Below is a transcript of a podcast I recently recorded.  It has been lightly edited for clarity.  You can find the podcast by searching for “scuttleblurb” on Apple or Spotify.

So Align technology is the company behind the Invisalign brand of clear liners. And so those are the clear removable plastic trays that are used to straighten out misaligned teeth. There are somewhere around 14 million malocclusion cases started every year. So malocclusion, by the way, when I say that, that just means misaligned teeth. 80% of those 14 million cases are still corrected with traditional wires and brackets, which implies that Align with 1.9 million cases has 70% share of everything else.

So we’ve all heard of Invisalign. I think we’re all pretty familiar with clear liners by now, but back in 1997, when Invisalign was founded, these clear liners were basically seen as a gimmick. They weren’t really seen as a real orthodontic appliance and orthodontists who were trained in wires and brackets took a lot of pride in doing these cases by hand, and they were generally very skeptical of the idea that you could fix crooked teeth with plastic trays. And so these wires and brackets were sold by companies like Dentsply and 3m Armco. And this was a B2B sale. So patients didn’t know or care about the brand of the braces. And what Align basically did was they created a consumer brand around clear aligner technology.

So they had the whole market to themselves for a while because the incumbents were realizing steady cash flows from selling these conventional braces and they weren’t going to cannibalize that business by making a big speculative bet on a product that nobody believed in. So Align technology with their clear aligner treatment was really like counter positioning against these incumbents.

The two relevant constituents here are the consumers and the doctors. So Align sells the clear aligner treatment to the orthodontists who then mark it up and then sell it to the consumers. And the value proposition for the consumers is pretty straight forward. It has to do with comfort and aesthetics. So instead of having these visible metal wires, they’re wearing a clear piece of plastic that can be hard for other people notice; it’s more comfortable because you don’t have the wires and brackets rubbing up against soft tissue; and it’s more convenient because they don’t have to make as many trips to the orthodontist for these mid treatment checkups.

And then as far as orthodontics go, the, the questions really come down to: does this work, is it economic for me? And do patients want this? So as I said, orthodontists were skeptical of this product at first, but they started feeling the pressure from two sides. Aline was doing a ton of brand marketing, so consumers started asking for Invisalign by name and clear aligner technology got better and better over time and doctors felt more comfortable prescribing it. The economics were also better. So what orthodontists realized was that even though they were paying more for Invisalign than wires and brackets, four or five times as much in some cases, the Invisalign treatments required less chair time because with traditional braces the orthodontist has to tighten the wires whereas with Invisalign, most of the treatment planning is done with software. So I’ll talk a little bit about the treatment flow.

So what happens is the patient gets their teeth scanned at the orthodontist office and that scan is electronically submitted to an Align lab. And at the lab, a technician creates a treatment plan in ClinCheck – and ClinCheck is just aligns proprietary CAD software – so it goes into ClinCheck and then the treatment plan is reviewed by the orthodontist for 10 minutes and the orthodontist and technician will sometimes go back and forth to get the treatment plan, right, but this process still saves time relative to tweaking the wires and brackets. So what that means is that the orthodontist can treat more patients and on a per chair hour basis, Invisalign is actually cheaper once the doctor gets past a certain volume threshold.

So to be more concrete about the savings here with wires and brackets and orthodontist might charge the patient, let’s say $6,000 for a malocclusion case. And the doctor will pay like 300 or 400 bucks for the wires and brackets. So the doctor makes like 5,600 bucks or 5,700 bucks per case. With Invisalign, the doctor charges the patient the same $6,000 and will pay anywhere between $900 and say $1,500 depending on their volumes. So let’s just use $1,500. The profits on a $6,000 case are 4,500 bucks. So for a single case obviously conventional braces are a lot more profitable for doctor. You’re talking 5,700 profits versus 4,500. But the key is that the total chair time is way lower for Align because Invisalign, because there are fewer mid treatment appointments and emergency visits. And there’ve been some studies on this. One of them I read was from 2013 – I think it was from an industry trade journal and I can’t attest to the accuracy of this study – but the claim was that the chair time is basically cut in half when you use Invisalign.

So yea, now with Invisalign you still have to include the time it takes to review the case in ClinCheck, so maybe that’s another 10 or 15 minutes and so maybe you’re not doing twice as many cases but you’re doing let’s say 1.7x as many cases if you assume the typical traditional case takes 180 minutes of chair time.

And also remember this study was done like eight years ago and Invisalign has gotten better and faster since then, whereas the same is not true of traditional braces. So you can frame this as clear liners versus traditional braces, but at a higher level of abstraction, this is also digital versus analog workflows, because really what you’re trying to do is straighten out these teeth as quickly as possible and a digital process can get faster and better the way an analog process cannot. With Align, there’s there’s been more like automation baked into ClinCheck, and that saves time. They rolled out a teledentistry platform last year, that saves chair time. They have a scanner, iTero, that’s gotten better, whereas I imagine it takes probably the same amount of time to do wires and brackets as it did a decade ago.

And then also orthodontists have an added incentive to move more of their caseload to Invisalign in order to obtain Elite status. And so once they get there, the orthodontist only pays 900 bucks per case. And the profit scenario I walked through earlier is obviously even more compelling.

So Invisalign is the dominant player in clear liners. And as I see it, the advantage it has basically comes down to vertical integration, patents, and then having a huge start on the competition. Align was well funded from the start and they used the capital that they got to invest in marketing, direct sales, and manufacturing from very early on. So you might be surprised to learn that Align is the largest 3D printing company in the world. So they use 3D printers to make the clear aligner molds and using these molds, they can mass customize hundreds of thousands of clear aligner trays every day. There’s a lot of small things that go into this. They’ve trained their own machine vision system to read the unique identifiers on the aligners to make sure like the right aligner, it goes in the right package. They’ve got these lasers that can trim the aligners in this very precise way so that they aren’t discolored. And so over the course of 20 years, they’ve just added new technology to their manufacturing process and they’ve gotten better at making these aligners faster, with much less material, and using less labor than their peers.

And then other parts of the process. So they have technicians creating the treatment plans in a remote lab using ClinCheck, which I mentioned earlier; they own the CAD software and there’s more automation being baked in over time; and they even have their own scanners. So it used to be that to get a mold, a doctor would apply this cold PVS goop to your teeth, and then they had to FedEx those to the lab. And those PVS impressions have been largely replaced by digital scanners, which allow doctors to get the images to the lab faster and also dramatically improves the accuracy. And they’re also like a sales tool. So with a scan, you can show the patient, while they’re sitting there in the chair, how their teeth are going to move over time and that apparently improves conversion.

And getting into scanners was a prescient move. They got there by acquiring Cadence in 2011, and this was a pretty unpopular deal at the time. So Cadence was unprofitable. And even if they got to large scale, the margins would be a lot lower than clear aligner because scanners are kind of a commodity, but what Align got early on was that scanners were going to be a key part of doing these cases more efficiently and that would drive more case volumes in the aligner business. Okay. So they got the software, the manufacturing, the scanners, all that stuff integrated, they created scale economies in manufacturing, more accuracy and speed in the treatment planning. And it’s sort of like a classic Clay Christensen right here, they shifted the basis of competition, orthodontia from effectiveness to comfort and aesthetics and then they vertically integrated key parts of this process flow in order to make a big dent in the doctor and the consumer experience.

So that’s the vertical integration piece. And then the second thing is they had just a huge headstart relative to peers. So I think the first serious direct competition was ClearCorrect. And ClearCorrect came on the scene like seven or eight years after Align. They were largely a bootstrapped company. They weren’t nearly as well funded and they didn’t start integrating manufacturing till about 2008, so they were close to a decade behind. And then along the way, Align built up a huge patent portfolio and those patents related to treatment planning; the source code that was used to create the 3d image of a patient’s teeth; the manufacturing technology; and then they aggressively defended these patents.

