Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

{audio:0:03:39} Before getting into what I want to touch on, I’d love to hear more about you and your background, what you’ve worked out throughout your career, just to give everything some context.

{audio:0:03:57} Born and raised and went to school in Chicago, started a business in Chicago, and I’m still in Chicago. The first chunk of my career, 10 or 15 years, was in B2B sales. Most of it was in telecom, so selling metropolitan dark fiber-optic networks. In a sales marketing capacity, I worked at a local startup, called Looking Glass Networks, towards the end of that portion of my life. I met another guy there who said he wanted to start a furniture business, importing and distribution. There wasn't much to lose, so we kicked in about $70,000 each and bought two containers from China. A third party was helping us arrange what to get. 

{audio:0:04:49} In the beginning, I loaded it in the back of my car, drove it around to all the furniture stores in Chicago, and sold it out of my car. Then we got a bunch of broken stuff from one of the vendors. They just kind of shoved it in the back of a container. I wanted to dump it, so I took a couple of pictures way back when and put it on Craigslist. People started coming out pretty quick. We said maybe we should try a bit more online, so we started on eBay and got a bunch of sellers. In the first year, we probably did a million. Over the next 12 years, we just made direct calls to Target, Amazon – back then it was CSN Stores – anyone that was selling furniture online. We built it to, when I left, around 2,000 to 2,200 containers year-round, a $55 to $60 million run rate. I left because we had pretty severe partnership disagreements, and we had a shotgun clause in there, and a take your pay, so I put a number up, and he paid it.

{audio:0:05:59} The biggest challenge was when we started selling on eBay way back, in 2002 or 2003, damage issues were really big. On my side, it was just another guy and me. We unloaded the containers by hand ourselves at the beginning of this thing.

{audio:0:06:25} It sounds like you were maybe more focused on the smaller home goods categories if you could sell out of the back of your car. Or were you doing tables and sofas and things like that?

{audio:0:06:40} In the end, we had about 1,000 SKUs. That doesn't mean productive, but it did everything from full-sized sofas, dining room sets, chairs, tables, ottomans, bedroom sets, and mattresses. It was the full line. Everything.

{audio:0:07:13} Going back to the glass tables at the beginning, we had a high damage rate of 80% or 90%. When you do that, you lose outbound shipping if there’s any kind of disposal fee at the far end, and then you have to ship a product replacement return or do a refund on that thing. So every time you have damage, it's a total disaster. I spent months in the warehouse because every time a table came back, I'd reinspect with packaging, try to reinforce it, figure out what to do, and work with the vendor to make it better and try to make this thing still profitable. That was the basis of what this whole thing evolved into. Since then, we built photo studios, we had thousands of products, had three stores in Chicago. We had a very active parts and damage return department; you name it. 

{audio:0:08:20} I'm trying to research and understand the topic of Wayfair. One of the angles I'm exploring and have been exploring is what they're doing on the fulfillment and logistics side. A lot of links in the chain go from a manufacturing facility across the ocean to a customer's home. From what I've heard from others, and I'd love to get your perspective on this, it feels like a lot of the breakage happens once a container comes off a ship; that's when the clock starts on breakage. It usually doesn't happen when the container is on the ship. I don't know if that's true, but that's what I've heard. I'd love to understand the whole supply chain as you saw it, how you put it together, how many links are in that chain, and where you thought the biggest problems were. Is it in the last mile delivery, or is it in the middle mile? Is it on the front end, from the factory to the container on the loading? Is that where the problems were? Or is it once it's on the ship? I don't have a good sense of all the links in the chain from factory to customer, and where you found most of the problems and complexity. Maybe we can start there.

{audio:0:10:07} I could go on for quite some time on this. I want to ask a qualifying question; what angle are you trying to think about? 

