Matters of Scale: How Lemonade and Root Followed Very Different Paths to Success

As we dive deep with founders in the heavily-regulated insurance space, the Primary team researched the scaling stories that led Lemonade and Root to billions, seeking to learn what “great” looks like in this massive industry.

This piece was written alongside my colleagues Tobias Citron and Elaina Atallah, who I want to thank for their hard work and hours of research time.

You can pretty much count the number of seed-stage investors who have seen a massive insurtech scale-up on one hand. Between Root, Lemonade, NEXT, and Metromile, only Drive Capital, Aleph, Sequoia Israel, Ribbit, Index, NEA, and First Round have seen this up close. Some more have experienced the rise of health insurance startups like Oscar and Clover, but the bottom line is that very few people know what the trajectory should look like from experience. At Primary, one of our core values is diving deep, so rather than speculating what great looks like, we decided being the best board members and partners to our portfolio companies means we need to do some deep research and analysis. In this post, we take a look at the tactical choices made by two insurtech rocket ships: Lemonade (renters) and Root (auto).

The first thing we learned is that there isn’t one right way to start or scale. Although these companies are nominally similar — both are “insurtech” businesses that went public in 2020 and have current market caps in the billions — the backgrounds of their founders and their tactical journeys are a wee bit different. By comparing them, we got to do some deep thinking about the pros and cons of a few different directions, so we wanted to share that with early-stage founders. (And it goes without saying, if you’re one of these founders, let’s talk.)

Rooted in insurance

The story of Alex Timm and Root is one of domain expertise and founder-market fit. Born and bred in the world of insurance, Timm was the son of a Nationwide executive. After graduating from Drake University, Timm decided to follow in his father’s footsteps by joining the rotational program at the company. Four years into his insurance journey, where he ended up as a senior consultant on the Corporate Strategy team, Alex’s curiosity brought him to the offices of Drive Capital, a VC based in Columbus, Ohio. While Alex’s eyes were set on an investment role, the investors at Drive had a different idea.

With a keen interest in insurance, Drive saw opportunities to disrupt the category through technology. Using some VC negotiating magic, the team convinced Alex to start a company rather than join them on the other side of the table. Drive invested early, nearly incubating the business that became Root.

Startup nation strikes again

Thousands of miles away in Israel, a founding team was ready to build their next big thing…but they weren’t starting from zero.

Lemonade was founded by Daniel Schreiber and Shai Wininger, two long-time tech executives. Schreiber, Lemonade’s CEO, had previously been a president and board member at Powermat. (Remember those charging pads embedded into the tables at Starbucks back in 2014 that seemed to never work? Yup, those.) Prior to that, he founded and worked at a variety of other startups.

Wininger, Lemonade’s President and COO, cofounded Fiverr, the legendary marketplace business that caught fire with its simple five-dollar service offerings. That business is now publicly traded and worth nearly $8.5 billion. Wininger played a critical role in the complex marketplace business as its CTO and chief product officer for over five years.

Safe to say both founders were seasoned entrepreneurs with well-established tech networks and clout. However, let’s be clear, neither had an ounce of experience in insurance. To quote Schreiber, “When we started thinking about a new concept in insurance we just had a rudimentary understanding of insurance. We had the advantage of being ignorant. We had no preconceived notion. This helped us to question the basic principles of the industry…”

And It burns, burns, burns

Many tech outsiders look at the world of startups and are blown away by the amount of capital companies lose on an annual basis.

This “burn” might seem like out-of-control spending, but it tends to be guided by a very specific strategy. However, the idea of running a company that is losing over $10 million a month as a result of high operating expenses (OpEx) is something many can’t even begin to wrap their heads around. While Shai and Daniel had experienced that feeling firsthand before, Alex Timm had not. How did this manifest in the operations of the two businesses? How did they approach burn?

