a number of analysis of marketplaces, including Lyft and Farfetch. Farfetch is a luxury retailer, obviously Lyft is far better known. But the premise behind both companies is that, the company itself is kind of a middleman. They operate between the buyers on the one side and really the sellers on the other. It just depends on the product and service that’s being offered. So what’s interesting was in both of those cases, the companies were significantly unprofitable, but we saw that the underlying repeat behavior of the customers at both firms specifically for us with Lyft, it was the riders. And then at Farfetch, it was with the buyers. That they tended to come back and not only do they come back, but they actually, over time, they tended to expand the amount of business that they did with the firm, so even though they were losing money.
Dan McCarthy:
A lot of the reason for that was because the firms were spending a lot of money upfront to bring in new customers that tends to be fairly expensive, but they were then getting these very profitable repeat purchases from existing customers. We were just basically doing this exercise. We said, “Let’s train a series of statistical models for future customer acquisition, retention, ordering and spend.” And we could just see that the proportion of profitable repeat orders would continue to grow. And so assuming that these companies were able to penetrate the markets like they should, they should be able to create operating leverage and grow themselves in profitability. So ultimately, we were able to kind of form that more positive assessment because we could understand what the underlying kind of customer driven drivers of the business were.
Dan McCarthy:
I guess the final point that I’d make, just to kind of round out those two examples. In the case of Farfetch, we ended up inferring that their IPO price was too low, that actually they were worth more than the market was describing them at the time of the IPO. For Lyft, we inferred that they were a very valuable firm, but not quite as valuable as the public markets had been suggesting. So in one case, we were bullish, in one case we were bearish. Obviously, it doesn’t mean that we’re always going to assume that these companies undervalued. The underlying framework, I think holds very, very nicely, whether we’re talking about marketplaces or whether we’re talking about more traditional businesses that you primarily operate on one side of the market.

Is CBCV catching on with financial analysts?
Sylvain Perrier:
Are you finding Wall Street or in Canada Bay Street, as it’s more known, that they’re willing to actually use a model like this in industry for evaluations?
Dan McCarthy:
It’s still, I’d say an under appreciated way of looking at the world. But I would say that we now have basically spoken with a number of sell side investment banks and some of them, like sell-side equity research analysts are featuring our measures and analysis in their reports. So I think we’re seeing a lot of progress. I’d say the other area, which has been very promising, for those who follow me on social media, I’m kind of like a birdwatcher when it comes to customer disclosures. And so we have all these companies that have been going public recently and in their pre IPO prospectuses, in their S-1 filings, they all just kind of take a once through to see what they’re putting in there. And very frequently now, I’d say it’s more the norm than not that we see a whole bunch of really nice customer disclosures to do the following. And so while that’s not specifically customer-based corporate valuation, it’s the fuel that we need. It’s the data that we need to be able to run the models. And the fact that we’re seeing those metrics come up with so much more regularity. I think it’s a testament to people looking at the world increasingly this way.
Sylvain Perrier:
And is there a specific barrier? I mean, you’re talking about how data is now becoming more disclosed and so on, but is there a specific barrier that would prevent some of the research analysts or the equity analyst wanting to use such a model?
Dan McCarthy:
Yeah, I’d say, the biggest one … I’d say there’s two, the first is data availability. Obviously, when you’re talking about primarily about groceries, this could be a real issue at companies in general that have a lot of physical brick and mortar presence. And so, when we’re thinking about that regional grocer, there’s just some additional work that we need to do because if a customer comes in and pays in cash, or maybe even pays in card, just depending on the privacy. The privacy protecting mechanisms that the company has in place, the company won’t necessarily know who that customer was. And so obviously, everyone’s trying their best to be able to tag and track more and more of what their customers do.
Dan McCarthy:
But ultimately the smaller the proportion of orders that you can link back to people in your customer file, the harder it is to be able to use this. Or essentially, what you’d need is, you need some way to be able to probabilistically attribute those orders to customers in the file. But if, you have to do all sorts of mathematical gymnastics, then suddenly that becomes a bit harder let’s say, in SEC filings.
Sylvain Perrier:
Right. Right.
Dan McCarthy:
From a data standpoint, that’s probably the biggest issue. Obviously, there’s the other kind of somewhat small issue of actually getting people to kind of embrace the methodologies that we would need to run these models. I think we can all kind of philosophically agree revenue comes from customers. There’s this deep proposition, but sometimes math can be a little bit of hard. And so there’s kind of an education process that we need to go through, where we kind of train the next generation of analysts to be able to use these methods and actually be able to crank out evaluations this way. And because we’ve kind of done it the standard way, the traditional way for so long, it’s going to take time for that change to take place. I think that there’s enough competition in the marketplace now that we will see this change over the next bunch of years, but ultimately, there is some inertia that we’re going to need to kind of overcome.
Sylvain Perrier:
And that’s great.
The role of customer lifetime value in valuations
I have a question for you. This industry in food retail has, I would say a strong presence of a lot of unicorns. Companies, valuations or north of a billion dollars. And I know that you’ve done a tremendous number of reviews of these, of companies that have gone public and so on. What do you think is driving these valuations for these companies and where they’re raising tremendous amount of capital?
Dan McCarthy:
Yeah. For one, I think there’s the need for that capital. A lot of these companies are losing a lot of money.
Sylvain Perrier:
Mm-hmm (affirmative).
Dan McCarthy:
And obviously what they would say is, they’re making investments in their own future growth. And as long as they’re able to acquire customers that have positive customer lifetime value, then in theory, they really should be making those investments. But it does mean that they need to raise capital. And so the fact that you are seeing these companies raise these very big rounds, in part it’s because they need the money. In terms of being able to get very high valuations, we would say that’s a function of the underlying unit economic health of the business. I’d say the good thing is, almost everyone would agree. The market size that we’re talking about here is going to be tremendous because we are talking about people buying food and obviously people spend not only a lot of money on food, but it’s also a very regular purchase.
Dan McCarthy:
If you do have a way of being able to tap into kind of the regular ongoing need of consumers, you can very easily see how customer lifetime value can end up being very large. For them, the big question then is being able to show that the model scales very well. That they’re able to, at least when they’re at scale, turn a very strong economic profit on each new customer that they bring in. And I think that they do rely very heavily on selling the story of network effects. That the bigger that they get, the easier it is and the cheaper it is to bring in customers and the more customers that they have, the easier it is for them to bring on board suppliers for cheaper. And there’s kind of this virtuous cycle that can happen.
Dan McCarthy:
So I think specifically with marketplaces because of the prevalence of network effects, it’s very easy to kind of say, “Well, if this company does end up making the model work they’ll be tremendously valuable.” So I think the big question then becomes, can they get to that scale? When you’re talking about a more traditional one-sided market, every business has some elements of network effects. You can always kind of negotiate a little harder with your suppliers, et cetera, et cetera. But the intensity of those network effects is much lower. It’s a little bit easier to rely on kind of more standard traditional ways of thinking about valuation in the customer. I think that compare and contrast is why we’re seeing big rounds being raised and oftentimes it’s in fairly high valuations.
Sylvain Perrier:
Absolutely. And I got to think enough, if I take Instacart as a comparison because of the strength of their network effect. The more push they have and pull against the vendors, the CPGs, which could be to their benefit. But it’s also probably a significant detriment to the grocery retailers themselves.
Dan McCarthy:
Yeah. They get a lot more negotiating leverage.
Sylvain Perrier:
Absolutely.
Dan McCarthy:
Yeah. They can negotiate much stricter terms. Obviously, they can kind of maintain their commission rates or even expand them. Then they pitch themselves as a new customer acquisition channel in their own right. They’re not just simply a means of being able to get your order from Whole Foods without having to go into the store. You’re getting whole new people who never would have gotten Whole Foods. So the extent they’re able to preach that, they’re definitely able to extract a lot more surplus from those retailers.

