Why Stitch Fix Could Be the Next Netflix

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The market doesn't quite know which box to put Stitch Fix Inc (NASDAQ: SFIX) in. It sells clothes, but it's not a traditional retailer, nor does it feel quite accurate to call it an online retailer even though its business is based on e-commerce. It claims its data-driven model gives it an advantage over the competition, but it's not really a tech company.

The stock it's most often compared to is Blue Apron, another subscription-based delivery service, but that doesn't seem fair since Blue Apron's six months as a public company have been mostly disastrous. Unlike Blue Apron, Stitch Fix is profitable, growing steadily, and doesn't face the range or caliber of competition that the meal-kit service is up against.

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There may be no adequate peer to compare Stitch Fix to, but there's one popular company that the styling specialist does share a surprising number of characteristics with: Netflix (NASDAQ: NFLX).

Like Netflix before it, Stitch Fix is focused on disrupting a giant industry that has not fully embraced the power of e-commerce. Also like the video streaming giant, Stitch Fix's proprietary and data-driven approach gives it an advantage in designing and choosing clothes for its customers. Similarly, Netflix leverages its users' preferences when deciding what types of shows and movies to produce and what to recommend to viewers.

Here comes the disruptor

Netflix started out as a DVD-by-mail service after CEO and co-founder Reed Hastings was slapped with too many late fees at the local Blockbuster. Over the years, that innovation evolved with technology into video streaming and then original production. Netflix has always been focused on using technology to disrupt the video entertainment market. It was a giant opportunity: The domestic entertainment and media market was estimated to be worth $655 billion this year, with the global market valued at about three times that.

Similarly, Stitch Fix CEO and founder Katrina Lake says she started her company because traditional clothes shopping, both in-store and online, was too time-consuming. Both demand that the consumer shuffle through dozens of items, and it was too hard to find items she liked that fit well.

So she used the power of the internet and improvements in package delivery to create a personalized styling service that sends clothes directly to customers based on their preferences. Customers can then buy the clothes or send them back. Since launching, the company has expanded into new categories like menswear and plus size, partnered with luxury labels, and, most importantly, launched its own private label exclusive brands, which it says contribute a higher margin than its other categories.

Like Netflix, Stitch Fix is chasing a huge opportunity: the U.S. apparel, footwear, and accessories market was worth $353 billion in 2016, and the e-commerce apparel market was worth $55 billion and is expected to grow to $94 billion by 2021.

The data-driven approach

When Netflix bid on House of Cards, its first hit original TV show, it had a strong sense its audience would like it. Because of the data it had collected on its viewers over the years, Netflix knew that members who had seen the original British House of Cards also liked movies directed by David Fincher and starring Kevin Spacey, who were both attached to the political drama. It wasn't surprising then when House of Cards turned out to be a hit.

Similarly, Stitch Fix has more knowledge and data on its customers' preferences than traditional retailers. The company uses the phrase "data science" 64 times in its prospectus, and it's clear why. It wants to convince investors that data science is a key part of its strategy and a competitive advantage. With its knowledge of customer tastes, which it gains through detailed reporting on each "Fix" it sends to its clients, it's easy to see why the company could better design clothes in its exclusive brands than competitors that lack such detailed data.

Since fashion design and video entertainment are both creative endeavors, it's important to note that neither company leads with data in creative fields. Stitch Fix acknowledges that its stylists' "human judgement" plays a key role in selecting clothes. But the deep-level knowledge on their customers informs how both companies choose products, separating them from competitors.

Long tail of growth

Disrupting giant markets like video entertainment and apparel presents an opportunity for years of strong growth, or a long tail, as brand awareness grows and those businesses attract new customers with a better model.

Some investors are concerned about Stitch Fix's decelerating revenue growth -- sales growth dropped from 113% in fiscal 2016 to 34% in fiscal 2017 to an expected 20%-25% for fiscal 2018. However, Netflix's growth slowed similarly as it approached $1 billion in sales, and it has maintained a strong growth rate thanks to the huge opportunity in front of it. The streamer posted 30% revenue growth last year, which was its fastest clip in five years, and only once in the past decade has it grown faster than that.

Similarly Amazon, another breakout disruptor, has maintained a rapid rate of revenue growth as it penetrates giant markets like retail and cloud computing.

Considering Stitch Fix hasn't even launched operations outside of the U.S. and is only a 6-year-old company, it could be on the verge of a decade of growth like Amazon and Netflix have just had. Whether that happens depends on how well Lake and her management team execute and delight customers.

Amazon, which is set to become the biggest apparel retailer in the U.S, has proven that Americans want to shop online, and other companies like Nordstrom and Bonobos have embraced the personalization model, realizing that customers want more than the traditional clothes shopping experience.

The market opportunity is there, and Stitch Fix is in front of two key trends in clothes shopping: e-commerce and personalization. The company may be a long a way from the powerhouse that Netflix is today, but it has the formula and the potential to get there.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Jeremy Bowman owns shares of Netflix. The Motley Fool owns shares of and recommends Amazon and Netflix. The Motley Fool recommends Nordstrom. The Motley Fool has a disclosure policy.