Updated: Oct 6, 2021
Artificial intelligence is changing the way we do business. Companies that creatively use machine learning can gain a competitive advantage over other firms in the marketplace. And startups have been using AI to disrupt some of the oldest industries. In this post, I will look at two companies, one in insurance (Lemonade) and one in lending, (Upstart) and analyze their market prospects. These two are great case studies as AI seems to only be one part of the equation for their success and one stock the market has loved (Upstart) and the other stock the market is a little bit more skeptical (Lemonade). Although both of these companies have a strong tech focus (giving them a competitive advantage) it may be their customer-centric approach that ends up giving both of them a sustainable competitive advantage.
Upstart uses AI to approve loans for individuals who wouldn’t otherwise qualify and in many cases on much more favorable terms than what other lending companies could offer. Most of the loans go through a handful of online finance sites and then Upstart has established partners that they turn around and sell these loans to. In this way, they are acting as a middleman in the lending process. The default rates on Upstart’s AI enabled loans has been incredibly favorable and the huge earnings beats (which the company seems to be almost making a habit of) has really created some optimism among investors.
Lemonade uses AI to streamline the customer acquisition process to approve new insurance applications much more quickly than other insurance companies. They also use AI to streamline the claims process as well. AI allows approval for new customers in as little as 90 seconds (this can take days for traditional insurance companies). Lemonade currently chooses to focus on the customer experience and new customer acquisition rather than trying to manage a large insurance portfolio. They do this by using reinsurance on about 70% of their new policies. The simplest way to explain reinsurance is that it transfers away the risk to a third party but also transfers away some of the profits as well.
A key difference between Upstart and Lemonade is that Lemonade keeps their own customers instead of acting as a middleman. This is more resource intensive (and I think drains Lemonade’s profit margin as well over the short term) but I think in the long run Lemonade’s highly satisfied customers could become yet another source of sustainable competitive advantage. Plus as Lemonade grows and offers new insurance options (such as auto), they can leverage their existing relationships to sell more coverages. Another cool factor about Lemonade is that they when they have a great quarter and have low claims, they are able to give away a portion of excess customer premiums to charities of the customer’s choosing. This can develop goodwill between their clients and the company and helps to dispel the cynical customer belief that all insurance companies only care about their profits. Lemonade is a registered B Corp. (I love to talk about B Corps in my ethics classes and will probably create a blog post about B corps sometime soon!) B Corps have a dual mandate to be a good community stakeholder (and they have to make progress toward this goal) as well as to be profitable for their shareholders. Through all these actions, Lemonade is quietly creating a strong brand identity around corporate social responsibility and high-quality customer experiences. And in the long run should be able to not only retain their customers (brand loyalty) but also to generate positive word of mouth. As more and more people become aware of Lemonade (brand awareness) they should be able to build strong brand equity and thus a sustainable competitive advantage.
There has been a huge difference in stock performance between these two companies. Lemonade’s stock since their IPO in July 2020 has risen from $29/share to over $70/share as of today (Sept. 23rd). But, is down significantly from its peak of over $163/share in February of 2021. Meanwhile Upstart is way way up from an IPO price of $20/share in December of 2020 to a current and all time high price of over $336/share. So, there is a huge difference between these two companies with Lemonade up 141% while Upstart is up 1584%. Why the difference? Well, there is no denying that Upstart seems to have found the secret sauce somewhere in its AI algorithms and they have executed flawlessly up to this point. Upstart is already profitable with the likelihood that profit margins and growth will only expand. Plus the huge size of the loan market means that Upstart has an incredibly long runway for growth. Lemonade on the other hand had some losses (losing almost a dollar a share in the second quarter of 2021). They have stumbled in their execution and had higher than expected loss ratios (because of the Texas freeze). If this is a one-time hiccup and they continue their rapid pace of growth with a high customer retention rate, then it is possible that we could see Lemonade’s stock going once again for all time highs. They are also operating in a huge market (5.5 trillion dollars) and should also have a long runway for growth, but until they can become profitable I think investors will remain skeptical. Building an insurance company from scratch is just a hard thing to do.
In conclusion, both of these companies are great opportunities for investors for somewhat different reasons. Both have a competitive advantage with their AI-enabled business processes which is allowing them to enter very large and competitive industries and succeed. Upstart has the momentum and generally speaking, market winners tend to keep on winning. Meanwhile, Lemonade is investing heavily in its brand and the brand equity that they are building could become a huge sustainable competitive advantage in the future. Upstart is valued at $26 billion currently while Lemonade is only valued at $4.39 billion. This is shaping up to be the race of the tortoise (Lemoande) and the hare (Upstart). I recommend buying shares in both and then sit back and enjoy the race!