So there’s this competitor Orthoclear that came up in 2005. It was founded by one of Align’s co-founders and they allegedly stole Align’s IP and trademarks and in doing so, they were able to grab like 20% share of the clear aligner market in the US very quickly, but then Align basically sued them out of existence. They shut down within two years of launch. So Align’s got a lot of things going for it, but in the past it’s actually been subject to a lot of negativity by investors, at least in the circles I roll in. And my sense is that a lot of this kind of ties back to the intuition that, well, “this is just a piece of plastic that moves teeth, anyone can make that, and no one should be earning 25% EBITDA margins on this and when some of their key patents expire, they’re going to be swarmed by competitors who will underprice them”.

So yes, key patents related to digital treatment planning and CAD technology have expired over the years. That’s true and it’s important. There’s this company called uLab that launched a competing CAD software in 2018, after some of Align’s patents rolled off a year earlier, and we’ll talk about that later. But there was always more to the story. They spent years building the brand and getting a consumer adoption. They got widespread buy-in from doctors who habituated themselves to the ClinCheck system. The case volumes brought scale economies in manufacturing, which allowed for reinvestment in marketing and product development, more experience treating harder cases, which in turn drew in more adoption by orthodontists.

At least what I’ve heard from morph does is that Align just saves them time and they just know it’s going to work for most of the cases that they come across. So like why risk moving to another system when this one seems to strike the right balance between efficacy and price? I think there’s just something to be said about the power of incumbency, especially in this industry because orthodontists tend to be resistant to change. And by the way, Align learned this the hard way themselves. I think like in the early days, they invested way ahead of demand. Orthodontists were making a good living on wires and brackets, this is what they were taught in school, and they didn’t really see an urgent need to change.

So it took a lot of education and product improvements and consumer demand to finally get traction. And then the other thing is Align’s always been a pretty innovative company. They were the first ones to get into 3d printing, they built out some of their technology. Management likes to tell this story about how in their manufacturing, they tried some off the shelf, optical character recognition systems to read the identifiers on the aligners, and when that didn’t work, they built their own. Buying cadence in 2011. I talked about that earlier. I think that was a non-obvious forward looking move. I mean, I just think they’ve made a habit out of really understanding the workflow for malocclusion cases and then just like ironing out as many friction points as they can.

And then finally there are a few other possible like growth pockets to the story. They’re on fire in China. So they basically share that market with a local player called Angel Align. If you look back four years ago, China wasn’t even in the top five countries for Align and now it’s like their second largest market. So they put in a lot of resources educating and training doctors, they’re opening permanent manufacturing capacity there and introducing scanners. There really isn’t any other major US player that has made as much progress. And then Align is also making a big push and going after dentists.

Align mostly sells through orthodontists but there are like 10 times more dentists out there in the US. So there’s this metric called utilization that management discloses and it basically refers to the number of cases shipped per doctor. And for orthodontists, that number is 67 per year. It’s more than doubled over the last five or six years, but for dentists it’s only like 10 and that’s only up from seven. This could be an opportunity for them, though utilization for dentists will always be much lower than orthodontists, obviously. And I also think it’s probably a more competitive channel to get after, but we’ll see.

So that’s all good stuff, but here’s some things that worry me about Align. So first of all, something like 70% or 75% of malocclusion TAM is teenagers. And these tend to be more complex cases because their teeth are still maturing and you have to factor in jaw movement. And Invisalign can actually handle those complex cases now but there’s also a compliance issue. The ability to remove aligners…that’s obviously a problem for parents who don’t want their teenagers taking these things off and not wearing them as often as they should and losing them. I mean, you have to wear these things like 20 hours a day and then brush your teeth after meals and it’s just a tall ask for some teenagers. For the vast majority of comprehensive teen cases, as a parent, you might just prefer to like lock your kids in metal braces. So yeah, teens make up less than 20% of Align’s business, so the company is way under-indexed here. And you could look at that as an opportunity because parents tend to want the best for their kids and if parents want to get clear aligners for the kids, they’re going to pony up the five or $6,000 for Invisalign. They’re probably not going to, you know, get Smile Direct Club for their 14 year old would be my guess. But there may just also be a huge chunk of teenagers who aren’t addressable for compliance reasons, in which case what you might be banking on with clear aligners is TAM expansion, where adults who may never have considered braces come into the market.

