Good morning, everyone, and thank you so much for joining us. My name is Nathan Feather, and I'm Morgan Stanley's small and mid-cap internet analyst. I'm excited to be joined today by James Reinhart, founder and CEO of ThredUp, along with Sean Sobers, ThredUp's CFO. Thank you both so much for joining us today.
Thanks for having me.
Thank you. It's good to be here.
Now, before we begin, quick housekeeping item for important disclosures. Please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, let's start it off. So I think it'd be helpful to start off with an intro, James, for those that may be, you know, less familiar with the company. Can you walk through a quick overview of your strategy and the competitive differentiation?
Sure. ThredUp's a managed marketplace for women's and kids' clothing. So we help women primarily. We don't do men's—clean out their closets, get rid of all the clothes that they're no longer wearing, in a convenient service, and then we put all those items online through our distribution network to allow women to shop this incredible assortment of secondhand clothing. And I think that uniquely differentiated across, say, you know, other marketplaces is that we manage the entire experience. And so rather than sort of an eBay experience where you would list your own things and sell them and fulfill them and do customer service, we take all of that in-house, and so we run a network of distribution centers. We have enormous amounts of data and processing power to put all those clothes online. And we think ultimately what that does is expand the market opportunity.
So we think the TAM is much larger for a managed marketplace, although they take longer to build, longer to scale, they require more Capex, but we ultimately think, incredibly defensible over time. That's the journey that we've been on.
Okay. Great. Well, let's dig a little bit more in the TAM when you put out a lot of work on this. So, you know, can you help investors size the market opportunity for ThredUp across U.S., Europe, and then globally?
Sure. I mean, the resale market is the fastest growing part of the broader retail, you know, apparel environment. And depending on the, the report that you read, you know, it's growing anywhere from 10-15 times faster than traditional retail. And it's really being driven by young people. And I think the way that the market sort of studies work is they talk to people about are they, how are they selling? And, are they selling in the market? How are they participating? And what are they gonna do in the future? So a lot of the growth rates, Nathan, that you kinda see in the future, is really consumer surveys around how they're going to participate in the future. 'Cause what you tend to see in these types of markets is once a consumer participates in secondhand, they become pretty sticky.
And I often talk about, like, the woman who first gets the J.Crew dress for $24, and it's amazing, it's kinda hard to go back and buy a $178 J.Crew dress again. And so there's real stickiness on the engagement side. And so the market is growing in the U.S. I mean, there's been some volatility, obviously, with the pandemic, and interest rates going up. But if you take kinda the long arc, we think this is a huge market over time. In the U.S. and then in Europe, it's a similar size. And so, we think it's a massive TAM over there. As some of you might know, we have a business that operates in seven countries in Europe. And we think both of those are great vectors for growth.
Okay. Great. Well, you have been navigating, I think, a challenging near-term macro environment. So, it'd be interesting to hear what your current read of the consumer is, how that's trended over the past few months. Then are you still seeing pressure, and especially some of the value buyers that you have on the platform?
Yeah. Look, I think that the consumer is just living through the compounded effects of inflation. I think all of the news media talks about how inflation's coming down, but, like, you can't forget that since 2019, it's elevated quite a bit. So I think the consumer is dealing with the lingering effects of that. If you look at credit card balances and credit card default rates, as, you know, we can debate how big an indicator they are. But, like, I think it speaks to an indication that there's a little bit of stress on the consumer. You look at sort of rent costs, groceries, these things are just they hurt the pocketbook.
You know, even if you're sort of a wealthy consumer and you're here at the Morgan Stanley, like, tech conference, like, you can't ignore the grocery bill. You're like, "Man, groceries are more expensive." Like, dining out, that's more expensive. Airline tickets, they're more and, and so all that stuff, I think, puts pressure on discretionary categories. Apparel is a discretionary category. By definition, none of us need a new pair of pants tomorrow, right? But we do need to eat. We do need to get to work. We do need to pay for our kids' things in school. So, so I think that's where we're living in. I think consumer confidence, while improving, is still not in a position where I think people are feeling, particularly, like, they wanna lean in on the discretionary side.
What I would say is that I think that that is the trend line is more positive than it was over the last couple of years. And I think the catalyzing events are going to be things like interest rates starting to come down, because I think there's a psychological effect there that's really, really powerful. So, but until that happens, I think consumers will feel like they're getting better. But I don't think their purchasing power for discretionary is gonna be squeezed.
Okay. Well, and any impact on some of those value buyers? Or is that cohort behaving differently than some of the more, like, tried-and-true resale buyers?
Yeah. I mean, I definitely think it's hurting the value buyers more, you know, because I think they just have less discretionary dollars to spend. And I think the Q4 holiday season was interesting because I actually think people did spend a lot, but everything was on sale and deeply discounted. And so you might have had some pull forward of demand, you know, which is normally typical, but I think things were really discounted in the back half of last year, specifically in apparel.
Okay. Great. Well, I wanna dig in a little bit more of that later. First, I wanna talk to you about one of the strategies that you put in place to try to address some of these concerns, which is shifting up market.
Yep.
And so first off, what's that strategy behind the shift? Is it primarily macro, or what are the other kind of impacts in the marketplace? And then can you help people understand, you know, I think people would think up market, they often go immediately to luxury.
Yeah. I sure know.
That's not what you're talking about here. So, you know, what do you mean by what is now the kind of bread-and-butter item on the platform and ASPs you're looking for?
Yeah. I mean, I think the shift has been subtle, but it, it has been upward. And the distinction would be that, you know, I don't think there's a lot of room to compete with Old Navy, right, in a resale context. I think it's hard to compete with a private-label brand at Target, right? It's and so I think what we've tried to do is actually move up to a brand assortment where there is actually some, some opportunity. And that's brands like J.Crew. It's brands like Ralph Lauren. It's a brand, like Banana Republic who's trying to move, right? And so there's, like, a lot of those brands that I think we're trying to sort of inched up.
I think the lag is that you have to both in a managed marketplace, you have to acquire both supply and demand. And if you acquire all the demand without the supply, then you have a lot of unhappy buyers. If you acquire all the supply without the demand, you have a lot of unhappy sellers. And so we've had to methodically move that up. But I think now we're at a point where, you know, average prices on ThredUp are in the mid-20s. You know, five, six years ago, they were in the high teens. And so we've definitely made that shift. And I think it's been super positive for our business. And, yeah.
Okay.
I think, Nathan, just to add to that too, is I think that people sometimes misunderstand how we take, you know, 4.5 million items, which we currently have listed today, and transition the ASPs from, let's say, $19-$25. But, you know, I think people don't understand the magnitude of our operations. We're processing, on average, 100,000 items a day. So it's not that long for us to go through the full cycle to be able to make that shift and transition on ASPs.
Okay, well, that's great. I wanna talk about something maybe a little bit more exciting. In some of the comments, you were talking about, James, in the earnings call on GenAI, and so I'm interested to hear specifically on the buyer experience. What are some of the key projects you're working along or working on? How far are they along in the development process? And, generally, when should we expect to start to see some of the impacts from those other projects?
Yeah. It's super exciting for us. I think we all know, like, AI has gotten a lot of hype. I actually think it's underhyped, right? I think it's transformative. I was a history major in college. Like, it's like the printing press, right? Like, or the invention of the internet. I think it fundamentally would change the way the world works in so many profound ways. And so as the founder, I have spent a lot of time over the last six-12 months, like, rethinking how it will impact the customer experience. And so what we've done today, we fully launched it last week. We talked about it on the earnings call earlier this week, is launched a fundamentally new AI search product. And you might say, "Okay.
That doesn't sound super interesting," but, like, in secondhand, where you have 4 million items, and you're adding 100,000 a day, one of the biggest things we hear from customers is, "Oh, I can't find something I want." And this is a dramatic. I mean, it's not a step function. It's like it's two step functions improvement in how it works. And because what AI is able to do for us now is catalog. We used to be able to tag maybe four to six attributes that a customer might search by, and we would have to use human intuition to sort of do that, right? And we would sometimes use some computer vision. But it was kind of a dumb way to do it, which is a computer before this could see stripes. It could see color.
