Weekly Update: IKEA, Wayfair, & Omnichannel Furniture Retail
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IKEA, Wayfair, & Omnichannel Furniture Retail
Just as B2B distributors are structurally advantaged businesses, we believe vertically-integrated ecommerce businesses are advantaged because of the superior customer experience relative to offline competitors. Companies like Amazon, JD.com, and Carvana vertically integrate into owning inventory, warehousing, and last mile delivery to provide customers with a more convenient, quicker, and typically cheaper shopping experience than incumbents.
We’ve previously explored how Wayfair is following Amazon’s footsteps in the furniture industry through various primary research interviews, IP analysis articles, and an IP Investor Dialogue:
Former Wayfair VP on Wayfair First-Mile Logistics
Former VP Fulfilment Engineering at Wayfair on CastleGate
Our analysis of Wayfair’s CastleGate Logistics
Our analysis comparing Wayfair CastleGate with Amazon FBA
Former Global Supply Chain at Wayfair on building global e-commerce supply chains
Wayfair In Practise Investor Dialogue
We recently interviewed a Former Deputy-CEO of IKEA Germany and France to explore how IKEA plans to shift from offline to omnichannel furniture retailing. This interview is the first in a series of research to understand the potential advantages and disadvantages of IKEA vs Wayfair’s vertical-integrated online model.
Founded in 1937, IKEA is the largest furniture retailer globally. The company has 458 stores and generated over $46bn in retail sales last year, over 3x Wayfair’s revenue. IKEA runs a franchise model: Inter-IKEA owns the intellectual property, procurement, and manufacturing assets and licenses the IKEA concept to franchisees globally.
The INGKA Group is the largest franchisee and runs stores in Europe and the US which amounts to ~90% of IKEA's total retail sales. INGKA is also one of the biggest shopping center businesses globally with 52 centers in 15 countries.
IKEA’s historical retail strategy was simple: buy great shopping center assets, put IKEA as the anchor tenant, and add other great retailers to increase the traffic to IKEA stores.
This strategy was great until customers started shopping online. COVID only accelerated this structural shift.
In the last 5 years, IKEA’s online sales mix has increased from ~2% to 30% and the number of visits per store has declined 27% from 2.32m to 1.69m per year.
IKEA reports summary financials for both Inter-IKEA, the franchisor, and the INGKA Group, which includes the retail, shopping center business, and other investments. Over the last 5 years, INGKA’s retail sales have compounded at only 1.8% per year and the retail EBIT margin has declined from 4.7% to 0.9%.
If we assume the Center business operates at ~65% EBIT margins, similar to Westfield owner Scentre Group, INGKA’s restructured income statement below shows that the IKEA Retail business is barely profitable.
IKEA faces the challenge of leveraging its existing physical infrastructure to fulfil online delivery and click-and-collect orders.
IKEA are struggling with the last mile delivery. They receive huge volume of goods and distribute those to stores for offline sales. Online sales are different and consist of click and collect and delivery. During the pandemic, they prepared goods from the store because the last mile delivery was closer to the end consumer. There has been a huge change because stores are not equipped or built like a warehouse, even though they have a small warehouse in-store. Most of the time when you pick goods for customers, it occurs in-store. Picking small accessories in the market hall is challenging without original packaging and sometimes items break, so it's difficult to implement that way of providing goods to end consumers. - Former Deputy-CEO of France and Germany at IKEA
The average traditional blue IKEA warehouse store generates $100m+ in sales over ~320,000 sqft and has a one-way system that leads customers through the showroom into the ‘Market Hall’ warehouse where customers pick up products. Each store is the equivalent of 5 football pitches and includes restaurants with large dining areas.
The stores are supplied by Regional Distribution Centers (RDC’s) of a similar size. IKEA's pre-internet supply chain looked something like the following:
IKEA manufactures ~15% of its inventory and its scale enables the company to charter its own ships and now even own its containers.