Then there’s competition. So there are several incumbent competitors out there….the wire and brackets guys have gotten into this, their distributors have gotten into this….3M, Dentsply, Danaher, Henry Schein. I’ve heard good things about Envista.

Envista was spun off of Danaher, ClearCorrect was acquired by Straumann, which maybe gives them an edge in the general practitioner channel. For the most part, nobody has really gotten much traction. I think the reason why they’ve had a hard time breaking Align’s dominance is that they’ve essentially competed on the same terms where they’re selling these aligners that are sort of similar to Align, maybe not as good, for like 30% cheaper. That didn’t work for the reasons I talked about and if it was just those guys, I wouldn’t worry too much about Align’s competitive positioning. But where I do think Align faces some serious challenges now is on two fronts. The first is Do It Yourself treatment planning and the second is direct-to-consumer.

So we’ll start with Do It Yourself and this would be doctors 3D-printing aligners in their office. That’s what I’m talking about. So orthodontists at this point are very familiar with clear aligners. They’ve been trained on them and they know how to use them. Plus the technology has really advanced over the last decade, specifically the accessibility of computing, machine learning, and the cost of 3d printers. So it used to be that technicians would have to manually carve out each tooth in the software, and that took like eight man hours to segment each case. And that was late ’90s/early 2000s. And then fast forward to today and you can use machine learning and software to do it.

There have also been big advancements in manufacturing. So 15 years ago you would have these huge, expensive milling machines that would make the aligner molds, and they could make one model per hour. And you compare that to today, you can have a $4,000 3D printer print a model in like five or six minutes. These printers will get better and better and the regulations around this will change for the better I think. I believe right now 3D printers are technically able to print aligners directly, it’s just not FDA approved. The way it works now is you’re printing out the mold and then wrapping the thermoplastic around the molds. But from what I understand, the FDA has approved direct print of retainers and they’re going to soon allow for the direct print of aligner trays I think, which should save the doctor and the patient some time. So there’s this company called uLab that takes advantage of this technology. uLab was founded by the former CTO of Align in 2015, and it makes the CAD software that orthodontists use to design the clear aligners.

And that software integrates with third-party 3D printers. So their model is that they give away the software for free and then they charge the orthodontist per aligner. So you have, as the orthodontist customer, you have like one of two options here. You can have uLab make the aligners in their manufacturing facility in Memphis, and that will cost $19 per aligner. Or you can send the STL file to your in-house 3d printer, in which case you’re paying $2.50 per export. Or you can do a combination of both actually, so maybe you do like the first few stages in-house so the patient gets their aligners right away and then have uLab manufacturer the rest. And the kicker here is that the maximum you ever pay per case is $950. So in most cases it’s a cheaper option than Align.

And this seems to be getting traction. They launched the software in 2018 and they passed 250,000 cases recently. My best guess is maybe they do, I don’t know, 150,000 or 200,000 cases over the next year? To put that in perspective, Align did around 1.6 million over the last 12 months. So it’s still small compared to that, but yeah it’s interesting. The downside to uLab is that it’s still slower for comprehensive cases. And the reason for that is with Invisalign, the doctor is basically outsourcing the treatment planning to an Align technician, whereas with uLab, the orthodontist – or more likely the assistants – are doing the treatment planning work themselves. But uLab software I’m sure will get better at handling these more comprehensive, comprehensive cases over time. So manufacturing these aligners on your own 3D printers is still kind of a fringe practice, but I can definitely see it catching on as the software gets better and the 3d printers get cheaper and faster.

And then the other downside to uLab is that orthodontists don’t get the Invisalign brand. And my take on this is that I think brand mattered a lot when clear aligners were a nascent technology, but everyone knows about these things now. And I’ve heard orthodontists say that patients will often just go with whatever treatment they recommend, even if [the patient asks] for Invisalign at the start. So sometimes a patient will ask for Invisalign because they just don’t know what else to call it. It’s kind of the same way you might ask for Kleenex when what you really want is tissue paper…you don’t really care about the brand per se.