It could see some pattern. But it couldn't pull out Golden State Warriors. It couldn't pull out that that's a four-leaf clover for St. Patrick's Day. And those are two, like, of the most simple ones. The AI approach now is tagging hundreds of attributes. And then it's clustering those attributes in ways that it can intuit what the user is actually looking for. And so already, we're seeing consumers do more searches, find more product. And right now, what we have to do is educate. What's funny about this is the hardest problem has been we have all these customers who are used, I'm gonna be brutally honest, are used to the ThredUp search kinda sucking, right? And so they figured out, like, they know how to use filters. They don't necessarily trust the search results.
And so, there's this massive education of, like, "Oh, no, no, no. The new search is amazing. Let us show you how it works." And the users that, like, are getting on that journey are converting at higher rates. They have higher add-to-carts. Like, it's a pretty like, you can clearly see it. And the way to see that is for new customers. So new customers who don't have any legacy baggage around what search used to be, new customers are using it in ways that are, like, quite, quite amazing. So that's live. And then we're working on a number of other things across outfitting and merchandising, that I think will also be really powerful on the front end.
Okay. Great.
I would say even add a little deeper 'cause I think the concept of finding the Golden State Warriors is almost logical. We can understand that. And, you know, it's capturing the image and all this. But a simple thing we did with an investor yesterday, they said, you know, "Search Stevie Nicks." And I was like, "All right. I don't know if we're gonna get Stevie Nicks concert shirts or what are we gonna get?" But it actually was Stevie Nicks style. So a bunch of boho dresses. And so it's so much more intelligent than.
Yes. 100%.
We find the word Stevie Nicks. We find who Stevie Nicks is, style and what, what, how that works. And so it's really interesting how it works.
And you can then take what's become trending, whether it's across social or Instagram or Vogue, like, pick whatever sort of influencing sort of style. You can sort of take what's happening on the internet and magically inject that into what's shoppable on ThredUp and give the customer something that's highly relevant and shoppable. Like, there's a trend right now around sort of urban black cowboy. Like, it's like a thing. Like, you can now take that from a merchandising perspective and deliver customers a search experience where, like, when you type that in and create that, you're like blown away with the results. You get cowboy shirts. You get boots. You get cowboy boots. You get denim that would fit a cowboy.
You get a whole bunch of cowboy hats. You get some bolos. Like, it's kind of I mean, it's magical in a way that I think customers are gonna love.
Okay.
We have cowboy hats?
Nope. Turns out. Well, this is a great example. You know you could never find cowboy hats 'cause to find cowboy hats, you have to, like, go find the filter. And you put cowboy in. And cowboy's a brand. And so there's a lot of, like, technology behind the scenes that's changing.
Okay.
Yes. Hats. I'll tell them. Get you one.
Well, that's really exciting. So I also wanna focus on not just on the front end but also on the back end and how you're thinking about leveraging AI within your operations. So, I mean, the efficiency of your DC network, it's long been a real competitive advantage for you all.
Sure.
How do you believe that GenAI can help deliver that next stage of efficiencies?
Yeah. So, like, we are, if we're processing 100,000 items a day in the DC, we're taking 200,000 photos a day with, you know, highly automated but still manual, like, process. Like, there is somebody who's hitting a button that makes a camera work. I think in the future, you're gonna be able to to radically alter sort of the flow of inbound process to be able to do two things. One, essentially take any item that in any so even if w if we had an item up on stage, Nathan and I just pulled it up, and I just turned it around, and there were cameras hitting it, I could immediately stitch that onto a human.
And not only that, but I could stitch that onto a human and it could be if you're an African American who's shopping, I could stitch it onto an African American woman so you could see. If it was a plus-size item, we could stitch it onto somebody who's plus-size. If it and then we could take that item and say, "Hey, show me that in a context for going out on a date in New York City." And we could generate that. And then we could say that the same process could say, "Hey, and show me some boots that I can wear with that dress." And we could do that. And so all of that stuff done right with the computing power of AI. And so so many things today that we have to do manually, I think, and we've gotten better.
