Figs: The Ultimate DTC Company

Why the scrubs company is the best example of the possibilities of the DTC model

Hey everyone,
Greetings from Washington, D.C.!

Every now and then, a company comes along which shows why a particular business model should exist. One relatively recent example of this was Zoom, which had its IPO in early 2019 and showed how internet enabled tiny SaaS companies with deep engineering expertise can outpace the likes of Microsoft and Cisco.

There is another company that had its IPO earlier this week that fits the genre of business-model-affirming and follows in the footsteps of Harry's, Allbirds, and Warby Parker to take its rightful place in the DTC Hall of Fame — Figs (NYSE: $FIGS).

If you're not in the healthcare industry, you may not have heard of Figs before. But if you are, it is almost impossible to ignore their colorful scrubs with the subtle white crosses on a grey capsule-shaped background. And that's the point — Figs have created an amazing product for a historically ignored customer and in doing so, have created a cult amongst nurses. To top it all off, they have the rarest thing of all these days — a profitable direct-to-customer company at IPO!

In today's newsletter, I want to share their story, explore what led to their success, highlight some of the important numbers, try to predict what the future holds for the company, and the lessons that founders and investors can learn from Figs' success.

Lululemon walked so Figs could run

Founded in 1998, Lululemon did not become the ubiquitous customer brand for everyone from my yoga-loving friends to my friend's dads until the last half a decade. But it set customer expectations way before then. See this founding story from Figs’ website: 

The ah-ha moment happened when Co-CEO and Co-Founder, Heather Hasson was grabbing coffee with a friend and nurse practitioner almost a decade ago. She couldn’t believe that her friend, who spent 16-hour days serving others wearing boxy, scratchy, uncomfortable scrubs— and worse still — she didn’t have any options available to improve her situation. Heather could not help but think about how many apparel companies were focused on giving professional athletes every possible advantage through cutting-edge materials and purpose-driven designs. So she thought: What about the people saving lives? Who is focused on them? With a background in fashion, Heather set her sights on revolutionizing the industry by creating technically advanced apparel and products for the modern healthcare professional. 

This is something we see all the time in markets. One player moves the entire market forward. Apple launched the original iPhone in 2007 with touchscreens and we have never looked back. Amazon made two-day free delivery an expectation and now every e-commerce company has to cut into its margins to meet those expectations. In a similar way, Lululemon made comfortable and functional apparel an expectation for those willing to pay the price premium. If they wear already wearing a brand like Lululemon for their workouts, why should nurses expect any different from their day-to-day uniform?

From that "ah-ha" moment, Heather recruited co-founder Trina Spear. They bought an initial inventory using their personal savings and sold their now-iconic scrubs from the back of a van in the parking garages of hospitals. The rest, as they say, is history.

The canonical DTC company

What I like most about Figs is that it is a company uniquely enabled by the internet. It's not that scrubs did not exist before the internet, but that the end user of the scrubs was not necessarily an important stakeholder in the design and purchasing decisions.

Before the internet enabled a company like Figs to reach out directly to nurses and other healthcare professionals to sell scrubs, there were mass-market scrub makers which would sell directly to hospitals. So some accountant in the finance department of a hospital would make the decision of what scrubs all the nurses would wear for the whole year based on little more than numbers on a spreadsheet. Even if nurses were asked to buy their own scrubs, little variety existed in the market because it was not profitable to create high-quality technical apparel if you could not reach the target audience at a reasonable cost.

The old models of advertising such a product would be to put out an ad in the newspaper, buy a banner in front of hospitals, purchase some airtime on the local radio, or put up flyers in high-visibility areas. But it was tough to measure the impact of any of these initiatives. Moreover, you were competing against products that had much more mass appeal compared to your relatively niche market. If Proctor & Gamble wanted to buy the same advertising spot on a newspaper for $10, it made a lot more sense for them to buy that space because they would likely see a much higher return for it since they have a much broader customer size compared to your target customer of nurses.

For all its ills, internet-enabled targeted advertising enables a company like Figs to exist by allowing them to market in a targeted way to customers who are much more likely to be nurses. And it allows them to do so without having to compete with a behemoth like P&G.

Simple put, with Facebook and Instagram, Figs would not exist¹.

Enabled by this targeted advertising, a company like Figs can engage in a bottoms-up selling strategy. Instead of a company having to convince someone in accounting that buying their scrubs makes financial sense, Figs has to convince nurses that their scrubs are superior. In some ways, it's a tougher problem — you have to do the selling one-on-one to each individual customer. But word-of-mouth marketing exists, and it particularly exists for Figs. From their S-1 filing²:

Hospitals and other healthcare institutions, which often employ thousands of healthcare professionals working in close physical proximity on a daily basis,serve as ideal environments for growing awareness of our brand through word of mouth.

Figs have executed so well on this vision of "cutting-edge materials and purpose-driven designs" and word of mouth advertising that the numbers are very pretty.

When the numbers are this pretty

Let's look at the heart beat of every DTC company — the direction of the metric which determines whether or not the founder and the executive team sleeps well at night or not — the Life Time Value to Customer Acquisition Cost ratio, or the LTV: CAC ratio.

While they don’t share LTV, they do share a proxy metric — net revenues per customer and Figs' have been steadily increasing. In 2020, they made $202 dollars per customer on average and spent only $39 dollars acquiring them. This was up from $168 of net revenues and down from $101 in 2018, respectively.