Here’s another thing. Another pushback you might give to uLab is that Align has all this case volume data that uLab doesn’t have and this data advantage is something that Align’s management brings up a lot. So they’ve done something like 9 million cases over their life, and the idea is that they can use data from these cases to accurately predict how teeth are gonna move in a way that takes into account all the different biomechanical knock-on effects. But yeah, I don’t know, this claim has always seemed somewhat overstated, because it’s not like Align is getting a complete scan of the patient’s dentition at every stage of the treatment process. Like the doctor isn’t taking another scan at month three, and then month six and month nine, and then sending those to Align, right? So all Align really sees is that initial scan, so they don’t really have insight into how each case is progressing over time. Now, the initial scan is important for segmentation. So, segmentation is the step where you’re identifying each tooth in the software. The software is told “here’s the canine, here’s the first molar, here’s the central incisor” but it’s not so much that you need like tons and tons of data [to do this].

I was talking to a former Align employee who worked in R&D about this and even in that initial segmentation process, there’s likely a plateau to how much of that data helps….like having 9 million cases probably doesn’t help you that much more relative to having only 3 million cases or maybe even 1 million cases. Now having said that, where I think case volumes could be helpful beyond segmentation is that while you’re not getting longitudinal data for each patient, you might still get a sense for how teeth develop, like the speed in which they move in teenagers or how big each tooth eventually gets, just by looking at patients across different age groups. And plus, there are some cases that may not go according to plan, and the doctor has to take a second scan and send that scan over to align. And so with more case volumes, you might see more of those edge cases, but yeah, I don’t know, it’s not like there’s this awesome data network effect flywheel, whatever in place here. So yeah, just wanted to calibrate this claim about the importance of data.

So anyway, the second major competitive threat I think is direct to consumer and that brings us to Smile Direct Club. Smile Direct, as well as a growing number of direct to consumer aligner companies, are bypassing the traditional orthodontist channel by selling directly to consumers, obviously. So under the Smile Direct model, there’s basically two ways that you can get treated. The first way is that they’ll mail you the PVS goop that you put over your teeth. And then you send that back to an SDC lab and SDC converts that mold into a 3D image.

The second way is that you show up at one of the Smile Direct stores. So Smile Direct, they run their own freestanding stores as well as stores inside of Walgreens and CVS. So you show up to the store, get your teeth scanned there. So before COVID the vast majority of their business, like 80% or 90% was coming through these stores. But whichever path you take, a dentist or an orthodontist that is part of the Smile Direct network is going to review the scan in SmileCheck – and SmileCheck is just Smile Direct’s software platform – so they’re gonna review it and then create a treatment plan. And then the consumer accepts the plan and uploads photos of their teeth every few months for the doctor to review. So the company it’s sort of like a tele dentistry platform bolted onto a DTC business model, you might think of it that way. But the main idea is that orthodontists are no longer the gatekeeper. So with Align, Align owns the brand that consumers ask for, but the orthodontists still keep the customer relationship, whereas in this DTC model, Smile Direct owns the customer relationship while orthodontists are kind of shoved to the back, where they’re just reviewing the cases.

This is kind of like the next phase of counter positioning. So in part one Align, counter position against the traditional wire and bracket incumbents by creating a consumer brand around this new aligner technology. And then now here’s Smile Direct and all these other guys counter positioning against Align by selling direct to consumers. This is something that Align will find very hard to copy because of channel conflicts. So Align has struggled with channel conflicts in the past. When they first launched, Align just targeted orthodontists but they were sued by dentists who thought it was unfair that only orthodontists got the product and they thought they should be able to have it too.

Align then figured if they’re going to sell to GPs anyway, they may as well proactively do so. And I’m just speculating here, but it could be that that was one of the reasons why Orthoclear stole so much share from Align back in the day. Align’s second misadventure with channel conflicts came a few years ago. They bought a 19% equity stake in Smile Direct and then agreed to supply Smile Direct with aligners. And soon after they did that, Align opened these freestanding showrooms where they could provide consultations to consumers. And what they told orthodontists was that this would be good for them because Align would funnel traffic their way. Nobody bought this. Everyone like saw through the ruse. This was clearly an attempt to go DTC.