To answer that question, let’s look at 2019 SG&A, short for selling, general, and administrative expenses. We can start with a similarity: Both of these companies spend a lot on operating expenses, specifically SG&A. Although Lemonade and Root don’t report one SG&A number, they do report sales and marketing, G&A, and technology development. We can add those up to approximate SG&A. It’s not perfect, but it’s pretty good.

In 2019, across four large property and casualty (P&C) insurance comparables (Allstate, Chubb, The Hartford, and Travelers), SG&A as a percentage of revenue averaged 14 percent. Check out those numbers for Lemonade and Root. Turns out scaling is expensive :)

Ultimately, it’s not surprising that Lemonade and Root have way higher operating expenses than traditional insurance companies. Let’s dive deeper.

Squeezing the lemon

Coming off 2017, a year in which Lemonade brought in $2.4 million in revenue while spending $30.4 million on OpEx (1,267 percent of revenue), Softbank led a $120 million Series C in the company at a pre-money valuation of $500 million.

Less than a year and a half later, after nearly 10Xing revenue over the previous 12 months and tracking toward 3Xing revenue in the next year, the Japanese giant flushed Lemonade with cash via a $300 million Series D round. While OpEx as a percentage of revenue has slowly come down, the gap has been closing at a slower and slower rate. For Lemonade, heavy investments in operating expenses at the cost of short-term profitability have coincided with mega fundraising rounds.

Lighter roots

Root also spent above industry benchmarks, but less so than Lemonade. In March of 2018, Root raised a $51 million Series C led by Redpoint Ventures, followed by a $100 million Series D Tiger Global led in August at a $1 billion valuation. That same year, the company did $43.3 million in revenue, spending 257.5 percent of revenue on OpEx. At the time of their IPO, Root’s OpEx as a percentage of revenue was close to 170 percent — still high, but lower than Lemonade’s.

If you were to put Lemonade on one side of extreme OpEx spending and industry incumbents on the other, Root is somewhere in the middle.

Sell, sell, sell…

There’s more to this story. The real insights come when you break SG&A into (1) Sales, Marketing, and G&A, and (2) Technology Development:

• Lemonade spends proportionally much more on sales, marketing, and G&A than Root does. Sales, marketing, and G&A were 227 percent and 163 percent of Lemonade’s 2018 and 2019 revenue. At Root, they were 115 percent and 53 percent.
• Tech development is less clear. Lemonade’s tech development as a percentage of revenue is slightly higher than Root’s, but the numbers are pretty comparable. In fact, when you take tech development as a percentage of operating expenses (which are much higher for Lemonade), Root actually posts a higher number in 2018.

So what? Lemonade invested heavily in sales and marketing, which drove up operating expenses. Root invested much less as a percentage of revenue there. On the other hand, technology development expenses are similar, with Lemonade perhaps holding a slight edge.

But why? Getting to the root cause

Leading to its gangbusters IPO, Lemonade had higher expenses as a percent of revenue across the board. Clearly Daniel and Shai were up to something, and this spending magnifies different approaches to strategy and tactics. With that said, Lemonade has spent less overall on technology development than Root has and a similar amount on a relative basis as well. Lemonade discusses the importance of its product more in its S-1 and has more recognition for its intuitive and sleek UI. Perhaps Lemonade is the more efficient investor in technology.

So was it just that two tech entrepreneurs had more chutzpah than the midwestern insurance kid? No. Root’s advantage lies in the type of insurance it offers.

Renters insurance? What’s that?

In a 2017 interview, Lemonade Founder Daniel Schreiber said, “No less than 87 percent of our customers are first-time buyers.” That is a staggering figure. But what does it mean?

For Lemonade: Because Lemonade plays in renters insurance, an unfamiliar and optional insurance category, they have to work harder to educate potential customers on the product. Lemonade had to make a strategic decision to spend more on customer education, acquisition, and service because so many of their customers had no prior experience with the product Lemonade was selling. In other words, growing a market is expensive.

For Root: Root sells auto insurance. Sure, Root has a novel approach to the product, but when customers buy a car, they know to buy auto insurance to go along with it. You learn about auto insurance when you turn 16 and your parents make offhanded comments about how much more expensive their insurance policy just got. So Root doesn’t need to do as much customer education.

