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:0:00:23} Shaloo, can you share a bit of context to your role and responsibility at Wayfair?

{audio:0:00:27} As you know, I am currently the Director of Analytics at EverQuote, which is an insurtech startup in the Boston area. I joined EverQuote, from Wayfair in 2020, during the pandemic, after working there for three years as the Associate Director of Pricing Strategy and Analytics. That refers to the prices and, by definition, the gross margin that Wayfair sets, for the products that it sells on its website. I was involved, not only with the analytics around the prices but also in measuring, monitoring and managing business performance more broadly. With that responsibility, I found myself working very closely with Niraj, the CEO, as well as the executive team. I also participated in our weekly leadership team meetings. I had a good and close understanding of cross-functional business performance.

{audio:0:01:34} During that time, I saw Wayfair’s business grow tremendously, from 3.5 billion in annual revenue to over 13 billion. It was quite the ride.

{audio:0:01:43} What were those leadership meetings like?

{audio:0:01:45} For some reason, they were always intense. A lot of the attention is often on Niraj and Steve, given that it is a founder-led and founder-run company. What they have to say and their opinions obviously carry a lot of weight. At the same time, I would say that although the meetings might have been quite intense, they were always very productive, efficient and effective. Niraj had instilled a very strong meeting culture at Wayfair, including things such as every meeting had to have a pre-read. I would often be scrambling, the day before, putting the pre-read together and making sure it was sent out.

{audio:0:02:28} We followed in Amazon’s footsteps and prepared documents. Less a presentation and more a document format. Nothing too formal. Wayfair has a culture of efficiency so they didn’t want us to be spending a lot of time polishing slide presentations. It was more about getting to the heart of the matter.

{audio:0:02:49} For example, Niraj had instilled a practice where, if a meeting does not have a pre-read, then you don’t have to go. That is how disciplined it was, as a culture, making sure that people’s time – especially meeting time – was spent really well.

{audio:0:03:05} Did Niraj typically take the lead on those meetings?

{audio:0:03:12} In the ones I attended, it was more my team taking the lead because we were the ones sharing out on business performance, trends, updates on the pricing strategy and the insights that came out of the analysis that we had done. He was, obviously, as stakeholder, actively participating, but also on the receiving end of the information that we, and others on the team, were sharing with them. He was very vocal and candid about asking questions throughout.

{audio:0:03:40} How would you describe the way that Niraj and Steve worked together?

{audio:0:03:43} Sometimes, both of them were in the room but, other times, one or the other was there. I think they had pretty clearly delineated roles and responsibilities. Steve works more on the technical side, on the engineering side, working very closely with the CTO. Niraj is more business and strategy minded, so he works more closely with the business side of the organization. They have been working together for so long now. I’m not sure if you have heard their ‘How I Built This’ podcast, but that gives great context into how they started their business and how long they’ve been running it for.

{audio:0:04:26} They are very elaborative with each other. They always seem to be on the same page, but that doesn’t mean that they aren’t open to disagreeing and challenging each other, respectfully. I would say that, in the meetings I was at with them, they rarely disagreed on the vision and the strategy. I think that comes from both of them being at the helm, being majority shareholders and having been with the company since inception. They have really created a solid vision and unwavering strategic focus for what they want to do, which is to make Wayfair the winners in the home space, online.

{audio:0:05:01} With that, there isn’t a lot of concern about them disagreeing with each other on major points, changes in strategic directions or a lack of alignment between them, from what I noticed.

{audio:0:05:13} How was pricing structured when you first joined Wayfair?

{audio:0:05:16} I led the pricing strategy and analytics group, which was more of a business and stakeholder facing group. That group also drives the strategy, the testing and the implementation of changes to the pricing algorithm. At the end of the day, Wayfair’s approach to pricing is algorithmic; it is a dynamic pricing strategy. That means that prices change, dynamically, on a daily basis – sometimes several times a day – in response to consumer trends.

{audio:0:05:48} In order to do that, my team had to partner closely with the pricing engineering and operations team. Basically, that team implemented changes to the strategy that we were recommending. As you can imagine, it is quite an operational effort to update over 10 million SKU prices, on a daily basis, in a timely manner. For example, if there is a sale starting, you need all those prices updated right away, which is why we need to work so closely with the engineering and operations team, who actually makes those changes.

{audio:0:06:18} We also work closely with the pricing data science team, to conduct the testing and the experiments that we want to do, into hypotheses that we have, about how consumers are interacting with the prices they see on our website, and how we can optimize the pricing algorithm further.

{audio:0:06:35} Those are the main groups within pricing; pricing strategy and analytics – my group – engineering, operations and pricing data science. Within that, there are obviously individuals, people who are focused on different product categories or stores and brands within Wayfair. As you know, Wayfair has several different brands under the Wayfair umbrella, such as Joss & Main, Birch Lane, AllModern, Perigold. There are people working on the pricing strategy for each of those.

{audio:0:07:01} That is the general structure and then pricing is part of the broader analytics and data science organization, which then rolls up into the Chief Merchandising Officer, Steve Oblak. You could think of him as the Chief Operating Officer.

{audio:0:07:20} How would you compare the algorithmic pricing structure to the more traditional retail pricing?

{audio:0:07:28} What is interesting and important about Wayfair’s pricing structure is that, first and foremost, it is important to note that pricing is a separate and distinct central function. The pricing for products is not managed by a supplier relations team, the product team, the merchandising team or anybody else. It is a centralized, global algorithmic pricing team that prices products based on relevant known data inputs and estimations that are available to them, across the business. That is one key area of differentiation. In some places, it is actually the supplier management team that manages the prices, as well. That is not the case at Wayfair.

{audio:0:08:13} Another key area of differentiation is that pricing at Wayfair is based on consumer sensitivity to price, or price elasticity of demand, at the product level. For every product, Wayfair is able to calculate the unique optimal price, for a product, based on everything the company knows about how sensitive customers are going to be to changes in the price of that product.

{audio:0:08:38} This manifests in a few ways that are different and interesting. Wayfair measures product elasticity and this can change for every single product. It varies over time; it varies by time of year, with seasonality and things like that. As a result, each product has its own customized margin profile. The idea is that prices become more inelastic, over time. That means that margins and should increase over the long run and that is the result of all the investments that Wayfair is making into its overall business model, to make customers sticky and more loyal to the Wayfair platform. That is really what is at the heart of Wayfair’s strategy. Those investments in supply chain, merchandising, selection, availability, service, all translate into customers being willing to pay more for a product they see on Wayfair’s platform.

{audio:0:09:34} Why would pricing become more inelastic?

{audio:0:09:40} The thesis is, as customers become more loyal, they become less sensitive to price. For example, when you make investments in the supply chain, such as building out a CastleGate network, you can then offer fast delivery; you can badge products with one or two day delivery badges. Customers are, indirectly, willing to pay a premium for product if they can receive them, not only faster than other products on Wayfair’s platform but, potentially, faster than other competitors.

{audio:0:10:11} Visual merchandising is another example. Wayfair invests a lot in beautiful imagery and there is a reason for that. One of the pain points for shopping for your home, online, is being able to replicate that experience of going in a store and really knowing what you are purchasing. I remember, when I joined Wayfair, five years ago, people were still questioning whether anyone would buy a sofa online, for all of these reasons. Wayfair’s entire strategy is built around overcoming those obstacles that customers have in making purchases like that, online.

{audio:0:10:49} How do you have beautiful imagery? How do you have great reviews? How do you offer customers samples? All of that translates into inelasticity because customers are willing to pay more for all those things, for a product online, over time.

{audio:0:11:02} It’s less about the pricing strategy, specifically, making the customer’s price inelastic. It’s actually the little things that are adding together, to drive more inelasticity?

{audio:0:11:14} Yes, that’s correct. That’s a good way to put it.

{audio:0:11:16} Can we just walk through an example of pricing a product? Let’s assume that Wayfair has a standard, non-CastleGate drop-shipped product, such as a sofa. How would the pricing system work?

