How Blue Apron Plans to Juice Its Gross Margin

Last year, Blue Apron's (NYSE: APRN) gross margin fell more than four percentage points to 28.7%. That's in part due to struggles to properly fulfill orders out of its new Linden, New Jersey facility, but also points to the competitive pressure Blue Apron is facing.

In the last year, retail giants (NASDAQ: AMZN) and Walmart (NYSE: WMT) have each launched their own meal kit efforts. Germany-based HelloFresh -- Blue Apron's largest competitor -- has eaten up market share as Blue Apron pulled back on marketing. Dozens of other competitors have popped up, as the start-up costs for meal kit services are relatively low.

If Blue Apron hopes to survive the competition and break even by the end of the year, it needs to show that it can either expand its gross margin or grow sales like it did before its IPO. Competition will put pressure on both of those metrics, but here's how Blue Apron can juice its gross margin.

Decrease food waste

The biggest factor in Blue Apron's cost of goods sold is its food costs. As Blue Apron grew larger, it was able to exercise buying power to get better prices on ingredients for its recipes. But with the days of doubling revenue behind it, Blue Apron needs to find new levers to keep food costs low.

The best way to do that is to decrease food waste. "There's a lot of food that never gets into the offering for our customer[s]," Blue Apron CEO Brad Dickerson said at a recent investors conference.

Cutting down on food waste would provide Blue Apron with the biggest bang for its buck. The strategy will minimize its biggest cost, but it also won't impact the quality of the product customers receive.

Unlock labor efficiency through automation

A big part of the Linden facility is its automation technology, which has the potential to make its workers more efficient at getting the right ingredients in the right box and out the door. Automation technology has been a big unlock for labor costs at Amazon, which manages to generate significantly more revenue per employee than Walmart and other retailers.

Improving labor efficiency can improve other costs for Blue Apron as well. "Although food is the largest cost, labor is probably the most impactful cost," Dickerson said.

Automation can reduce the need for prepackaged food, lowering food costs. If workers are able to increase their speed and accuracy for fulfilling orders, it means more orders go out the door when they need to, and Blue Apron doesn't have to pay extra for expedited shipping. It also means fewer unhappy customers calling in and asking for refunds because they were missing ingredients.

Achieve packaging and shipping efficiencies through family plans

Blue Apron introduced a family plan at the beginning of 2015. By 2017, family plan orders represented just 21% of total orders, even though Blue Apron sees the market for its family plan as roughly the same size as the market for its two-person plan.

That would imply the long-term potential for family plan orders is between 33% and 50% of orders (depending on Blue Apron's definition of market size -- people served or units shipped). If Blue Apron's family plan can grow, shipping and packaging costs will come down as it sends more food per box.

Finding new methods to send more food per box is another key to reducing cost of goods sold, but that might not always be possible. This past year, Blue Apron introduced the option for customers to receive fewer meals per week (or more meals). The bet is that the average will remain the same as its standard three meals per week. But if more customers opt for fewer meals per week, that could cause Blue Apron's shipping costs as a percentage of revenue to climb.

Should Blue Apron focus on gross margin?

Blue Apron hopes to break even on an EBITDA basis by the fourth quarter of 2018, but that might be a bit short-sighted. With Walmart and Amazon getting into meal kits, Blue Apron could face significant pressure on its product pricing as well as its ability to attract new customers. Walmart's meal kits are lower-priced, and Walmart's in-store pickup offers more flexibility than Blue Apron's subscription plans, for example.

As such, Blue Apron's cost-of-goods-sold efficiencies may be better invested into increasing the value of its product for customers. That can be done either by offering a significantly more premium product compared to Walmart or Amazon, or by offering a lower price point to consumers -- something Dickerson says he's considering.

It'll be hard for Blue Apron to show improvements in both gross margin and revenue in the face of strong competition. Long term, it would be better to use the cost-of-goods-sold efficiencies it could realize this year and keep gross margin relatively low in order to scale its customer base in the face of competition; it could then drive operating leverage in the future. But management seems more intent on improving profitability right now.

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