Size matters

The average auto insurance policy ($1,427/year) costs over 4X the average renters insurance policy ($326/year). So, one customer goes a much longer way for Root’s topline than Lemonade’s. Although it is hard to say exactly how much more, because we don’t know Root’s reinsurance rate, the point holds directionally. Additionally, Root’s CAC is about 1.6X Lemonade’s: Root’s was about $330 from 2018–2020, and Lemonade’s was about $200 over the course of 2020 — much less than the 4X difference in policy cost. As a result, Lemonade has to spend more than Root does to generate the same level of revenue, purely because of category premium differences.

These differences between renters and auto insurance contribute to the divergent tactics each company has used to grow. Lemonade has to spend a ton on digital marketing and customer service representatives to reach more customers and handle its higher customer volume (read: sales, marketing, and G&A), while Root gets to invest less in these areas.

Better underwriting = better performance, loss ratio 101

Next up is loss ratio, probably the most important metric people use when evaluating insurance companies:

For context, loss ratios at established insurance companies in the auto and renters insurance categories are about 65–70 percent. So, of the money insurance companies take in through premiums, about 70 percent goes out to cover claims. To increase profitability, insurance companies therefore need to accurately assess (a) risk when determining rates and (b) claims and fraud.

Alex Timm said in a 2017 interview, “High loss ratios are a function of either (1) inaccurate pricing and adverse selection, in which case data and pricing segmentation need to be addressed, or (2) a willful decision to lose money to gain market share.” Both Lemonade and Root believe that technology will improve this process and provide a competitive advantage.

In the beginning, both companies started with more than 100 percent loss ratios, which is not surprising given effective underwriting takes time. However, as they grew up, the loss ratio stories for these two companies differed greatly.

Lemonade = reduce claims fraud + anticipate short-term risk

Lemonade reduced their loss ratio by reducing fraud and predicting risk, through a few tactics:

1. Data advantage: Lemonade collects data on its policyholders that get translated into a ‘risk score’ that accurately predicts future loss ratios. This helps the company price more effectively to try and avoid losing money.
2. Catching fraud: Lemonade has created an AI-based Forensic Graph Network that catches millions of dollars’ worth of potential losses, leveraging behavioral economics, big data, and AI.
3. Curbing inaccurate claims through non-profit giving: Part of the Lemonade secret sauce is that if a cohort has a loss ratio of less than 60 percent, up to 40 percent of its premiums are given to a communal cause of members’ choosing. This, the company claims, dissuades consumers from submitting inaccurate claims, even if loss ratios never approach that level! This tactic is called “priming,” a favorite of Nobel Prize winner Dan Ariely, Lemonade’s Chief Behavioral Officer.
4. Fortifying the fort: Project Watchtower uses NASA satellite data to detect catastrophes such as severe weather and alert customers. This helps protect against risk.

Root = accurately assess risk profiles to reduce claims

Lemonade first acquires the customer and then worries about loss ratio. Root has a different approach. Root requires customers to go through a two-week driving assessment using an app on their smartphone. Leveraging the data collected during this process, Root claims they can better determine consumers’ risk profiles and price premiums.

Timm said in 2017, “only using mileage leaves over 80 percent of the predictive value of this data on the table.” Most insurance companies in this category determine risk via 10 –15 data points, whereas Root has two weeks’ worth. The company uses technology and more data than incumbents in the industry to price premiums. If Lemonade is reactive, Root tries to be proactive in trying to improve loss ratios and hedge against risk.

The big bet: expansion

Expanding as an insurance company is tough. Growing up and launching in a new state requires a whole new set of fillings, and state regulations vary widely. So an ideal first market is both big and has kind regulations. For these companies to grow, they either need to achieve deeper penetration in a given state, which can get more expensive over time, or launch more states to increase the market size. Lemonade’s first market launch was in New York, a mistake that founder Daniel Schrieber has been very open about. “We decided to get our license from NY… Getting our license [in NY] was incredibly difficult.” Root, on the other hand, launched in Ohio, home to their headquarters and an easier market to launch in.