Doctors were furious, SmileDirect sued them and Align was forced to retreat. So anyway, the direct to consumer model proved very popular with clear aligners and heading into COVID, Smile Direct was growing like a weed. They did close to $700 million in aligner revenue in 2019 and they were really only around for five years up to that point. To put that in perspective, it took Align 16 years to approach that level. So Align basically created this clear aligner category and then Smile Direct found a way to piggyback on that with a different distribution model at a much lower price point. Align will run a consumer somewhere between $4,000 to $8,000 whereas a Smile Direct case will go for 1,800 or 1,900 bucks or 2,300 bucks if you use financing. So it’s a massive, massive cost savings.

So I talked about all the things that Align vertically integrates…the CAD, the scanners, the manufacturing. Well Smile Direct also does manufacturing and it has its own proprietary software, but it takes things to the next level in that it leases the stores, it handles the customer service and it provides installment loans to customers to pay for the product. Basically the cost that an orthodontist would typically bear to run a practice, Smile Direct is putting on its own income statement, right? So they’re doubling down on vertical integration in the hopes that by doing so they can offer a better customer experience and then get the volumes to realize scale economies.

You can start with counter positioning but eventually you’ve got to work your way up to scale economies.

I’m not saying anything new here, but these DTC businesses, they’re easy to start but hard to scale. And so right now, this vertically integrated approach means that Smile Direct is burning lots of cash. So in 2019, before COVID, they generated negative $440 million of free cashflow on revenue of $750 million. And it just seems like this process of getting to scale is like getting harder over time. Like a decade ago when Dollar Shave Club and Warby Parker were coming up, maybe you could just throw money at Facebook and Instagram to acquire customers at attractive ROIs, but then that gradually got competed away. And these DTC brands had to find other ways to boost conversion by pulling levers in other parts of the funnel. In many cases that that meant going as far as opening stores.

So now we’ve moved into this next stage of DTC where the conventional wisdom has become “rent is the new CAC”, right, where you complement your online presence with stores. So that’s part of the playbook now. And I feel like Smile Direct has had to emphasize brick and mortar especially because it faces some unique challenges with clear aligners. Because in the online delivery model, they have to ship you the PVS stuff, and it’s up to the consumers to take their own impressions and this just isn’t a great experience. And in fact, one of the key reasons why they opened stores in the first place was so that customers could get the digital scans instead.

So you think about all the steps here: you need to ship the PVS to the consumer’s house; the consumer has to feel confident enough to like take their own impression – that’s something that’s usually done by a dental assistant – and then they have to mail that back; and then an orthodontist has to see if you’re a candidate and then Smile Direct has to come up with a treatment plan. So, I mean, there’s a lot of friction there and a lot of places where a potential customer can fall through the cracks. They opened the stores in part to keep prospects in the funnel, but I think maybe Smile Direct went too far with this. They had around 400 units and those stores were like 25% utilized heading into the pandemic. They’ve had to dramatically pare back their footprint. I think they originally thought the stores would serve as a customer acquisition vehicle but what they discovered pretty soon was that for the most part, the stores were just being used as fulfillment.

Fortunately for them, 40% of their stores were through CVS and Walgreens where they’re basically on a revenue share agreement and they’re not paying the fixed cost of rent. And then also most of their leases were month to month. So they’ve let those leases roll off and I think the plan is to just walk away from the stores. Now they’re thinking that patients will be willing to drive a little bit further to get to a Smile Shop. The other thing they’re doing is partnering with dentists. So this is a partnership model where dentists take the scan and then share the revenue. They have like a thousand dental practices now participating in this network. So it seems like they’re emphasizing the traditional channels for customer acquisition. In some ways, it kind of validates this idea that online direct to consumer is really just a starting point. It’s not the end all and certainly not a moat. It’s just a way to find customers and get initial traction.