As online penetration increased, IKEA has had to supplement both ends of the supply chain by adding Customer Distribution Centers (CDC’s) to fulfil home delivery orders and new, smaller retail formats closer to customers for click-and-collect.
The CDC’s are run by a 3PL like DHL and are injected into the supply chain alongside the Regional Distribution Centers (RDC’s) to serve online orders and replenish stores. With 458 stores and 93 DC’s of similar size, IKEA now runs ~176m sqft of retail and warehouse space.
As visits per store are down 27% over 5 years, IKEA is now operating and experimenting with many store formats to stay close to the customer:
Traditional big blue boxes: 320,000 sqft stores out-of-town. One-way showroom, Market Hall, and restaurant on-site. Each box averages $100m in sales per year and saw 1.7m visits in 2021.
Smaller stores: ~12,000 sqft IKEA stores within cities that offer a selection of home furnishing products for shoppers to carry out. Customers can explore and order products from the whole range in-store. Smaller Deli restaurant is on-site. A recent example is the new Hammersmith store in the UK.
IKEA Shops: centrally located destinations to inspire customers about a specific part of IKEA’s range. The new Paris store is an example; ~10k sqft, focused on home furnishings. Products can be planned, ordered, and purchased.
IKEA planning studios: city-based studios that offer customers personalised planning services. No products are in the store to carry-out but can be touched and tested. Full range can be ordered and purchased in the studio.
IKEA pick-up points: locations for customers to click-and-collect orders.
With the added distribution space and new store formats, its supply chain now looks more like the following:
IKEA is building out additional distribution infrastructure and smaller points of sale as the majority of the store base loses traffic.
If you believe ecommerce will grow to a significant portion of industry volume, it’s hard to argue this is the optimal way to build the supply chain.
In fact, if you asked most physical retailers to build their business from scratch for a market with ~50% ecommerce penetration, how many would start with their existing infrastructure?
The endowment bias and sunk cost of incumbent retailers' legacy infrastructure can limit the possibility of truly defining a best-in-class customer experience. Long-term leases with expensive break clauses can limit more ambitious omnichannel strategies and confines retailers to a customer experience that maximises the leverage of a declining asset.
This is not necessarily true in all retail categories. For example, Target fulfils near-100% of online orders from its stores given the product dimensions are suited to micro-fulfilment solutions. Products can be picked and packed at the back of the store and easily injected into UPS or Fedex's last-mile delivery service.
Shipping sofas and other large and bulky items is more difficult. IKEA is in the tricky position of balancing the operational leverage of its 126m sqft of store space with winning share of online orders . Each incremental online order that is not fulfilled by the store, deleverages the huge fixed cost of 458 stores.
Like Carvana is building a supply chain from scratch to sell cars online, Wayfair is building a furniture supply chain for an industry that fulfils the majority of orders online.
An important potential difference between the two is that Wayfair needs to inspire customers, not just fulfil online orders.
Furniture is mainly unbranded goods and although cars are arguably commodities, OEM’s spend huge amounts on advertising to inspire customers.
Carvana can win by providing the widest selection with the most trusted, seamless transaction and fulfilment experience. Its IRC process and 7-day free return policy instills trust, but the company doesn't necessarily need to inspire customers to purchase a Mercedes or Honda. The OEM's take responsibility to inspire.
Home furnishings is different. Wayfair needs to inspire customers to imagine certain products in their homes. After all, there is a reason IKEA makes you walk through the whole showroom before being able to purchase a product. Wayfair understands that inspiration is best achieved in-person and is strategically opening physical showrooms. Only small products will be available for purchase in the showrooms and all bulky products will still be fulfilled from CastleGate FC’s.
This is what Wayfair’s small parcel supply chain will look like including the new showrooms:
It seems far easier for Wayfair to back into physical retail rather than IKEA into ecommerce infrastructure. Just as IKEA is adding smaller formats in cities closer to customers, Wayfair can efficiently open showrooms with little inventory to inspire customers and fulfil all orders from CastleGate.