{audio:0:10:37} In talking with a former Wayfair employee who left last year, I asked him about the orientation of the management team. When Niraj and Steve were running CSN Stores, it was very boot strappy and focused on the unit economics of the business. They seem like very intelligent, rational capital allocators. Still, Wayfair as a business has not generated sustainable positive free cash flow throughout its existence until you had the surge and demand from Covid. I think there's a pretty robust debate around the end-state or mature-state profitability of the business. This former employee that I talked to suggested that the bulk of the problems in profitability come from the breakage and the incident rates being too high.

{audio:0:11:38} The more Wayfair controls the middle-mile and the last-mile delivery, the lower the incident rates. When you use a logistics provider like FedEx or UPS, the rates are 15% to 20% higher compared to the Wayfair Delivery Network. That alone, because of all the costs associated with damaged goods, returned goods, whatever, can be a material swing factor to the profitability of the business in the mature state. I'm starting from that perspective of, how much they can do. If I take a big step back and say, okay, is it a profitable business to sell furniture online? How different is it from selling it in a store? This is not a doorbuster, loss leader category. This is a category where there is not very much price transparency. Nobody knows if a table should cost $100, $200, or $500; if it's in the $500 category, it could be plus or minus $150. It feels like a category that can make product margins, probably pretty good margins, as a retailer of these home goods. It doesn't strike me as a business that shouldn't be able to generate margins, so I'm trying to peel back the onion on why hasn't it generated a margin, what are the big sticking points, and is it investments in growth? 

{audio:0:13:32} One area I want to zoom in on is the logistics side because the clear signal I can see from what they've done over the last few years is they think it’s really important to have the freight forwarding business across the ocean. They think it’s really important to have the CastleGate delivery hubs or logistics and fulfillment centers, and they think it's really important to have WDN do the last mile for the large parcel. If you watch what they've done, that's where they've deployed a lot of their additional capacity, a lot of their capex and opex. It feels there are like a lot of management tensions on the plumbing of how to get the goods from the factory to the customer. That's kind of where I'm coming from.

{audio:0:14:35} Essentially, what you said is they're building out a network to facilitate a closer network to the end customer, which should reduce damage. The full network they create nationally and internationally should decrease handling, which should decrease damage and improve margins. And I believe you're exactly on the correct theory for Wayfair. I've had a lot of touch points with Niraj over the years. When they were at CSN, we worked with them, and we were a top hundred vendor while we were working with them. 

{audio:0:15:18} We had many, many dinners. On a personal level, I like both of them; Niraj is much more outgoing, and from the first minute that I met him, CastleGate has been first and foremost on the mind. As we were growing up in the vendor ranks, you got more touch points. Everything has been about how can you supply to the CastleGate end network and facilitate this; this is our plan. We're trying to get to one or two-day delivery to all points across the country. That's been consistent as the direct message since the beginning and when I worked with him. That's a decent question to ask. When is the actual network built out, at what scale in each city is it built out, and when will that stop. Because then you're going to have an understanding of what your monthly costs are. What will be the lease and employee fees associated with this? And I don’t have a clear answer on that specifically.

{audio:0:17:00} First, it's the top-down thing. He says, let's talk about getting the inventory from where it originates into the Wayfair network, and let's talk about the US specifically. Containers are packed and shipped in China, Malaysia, Indonesia, and Vietnam. The container flows took a dip in the pandemic, and you're still above the container flows coming out of those areas in the furniture business. If you want to talk specifically about damage returns, when I was training new employees and we walked into the damage section, everyone in my company got the same speech. There are 10,000 reasons why something is in this pile, and it's almost never damage. Damage is one of the codes. It's everything from, I don't want it anymore, I opened it and it didn't fit into what I wanted it to, or it's the wrong color, to I got a divorce, I got a new job, to I left, I died, the neighbor died; it's everything. But the way the returns function works at Wayfair, and essentially all of the other companies, is that it falls back on the wholesalers, which would have been me, or whomever the supplier is. 

{audio:0:18:26} At the end of the year, there’s a hey, we're not paying this fee. You can call it a marketing fee, a customer service fee, or whatever you want. But there's going to be a deduction off the last payment.

{audio:0:18:50} They get a true-up at the end of the year.

{audio:0:18:53} Yes, but the true-up is arbitrary. Contractually, there's a price somewhere that says you can take a lump out. As you say, we'll take 8% off the top at the end of the year to deal with these things. On the broad scope of what I just spoke about, why the damage returns occur, it's every reason under the sun, and there is rarely damage. If the box looks bad, somebody might reject it. If the box has tape on it, people might reject it. Everything will be rejected and sent back. And then the two things are the incentives. If you look at Amazon, for example, if you want to return to Amazon and say, I don't like it, they're going to charge you the shipping fee. To ship a sofa back, for example, figure it's $400 easy to get it out of there. Plus, the packaging isn't going to be right anymore, and that thing will be thrown on the back of a flatbed truck, it'll be scuffed and damaged, and it'll be worthless. That's why it's easier to just dispose of it on-site for some of the larger stuff. 

{audio:0:20:14} I had a friend, another guy running an online store, talking about six or seven hutches they sent to the same person, and they were like, every time it's damaged. One of them had a scratch on it. That’s going to occur in any of these kinds of things. When you have a delivery guy or people who are fussy about the thing, you're going to get to the point where there are many more returns.

{audio:0:20:45} You had physical storage when you sold online; you're not walking out with the goods in most furniture stores? Are the expectations different for an online customer versus an in-store customer for product delivery?

{audio:0:21:26} Our returns for instore sales were right around zero.

{audio:0:21:34} So the return rate for online is higher. Well, it wasn’t zero. What do you think the difference was?

{audio:0:21:45} 10% to 15%, off the top of my head. The amount of space dedicated to that is large. In our situation, we had a warehouse, so we would take the returns in, log them the best we could, and somebody would open them up and see what parts were around or not. If it's like KD, knockdown stuff, we had a big dumpster, and you just stack the dumpster because the quantity would be too large to reasonably do it. Then we'd move over to the outlet store and sell it. Wayfair is now following a similar model, opening its own outlet stores. Overstock also had theirs for damage returns of what could be salvaged and resold.

{audio:0:22:39} Let me make sure I understood. You said the return rates for your in-store products were close to zero, but the return rates for online ordered products were 10% to 15%.

{audio:0:22:54} If you want to look deeper into this as an aggregate in the industry, Wayfair put out a number that was going into CastleGate, the amount of the containers a couple of months ago. When looking at a 40 foot, not too many people ship 20 feet in furniture; just to give yourself a standard back of the envelope, say it's about $20,000 for each container. That's estimating too high, but it’s still fine. If they're utilizing the CastleGate from suppliers, you can see how many containers are flowing directly there and how many are flowing to other people's direct warehouses. Why is that important? If you're looking at the profitability of items, let's say I have a competitive $20 ottoman. Those can pack up into the back of a container. The profit margin on those things, to me, if they all make it, might be a dollar each. It's very low. 

{audio:0:24:30} Now, say I'm getting damage rate on that ottoman and want to improve packaging, I won't be able to improve packaging for a dollar. So I will lose, call it the buy box, I will lose the competitiveness, I'll lose everything. The next thing I have to do is either degrade the quality of the material to make up the damage rate, drop the item, or collect, reduce handling, shipping and fees, and become more operating proficient on my side. 

{audio:0:25:03} When you're operating a lot of different product SKUs that are competitive in that marketplace, and as they say they have thousands of vendors, do you believe that all of the vendors would have consistent packaging? The answer is absolutely not. If somebody is trying to squeeze a buck out, they will squeeze in the tiniest covering of whatever it is that you've got. That will cause a very high SKU damage rate for that particular product, and that could be anything you can imagine at one time. It could be a change in packaging, and it could be somebody else that got a competing product that looks like the one that you got, that is the same thing but now different. You can get nasty runs if you have a warehouse manager and poor packing training. There was a run where we had a crapload because we had a new manager. The edges of all the tables of a huge run went over the edge of the palette, so then we got damage down the line. But this is called standard operational issues.

{audio:0:26:22} I want to understand something. Were the products handled differently if they were ordered from a store versus online? Is that 10% to 15% difference because you had the products in inventory and delivered them locally, so there was none of this issue? Or you would have known about the issue before you even brought it to the customer's house? Or is it the processing? Once you put the order in, whether in-store or online, what were the key differences between the two? Is it national versus local delivery, and that’s the difference?

{audio:0:27:11} Probably customer expectation in terms of the deal. On our side, if somebody’s coming into the store, they would place an order physically. If they walked into the store, it was a warehouse store, and it is what it is. 

{audio:0:27:29} They can see the thing they want to buy physically. They're touching it, seeing it, and then it gets delivered to them later?

{audio:0:27:35} They could see a showroom model, and back then, we had two buildings, 300,000 each. So there were 300,000 square feet of racking and merchandising behind them. It's like walking into an Ikea situation where you've got one part warehouse, one part showroom, but the showroom is a dirty, dusty warehouse. So first, the expectation is lower. Second, the return policy that we had was no returns.

{audio:0:28:08} Got it. No wonder why your return rate was zero.

{audio:0:28:13} Also, the issue of the returns gets a bit funny, depending on the vendor. Sears is out of the picture now, but historically, there was a loophole where Sears was taking anybody's return, issuing Sears credit back to the customer, and charging us back for the returns. Then some savvy customers understand this system, so odd things can occur. 

{audio:0:28:50} It didn't make that much sense that there could be a big delta between in-store and online if the goods are going through the same middle and last mile. But it’s clearer if you have a no-return policy.

{audio:0:29:10} How about if you have the most liberal one, which includes, I don't want it. If somebody says they don't want it, the chargeback, for the most part, flows through back to the wholesaler.

{audio:0:29:29} Going back to Wayfair, at the end of the year, if you sold through CSN or Wayfair, they charge you an arbitrary fee and tell you a number, and you have to take it? Is that how it works?

{audio:0:29:43} It's the same with Amazon, with a chunk of the online stores. The way it's positioned is fine. If you don't want to accept this, we'll take your products down, and by the time we negotiate this, you can get this back again. From their side, it’s realistic and reasonable, and from our side, it was okay as long as it was profitable. Where that ends is if it's no longer profitable, then the whole thing shuts down. I always made money on the thing.

{audio:0:30:21} What do the wholesale margins look like in this business. If you’re a supplier, what do the wholesale margins look like?

{audio:0:30:29} They’re good? So there’s plenty of margin to work with?

{audio:0:30:34} Yes; a lot. I'm not going to give you the straight number because I'm on a recorded call, and I don't want this to bleed back into me from the old business relationships, but, Apple. That’s the best I can say, from both gross and net.

{audio:0:31:15} A place like Restoration Hardware has 150% gross margins on its furniture. That's luxury furniture, luxury price points, but the merchandising margins for a Williams Sonoma or some of these other stores are more like, I think, the generally high 30s to low 40s for their retail side. I assume nobody except Restoration Hardware is running at super high operating margins, but I assume there are pretty good margins in the middle as well, as a supplier. But you're not going to do any of your customer acquisition so it's a lot to lean your operation on. It's more of a B2B business? So it should be lower sales and marketing on that organization. 

{audio:0:32:06} I was the sales. There are a couple of other structural things about the industry. In general, the way that CSN evolved was that there were a lot of different storefronts, so to speak; both theirs and everybody else's in the world. What would happen is what I call who's the hot hand. You could go on AdWords and see who's advertising the most, and that's the guy you have to call next. It's pretty simple.

{audio:0:32:40} Whoever is spending the most is going to acquire the most customers and is going to sell the most volume. If you stop advertising and you don't have an established customer base, like everybody else, your business starts dying off rapidly. This industry was consolidating for years. But in a sense, lots of large chunks went out of business pretty quick. In the beginning, the mom-and-pops all got consolidated into a couple, calling it any kind of regional or name brand. Even Macy's, even though they took a long time to get their act together on this. Macy's could roll up 200 mom-and-pops just by starting the business. The other guy’s business will just disappear. 

{audio:0:33:30} Then you have to get more theoretical and into the long-term value of an individual customer. Who is willing to spend more to make that customer acquisition because we're all making estimates into the future? It's difficult. Whoever has the hottest hand and rolls the largest budget is trying to make it profitable in the end, and you don't know. Nobody knows. You hope. Patrick Byrne, I believe it was, put out some pretty good comparisons about Overstock's attempt to out advertise Wayfair, I don’t know if you read that.

{audio:0:34:08} it's worth it to explain what happened to Overstock. A lot more customer acquisition, a lot less profitability. And he outlines it quite well, succinctly. Say what you will about the individual, he was at least thorough.

{audio:0:34:29} It’s good. Structurally again, they rolled it up. They were the ones with what I'd call the hot hand with the advertising, and they got customers. What happens when advertising slows down? That's when everybody's magic guess comes in. When will the network be built out, and what happens when you stop advertising? That's where we're in speculation.

{audio:0:34:55} I want to ask about the difference between Amazon and Wayfair in this category. Amazon is obviously the world’s biggest and best logistics, operation, retail, and I guess commerce-as-a-service kind of company. But they're set up for more standardized footprints in the fulfillment centers; robots, standard boxes, and general merchandise. I think it's harder to do when it's a sofa or a table, whatever the odd size is and different formats and configurations. What was your experience working with Amazon? How well set up do you think they are for this category, and how much of a focus is it for them? They're big just because they're Amazon, but I feel the consumer experience is pretty different between a Wayfair and Amazon, just from the focus.

{audio:0:36:00} If you're looking at numbers, it's the three. Overstock, Wayfair, and Amazon. That's who owns the business. You will have lesser dollar amounts coming off anybody else. The three are far and ahead. Overstock ran this industry until Wayfair started to run the advertising much heavier. Then Amazon started leading in. The top three customers that we had would be those three. Amazon is big, so they'll get a lot of frictional business no matter what they do in this space. Again, the more people that get educated in one area, they'll go to another area if they have a better experience. It's going to grow. It probably won't grow at the same rate that the Wayfair stuff did because it's not the head, but if I fired it up again, that would probably be the first place I would go because it's the easiest. There's nobody to talk to on the other side; you just sign up, automate your account, and start running. At Wayfair and Overstock, you have to talk to somebody.

{audio:0:37:18} When you look at the warehouse distribution, if you're shipping stuff to Amazon, you're generally shipping light, cubed stuff. You don't want to send them anything heavy because it will require a two-person thing. It will be more complicated. If it's in two boxes, you have a higher chance of one box arriving. That's another reason for a return because it's two boxes and one box got delivered on one day, and the other got delivered on another day, so they canceled the order and that second box got delivered on the second day, or it got lost. It’s one of the many, many reasons for that. So you send them simple products in a box. A mattress in a box was a good product for them because it's square and in a box. If it has anything that could sustain corner damage, you want to be the guy that handles it if you can because someone will drop it. If it's a multipiece sofa, it's not a great product for anybody – or anybody except for you – to handle. You want to get to the stuff that's easy for an average warehouse worker around the country to understand, have labeled, and get out the door.

{audio:0:38:36} Wayfair has invested a lot in the specialization within this category. Do you think even they haven't figured out how to be differentiated from an Amazon when it comes to the large parcel home goods stuff?

{audio:0:38:51} They can. When you call it specialized, it’s the issue of whether employees can handle a two- or three-piece package, and be sure it gets out every single time.

{audio:0:39:10} I don't know if anybody will ever be there because it's a manual process where it's prone to human error. It will be a percentage of your problem no matter what you do. Look at the amount of physical checking you have on a two-piece sofa. You have to have the guy pick it; a supervisor goes through to double-check to make sure the thing's there; a shipping supervisor has to double-check what the packing supervisor did; then you need the guy that leaves and puts it on the truck; double check it again. That's for a two-piece, clearly labeled sofa, and you still get errors. When you send the truck out in the morning on this kind of thing, even for local deliveries, you will have pull-in problems. You can substitute furniture for two-part epoxy glue where some guy will get the same part twice; that's just the nature of this. It doesn't matter who it is.

{audio:0:40:29} You were talking about the structure of the industry and said there's been a lot of consolidation; a lot of the small mom-and-pops have been taken out of the business, and the bigger guys are starting to roll up the business. If you listen to Wayfair and believe them, they talk about having less than 2% market share across the industry in their operating markets. I struggle with this. If it's true that they're such a small percentage and all these smaller subscale guys can be taken out or lose share over time, it kind of shocks me that they could have double-digit revenue declines. Yes, the comparables are very difficult, but shouldn't they be outperforming everyone? Shouldn't they be gaining share all the time? Maybe they share gains in a good year, they grow 30; maybe in a bad year, they grow five, but why should they ever decline if there's so much share to take over time? What do you think of that? 

{audio:0:41:39} One conclusion could be that it's a lot more mature or the market share is a lot more stable than they would suggest, that this $100 billion revenue target in 2030 is an impossibility, not even close. They'll never touch that. Because the industry structure is not what they think it is and not what they say it is. But maybe they just have bad execution, and maybe they don't have the right product, maybe they were disadvantaged from their business model, which I think is false because they don't pay for inventory.

{audio:0:42:16} You think that's a disadvantage?

{audio:0:42:20} When everyone is supply-constrained and shipping immediately, I think Wayfair's advantage there wasn't relevant and lost, for the tail end of 2021 anyway. 

{audio:0:42:34} Did you look at what Target just said about their furniture inventory yesterday?

{audio:0:42:38} I know. Right now, I'm talking about the second half of 2021, maybe first quarter. I feel like we're now getting to the sweet spot where Wayfair's model should shine much more. But nobody’s forward positioning inventory in CastleGate; the CastleGate utilization dropped from 30% to 20% during Covid, because nobody needed a forward position. They were just selling out. They couldn't get the product; Vietnam shut for three months; that's a problem. Taking a step back, is there something about the industry structure that makes it much harder for them to grow than they would suggest looking farther?

{audio:0:43:26} I'm going to say a few things about this. I wouldn't have expected it for the amount of money they're putting into sales, and I don't believe anybody would have expected it 10 years ago. The volume that they're doing is ridiculously high; it's a lot. It's a lot more. Now, how much further is it? To tell you the truth, I think 2%, what they're saying, is a higher number, but I'm just guessing, probably like they're guessing. But when you start breaking down furniture, it gets down to this. Which SIC codes are we talking about? Office furniture could be on the Herman Miller side as opposed to a standard office desk. What had substituted for a brief period in the pandemic may have been desks that were shipped like home office desks that employers paid for as opposed to personal purchases. Then you start going into the lighting category, which is so broad as to be meaningless and the same if you're talking benches; tell me what a bench is and which part of the bench you're looking at. 

{audio:0:45:09} They talk about this $800 billion market that's going to grow to a trillion, and they think they can get 10% market share, so $100 billion if they expand the geographic footprint into all of Europe or western Europe, obviously the US and Canada. But when you listen to Gary Friedman of Restoration Hardware on last week's call, he said we're going even higher-end because, for most of those dollars, the kind of spending distribution looks like income distribution. But it's not that the top 1% spend only 1% of that $800 billion; they're punching way harder than that. They're going way higher. Maybe the top 1% is spending 25% of the market in dollar value. I don't know what the number is. That's what I wonder. Is Wayfair playing in the mass market, which is a lot smaller than what they would suggest, and those TAM analyses.

{audio:0:46:17} I don't know. Break down what furniture is and have them break down what the furniture category is and what they can address. When you're talking about a trillion-dollar market, I'm not sure what that comprises. There are a couple of things I do know. Have you gone through and looked at Panjiva? I don't know how helpful any kind of granularity will be. The container statistics that go into a particular location are public. You can figure out what's going in and going out of CastleGate or any other facility in this country.

{audio:0:47:18} I’ve been looking for a way to find that out. Is that public data, free public data?

{audio:0:47:29} Panjiva is an SMP product, so there's no way it's free.

{audio:0:47:32} There’s Panjiva; ImportGenius is the other one.

{audio:0:47:43} ImportGenius, I'll look into it.

{audio:0:47:47} You'd have to pay $199, $2,400 a year; that's what it is. If you believe in getting more specific about what is happening from where, you're going to break it down by what's in each shipment. You can then divide it up and say this is not a home good, this is not sellable, and then this is.

{audio:0:48:27} I don’t know if I want to go that granular. That feels like a pretty big data science project.

{audio:0:48:34} Here's the reason why. If you want to figure out if you have the CastleGate locations you can easily dump it into ImportGenius, and you can see all the containers going in there. You won’t see the stuff domestically reshipped to those locations, but you'll see everything else that goes there. So if I have a warehouse in Chicago, I think they have a couple of them, and they're building a big one, I could pick the address and say who sent the stuff here if I wanted to get technical about it. Also, you should look at the nature of what you would, as a vendor, ship there.

{audio:0:49:15} As I mentioned, let's make it obnoxious and say I was shipping a six-piece bedroom set, which I wouldn't do. That wouldn't be something I would send to a CastleGate facility. The next thing is, say I'm launching a hundred products a year; it's going to be more than that. At 100 a year, I wouldn't ship anything to a CastleGate or an Amazon warehouse that I don't have any run-through rate on. Because at this point, I need to know my velocity, and I'll probably short that velocity because I don't want to pay storage if it has to go there. 

{audio:0:50:07} There is a sweet spot of your top 5% maximum of sellers that would easily make it into that type of system, and then the rest of the stuff is what I call ineligible. Would you ship a bunch of things that you don't have pictures to a place you have to pay, call it, by the square inch? You don't do that. And/or if you have a dead product. By the way, if you look at the warehouses of any wholesalers, if 50% of the warehouse isn't just dead, unmovable product, then they're doing something really good.

{audio:0:50:51} Only a quarter to a half of the warehouse turns. But it turns a lot.

{audio:0:50:57} Interesting. I'm trying to think through what they've said. CastleGate Forwarding has gone from 46,000 TEUs to 80,000 in 2021 to now 160,000 in 2022.

{audio:0:51:18} Divide it by two, you get a 40-footer.

{audio:0:51:24} Exactly. So 80,000 40-foot containers. They've suggested that they have presold all that space ahead of the shipping season, which started in May, to suppliers, and they pre-negotiated the rates well below the spot rates, I’ve heard.

{audio:0:51:48} Are you talking about container pricing?

{audio:0:51:50} Yes, on the containers. And then they’re bundling the container, the forwarding with the logistics on the back end, trying to get more goods into the CastleGate Logistics centers, fulfillment centers.

{audio:0:52:03} Do you know how container shipping is priced? Are you pretty familiar? 

{audio:0:52:08} I don’t know where theirs are. I know they negotiated them a while back. 

{audio:0:52:14} I mean do you know how, if you were going into this business today, how you would approach it, or I would? It's important to this conversation.

{audio:0:52:27} I would love to hear. I can see the spot prices and all that. I know that many ocean freight guys won't even take small orders from a guy like me. I couldn't buy a five containers capacity or something. But tell me. I’d love to hear. 

{audio:0:52:46} It's relatively inexpensive for someone else to handle the freight forwarding business; it's like $50. It's not a lot, but it's not a lot of work; you've just got to file. When you look at ImportGenius or Panjiva, where all this information comes from, you find a little freight forwarder, and that guy either has a long-term rate that he negotiated that he marks up to us, or he’s going to go on the spot market for this. Most likely, he'll go on the spot market. He's not going to have a fixed rate. This is because for many years, as the container shipping rates were in a downward trend, I could call in the major carriers and say I want to do a 1,000-unit contract on this thing; 1,000 forty-footers or double, 2,000 TEUs. They would say great; the price you need to lock this will be double the spot rate right now. You might get a little bit here and there where it goes from 2,500 to 3,500, and then your bunker fees and all that, but the range would max out at about 5,000. There hasn't been inflation in 12 years on this price. 