{audio:0:11:32} There are three key components to pricing a product at Wayfair. The first is understanding the cost of goods sold. That is not just the product cost, but all product variable costs. This is a really critical part of Wayfair’s strategy. All product costs means including things like shipping costs, incidents, estimated damages and return rate, to arrive at the fully-loaded product cost. The pricing algorithm will then calculate the markup to apply on top of the fully-loaded cost, based on the optimal margin profile of the product.

{audio:0:12:13} Note that markup and margin are not the same thing. Let’s say, using simple numbers, a sofa has a fully-loaded cost of $100 and the optimal margin profile is 30%. It actually translates into a markup of $43, to hit that margin target, based on how the math works. The retail price would be $143 and the profit would be $43, for a margin target of 30%. In a nutshell, that is how the pricing for a particular product might look.

{audio:0:12:51} How is the optimal margin set?

{audio:0:12:55} The pricing system currently optimizes for product margin or, more specifically, variable contribution margin. Wayfair is not trying to optimize for revenue or being the lowest priced player in the market. As you can imagine, if you play that through, quite quickly, it becomes a losing strategy when you are not Amazon, because you don’t have the scale to be the lowest priced player in the market. But there is a natural tradeoff between revenue and margin. Wayfair doesn’t always go with what the pricing system says, if there is a business decision made to optimize for revenue instead.

{audio:0:13:35} The pricing system itself is optimizing for profit or margin but there are discussions that happen, within the executive team, around what they are looking for right now. Do we need to shore up our margin profile this week, this month or this quarter, or do we need to focus more on revenue growth? In the future, I can see Wayfair optimizing for something even further down the income statement, such as gross profit margin after variable costs. That would include ad costs, as well, on the optimization, which would make the pricing system even more sophisticated.

{audio:0:14:08} How much control do management really have over the gross margin and those targets? Let’s say, quarter by quarter, if they want to flex more revenue or more margin, how accurately can they actually flex that?

{audio:0:14:21} That’s exactly what happens and that’s exactly the type of discussions that my team is having with Niraj and Steve, on a quarterly basis, as well as with finance, to figure out, based on our overall business plans, where we need and want to run the business, as a whole. The pricing algorithm then optimizes for those outcomes.

{audio:0:14:46} It’s not perfect; it’s complicated, because the pricing algorithm is running and optimizing every day, rerunning prices every day, which is why we have these checks in place; we have weekly, bi-weekly and monthly checks to see how far off we are from our plan and what we need to do to correct. Do we need to lower our margin target? Do we need to get more revenue? You can’t leave it up to the algorithm entirely, because there are real business considerations. Things happen that the pricing algorithm is never going to know about. For example, it’s Christmas; it’s a highly promotional period so that is going to really change the environment and change what Wayfair is trying to optimize for.

{audio:0:15:31} Going back to the sofa example, with $100 fully-loaded cost. What is, roughly, the difference in the product costs, shipping costs, damage or return rate? How do you look at the components of that?

{audio:0:15:50} The bulk – 60% to 80% of that cost – is going to be the actual product costs themselves. COGS is the single largest component of the cost structure. If you say 70% is the cost of the product, then 10% to 15% is the combined shipping costs; the inbound and outbound shipping cost. The residual is incidents, so things such as damage, defects and returns. Those are the three main cost components.

{audio:0:16:32} So the return rate is adding about 5% to the actual cost base, per unit?

{audio:0:16:41} For an overall average, I think 5% sounds reasonable. But the actual return rate varies dramatically, by product. Products in CastleGate actually have lower return rates than products outside of CastleGate, because there are fewer touches, so it’s less likely to get damaged or returned.

{audio:0:17:07} Is the CastleGate return rate materially different from drop-shipping?

{audio:0:17:15} Yes, I would say there is quite a material difference. If we take a step back and think about what’s happening here, in the drop-ship business model – the original business model for Wayfair and a lot of other players – suppliers are shipping out these products directly. These suppliers were never built to be commerce companies. They don’t necessarily have the infrastructure to fulfil orders. As a result, you get things like poor packaging and, consequently, the damage and return rates on those are a lot higher. These suppliers were never meant to ship directly to customers so when drop-shipping took off, this was a huge change and shock for their business. This is why Wayfair, and other retailers, have added these supplier services, such as CastleGate and the Wayfair Delivery Network, to alleviate that burden.