For small parcels, IKEA and Wayfair’s supply chain is converging. It includes a core distribution network integrated with smaller formats to inspire customers.
However, Wayfair’s own large and bulky supply chain is differentiated:
By owning the middle and last-mile journey, Wayfair can cut costs and control the experience when shipping bulky items, around 30% of Wayfair's total sales.
Assuming ever-increasing ecommerce penetration, as Wayfair scales its physical presence, what advantage does IKEA really have?
IKEA can inspire but it has a real challenge in fulfilling online orders efficiently.
The company has recently implemented Autostore’s solution in its Zagreb store to test micro-fulfilment from the big blue boxes. Managing inventory in-store availability between offline and online customers is a difficult challenge that we’ve explored with incumbent grocers.
In the UK, for bulky items, IKEA outsources last mile and charges anything from £15 to £40. For example, for a £50 bedside table, the delivery is £15.
For a £499 sofa, the delivery charge is £40. If you want to collect the sofa, IKEA is partnering with a self-storage business to offer customers within 45km of a unit the option to collect for £10 or free for orders above £200.
Given it costs ~£32 per sqft per month for self storage space in London, this seems an expensive way to fulfil bulky orders and is still a hassle for the customer who needs a large vehicle to collect the sofa.
In contrast, Wayfair offers free home delivery on all orders above £40. Wayfair also has 3x the number of sofas within £400 and £599 vs IKEA and each product is labeled with clear availability status and free delivery tags to drive conversion.
Herein lies the potential competitive advantage of Wayfair. By centralizing inventory through CastleGate and offering fast and cheap logistics, the company can offer a wider selection at lower prices which drives turns and higher ROIC. This results in a combination of a superior customer experience at similar or better unit economics.
After adjusting for INGKA’s Center business, it’s interesting to compare the operating costs with Wayfair:
Since 2017, we estimate INGKA’s retail gross margin has declined from 32%+ to ~29%, similar to Wayfair’s gross margin today. Given 90% of Inter-IKEA’s product sales are from INGKA, the implied retail COGS is 58.4%, or a 41.6% product margin. This is 240bps lower margin than Wayfair because Inter-IKEA also earns a 13-15% wholesale margin selling the retail goods to INGKA.
Wayfair's fulfilment cost is only 120 bps higher than INGKA's implied fulfilment cost. This could suggest INGKA is paying high prices for 3P last-mile delivery and few customers are collecting items given the store is so far away. As CastleGate penetration increases, Wayfair’s fulfilment cost as a percentage of sales will also decrease as Wayfair accounts for CastleGate fees as contra-revenue.
INGKA pays a 3% royalty to Inter-IKEA which covers advertising and use of the IKEA concept. After netting out the royalty for INGKA and advertising expense for Wayfair, Wayfair’s opex is 580bps lower than IKEA. This is due to Wayfair’s more efficient use of fixed assets:
Wayfair’s normalised sales per sqft is also likely much higher given it has increased warehouse space by 25% since 2019.
Wayfair has the advantage of driving more volume through fewer facilities with larger square footage which helps reduce the unit cost per shipped item. Excluding 2021, we can see the steady improvement of Wayfair’s unit economics below:
As the industry moves online, Wayfair can put more volume through its fixed costs while aiming to decrease advertising spend to mid-single digit percentage of sales. As fulfillment costs are also paid by suppliers, it’s possible Wayfair has a superior skeletal structure to serve online orders than IKEA.
This reminds us of one of our favorite Nick Sleep quotes:
It seems to us that the basic building block of internet retailing, its skeletal structure, is far more robust, scalable and cheaper than the high street equivalent. In other words its power law is very high, and implies that businesses with the simplicity of operation as say, Amazon.com, have a shot at being far bigger, quicker and more profitable than their high street equivalents. - Nick Sleep, Nomad Investment Letters
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