Casper Return Rates: Part 2

February 1, 2020 By Michael Magnuson

Over the past few weeks, there has been much discussion of the Casper S-1 — from the business press to Wall Street to the mattress industry, including during a “Bedding CEO Round Table” in which I participated this past week.

In all of this conversation, one of the most hotly debated topics continues to be Casper’s return rates, since they were not disclosed in Casper’s public filing. A couple weeks ago, I published a ball-park estimate of Casper’s return rate, placing it in the 12-14% range. The purpose of this post is to share some updates to my thinking based on some feedback I’ve received since then, as well as other methods I’ve seen.

Could Casper’s return rates be higher than my estimate?

If you haven’t yet read my earlier estimation of Casper’s return rate, my method was to back out returns from the lump sum of “refunds, returns, and discounts” that Casper did provide in the S-1. In brief, my assumptions were that refunds were relatively immaterial, but that discounts were material.

One of the most compelling arguments made to me over the past week has been that my methodology overstates the extent to which Casper’s discounts would actually be captured in their accounting. My estimate was based on real data about the specific promotions that Casper ran over the past several years. However, one online mattress CEO with whom I spoke made a solid case that such discounts would never have hit Casper’s accounting system, since they were already taken out in the shopping cart before the user’s credit card was even charged. While this comment would not have any bearing on discounts applied after the purchase (eg, rebates and referral programs), it would remove most of the discounts I had factored into my assessment. So, apart from the possibility of large scale wholesale discounts, the discounts that would be captured in this line item would be relatively minimal.

How high could Casper’s return rate be?

If this person is correct, that would leave relatively little to back out of the lump sum they provided, putting return rates much closer to the theoretical upper bound of 15-20% that I discussed in my prior post. Notably, it would also imply that Casper’s return rate has grown substantially over the past two years — something on the order of a 500 basis point increase between 2017 and 2019.

Could Casper’s return rates be lower than my estimate?

This week, a research analyst at Stifel published their take-aways from Casper’s S-1, which included their own estimate of return rate. Unlike my estimate, theirs was based on a footnote that contained a “product return reserve” balance sheet line item. To calculate return rates, it appears that the crux of their method was to divide the ending reserve balance by the total revenue of all products sold within a look-back period equal to the return policy length. Based on this method, they pegged Casper’s return rate at around 8-9%.

Fictitious Example: Acme Mattress Co.

While I understand their logic in general, I find their conclusion less convincing. To illustrate, let’s use a fictitious mattress retailer (“Acme”) with some very simple operating stats:

  • Annual revenue: $12,000
  • Return rate: 10%
  • Return policy length: 4 months
  • Product return reserve balance (end of year): $400

According to Stifel’s method, Acme’s return rate would be 10%, calculated by dividing the year-end reserve balance ($400) by the total revenue of all products sold during the last 4 months of the year ($4,000).

The problem with this is that by the end of the year, some portion of the units sold during the past 4 months would have already been returned. Thus, the cost of these returns would have already been deducted from the return reserve account before the year-end balance is tabulated.

To sanity check this logic, let’s further assume that Acme’s monthly sales consist of one $1,000 unit sold on the 15th of each month. So, as of 12/31, these would be the 4 units factored into the return reserve:

  • Unit 1 — sold 9/15 (105 days ago)
  • Unit 2 — sold 10/15 (75 days ago)
  • Unit 3 — sold 11/15 (45 days ago)
  • Unit 4 — sold 12/15 (15 days ago)

Stifel’s method implicitly assumes that as of year-end, none of these units has yet been returned and all 4 of them still have a 10% probability of being returned. This includes Unit 1, which only has 15 days left to be returned.  Here’s the thing: The only way that Unit 1 would still have a 10% probability of a return is if 100% of returns happen in the last 15 days of the return window. This seems unlikely.

More likely is that returns would be distributed more evenly across the 120-day window. In this case, the probability of a unit being returned would decline as time goes on, meaning that some units get returned in the first couple months, and that units sold longer ago would no longer have a 10% probability of being returned. If, for example, Acme’s returns are distributed evenly across the 120-day period, then the same reserve return balance used in our example above would imply that Acme has a return rate of 20%, rather than 10%.

How low could Casper’s return rate be?

Of course, Casper doesn’t provide the actual time series distribution curve of their returns. Nor do they provide a whole lot of detail on how they account for returns. But given what we do know, it would appear that Stifel’s method most likely underestimates their return rate, quite plausibly by as much as half. That said, their method is still useful in that it does seem to provide a confident lower bound of 8-9% for Casper’s return rate.

So, what is Casper’s return rate?

Taking this additional input to heart, my sense is that if anything, my original estimation of Casper’s return rate may have been on the low side. If this is the case, it would follow that my method may have also understated the increase in the return rate over the 2017 to 2019 time frame. At most, this could bring return rates into the range of 14%, 17%, and 19% (for 2017, 2018, and 2019, respectively). That said, we still don’t have enough concrete details to make a confident calculation. And from the standpoint of my personal gut instinct (an admittedly less scientific approach), those higher numbers just feel a bit unlikely to me. So for now, my best guess is still something around, or perhaps just slightly above, my original estimate — call it 12-15% +.

Why does Casper’s return rate even matter?

A reasonable question one could ask is why am I focusing on this particular stat in the first place. I certainly don’t mean to pick on Casper here. From everything we see, their brand and products have resonated extremely well with consumers, so there is no reason to think that their return rate is far out of line with other online brands that have similarly consumer-friendly return policies. And although my finance DNA gives me a natural interest in dissecting S-1’s with an investor’s mindset, this is not my primary intent either.

My personal interest in return rates is principally in how they affect the consumer — and, even more importantly, the environment. Because the cost of online returns gets built into the price that future consumers pay, higher return rates are actually bad for consumers. And because the mattress donation ecosystem (through which online mattress companies purport to find homes for returned mattresses) is likely reaching a level of saturation — and mattress recycling options are still far from ubiquitous — more and more returned mattresses are finding their way into landfills. Assuming Casper’s return rates are representative of other D2C mattress sellers, this could mean that hundreds of thousands of “returned” mattresses are ending up in landfills each year — above and beyond the millions that are unavoidably disposed of at the end of their useful lives.

Reducing this waste is one of the problems we are solving at GoodBed. By providing consumers with the objective and personalized information that they need, we are helping more consumers choose the right mattress the first time. Unfortunately though, not all consumers know or bother to take advantage of GoodBed, which is why I think that the industry should take some steps in this regard as well.

Moving the mattress industry toward a “Utopian Return Policy

To provide a longer-term solution to this problem, I believe that the mattress industry needs to gravitate toward a more “utopian” return policy — one that is still consumer-friendly, but is also environmentally-friendly. The key will be for the industry to standardize around a policy wherein both consumers and businesses have “skin in the game” in terms of making sure that the right mattress is purchased the first time. Getting from here to there will involve numerous hurdles, but to me it feels like an issue that is worth the effort.

More on this in a future post…