{audio:0:54:25} But you lost nothing by not locking it in at $5,000.

{audio:0:54:28} Right. And then if I locked it in with anybody, Maersk or whoever it is, they'll say we need a guaranteed take or pay 100 containers a month, and on top of that, it's double the price, so say I'm paying $3500, theirs would be $5,000 for the long-term shipping rate. But that guarantees you a spot on the boat. Now, if you've got a guaranteed spot on the boat, there's a little honey spot where the spot rates go up to $10,000. If you look at the average vendor sitting there supplying to anybody in the US, and you're talking to guys like me, which is the bulk of, call it, the economy, these wholesalers are bringing this in. They're the vast bulk of Wayfair's revenue. 

{audio:0:55:21} Then you have an issue because your spot rate is now on your products where you were making a margin. The ones that were really competitive where you're barely making a margin, say on 1,100 units of whatever I can shove in that container, I made a dollar on each. The shipping rates just went to $5,000. If I’m earning $1 each on around 1,000 products per container, at $5,000 spot price, I’m $4,000 in the hole for every container I ship. 

{audio:0:56:04} So, to shorten this up, normally, we go to the freight forwarder that has most likely a spot rate, or he’s going to charge us closer to the spot rate because he's the one showing me the demand. I won't have a fixed rate. Therefore, this inflation thing would just completely stop my supply chain. When it stops my supply chain, my deposits are already in at all the manufacturers, but I will refuse to ship the container because I won’t pay the rate.

{audio:0:56:37} You're guaranteeing losses on that container the moment you ship it.

{audio:0:56:41} Think of how big the losses are because the loss is more than I put out; I can walk away from a 30% deposit. So when Target said they would be canceling orders, you go wait, hold on. Well, theoretically, your discounters will go up because this will get stuck somewhere, and the guys that buy on that direction buy on letters of credit because this happens cyclically. The guys supplying will sell the Target purchase order, get a letter of credit, and pay the far end. Then it gets stuck in the port because Target won't take delivery, and just because they had a purchase order, call it their letter of intent; it's a cancellable purchase order.

{audio:0:57:33} So if that product is created and Target won’t take possession, does that mean the suppliers are on the hook for that, and they can clear that through someone like Wayfair? They'll start looking at these other channels, Overstock, Wayfair, Amazon, whatever, and that product just moves through those channels instead?

{audio:0:57:54} Yes. It’s odd because the ultimate guy that has the bill at that point is the freight forwarder. The freight forwarder is the one who owns the container when the container starts sitting at the port.

{audio:0:58:14} Really. I wouldn’t have guessed that.

{audio:0:58:16} Sitting at the port or it gets picked up and makes it to the trainyard, then it sits there, and they start charging to merge on top of it, so $100 to $200 a day to sit there. You start getting frantic calls from the freight forwarder saying do you want to buy this thing because we are stuck with this thing, we can't recoup our costs, there's very little value to the inventory in there, it's a busted deal, and on top of it, I'm getting paid to store it. 

{audio:0:58:48} So it went from Target canceling an order to now the freight forwarder has to figure out what to do with a container of goods that he didn't manufacture or doesn't know much about. Now he's got to hand it off to someone.

Wayfair, CastleGate, & Damages: A Supplier's Perspective

Founder & Former CEO of a US Furniture Wholesaler

inpractise.com/articles/wayfair-castlegate-and-damages-a-suppliers-perspective

Wayfair, CastleGate, & Damages: A Supplier's Perspective(August 12, 2022)

Founder & Former CEO of a US Furniture Wholesaler

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