This has allowed them to get to a place where every DTC e-commerce company wants to be — a customer is profitable on their first purchase. From their S-1:

In 2020, we successfully increased our marketing efficiency such that we achieved 1.3x our CAC on a customer’s first purchase contribution profit.

Okay, so the company is acquiring new customers efficiently. But taking a step back, this is not the only way that a company can continue to grow. Another way is to sell more to existing customers. Figs is doing this well too.

As a percentage of total net revenue, revenues from existing customers has become an increasing part of the pie — from 44% in 2017 to 62% in 2020. This means that existing customers are not just satisfied from the current offerings, but are willing to try out more products from the same brand — not always a given in the DTC universe.

The secret to this financial success is two-fold.

First, they have chosen a good market. Nurses are a neglected customer base who have the financial resources to try out something better. The average resident nurse's salary in Washington, D.C. is $94,820³ which is almost double the average individual income of $49,542 in the city⁴. Figs also don't believe affordability to be an issue. Again, from the S-1:

As a testament to the affordability of our products, in 2020, approximately two-thirds of our customer base earned less than $100,000, and approximately one-third of our customer base earned less than $50,000. Due to the high proportion of our customer mix that is comprised of students and young professionals whose earnings will grow over the course of their careers, we believe we are well positioned to retain and increase engagement of these customers, expanding our share of their uniform and lifestyle wardrobe over time.

Add to this the fact that nurses wear scrubs every working day for hours on end which means that they would be willing to pay a premium for better comfort and quality, and you’ve got near-perfect product-market fit.

The second is that they have expanded out from their core products to offer limited edition scrub styles and other lifestyle products like socks, jackets, and athletic wear. These currently only form about 18% of net revenues, but that number is likely to increase as the company expands. These products are also likely to have higher margins⁵ and so the profitability profile of product mix goes up over time.

This combination of profitability at first purchase, strong cohort performance, a solid core market, and the potential to expand into others profitable products makes Figs a benchmark for DTC apparel companies.

Future of Figs

The new Drake song asks the proverbial question, "What's Next?" In the case of Figs, what’s next looks pretty good. They will continue to execute on their playbook of acquiring new customers and selling adjacent products to existing customers. Let's breakdown what those two will look like and what potential risks might the company have to mitigate:

1. Acquiring new customers: This can be a tricky thing to do. Companies typically acquire their best customers first and the marginal customer needs an increasing level of convincing (read: marketing dollars) to be acquired. One of the better strategies here in Figs' context would be to acquire customers in previously untapped markets. International growth can certainly be a big portion of this but selling to more rural parts of the country would likely also be more dollar-efficient.

2. Selling more to existing customers: The adjacent product strategy, coupled with limited edition drops and thoughtful partnerships, is pretty much the standard playbook right now. What will be interesting to see is if they can execute it in a way that companies like Allbirds have. Reputational risks are also really important to manage given the word-of-mouth nature of their marketing. A bad report on their manufacturing practices and/or examples of their products not performing well could have higher-than-average impact on the willingness of existing customers to refer others when the job at hand is literally dealing with life and death situations.

As things stand right now, I don't believe competitor risk is a really thing for Figs today, as it has far more brand recognition than the other players. It is still in the early innings of eating into the traditional top-down scrubs market. 

Lessons for founders and investors

A well-executed strategy offers many lessons for investors and founders. Here are three that I took away from Figs:

1. Look at a highly regulated industry where barriers to entry are really high and build around it: Healthcare tech companies are notorious for being difficult because of the slew of regulations and barriers. But given that the healthcare industry is so large, not all of the economic value is in the core service of providing healthcare. You can build in the adjacency of such a large market and have a great product that appeals to a subset of stakeholders in that market. Another company that comes to might here is RigUp, created a marketplace for on-demand services and workers in the oil and gas and alternative energy sectors, and was later rebranded as Workrise to expand into the broader market of blue-collar jobs.

2. Apply what's happening in other industries to your domain: Around the time when Heather and Trina started Figs, there was a surge of DTC companies being started in every industry. They became the leaders in scrubs which underscores the massive first mover advantage.

3. Keep it simple stupid: Too many companies launch a skew of initiatives and fashionable products before nailing down what their company will be built around. Focus remains underrated. 

Figs seems to be getting rewarded for all the good work they have done by Wall Street. They closed their IPO week 22% up from the initial listing price of $22, valuing the company at more than five billion dollars. As always it is with IPOs, it'll be interesting to keep up with the next phase of their growth and how they deal with being a publicly traded company.

Until next Sunday,
Sid

1. This is the key point missing from the popular discourse in the fight between Apple vs. Facebook on the in-app “tracking” changes in the new version of iOS. Would the average person who hails Apple as “a protector of privacy” know about how this move would stifle businesses like Figs and many others like it which are currently able to profitability reach their customers? It’s fine if they decide that even given the potential death of theses businesses that Apple should go ahead with the decision — that tracking is so fundamentally pervasive to our right to privacy that nothing should supersede it — but my intuition (and a few conversations with people who don’t follow these developments very closely) says otherwise.

2. Link to the S-1, all numbers and figures are sourced from here

3. Average Nurse Salaries, by State

4. Washington, D.C. Median Salaries

5. To quote the 2012 Macklemore classic: "Limited edition, let's do some simple addition"