This is again, it's a step function or two-step function changes in the how we can do that, which lowers our cost and I think radically improves the customer experience.
Okay.
Well, I think if you tie in what James is saying and get precise on maybe what the opportunities are, we process 20+ million items in the U.S. So if we're able to use AI in a way where we're not putting items on a mannequin and then off a mannequin, which we physically do today, you're gonna save some amount. But assume we save $1, and everything else stays the same. So you're gonna drop $20 million-$22 million to the bottom line. So it's pretty amazing. And it's super impactful.
Okay.
And then everything scales 'cause you're not building more of those stations to do more of those things. So more of your space can be used for inbound and outbound processing. And so, so yeah, we believe it's fundamental, fundamental transition. We are the smartest people at the company. We're spending 110% of their time on it.
Okay. Great. So it's all really exciting. Wanna flip over to another, real growth area of the business, which has been Resale-as-a-Service or RaaS. So, I mean, 2022 saw this really dramatic increase in adoption. I think it was up 3.4 times or something like that.
Yeah.
And there was still growth in 2023, although a little bit more of a digestion period.
Sure.
And so given that you now have a lot of brands that have had RaaS partnerships for a year, two years, you know, how are their wants and needs evolving over that time frame?
Yeah.
And how are you meeting those needs? And then in terms of scaling RaaS further, how should we think about the 2024, 2025 roadmap?
Yeah. I mean, I think if you it kinda maps sort of your Gartner hype cycle, right? I think there was a lot of anticipation and hype around how brands could leverage, you know, resale. And I think a lot of brands launched. And, you know, it turns out products don't distribute themselves. And so I think now we're in the phase of, okay, brands understand how the customer is responding. They understand how a RaaS platform like ThredUp can power or, or, you know, there are some startups that are doing this as well. And so now it's, okay, well, how do I continue to evolve that customer experience? And so I think what you're gonna see this year is more brands sort of tweaking how their model works. And so I'll give you just an example.
Like, there are a number of brands who said, "We love the idea of branded resale. We don't wanna do anything, like, really complicated. We wanna just create a peer-to-peer market. Like, we wanna let connect buyers and sellers in this resale channel." It all sounds really good. But we all know, like, at the end of the day, you need to drive liquidity in that market. And so, like, there's a huge handbag brand, that has a peer-to-peer site. I think it's a $4 billion company. It's got 70 handbags on its peer-to-peer platform. It's, it's hard to imagine anybody at that brand cares at all about this, right? And so, so what, what I think you're gonna see in 2024 and into 2025 is some real reality you know, a reality check around what's actually, like, working and what's not working.
I think ThredUp is well-positioned to help these brands scale this, deliver for the customer. But I still believe over the you know, over the long term, it'll be an important part of what we do. It'll be an important part of what brands do.
Okay. Well, thinking about another area that's been growing quite nicely and Remix, really strong since the acquisition. I think it's outgrown the U.S. business. It's been improving on the profitability.
Yeah. Doubled over the last couple of years.
Doubled. Yeah. I guess what have been really the key improvements that enabled that growth? And then how much low-hanging fruit do you see remaining to really just leverage the ThredUp playbook at Remix?
Yeah. I think that I think in some in many, many businesses, you go through these cycles of sort of growth optimize, growth optimize, growth optimize, growth optimize. I think we've been in a growth phase for the last couple of years. I think we're much more right now in an let's optimize. The business has doubled, right? There's a new distribution center there. They've learned a bunch of new processes. There's new talent on in the team. So I think what, what this year is really an optimization year and primarily around the mix of goods. Consignment you know, we've been very public around the consignment shift, in Europe. I think it's critical to the success of that business, the way it's been critical, you know, to the success of the business in the U.S. We're really focused on that new competency.
And, and it's going what, you know, kind of going as planned. We sort of built all the technology. The difference in Europe relative to the U.S. is you're dealing with nine countries. And you're dealing with different supply chains and aggregation. And so we built most of that technology in the middle of last year. And then we started to roll it out in countries, like, over the course of the end of 2023. And then we launched a few more countries in January and February. And I think we'll be out to almost all of our current markets on the sourcing side, by April or May. And so but remember, Nathan, like, it takes you have to launch into a country. You need to get people to order bags. Then they need to fill those bags.
Then they need to come back to the DC. They need to be processed. And then they need to be sold for it to kinda hit the P&L. And so sometimes it's, you know, it can be 60, 90, 120-day lag from when you launch in a country from when you actually start to recognize revenue. And so a lot of the consignment revenue transition is backloaded just because it's the time is a real thing, right? It's not an instantaneous switch.
Okay. I think we do have real opportunity to take some of the things we've done in the U.S. and bring it to Europe. I think, you know, when we first were talking to Remix pre-acquisition, they brought us down to their room that was doing pricing. It was like a very dark room with a bunch of people in it. I was like, "Who are these people? What is it?" It was like the equivalent of a basement. It was very dark and interesting.
With a bunch of spreadsheets.
Yeah.
It was very wild.
So, but being able to take them, you know, further along on our journey in the U.S. and how we do pricing and make it make it sense in a sense in, in a style of, is it different per size? Is it different per season? Is it different per item? And, yeah, the answer is yes. You know, how do they, are they able to implement that and make a better, you know, environment for their consumer but also for the business itself? You're able to sell things more appropriately if you're able to get the right items in.
Yeah.
Okay. Awesome. Well, do you wanna talk about the full year 2024 EBITDA margin guide? So exciting to see that. Positive at the midpoint, I think 1%. You know, Sean, what are the key building blocks that get you to break even and then, importantly, past?
Yep. Yeah. So I think it's kinda like this year and then beyond this year is the way I think of it. And I think it's fairly simple in a sense that it's as simple as revenue growth is a big driver to this. And it's gonna drive, you know, EBITDAs. We have had it in 2023. But that's also gonna expand based on our guidance. And I think if you look at it, we don't share the unit economics in detail. But if you looked at the U.S. economics by the unit, they're great. Like, we need to just do more selling of what's happening in the U.S. And sometimes people get hung up on, you know, Europe's going through this change, and it needs some improvements to happen. But the U.S. it's like a reminder. The U.S. is 80% of the business.
So the more we do there, you know, life is better across the board. And getting to EBITDA break even I'm not saying everything's easy. But this is you know, we feel very comfortable with this. Then I think we get leverage on marketing. We get leverage on operations, product, and technology, SG&A. But I think it's, like, a very simple walk from where we are as we close 2023 to break even in 2024. And then I think you're headed towards, like, where do we go from here? you know, I think our long-term, target model is it hasn't changed prior you know, since the IPO. And that includes acquiring a business that had different economics. But the goal's still the same. So 20%-25% EBITDA. We want gross margins in the 75%-78% of revenue.
If you look at that particular in the U.S. business, we're already surpassing that, right? We've done greater than 78% a couple times. So now it's bringing up the European business to get there. Part of it is what we've already talked about, the consignment transition. Part of it is bringing kinda what we know and how we do things in the U.S. to the European business. We talked about pricing. But there's just all kinds of things like data science and intelligence that they just haven't used before. We know how to do that on the U.S. side and bring it to that business.
If I would just add, like, Nathan, well, the other thing is I think if you look at over the last 2 years, we've had sequential improvement in EBITDA every quarter seven of seven of the eight quarters. And 1 quarter was just a little flat, right? It was just a sort of a timing issue. But 8 quarters of quarter-over-quarter EBITDA expansion, right? Similar story, you know, for Q1. And if you look at a yearly basis, 2023 over 2022, almost 1,000 bips of margin so business grew double digits with 1,000 bips of margin expansion. And the guide for this year, you know, if you have to think about the consignment transition, but, like, the guide is essentially another double-digit growth with, like, 600 bips of margin expansion.