How can regional grocers use customer data in financial disclosures?
Sylvain Perrier:
Absolutely. Now, could this model apply itself to a publicly traded grocery retailer, like a Kroger or Safeway Albertson or so on?
Dan McCarthy:
It definitely could. I’d say there’s a few different ways that we think about it. So for one, there’s kind of the disclosure question, which I’ve kind of been alluding to a few times now. So what can Kroger put in their filings? Well for one, they can put in figures about their member base. And so to the extent that they’ve got loyalty programs, they can talk about the activity of the members of the program. There’s a lot of apparel retailers that are doing similar thing. They have the same sort of issue that they can’t tag or track everybody, but they can and do provide figures about the members. And for the companies that are more successful, actually, they’ve gotten to the point where you they’ll have 90% or more of the sales coming from members. People can basically say, “It doesn’t represent every single person, but it is representing the vast majority of the business. And so I can be able to take all those figures that they are providing me about the loyalty program and just kind of generally treat that as the business.” Plus or minus a plug.
Dan McCarthy:
From a disclosure standpoint, I would hope that regional and other groceries would do the same thing. When it comes to investing, obviously if the members represent 90, 95% of revenues, excellent. You can just basically plug those figures right in and use the sort of methodology that we will very regularly use, where we take those SEC disclosures and use them to back our way into customer retention, customer lifetime value. What’s the acquisition costs, et cetera? If you don’t have that level of disclosure, typically, what we’ll do is we’ll go to you what we call alternative data sources. So this would be a credit card panel data sets, where essentially companies they’ll … If you’re working with Mint.com, something like that. Implicit in their terms of service they say, “We’ll sell your data on.” And in these firms, basically you can see kind of your credit card statement for four to six million people over many years.
Dan McCarthy:
And so I can see directly the Kroger purchases on the credit card statement, I can see that over time. And so I can basically, use something like that to help drive my model and see customer retention, even if that customer was making that credit card purchase off of the loyalty program. So yeah, so data sources like that could be another way to kind of back your way in, when you’re using that in conjunction with whatever traditional financial measures, like those companies may have been providing.
Sylvain Perrier:
That’s great. Thank you so much. The subject matter is very enticing. How do people get ahold of you?
Dan McCarthy:
The best two places to get ahold of me, one is on LinkedIn. So if, you just search Daniel McCarthy, Emory. You’ll pull me up. Obviously, you got the LinkedIn link down over here too. Twitter is the other big one. I’ll typically post on both, I’d say I post with more regularity on Twitter. So D_McCar, M-C-C-A-R. That’s where you can reach me there.
Sylvain Perrier:
Well, thank you so much for joining us today. And Mark, how do people get ahold of us?
Mark Fairhurst:
Yeah. Thanks, Dan. That was great. You can get ahold of us at digitalgrocer.com. We’d love to get your feedback. Make sure you subscribe to our YouTube channel, hit the like button, so you get notified anytime there’s a new show. You can also reach us mercatus.com.
Sylvain Perrier:
Folks, don’t forget to tune into our next show, which I’m sure we’re going to be tackling a riveting subject. Peace out.

 

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