Watch Eargo Inc. for Clues to Success of Direct-to-Consumer Hearing Aids

If Eargo Inc.’s recent 2020 financial report is any indication, 2021 may be the year direct-to-consumer (DTC) hearing aid companies emerge as a significant growth segment of the global hearing-aid market.

It’s still an open question whether, or when, upstart DTC hearing aid manufacturers will grow fast enough and large enough to start muscling significant market share away from the “Big Five” who continue to dominate the industry. But a peek under the covers of Eargo’s financials indicates that its strategy of bypassing what they see as the traditional middle-man channel of hearing health professionals and brick-and-mortar retail suppliers may prove to be a business model with staying power.

The San Jose, California, company reported in its annual 10-K SEC filing that it more than doubled its revenue in 2020 to $69.2 million over the $32.8 million revenue reported for 2019. It reduced its operating losses in 2020 by more than 20% to $39.9 million from a net loss of $44.5 million in 2019. And perhaps most important, it ended 2020 with a war chest of more than $212 million in cash, most of it raised in its successful initial public offering (IPO) in October.

A Well-Lit Path for Direct-to-Consumer Hearing Aid Sales

Since its IPO, Eargo has emerged as a bellwether for the DTC hearing aid market. Dozens of privately held competitors, which don’t yet publicly report their sales or profits, have already established a presence in this new market selling directly over the web to consumers. Offering a range of new products with innovative distribution strategies that lean on high-tech telehealth offerings, they are striving to upend the traditional hearing aid industry’s sale model.

Eargo’s “invisible” rechargeable FDA-approved hearing aids, which sit completely within the ear canal and are designed for people with mild-to-moderate hearing loss, have proven popular with consumers. And its website offers an online hearing check, with personalized, telecare-based hearing support from licensed hearing professionals who counsel patients on whether they may be candidates for its hearing aids.

Employing a lower-cost, direct-to-consumer fulfillment model enables manufacturers to charge lower prices than hearing aids sold with hands-on support by audiologists. Eargo charges $2,950 for a pair of its top-end hearing aids, whereas hearing aids sold and supported by hearing care professionals that offer comparable performance can cost 50-100% more.

“We believe that our differentiated hearing aids, consumer-oriented approach and strong brand have fueled the rapid adoption of our hearing aids and high customer satisfaction,” the company said in its 10-K report, adding that as of December 31, it had sold 60 thousand Eargo hearing aids (net of returns). If Eargo continues reporting rapid rates of growth while it continues to navigate some significant market risks, it will forge a well-lit path for other DTC market players to follow.

A Solution for Housebound Consumers

Just as other companies such as Amazon, Zoom, and Peloton have prospered by offering remote services during the Covid-19 pandemic, Eargo said its telehealth model was a good fit for housebound consumers in 2020.

“Shelter-in-place restrictions and increased reluctance of consumers to be exposed to the virus, particularly among older consumers that comprise a majority of the population needing hearing aids, have increased customer interest to consider our vertically integrated telecare model,” the 10-K report says.  “We believe our sales model can help consumers decrease their risk of potential exposure to COVID-19 by avoiding multiple trips to hearing aid clinics and close proximity to audiologists and other individuals at such clinics, which are part of the traditional hearing aid sales model.”

If the Covid-19 lockdowns have prompted a permanent shift to more remote access to products and services by consumers, Eargo’s rapid growth may continue. However, the company acknowledged that it may see a falloff in the rate of growth if newly vaccinated consumers start returning to traditional hearing care professionals’ offices for in-person services.

Is a High Rate of Returns an Achilles Heel?