So, like, where we sit, we feel like we're running the business in a very effective way around continuing to grow top line, continuing to show leverage on the bottom line. So we expect that to continue. We have extreme confidence in the full-year EBITDA number. And then free cash flow kinda comes from there, right? 'Cause we have very minimal Capex. You know, we don't expect any Capex spend beyond sort of maintenance until at least 2026. So we're two+ years of living in a world with minimal Capex and expanding EBITDA. And so I think we feel good about that.
Okay.
I mean, you add in the transition too is as we migrate completely away from owned goods in the U.S. and we make that transition in Europe, there's less of a need to buy inventory, obviously, as well. So that's a little bit of a tailwind on the cash side also. So I think there's a lot of, you know, tailwind as it relates to break-even EBITDA that's gonna just start generating cash and then all the things in the balance sheet that will help us from the inventory side.
Well, James, you noted minimal Capex over the next two years. I wanna refresh. What has been the core of the Capex, which has been your DC base?
Yeah. Yeah. Yeah.
With Dallas partially built out, you know, what's your current capacity over the entire network utilization? And then given that, what are the key priorities for the DC base in terms of improving efficiencies over those kinda next two years, you know, given you're not spending that much on CapEx?
Yeah. I mean, we have about 9 million slots, right? 9 million capacity. We think we believe we can essentially double the business inside of that 9 million without requiring any incremental CapEx. So just right in the U.S. So lots of room to kinda grow into that primarily because we've become more efficient on turns. So we have less items, that are hanging in those slots 'cause we're turning them faster, right? Which I think speaks to all the sculpting and pricing and, you know, work that we've done. So we feel, like, really good about the network buildout. And you know, that was very expensive over the last couple of years. But it's kinda behind us. And so I think it's important for people to feel good about that.
and then on the optimization side, I think we will always, you know, we our team thinks about the operations process in seconds. So it's like, how many seconds does it take to move a good through inbound and outbound? And we know every second is worth, you know, X. And we have plans to take a lot of seconds out of the process, you know, this year, different, you know, excluding the conversation we had about AI, right? I think the AI piece is on, isn't in an R&D track. That's, you know, we're investing real resources to unlock that because we think it's profound. But you'll see this kind of progress from us on the way we've expanded it over the last few years. And then I think there's some big unlocks.
Okay. Well, it's also been a few quarters since you introduced the bag fee for sellers. And there's been different ways you've tried to tweak monetization on the seller side. So I guess talk through what that per-bag fee has led to in terms of inventory quality, unit economics. And then going forward, what are the levers you can pull, to either ramp faster or slower in terms of inventory, especially given the excess capacity you have within the DC network?
Yeah. It's a great question. It's funny. As a founder, you do something like this, you're like, "Shit. We should have done that earlier," right? Because it's not just the monetization of the bag fee, right, which has been helpful. It's that it fundamentally changes how sellers, you know, act in the market. And so when you have to pay a fee, people tend to put more items in the bag. They tend to make sure the items are higher quality. They tend to read the instructions like that we say around, like, what we want. Like, it's such a it's so obvious, right? But I think we had such resistance to keeping it, you know, free. And so the effect of that has been we get more items per bag that we leverage over our logistics.
We get greater acceptance, greater quality, more in-season inventory. So it has been successful on every metric that we have. And the lever is we can mess with the fee. So we have thought about it as something where if our logistics costs on inbound bags go up, can we have the fee float with that? So it's a very effective hedge around increasing inbound logistics. If labor increases, we can flex the fee. So it's a natural hedge in the supply chain that we think is really important. And then for our best suppliers who we wanna maintain, you know, total control of their selling, we can waive the fee. And people love that. It's like I remember when two-day shipping was just starting to become a thing that brands would do.
I remember on Bonobos, like, back in the day, you would order something. And then a day later, they'd be like, "We gave you two-day shipping." And it would come, like, the next day. And it was a surprise and delight moment. And so we're using fees as a surprise and delight moment in a powerful way.
Okay. Great. Now, you've also touched a couple of times on this shift from product to consignment, particularly within the Europe business. So, first off, just confirming. U.S. business, effectively fully consignment at this point.
So think of it this way. We ended 2023 there. We're probably about 80% consignment.