I think these are the right moves because realistically I’m not sure that having consumers like take their own impressions is a model that works long-term. During COVID, Smile Direct shut down their stores and what we saw then was that like the online channel just couldn’t pick up the slack. So if you look at aligner shipments in the last nine months of 2020 for Smile Direct, those were down like 27%, whereas for Align the case shipments were actually up 9%. So short of sending everyone digital scanners, I’m not really sure how you solve for that problem.

Smile Direct has the added challenge of regulatory capture. So you have dental and orthodontic trade associations arguing against tele-dentistry for orthodontics saying that Smile Direct is shirking the standard of care by not having doctors perform patient exams. And the dental boards in Alabama and Georgia have passed rules that said a doctor needs to be on premises when a 3D scan is being taken. But this is increasingly a moot point because Smile Direct is partnering with dental service organizations and they’re covered in network by more and more insurance carriers. So it feels like they’re being validated by important parts of the value chain and more generally, I just think fighting against teledentistry or like tele-anything is just a losing battle because COVID has normalized it.

And I think that sentiment and regulations around telehealth are definitely changing for the better. So, yeah, this feels sort of like one of those Uber versus cab drivers or Airbnb versus hotels cases where like if the product is so much more convenient and affordable and consumers are really asking for it, the ecosystem will adapt and the regulations will eventually accommodate. That’s kinda my opinion. But that’s not to say that Smile Direct, isn’t playing with fire a little bit here. I think Smile Direct is fine for simple cases, but you probably don’t want to be stepping too far outside of your technical capabilities because, like moving molars can change the bite and that can have long lasting impacts. It honestly wouldn’t surprise me if Smile Direct we’re we’re biting more that more than they could chew here.

But that needs to be offset by like all the good they’re doing by making orthodontia affordable to so many people. I mean, the way things are today, whether you have a complicated case or an easy case, it really doesn’t make that much of a difference in terms of like what an orthodontists will charge. It’ll still be like 4,000 to 6,000 bucks. So here’s smile direct coming in at less than $2,000….all things considered, I think that’s probably a net positive for consumers, even when you take into account the possibility that they may be doing cases outside their technical capabilities.

But I’m not really sure what would lead me to say that Smile Direct is the one to bet on versus all the other DTC aligner companies, maybe other than the fact that it has a lead on its competitors when it comes to vertically integrating the manufacturing.

And I alluded to this earlier, but there’s really nothing special about the online channel per se from a competitive advantage standpoint and asking like how an online DTC company succeeds is really not that much different from asking how any retailer or any brand succeeds….like the answer is not going to be found in a generic channel strategy. Casper likes to say it’s their data science and marketing skills and they like to pitch this narrative of not being a mattress company but rather a sleep experience company, meaning we don’t just sell mattresses but also pillows and pajamas. And then Smile Direct seems pretty good at this stuff too. It’s like, we’re about better smiles, meaning we don’t just sell clear liners, but tooth whitening and power flossers.

So yea, there’s something to say about consistent messaging and branding, but also realistically these companies have to define their value prop more broadly to make like their economics work. So I think at one point Casper claimed that historically they were able to bring in $3 of revenue for every dollar of marketing spend, but you know, their gross margins are like 50%. So $1.50 on a dollar of marketing, that’s not great, especially when you consider customer support and other costs. So yeah, they probably need to attach more and more products in order for the unit economics to make sense. And maybe the same is true of Smile Direct, although Smile Direct has much better gross margin.

I don’t know. What I will say though is it’s a lot easier to imagine how scale economies develop than it is to call the specific winners in advance. Align was also burning tons of cash as they tried to gain adoption and it took them nearly 10 years after they launched to start consistently generating profits. And then obviously they spooled up the scale economies over time. And the bull case here is that Smile Direct could pull off a similar result. Because look, first they have pretty good brand awareness now and second, it’s a really compelling value proposition for consumers. Like the treatments are so much cheaper than Invisalign.

