“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.' - Nick Sleep, Nomad Investment Partnership Interim Letter, 2007
This quote by Nick Sleep is always in the back of our mind when we’re studying internet retailers. When looking at new categories moving online, we question whether the building blocks of an ecommerce model are more durable than incumbent brick and mortar retailers. For example, does an online furniture retailer have an outsized chance of owning more market share than a traditional retailer?
We interviewed a Former Global Head of Fulfilment Engineering at Wayfair to explore how Wayfair solves the problem of delivering furniture online and why a potential solution could create a competitive advantage over traditional retailers.
Wayfair is not a typical furniture retailer. In fact, it’s possible that framing Wayfair as a retailer is completely missing the point. Consider this quote from our intervie:
“At one point, there was a conversation around turns which, in any other fulfilment world, would have been topic one. It was verboten in CastleGate; initially, we did not talk about turns. The reason being that it’s the supplier’s inventory; it’s not ours, as Wayfair. It is their decision what to do with it and we’re not going to force them to turn it because it’s not that type of relationship. It’s a different model from the one Amazon has.” - Former Head of Global Fulfilment Engineering at Wayfair
It’s rare you find a retailer that is not laser focused on turns. However, the quote is less surprising after considering Wayfair's history.
Wayfair started as hundreds of standalone SEO-optimised websites offering every individual category of furniture. Each website was effectively lead generation for third-party furniture manufacturers who didn’t have the expertise of selling direct-to-consumer.
One aspect of home furnishings is that the vast majority of the category is unbranded goods which makes it difficult for customers to find products they want and even harder for suppliers to sell DTC. This sparked the original insight of creating Wayfair: by merging all the websites into one brand, it could aggregate demand online and build loyalty with customers.
Between 2002 and 2011, the business was financed by free cash flow mainly driven by the negative working capital of the model. Wayfair collects cash upfront from customers and pays suppliers on average in ~60 days. This meant the company could self finance the marketing plan to build Wayfair into a global furniture brand and has allowed the two co founders to retain ~14% of the shares outstanding each.
In 2016, Wayfair went one step further and began investing into physical assets to control the logistics process. Thus, CastleGate was born; a service that forward positions suppliers’ inventory in warehouses to improve customer delivery time and cost. Today, the company runs ~19m sq ft of warehouse space, cross docking facilities, sorting terminals, and last mile assets to facilitate global shipping of online furniture.
Just as Amazon increasingly moved to own more of the customer experience for general merchandise, Wayfair is doing the same for the home by combining their retail brand equity with freight forwarding capabilities focused on bulky items. Wayfair is building the home furnishings equivalent of Amazon’s FBA; let’s call it ‘Fulfilled by Wayfair’ (FBW).
There seem to be two important technologies powering FBW: CastleGate and Buyfair.
CastleGate is the foundation of ‘Fulfilment by Wayfair’; this is how the Former Fulfilment Engineering Head described the service:
“CastleGate is fulfilment by Wayfair; that’s the easiest way to describe it. It is a set of a great many fulfilment centers, many millions of square feet, in North America and Germany – and I think the UK as well – that is forward positioning, making product available, next day ideally, but certainly within three days, to the vast majority of consumers for Wayfair. It is a large number of very big warehouses, type one through type four. Type one would be stuff that you could put in a mailbox, moving all the way up to type four, which is something like a hot tub. They don’t call them warehouses; they call them fulfilment centers for a reason. It is a combination of a distribution center and a warehouse that are racked and highly automated for all those different classifications.” - Former Head of Global Fulfilment Engineering at Wayfair
CastleGate positions the suppliers’ inventory in Wayfair warehouses closest to the end customer. Suppliers pay ~35c per sq ft per month for storage plus other ancillary services which barely covers CastleGate's cost but, just like FBA sellers, CastleGate suppliers see 20% higher sales conversion relative to alternative drop shipping delivery methods. Because of the higher sales conversion, Wayfair achieves a lower product cost for CastleGate items which is accounted for as a contra-COGS item in the P&L.
CastleGate is a win-win-win proposition; suppliers turn inventory quicker at a lower cost, the customer gets a better service, and Wayfair drives higher sales and lower costs through fewer returns.
Since 2015, Wayfair’s total warehouse square footage has increased from 2m to 19m sq ft and the cost per order shipped has decreased ~10% to ~$30. Today, CastleGate processes only ~18% of large parcels and ~21% of small parcel volumes. As more suppliers adopt CastleGate’s services, it’s possible that the gross margin increases closer to 30%.
Wayfair has also launched Wayfair Delivery Network (WDN), large parcel middle and last-mile delivery, and International Supply Chain (ISC), a cross-docking and consolidation service for freight in Asia. However, it seems that Wayfair’s Buyfair proprietary technology is of even greater importance when trying to understand Wayfair.
“There is a system called Buyfair which is the secret sauce of Wayfair. It is one of the first things that really occurs. We do a demand forecast which is trying to decide where the people are who want to buy our big items? What are the big categories? Then it tries to come up with an allocation guide. I’ve decided that this black chair that I’m sitting on is going to sell 10,000 units in the next quarter and there’s going to be the highest demand in these different geographies, so it also tries to assign a demand plan. It then sends out a bunch of proposals to the suppliers. This black chair that I’m sitting in, probably has 50 suppliers that can provide it to us. There are a lot of items that only have one supplier, but there are also many that aren’t. They get a proposal and they look at it and say, I can fulfill that. They have the choice of whether or not they want to go CastleGate. “ - Former Head of Global Fulfilment Engineering at Wayfair
Buyfair is the engine that powers CastleGate; it helps route the huge number of SKU’s across all suppliers to CastleGate or dropship warehouses at the lowest cost possible. Wayfair is integrated with the production schedules of suppliers to route the orders as effectively as possible. This was cofounder Steve Conine during the October 2019 earnings: