Wayfair.com, the leading purveyor of home furnishings online, recently delivered what many on Wall Street saw as a blockbuster quarter, reporting sales growth of more than 40%. Of course they also lost $144 million for the quarter, which about doubled the loss from the year earlier. For the entire year they lost a cool half a billion dollars, despite being at this whole e-commerce thing for over 15 years. Seems like selling at a loss and making it up on volume is now back in vogue. Despite the seemingly deteriorating economics, Wayfair’s stock is up 70% in the past year and the company is now valued at nearly $15 billion.
At one level, Wayfair can certainly be applauded for having gone from a fledgling start-up to a major retail brand with revenues trending at more than $7 billion per year. And having thrown many millions at broadcast media of late, their jingle (“Wayfair you’re just what I need”) is rapidly turning into an annoying earworm. There is only one eensy-weensy little problem with all of this : their business model, at least as presently executed, is deeply flawed and, well ladies and gentlemen there is no nice way to say this, those bidding up the stock might do better to short it.
While some may see Wayfair as the “Amazon of home furnishings” there are many reasons why those comparisons are largely specious (though their ability to lose lots of money for more than a decade is certainly an apt parallel). Yet unfortunately Wayfair doesn’t have an AWS to subsidize its losses, so eventually they will have to make money the old fashioned way–or hope to be acquired.
Here are four significant underlying issues with Wayfair’s business model, supporting why I predicted earlier this year that Wayfair’s stock is due to crash back to earth.
- Customers are expensive to acquire at scale. I’ve written many times about the challenges of scaling e-commerce businesses given the high cost of marginal customer acquisition. Wayfair is pretty much the poster child for this “reverse economies of scale” phenomenon. The last few earnings reports suggest that Wayfair’s acquisition costs remain extremely high and they are getting little leverage despite their growing scale. To keep sales growth booming they will almost certainly need to keep paying Facebook, Google and the rest of the toll-booth marketing industrial complex dearly to stand out in a highly competitive sector. And as Peter Fader and Dan McCarthy’s work illuminates, despite these pricey bounties many new customers will have insufficient lifetime value to be worth adding.
- Supply chain costs are big barriers to profitability. E-commerce may work really well in the search and discovery piece of the furniture shopping process but it does very little when it comes to a big piece of the value chain, namely the cost of (and complications associated with) home delivery of big and bulky items. So far nobody has figured out how to have delivery trucks get from point A to point B much faster. Nobody has figured out how to get a sofa into a house and up a flight of stairs without two guys going along for the ride. Amazon has its own challenges in dealing with spiraling fulfillment costs. While Wayfair is investing a lot to build better supply chain capabilities there are many daunting fundamental challenges inherent to home furnishings that will not be easy to overcome.
- Product returns are a killer. As I’ve written about previously, returns & exchanges are a ticking time-bomb for retail as online shopping grows. It’s particularly bad in the furniture business. Not only does buyers’ remorse tend to be higher in the home furnishings category, but the nature of the product often means items are more prone to damage. So when a product needs to come back it can be hugely expensive to handle the reverse logistics and refurbishing and/or liquidation cost. Want some evidence that this is a growing concern? Wayfair’s first physical store is an outlet.
- And what’s the deal with gross margin? There was a lot of excitement about Wayfair getting to 24% gross margin. Need I remind everyone that better is not the same as good? This might be an acceptable margin for a retailer with a low cost structure like Walmart or Best Buy. For a brand like Wayfair that isn’t close to sufficient. A better comparison is Williams-Sonoma–and their margin is around 34%. As Wayfair grows they can develop further efficiencies. They can also shift their product mix and obtain lower product costs–yet they already have a very high penetration in private label. What this low margin suggests to me more than anything is that their pricing is consistently too low. That may help explain the rapid customer growth, but it is hardly a recipe for long-term profitability.
While Wayfair has done many admirable things–and there certainly is room for a sizable digitally-driven home furnishing brand of some scale, should we continue to be impressed with a business that only seems to drive outsized growth with unsustainable pricing and crazy high levels of marketing, while offering free shipping in a business with notoriously high supply chain costs? If you don’t find this more than a bit crazy please contact me about investing in my new highly disruptive business model selling $20 bills for $15.
This likely doesn’t end well. Unless of course Amazon, Walmart, Target or some other huge player decides to acquire them in a “strategic move.” If things don’t start to improve much more dramatically in the near future that may be the best and only hope.
A version of this story appeared at Forbes, where I am a retail contributor. You can check out more of my posts and follow me here.