80%. Okay.
We expect them to be or them, us, the U.S., however you wanna look at it, about 95% consignment. We have.
By the end of the year.
Yeah. 24.
Okay. Great. And then, on the Remix side, how much is still within the product business? And then how should we think about both the gross margin benefits of switching over to consign, but also critically, the cash benefits of not having to acquire the inventory and, you know, hold it?
Yeah. So the European business essentially for 2023 was less than 1%. So call it 0. And we'll transition to about 20% for all of 2024. So the exit run rate will be higher than that. But for the full year, it'll be about 20%. From an impact, I mean, there's two types of impact, I think, from the shift to consignment. There's just the traditional accounting shift, which means the payouts associated to the item move from COGS up to contra-revenue. So inherently, you just get a better-looking contribution or a better-looking gross margin on that point. But your gross profit dollars don't change at all. And that is a big reason why we push people to go think about or we think about the business on gross profit dollar growth.
That's a true measure of what the growth of the business is in this transition period. I think the other side of it is, is you basically eliminate inventory risk. So you don't buy something that you're not gonna be able to sell. You aren't able to change the purchase price of the item because now you're actually buying it with the selling price known. So I think there's a big piece there. And if you look at inventory on the balance sheet, I think something like I don't know. 75% of it is the European inventory. Very little piece is the U.S.. And the U.S. is gonna continue to shrink. And now Europe's gonna start to shrink. So thinking how that's gonna work on net working capital, those are gonna both be beneficial as we go through 2024. And it'll continue in 2025 on the European side.
But it's just gonna continue to get smaller.
Okay. Great. And outside of that product to consignment shift, what other levers do you have to pull on gross margin in 2024 and 2025? And how should we think about that ramp?
I mean, I think there's the traditional stuff we've been talking about, what I call, like, our normal automation and process that we've been working on. And then I think there's these huge step functions of opportunity, I would say, on GenAI. I mean, it's from my point of view, I called our head of ops. And I was like, "When are we gonna start using AI in inbound or outbound processing?" He's like, "We've been using AI since you've been here." So but that's, it's like their thought process has always been far ahead there. But it's also this step function opportunity is huge. I don't know if there's any more specifics we can get into yet until those kinda start to take fruition.
Stay tuned. Okay. Great. Now, I wanna touch on one of the hot topics for investors lately, which is the potential impact of some Chinese-based exporters. And so first off, are you seeing any impact there on either the demand side or the marketing side, particularly performance?
Definitely. Definitely. I think it's been one of those things that has slowly accumulated, right, in its impact. But I think we would have our head in the sand, right, if we didn't acknowledge that there's some impact because just the scale of which Temu and Shein, right, are spending dollars in the U.S. is substantial, right? I mean, they ran all those Super Bowl ads so that they could teach us all to say Temu and not Temu, right? And so for sure, it's having an impact. And I think, like, it will continue to have an impact. I think they benefit from some loopholes, right? We can talk about the de minimis tax rule. There's definitely—I think Congress is looking into that.
Just yesterday, actually, there was a bill, that was, introduced in the Senate, about this exact issue, called the Americas Act, which we were actually, as a part of the spearheading coalition of that. So we were founding member of the American Circular Textiles ACT. And the ACT was the driving force behind this bill. And it, it has incredible, meat in it. It's the first bill ever introduced in Congress, that creates conditions to benefit resale, recycling, rental. I encourage you guys to look it up. It's, it's really exciting, because I think there's an acknowledgment that, that the U.S. companies are not able to play by the same the same rules.
And that we all understand that the government needs to be involved in sustainability the same way government was involved in regulating cigarettes and the same way government was involved in inspiring solar adoption and curbing emissions in cars. I mean, there's a Tesla truck parked out there, right? And so I do think I really believe, like, government is gonna play an important role in making sure that the U.S. and resale can be more competitive in this environment. And so, super exciting.
Okay. Great. Now, let's also talk a little bit about OP&T. I guess how much of that is.
That's a nice transition.
