Resources used in this article:
• 2018 10-k | The 10-k starts on page 93. The preceding 92 pages are the proxy statement.
• Financial statements | Income, balance sheet, and cash flow statement. You can’t edit, but you can copy and make your own.
• 2018 analyst day slide presentation.
iRobot (IRBT) is the best known public company and market leader in the consumer robot category. Their most popular product is the Roomba(left picture).
iRobot is a consumer robot company that designs and builds robots that empowers people to do more both inside and outside the home.
A more complete overview can be found in their 10-k; pg. 94 of the document. The first 93 pages of the PDF is the proxy statement.
(click chart to enlarge)
Since reaching $110/share in 2017 the stock has fallen ~50%; though it has rebounded from its lows. As long as $50 holds, the risk/reward favors being long in my view.
What products do they sell?
They have three main products:
• First up are their vacuuming robots. These robots range in price from $299-$899.
• They are designed to clean floors, under toe kicks, beds, and other furniture.
• These robots are designed to eliminate the need for manual vacuuming and can be used by the push of a button or through scheduling. (A disruptive innovation?)
• Their second product category is mopping robots.
• They range in price from $199-$299.
• These robots automatically dust and damp mop hard surface floors using popular cleaning cloths or our specially designed reusable microfiber cloths, and include a special reservoir that dispenses liquid throughout the cleaning cycle to keep the cloth damp.
• Their third product is robots for pool cleaning. These robots are developed and manufactured by Aquatron and brought to market under the iRobot brand.
• Currently, they offer one model priced at $999.
Who are their customers?
Prior to 2016, they had two customer segments.
• Defense and security markets
In 2016 they sold their defense and security unit to focus solely on consumer products.
Who are their competitors?
• In their 10-k, they note that consumer electronic companies have entered this market such as Samsung, LG, Xiaomi, and Shark.
• In addition, traditional cleaning companies such as Dyson, Bissell, and Hoover have entered the space.
How big is their addressable market?
During their analyst day, they note that their immediate addressable market is twice the size of their current install base(see above). Click here for the whole presentation.
• Current install base-13 million households(10% of total U.S. households).
• Immediate addressable market-26 million households.
The chart above is based on Geoffrey Moore’s book, Crossing the Chasm.
The danger for iRobot and the category as a whole is the chasm between early adopters and the early majority.
As they note in their slide above, they believe their product is in the early adopter stage and they’re basing their growth on the assumption that their product and the category as a whole will cross the chasm into the early majority. Not a guarantee by any stretch.
In his book, Mr. Moore speaks of two kinds of innovations.
• Continuous or sustaining innovations
• Discontinuous or disruptive innovations
Warby Parker made better-looking eye-glasses. This is a continuous innovation.
A disruptive innovation is a product or service that requires us to change our current mode of behavior.
Before Netflix, we had to go to the store to rent a limited supply of movies.
After Netflix, we press a button on our T.V. or phone and watch whatever we want to watch at any time. The way we consumed T.V. and movies changed because of Netflix.
Their full financial statement can be found here. You can’t edit it but you can copy and make your own.
For hardware companies, gross margin(red arrow) is the metric we need to keep our eye on.
Gross margin is important in hardware because if your product doesn’t have good gross margins, you won’t have enough money left to fuel your growth.
Quick reminder-Gross margin is Revenue minus Cost of Revenue. This metric tells us how profitable a product or service is before salaries, rent, and other business expenses are taken into account.
Scott Miller at the Dragon Innovation blog states that 50% is the minimum gross margin that hardware companies need to be healthy and drive profitability.
For a deeper dive into the hardware business, read this four-part series from Bolt.
Cash flow statement
Do they have a moat or any competitive advantage?
It’s helpful to use frameworks when evaluating potential investments. For this company, we’ll use a framework laid out by Warren Buffett in his 1991 letter to shareholders.
Our goal is to determine whether iRobot is an economic franchise or a business.
Warren stated the following:
An economic franchise arises from a product or service that:
1. Is needed or desired.
2. Is thought by its customers to have no close substitute.
3. Is not subject to price regulation.
The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital.
Moreover, franchises can tolerate mismanagement. Inept managers may diminish a franchise’s profitability, but they cannot inflict mortal damage.
In contrast, “a business” earns exceptional profits only if it is the low-cost operator or if supply of its product or service is tight. Tightness in supply usually does not last long.
With superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack. And a business, unlike a franchise, can be killed by poor management.
Let’s take these points one by one.
Is their product needed or desired?
They help humans do something most don’t want to do. CLEAN.
I can’t speak to the quality of the job these robots do, but if they do “good enough”, most people will accept the tradeoff of letting the robot do it if that means they don’t have to.