The fat head vs. the long tail

Lemonade appears to have consistently prioritized market size over regulation when expanding into new states. Their first four states (New York, Illinois, California, and New Jersey) have some of the most burdensome regulations but large populations. Shai Wininger said in a blog post in 2017, “We made a decision early on to approach regulation with open arms, instead of fighting it. The more we work with regulators, the more we appreciate this decision and the importance of regulation in general.” Lemonade leverages Cooper, their Exponential Efficiency tool, to launch in a state three days after they receive regulatory approval. Not a single Lemonade employee has to step foot in the state.

Equally impressive was how quickly Lemonade was able to expand its foothold in each of these states. For example, in two years, Lemonade was able to get 10 percent market share in Texas.

Lemonade also expanded internationally before it was operating in all 50 states. In 2019, Lemonade opened in Germany. When asked why they found the market so attractive, Schreiber said, “Germany has the largest insurance market in Europe. It is also one that is still very much dominated by traditional broker-based businesses…we like the idea of going into the markets that are still very traditional. We think that gives us the most pronounced difference between what consumers are used to and what we have to offer.” Launching in Europe has a unique upside. It is a single regulatory environment. Having one license makes expanding across the EU very easy, barring language and local competitive differences.

On the other hand, Root has not expanded internationally, and has yet to launch in the biggest U.S. market, California, which represents 50 percent of the U.S. driving market. While it has a large presence in Texas, it is not live in New York or Florida and does not generate substantial revenue in Illinois (top five states by population).

Root has chased long-tail states with lighter regulations; Lemonade pushed through challenging regulation in pursuit of bigger markets. It is hard to say which strategy has the highest ROI, but one thing is for sure: Geographic footprint supports an increase in retention. Millennial consumers are transient, and insurance companies, regardless of category, need to meet them where they are.

The cross-selling lifetime value narrative

A big bet on these companies is that LTV for insurance is very high, as it is a sticky subscription. With Lemonade and Root, there are two ways to improve LTV: (1) improving the percentage of customers that stay on the service and (2) increasing how much they spend with your company. The latter strategy, which is commonly used in insurance by, for example, bundling home and auto (shoutout to Flo) seems to be a big bet by these companies and public investors. Simply put, category expansion is an important LTV lever for insurance companies.

Lemonade and Root have approached category expansion differently. Lemonade expanded to homeowners insurance in 2018 (about two years post launch), and in 2020 announced they were expanding to pet insurance. Root, on the other hand, did not launch any new insurance products until 2020, when they expanded to homeowners and renters insurance.

Lemonade’s move to homeowners insurance is an easy build off its existing platform and technology. However, Lemonade’s rapid expansion both in terms of product and geography better supports the growth of a key metric: retention. Lemonade cited the primary reason for churn in its S-1 as policyholder life transitions. This includes younger, transient consumers moving to a state where the insurance company is not registered or needing new types of insurance that the company does not offer. That is why incumbent providers have coverage all over the U.S., across multiple types of insurance. It’s also likely why Root has expanded into many states, albeit not the largest ones, and recently unveiled new types of coverage.

So What’s the Conclusion?

Lemonade and Root are both unicorn insurtech companies, but that is where the similarities begin and end. In growing up, these two companies made very different tactical decisions and pursued separate strategies.

Going in, we thought we might uncover a story of more aggressive growth tactics leveraged by the startup veterans at Lemonade, and that’s exactly what we uncovered. From high sales and marketing spend as a percentage of revenue to quicker expansion on the product and geography front, the Lemonade team has approached scaling with an eye on the long run while leveraging reinsurance to cover their backs.

What’s the story here? Fundamentally there’s more than one way to be successful. There’s no secret formula for successfully building a company that everyone follows. Different types of people can be successful by using all sorts of strategies and tactics. Write your own story.