Yeah. Smooth segue. How much of that should we think about as fixed versus variable given there's a lot within that bucket? And within the variable expenses, you know, we've talked to a couple of areas to try to improve that. But how much do you think you can bring that down over the next few years?
I think it's probably 70%-75% variable. I think what people probably don't understand is as we went from 2019 to where we are today, labor rates and logistic rates have gone through the roof. Yet, we've been able to reduce our cost to produce or to move an item through the DC. That's impactful in a way that really has improved contribution margins. So what that means is we've really reduced a lot more than that 'cause we covered up those big increases in logistics and labor rates. And we're able to continue to do that literally. It's not forever. But I have great confidence in the operations team that we're gonna continue to make strides. And I know that things are working on before we even get to next-gen AI.
There are opportunities there that are gonna continue to improve that side of the business.
Well, what was the number? I think, was it we shipped 500,000 more orders? Was it 400,000-500,000 more orders?
500,000 more orders.
500,000 more orders this year or 2023 over 2022.
Mm-hmm.
Same OP&T, right? So I think it speaks really to the leverage, and the DC operations. I think it's a powerful thing.
Okay. Well, two more for you. First one. You know, in 4Q, you reduced the return rate by about 700 basis points year-over-year. Really impressive improvement. I guess what enabled the drop? How do delivery promise and Thrift Promise fit in? And then, what do you see as the white space to continue pushing from that metric down?
Yeah. I mean, it's pretty low now, right? So I would not count on it happening driving another 700 bips, right? There are, there's physics involved, right, around how the consumer sort of, you know, try stuff on and what ultimately fits. So, I think the delivery promise part has been great around just helping customers get their orders faster. And I think people, there's sort of like if you get it fast and the experience is good, you're more likely to keep an item, right, versus if you wait. But on the Thrift Promise side, it's been, we've used data science and sort of AI to figure out, "Okay.
Would we be better off letting that customer keep that item versus sending it back to us? And so a lot of what Thrift Promise has been able to do is only encourage customers to return items that make sense for them to return, right? And so not only is it reduce return rates, which are good for the P&L, it also there's no you don't have you're not shipping boxes with one item around. And so it reduces emissions. We think it's ultimately, like, you know, good for the planet. And so I think there's more room on that, Nathan. But I think we're probably at the point where it's probably at the steady state of where returns will be.
Okay. Great. Now, let's close it out with one a little bit more high-level. So what do you believe are the one or two things that you think investors most either underappreciate or misunderstand about the story?
I think if you can sort of look at the face of the financials and not understand that the sort of all the competitive advantage that we've built over time is, like, continuing to compound. It's not, you know, we're not a fly-by-night commerce direct-to-consumer company, right? We have, like, huge defensibility in our operations, our data, the customer experience that I think is only gonna compound with AI. And so, you know, I think we're a business that's continuing to build for the long term. And we're really committed. And sometimes it drives Sean nuts 'cause I'm like, "We're not gonna cut that 'cause we're committed to the long term." And so, you know, over the last year, sure, we could have done things that would have satiated the appetite of near-term investors.
We just never, we're just never gonna run the business like that. But I do believe everything that we're doing will compound over time to build a business that will generate a lot of, you know, incredible returns. So I think people don't get under the hood enough to really understand. So I think that's probably the first. And then I think there, I would say on the AI side, I think there, it's easy for investors to roll their eyes around the hype cycle that we're in. But it's a transformational opportunity for us. And I think if people really pay attention to that and play with it and think about, like, "Oh, yeah. How does this business benefit disproportionately compared to other ways that people shop online?" I think people, like, have a moment.
We're like, "Oh, yeah. These guys will really benefit from this." Relative. And I'm, I often tell people, I'm like, "Lululemon. We all love Lululemon. They have 900 SKUs. They take lots of photos. It's not gonna help them," right? Like, maybe in the marketing side but, like, it's not gonna materially change their business. We take 200,000 photos a day. We got 4.5 million SKUs. It will fundamentally change how the customer experience works for our business. And so I think that's the second piece I think people should pay attention to.
Okay. Great. James, Sean, really appreciate you both being here.
Thanks for having us.
Thank you.