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Going to the Mattresses:
Payden&Rygel Look at the Bed-In-a-Box
Battle Reshaping Mattress Retail

Stroll down the street in a posh fashion district of New York, San Francisco, or Los Angeles, and you might happen upon the sleek storefront of a Casper sleep store named The Dreamery. Yes, that’s right, the same online purveyor of mattresses plastering subway cars and popular podcasts with ads is also embracing what was once blasphemous in start-up circles: the physical storefront. It turns out that Casper, which has dubbed itself both the “Nike of Sleep” and the “Warby Parker of Mattresses,” isn’t killing the mattress industry but rather reshaping it for the 21st century.

The Caspers of the sleep industry are riding the wave of a cultural awakening of sorts about sleep. The medical press abounds with head- lines reporting the deleterious effects of sleep deficits. Yet, the average American gets an hour and a half less sleep per night than they did a generation ago. Given digitally-connected humans’ ever-growing time constraints, many have turned to devices to “optimize” their nightly slumber. With everything from sleep tracking watches to new mattresses, the sleep industry has capitalized on our latest fixation.

Tuck yourself in because this bedtime story ventures well outside of the box. Here, we’ll discuss how the mattress industry came to be, how the new players on the scene have changed the sleep landscape, and what shopping for a mattress can tell us about the so-called “retail apocalypse.”

Sleeping Beauty

The importance of the mattress is nothing new to American society. In the original Thirteen Colonies, the bed was very often the first item to be moved to safety in the event of a fire. Firefighters carried special tools to disassemble a bed frame in case of emergency. Such care may have been prudent, as scholars estimate that the bed represented up to one-third of the value of all domestic assets for middle-class homes!

Fast-forward to the mid-1980s when three guys in a small mattress shop in Houston stumbled upon a revolutionary idea: that customers like to try out their mattresses before they buy them. Whereas customers would previously shop at a department store or local mattress retailer and see plastic-wrapped beds, order them, and then wait 14 days for delivery, the new concept, Mattress Firm, would let customers test the beds in the store and then take them home that very day. With ambitions of building a truly national brand, Mattress Firm led the way as the retail mattress industry grew like wildfire, reaching more than $11.5 billion in revenues by 2015.

With more mattress stores than 7-11s in the U.S., some, including Casper, began to wonder why America needed so many.

The short answer is that purchasing a mattress is a confusing endeavor. Consumers have little to no insight as to the difference between a Dual Effects® gel memory foam from one manufacturer, Posturepedic™ foam from a second, or the SmartClimate™ System with Tempur® foam from a third. For good reasons, many saw the process of purchasing a mattress as downright bewildering. The confusion allowed Mattress Firm and stores across the country to mark up products as much as 150% without fear of educated customers shopping elsewhere. As such, mattress retailers found that they could operate a store selling as few as 20 high-margin mattresses a month and break even on their expenses.

To quote Jeff Bezos, “Your margin is my opportunity.” Casper and others pounced. The bedding beginners saw an opportunity with a sleek website, a vastly simplified choice of products (often just one type of mattress), and the ability to ship directly to your door. Casper and friends have altered the mattress industry as we know it. Casper was recently rumored to have revenues above $600 million while brick & mortar behemoth Mattress Firm filed for bankruptcy in November 2018 and announced the closure of 660 stores.

As Easy as Rocket Science

Casper’s journey began when engineer Charles Yost was hired by NASA in the 1960s to design a seat material that would protect an astronaut’s backside through the G-forces experienced in space travel. His solution was foam with billions of open cells that were solid but resembled a liquid at times.

Originally called “slow spring back foam,” a name that you’ll be shocked to find out never quite stuck, the material molded to the shape of any body, eliminated the sharpness of springs, and could absorb the shock of 36-Gs of force.

Sure enough, the dovetailing of new all-foam mattresses and the rise of a sleep-aware digital consumer brought about the advent of the bed-in-the box industry. The replacement of springs in a mattress meant not just the improvement of sleep technology but that the mattress could now be folded into a box and shipped just like any other “Amazonable” item.

With more than 178 bed-in-a-box companies nationwide and rumors of a $1 billion initial public offering for industry leader Casper, disruption is the word of the year in the mattress industry. The victims of the mattress-in-a-box have been the players too big and too slow to react, with Mattress Firm declaring bankruptcy and Serta Simmons, the largest mattress manufacturer in the world, on death’s doorstep with its debt trading at pennies on the dollar.

Consumers have been quick to swap the used-car salesmen pitches, harsh overhead lighting, and awkward showroom displays for two-day shipping, glossy pack- aging, and 90-day sleep-on-it trial periods. However, we, the Payden Economics Team, ask “what has truly changed in the industry?”

The first thought would be, well, the mattress, of course. However, very few of the leading players in the bed-in-a-box space build their own. In fact, the three major manufacturers for the bed-in-the-box industry produce the very same products for traditional mattress play- ers such as Serta Simmons or Tempur Sealy. FXI Holdings, one such manufacturer, has seen a boom in sales as nascent bed-in-a-box players approach them with the rough idea of a mattress concept and will pay richly to see FXI construct a new mattress from the same materials as a Tempur Pedic or a Serta Perfect Sleeper.

Instead, we must look to the business model of selling the bed as the key change in the industry, not merely the fact that a mattress can now be squeezed into a cardboard box. Gone are the middlemen taking an 80% cut on every mattress they touch. In their place, a crop of online players has given Americans their beds faster and cheaper than ever before.

Despite such stunning success, the profit dollars of these online businesses are near impossible to find. If industry leaders Casper, Purple, and Tuft & Needle are any indication, the business of mailing mattresses is a loss-making endeavor with publicly-listed Purple tallying a loss of $11.5 million in 2018 despite $285.5 million in sales. Just like many of their online retail brethren, bed-in-the-box companies are hemorrhaging advertising dollars in an attempt to woo new customers as standing out among a crowded field of online purveyors becomes increasingly difficult. Purple alone spent $111 million on marketing last year according to public filings, a figure nearly equivalent to all its other expenses combined.

With ambitions of an IPO of its own and an equally-bloated marketing budget, market leader Casper has decided to embark upon the very same business as the old guard that it sought to displace. The company will be opening 200 stores across the country, bringing the digital world to life with new-age showrooms and 45-minute mattress test drives available in minimalist sleep pods.

Casper’s Co-Founder, Neil Parikh, says that Casper’s customer base includes “everyone – everyone is in the market for sleep, because everyone can sleep better.” However, with increased scrutiny on unprofitable start-ups such as Uber, Slack, and, most recently, WeWork, the company will have its work cut out for it to prove that bed-in-a-box company investors will be able to sleep at night.

The Wrong Side Of the Bed

Profitable or not, bed-in-a-box players have catalyzed a significant shift in the mattress industry akin to those seen in the broader retail space. While Americans consume more mattresses than ever before, long-time giants of the mattress space, whether manufacturers (Serta Simmons) or retailers (Mattress Firm), have nearly been driven out of business. The e-commerce revolution and the ability to fit a foam mattress in a box have undoubtedly played a role in their demise. Still, a broader trend impacting how Americans consume everything from yogurt to beds was the writing on the wall for these mattress merchants.

Over the last two decades, American shopping habits have bifurcated the mattress space, with consumers eschewing the mid-tier category for either cheap value mattresses or high-end luxury ones, with little in between. As such, they’ve turned away from the $800-$1,200 mattress in favor of either a $300 Costco mattress or a $2,500 Tempur Pedic. Hence, while mid-tier-focused manufacturer Serta Simmons flounders, its luxury peer Tempur Sealy is more valuable than ever. It has capitalized on Americans’ renewed sleep awareness with promises of cutting-edge technology and a name brand associated with a luxurious night sleep that is 30 years in the making. The ability to differentiate itself from its peers has given the mattress producer pricing power to sell beds for as much as $5,000. Meanwhile, everyone from Tuft & Needle to Purple to Sleep Innovations struggles to differentiate themselves on anything other than price.

Quit Napping on U.S. Shoppers

The phenomenon is nothing new in American retail: for the last two decades, consumers have sought out discounted or “value” versions of the goods they buy. The likes of TJ Maxx, Dollar Tree, and Walmart have come to dominate the retail sector, as shoppers have discovered that they can get the same goods as at traditional stores but for 20- 50% cheaper.

While some say that this spells the end of the retail sector, we say the retail space is simply reshaping to the changing desires of the American consumer. Value-conscious shoppers have left the mom & pop grocery store or department store for the discount supercenter or dollar store. And much the same as the market for beds, quality, and convenience focused shoppers have also left for high-end organic options or expensive home delivery. The U.S. retail market is undergoing a paradigm shift wherein the center of the retail experience is slowly evaporating in favor of either end of the spectrum.

The mattress industry has found itself in the crosshairs of this trend, as Costco and Amazon find their way into the “value” segment of the market. Each retailer now sells a $350 mattress stuffed with foam made in China, well below the price of the waning Serta Simmons beds. At the opposite end of the spectrum, other luxury purveyors, along with Tempur-Pedic, have found a market for truly conspicuous consumption of mattresses.

A glance at a department store gone dark or a shuttered Mattress Firm may lead one to the false conclusion that retail is a dying proposition in the United States. We, however, take a different view. The convenience of the e-commerce age and the low prices of value stores are not harbingers of the end of retail, but rather the ushering in of a new Golden Age, replete with scheduled naps at your local Dreamery and the promise of a better night’s sleep, for less.

Editor’s Note Founded in 1983, Payden & Rygel is an investment management firm with $119 billion under management. Payden mutual funds provide investors with a globally-diversified array of equity, fixed-come and cash balanced mutual funds.

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