And here’s the other thing: consumers don’t actually know the difference between a good enough smile and a perfect smile, and they may not actually care in most cases. Smile Direct may not meet an orthodontist’s exacting needs for these comprehensive cases, but it might be good enough for the vast majority. And in fact, Smile Direct says up front, the goal is not to produce a perfect smile but just to make your smile better. So you can imagine a scenario where the low price point attracts volumes, they scale the manufacturing, they bring down their unit costs, which allows them to reinvest more aggressively than peers in customer acquisition, which brings in more consumers, which brings in more doctors to their network reviewing the cases, which means faster turnaround times, which in turn creates a better experience and draws more customers, more opportunities to cross sell toothpaste and night guards. So there are like these reflexive properties to scale. The second ingredient to this – and this isn’t specific to Smile Direct necessarily and it’s maybe a little bit more speculative – but I think there’s like this feedback between like capital and success, where to pull this off, you need a vertically integrated model, which means you need to raise more capital to absorb your burn until you get to scale.

And that money will flow to whoever capital providers think should win and will win in the category. There’s this self-fulfilling prophecy in a way where the people with the money are not just like finding the winners, but also anointing them. And they do so based on like who’s already winning because success breeds success given the scale economies and it feels like right now that player in DTC is Smile Direct. So they have pretty dominant share in that channel I think. And for now I think they’re the only ones vertically integrating the manufacturing. But I’m sure others will follow suit and yeah, the markets have just been super accommodating, so like Smile Direct’s cash burn really just hasn’t mattered from like a survival perspective. They secured a $500 million credit facility. They did a $650 million convert and that $650 million was upsized from $350 million. And this was like zero coupon, 40% out of the money. So, I mean, it’s kind of incredible the terms on which some of these companies are raising capital.

So switching back to Align, as far as I can tell most of the competitive impact – whether that be from do it yourself 3D printers or from direct to consumer – has been limited to the low end of the market. And whether competition is having an impact on Align’s numbers today, it’s sort of ambiguous. Like their ASP’s have been trending down for years….that could be pricing, but it could also be a mix issue because the less complex cases have also been growing. Or it could be like doctors getting volume discounts for ordering more cases. There’s also an accounting dynamic to take into account because part of the revenue is deferred if you use extra aligners and that can lead to a case where you’re selling these lower priced cases but those could show up as higher ASP just because you’re recognizing revenue faster.

Same thing with gross margin. Gross margins for the Aligner segment have been trending down for years, but even here, that could be pricing and competition but it could also be manufacturing costs being front loaded or volume discounts. I don’t think that management has really explained what’s going on there very well. But if the orthodontists are forced to take their prices down to match Smile Direct, the scenarios I think play out here are either: one, the orthodontist eats the lower prices, even as they continue paying Align what they did before; two, Align takes the margin hit. So Align charges lower prices to the doctor so that the doctor can maintain their unit profits; or three, Align has to find other ways to save the doctor money by helping them to do these cases more and more efficiently.

And I think probably all three of these factors are at play to varying degrees. But yeah, so on that third point what you’ve seen over the last year as Align is trying to help doctors save time. So they’ve rolled out a tele-dentistry platform where patients can make virtual appointments. They’re embedding more AI into this platform for virtual case follow-ups. And they’re rolling out this business consulting service to help GPs and orthodontists digitize and streamline their workflows. And they’ve had to accelerate this because of COVID, but I think more generally they’re launching these time-saving tools so that doctors can handle more cases and then preserve profitability that way.

But Align is in this position where they can handle more cases than anyone else today, but there may be a disruptive process going on where these competitors get better and better until like they’re functionally good enough and while Align is definitely the low cost producer of these aligners that’s not to say that their margins can’t be competed down from 25% to 15% or wherever. And yeah, I just see the competitive environment is getting more intense, not less intense, and this competition is coming from places that Align isn’t really set up to compete effectively against for like all the reasons I talked about. And that’s not to say that Align doesn’t have a lot of great things going for them, but you just have to be pretty confident in the growth opportunity and the moat when paying 80 times pre-COVID EBITDA for a $40 billion company.

So all right. That’s all I got to say about this. Thanks everyone for listening and for all your support and encouragement. It definitely means a lot and I greatly appreciate it. Okay, have a great week.