Is it thought by its customers to have no close substitute?
Again, this is hard to stay without testing each product on the market.
Luckily, there is a site where millions of products are sold and reviews mean a lot. Amazon
If you type “cleaning robots” into the search bar on Amazon, an iRobot product does not appear until slot #8.
This alone would be concerning. In addition, the Roomba model above isn’t their best selling product and has only one review.
On page 8 of their 10-k, they note that Amazon accounted for only 10.4% of total revenues. This is a good thing. More about this in the “final thoughts” section below.
Is not subject to price regulation
With all the products on the market, can iRobot maintain their prices in the face of rising competition?
Their most recent 10-k gives us a clue(page 32 & 33).
“The $227.8 million increase in revenue from our consumer business was driven by a 25.7% increase in units shipped and a 10.8% increase in average selling price”.
They also note in 2016 their average selling price decreased by 0.8%.
It’s unclear to me whether they can maintain or raise prices in the future as more competition enters the space.
Final thoughts and some things to think about
Though they are the market leader, I can’t put them as an economic franchise. I don’t know how differentiated their product is relative to other products on the market. From a brand perspective, it seems the Roomba is a household name and that’s a good thing going forward.
What’s the most difficult job of a company? In my view, it’s acquiring customers, profitably, in a sustainable way.
Let’s take existing customers out of the equation. Happy customers will recommend the product and unhappy customers won’t.
iRobots future will be determined by how well they acquire new customers. In today’s world with endless selection(Amazon) and increasing competition, the winner in this space will be the company who has the best combination of product, brand recognition, and distribution.
Product and brand recognition can be subjective, let’s take them out of the equation and focus on distribution.
Currently, they have three distribution channels.
• Retail stores(15 retail partners and distributors)
• Amazon(10.4% of total sales)
• Direct to consumer(DTC) (4.1%)
Any company can sell on Amazon and DTC(direct-to-consumer). If you type “robot cleaner” on Amazon, you will get over 3,000 results. A company will not have a sustainable advantage selling on Amazon, in my view.
In addition, the DTC channel is a decreasing percentage of their sales; 4.1%, 5.1% and 6.1% of total consumer robots revenue for fiscal 2017, 2016 and 2015, respectively.
Space in retail stores in scarce; which is a good thing. That means only a select few products in a category will make the cut; unlike Amazon.
Currently, the big trend is going DTC, but what many fail to realize is that with no distribution partners a company is relying on marketing and brand awareness. Since any company can spend money on Facebook and Instagram ads to build brand awareness, the cost of acquiring customers through social channels is getting expensive and is not sustainable.
They note on page 32 of their 10-k that the majority of their sales is to 15 customers. These customers comprise of retail partners and international distributors.
They don’t break down who their retail partners are but they do have two of the biggest; Target and Walmart.
I view them as having distribution partners as an advantage over their competitors.
Going forward I will be watching three specific things:
• Whether they can “cross the chasm” and move from the “early adopter” phase to the “early majority”.
• Can they maintain and expand their distribution chain on favorable terms?
• Can they maintain pricing and not succumb to discounting as competition mounts?
Remember, just because a category has the potential to be huge doesn’t mean the businesses in that category will be profitable if the companies are undifferentiated.
An additional framework to consider
Peter Thiel laid out four characteristics of a monopoly in his book ‘Zero to One’.
• Proprietary Technology–Is your product or service difficult or impossible to replicate? How hard would it be to build a better search engine than Google? Or offer more products at lower prices with faster delivery than Amazon?
In iRobots case, is their integration of software and hardware superior to their competitors? The Roomba integrates with Amazon’s Alexa. Is that an advantage?
• Network Effects–Does your product or service become more useful as more people use it? If all your friends are on Facebook, does it make sense to choose another social network?
I don’t think iRobot is the kind of business that has network effects built in.
• Economies of Scale–Does your business get stronger the bigger it gets? The fixed costs of creating a product can be spread out over greater quantities of sales.
According to their 10-k(page 9), their core competencies are design, development, and marketing of robots. They outsource the manufacturing.
They don’t have factories and other large fixed costs such as machinery. However, they do spend significant sums on research and development. The costs of producing the IP(intellectual property) gets spread out the more units they sell.
• Branding–Built overtime by the ability of a company to deliver a product or service that, in the customer’s mind, is special and consistent.
They spent 18.3% of their revenue on marketing and branding in 2017, up from 15.9% of revenue in 2015. They realize that brand recognition will be of utmost importance as competition increases in the years to come.
We’ll update this post as time goes on and as new information comes in.
If you have any thoughts, we’d love to hear them in the comments below.