Billion Dollar Unicorn club member Stitch Fix (Nasdaq: SFIX) recently went public. Its listing is worth celebrating because it is the the first IPO this year for a tech company that was led by a woman. The stock has had a choppy ride as investors are still trying to determine how to value this latest e-commerce in a box company. Nonetheless, in a market dominated by male CEOs, I personally am thrilled to see good execution and a milestone achievement by this company.

Stitch Fix’s Offerings

San Francisco-based Stitch Fix was founded in 2011 by Harvard student Katrina Lake who wanted to build a fashion retailer that would be able to integrate the human element of personal styling with high-quality clothing and proprietary algorithms. After shipping her first order out of her Cambridge apartment, today Stitch Fix has grown to become a multi-billion dollar business that operates on a subscription-based model.

While the company was founded with a focus on Women’s Apparel, it has extended beyond that category to Petite, Maternity, Men’s and Plus apparel, as well as Shoes and Accessories.

Stitch Fix offers a subscription service that allows consumers to sign up for the company’s style boxes by filling out a Style Profile. The profile tells Stitch Fix’s technology platform and its stylists about the user’s size, style, shape, budget, and lifestyle. This profile is then integrated with style suggestions from its advanced algorithms. Stitch Fix’s stylists next hand pick five items of clothing, shoes, and accessories that will fit the subscriber’s profiles and have them shipped out. Each time a style box is shipped out, the consumer is charged a shipping fee of $20. The user can choose what they like and return the rest of the products through a prepaid envelope. The $20 shipping fee is applied as credit toward anything that is retained from the shipment. Customers wanting to keep the entire box get a 25% discount on the order.

Stitch Fix offers products across multiple price points and styles from over 700 brands. It has scaled its business rapidly over the past few years. Revenues have grown from $342.8 million in 2015 to $730.3 million in 2016 to $977.1 million in 2017. Net income, however, has fallen from $33.2 million in 2016 to a net loss of $0.6 million in 2017. The reduced net income was attributed to one-time expenses that hit the company last year. During the year, selling, general and administrative expenses grew 56% to $402.8 million and Stitch Fix saw a $16 million increase in the re-measurement of preferred stock warrant expense. As of August 2017, Stitch Fix had over 2.1 million active clients compared with 1.7 million a year ago.

Stitch Fix has done all this with $46 million in funding from investors including Benchmark, Baseline Ventures, Western Technology Investment, Structure Capital, and Lightspeed Venture Partners. Its last round of funding was held in June 2014 when it raised $25 million from Benchmark capital at a valuation of $300 million. In a market awash with hundreds of millions of dollars in venture capital per company, $46 million is a relatively conservative number. I congratulate Katrina Lake for not losing her head and raising unnecessary amounts of capital.

Stitch Fix’s Concerns

Stitch Fix recently went public when it sold 8 million shares at a price of $15 each. It was originally expected to sell 10 million shares at a price of $18-$20 each. But tough market conditions drove the valuation down. Many attribute the low pricing to the tough market faced by another subscription-box company Blue Apron. While they are in completely different industries, analysts are worried about the profitability potential of these subscription box services.

Stitch Fix is also aware of these concerns. It believes that any additional growth that it forecasts will come at a price. The company expects to improve its compensation packages to attract more talent and spend higher marketing dollars to attract more customers. It has begun the effort by launching its first television advertising campaign.

Stitch Fix is also facing increasing competition. Amazon is trying a similar service in the form of Prime Wardrobe that allows members to order apparel online, try them out, and return for free if they are dissatisfied with the product. Shoppers will be charged for the products they keep and they also get additional discounts based on the number of items they retain. Nordstrom also has a similar service by the name of Trunk Club, based on the acquisition it had made three years ago.

Stitch Fix has a tough road ahead. Kathleen Smith, a co-founder of Renaissance Capital believes that after getting over 2 million customers, the real test for Stitch Fix would be delivering 20% growth and improved profit margins.

Its stock is currently trading at $23.60 with a market capitalization of $2.25 billion. It had fallen to a low of $14.48 soon after listing and had climbed to $25.38 last week.

Stitch Fix’s Potential

I happen to have quite a bit of understanding of the online fashion market, having founded one of the first ever online fashion companies in 1999. Here’s what I see is the potential for Stitch Fix: A high-end consumer of women’s fashion has a very big annual budget for clothes and accessories. The actual number can be well above $10,000. It is not price that drives this consumer segment. It is design, style, fit, the experience of shopping, discovering interesting new designers, and regularly checking the works of their favorite designers. A personal shopping/store site that can create a compelling user experience for this category could win, say, 20% of the wallet share of this consumer. Currently, with a billion in revenue and ~2 million customers, Stitch Fix has captured an average of ~$500 (5%) wallet share. With significant improvement in their personalization algorithms, there is a lot of headroom to improve this number. I would advise analysts covering the company to focus on this number. If the number can get to 20%, the company will easily, and like a rocket, reach $4 billion in revenue. For this to happen, the secret is not television advertising. It is the personalization algorithm and sophisticated merchandising.

I look forward to following how Katrina Lake leads the company through this next phase and wish her all the very best.