Another issue Eargo must contend with is a need to reduce the rate of returns of its products. With a 45-day no-questions-asked return policy, Eargo enables consumers to try out the hearing aids and return them for a refund if they’re not 100% satisfied. A consistently high return rate might indicate dissatisfaction with the telecare model and/or the product’s fit and features, whereas a lower return rate should indicate rising consumer satisfaction with the remote support model. In its 10-K report, Eargo provides a frank assessment:

The most commonly cited reason for returning our hearing aids is unsatisfactory fit, which we believe is a byproduct of our direct-to-consumer model and online distribution that results in nearly all of our customers ordering our product without trying it first. In addition to unsatisfactory fit, the next most cited reason for returns is that our hearing aids do not provide sufficient audio amplification. Customer return accrual rates were approximately 26% and 35% for the years ended December 31, 2020 and 2019, respectively. The decline in our sales return rate in 2020 and 2019 was a result of the growth in customers with health insurance coverage for hearing aids and repeat customers which have generally lower return rates than other customers, and our initiatives to improve customer service and enhance the quality of our pre-screening assessments.

Other DTC hearing aid companies will have to grapple with the same issues, especially the lack of personal, hands-on-support in the direct-to-consumer model. It’s safe to say they will watch and learn from Eargo’s experience, as it reports on revenue and return rates each fiscal quarter.

Risk Factors are Real

There are plenty of other market risks Eargo and other DTC companies must face as they seek out high returns in a new, high-growth market segment:

• Profits and losses: while the company has reduced its rate of losses, it has yet to prove it can make a profit with its direct-to-consumer model. Given its overall cost structure Eargo is on track to turn cash positive, but only if it continues to increase its sales at a rapid clip. A slowdown or flattening in growth rates might make it difficult or impossible to achieve profitability, which could undermine investor support.
• Competition: there are plenty of DTC competitors entering the market, and more product competition often means more price competition. If competitive offerings force Eargo to lower its prices, it will be that much harder to achieve its profit goals.
• Regulation: the FDA is going to be more than a year late in meeting a Congressional deadline for new rules governing over the counter (OTC) sales of hearing aids. If those rules require existing DTC hearing aid companies to change the way they do business, their growth could suffer.

Those are just a few of the market risks in the DTC channel. And perhaps the biggest and most obvious risk is the continued vitality of the “Big Five.”

The Big Five Aren’t Sitting Still

The world’s five largest hearing aid manufacturers, which still control more than 80 percent of the global market, have continued to innovate with new wireless products, rechargeable batteries, and many other useful features, all while responding successfully to lower average selling prices industrywide. As they anticipate competition from DTC providers, they are expected to hedge their bets with their own new ways of supporting consumers more directly. Among other things, all of them have telecare technology which, when employed by the hearing care professionals who fit and sell their products, can lower overall ownership costs of hearing aids while improving patient satisfaction.

They are also experimenting with new fulfillment models. For instance, in 2019 Sonova, the world’s largest hearing aid manufacturer, acquired Blamey Saunders Hears, an Australian hearing aid company that combines in-person service with a high percentage of remote online sales and support. And this past week, hear.com, an online hearing aid sales and support service owned by an investment group that includes Big-Five manufacturer WS Audiology, announced it plans an initial public offering of its own. In its announcement, it said it intends to invest in a business model that includes direct sales to patients without having them visit a hearing care professional.

Investments like these are only small forays by the Big Five into direct sales models. As pure-DTC players like Eargo begin to encroach on their turf, we can expect to see them respond in more creative and aggressive ways.

And What About Big Box Stores (and Pharmacies)?

And as Eargo and others anticipate the moves of the traditional Big Five manufacturers, they will also need to continue responding to even more immediate competitive threats from big-box suppliers such as Costco, which is already one of the largest sellers of hearing aids in the world. Costco’s in-store clinics have a high-volume, low-cost pricing model that has created enough competition to hold down prices of premium hearing aids industry-wide.

At the same time, big pharmacy chains such as Walgreens and CVS have considered moves into the market once the FDA clarifies the rules for OTC sales of hearing aids. In 2018 Walgreens and Big-Five manufacturer Starkey collaborated on a trial of in-store hearing health centers. And CVS conducted a four-year pilot project with 30 in-store hearing centers before shutting down the initiative in 2019.  If pharmacy chains decide to jump back in once the OTC rules are published, the huge potential volumes of competitive hearing aid sales through pharmacy chains could rapidly impact the average selling prices of all manufacturers.