{audio:0:18:11} It’s saying, hey, supplier, you don’t have to fulfil these orders; you don’t have to package them. Just get them to our warehouse and we’ll take care of the rest. We’ll make sure the customer gets it and that it’s defect and damage free, with lower return rates, and that helps everyone. The overall product cost is then lower, which means those savings can then be either passed through to the customer, in the form of a lower product price, or they can be retained by Wayfair, in the form of higher margins. It is a whole flywheel of benefits.

{audio:0:18:39} Wayfair penalizes products that have higher return rates on the platform itself, so they are hidden further down the product page. You don’t want customers buying those because they have poor customer satisfaction associated with them.

{audio:0:19:01} Going back to the example of the $143 item, how does the price change? What are the variables you feed into the pricing system that would determine changes in the price?

{audio:0:19:15} We can go through each of those components of the pricing model. The first is the fully-loaded cost. The actual product cost can change and that is, actually, a big piece of what the Wayfair supplier relations team is doing. They are working with the supplier, to drive down the actual product cost and incentivizing the supplier to offer lower costs because of the benefits of that, in the form of increased sales velocity. The product may also be discounted because of a promotion. There are some major promotions throughout the year with Christmas being a great example of that. There are also minor promotions taking place throughout the year.

{audio:0:19:56} Product prices are changing all the time and the shipping costs are changing all the time, as well. The shipping cost estimates are really complicated. They actually require machine learning algorithms. One of the fundamental problems of understanding cost and fully-loaded cost is, how to you know ex-ante, before an order is placed, where the customer is going to be. Figuring that out, and the expected shipping costs, is a tough data science problem to solve. Those estimates are constantly changing. Things like, how do UPS and FedEx contractual shipping rates flow into the pricing algorithm? How do we know how much Wayfair is actually paying for a product?

{audio:0:20:44} The markup can also change, based on seasonality patterns. Every month, time of day, time of week is different. Weekends and weekdays have different patterns. The other piece that we didn’t talk about as much, the third critical pillar of pricing is getting an understanding of competitor prices or market prices for a particular product. In other words, what do customers expect to pay for a given product? That requires a lot of complex techniques, such as Python-based robots that scrape the internet for matching products, product and pricing information, in real time, on a daily basis, and then store them in a database so that Wayfair can access them to inform the optimal price.

{audio:0:21:33} You can’t set a price in a vacuum because, if it’s totally off, then customers are going to notice. All your competitors’ pricing is the other piece that can definitely change daily, so it’s important to keep an eye on that.

{audio:0:21:43} Taking today, spot container prices are $20,000, trebled in the last 18 months. Every time a price is shown to the customer, is Wayfair estimating that process of where the item is coming from, the shipping price, the UPS last-mile price? Are all those being programmatically being priced, for every item, for every customer?

{audio:0:22:20} Yes, in real time. There is an entire team of data scientists working on that problem. We talked about the cost structure before and the product cost is the largest component of cost. But the second largest cost is the shipping cost, so it’s really important to optimize for that, to get the most accurate total cost, so that you can get the best price possible.

{audio:0:22:43} Given the work they are doing with CastleGate and now they have the ocean forwarding business, if they can guarantee ocean freight rates, 12 to 18 months in advance, then surely that can stabilize and lock in the pricing and have a lower priced item than others, who are paying spot prices?

{audio:0:23:07} That’s a great point and I think that’s why we’re seeing Wayfair invest in this, continuing to backwards integrate into the supplier chain and invest in what they’re now calling CastleGate Forwarding. They are providing a wide range of supplier services, not only to alleviate the burden on suppliers, for doing things that suppliers don’t want to do or haven’t, historically, been great at doing, but it also has a ton of benefits for Wayfair, as you mentioned, such as providing more visibility into upstream shipping costs so that we can price more accurately and sharply. Hopefully, they can price lower and better than competitors.

{audio:0:23:46} Does the price, for the same item, actually change on a daily basis, if these estimates change?

{audio:0:23:53} The algorithms are running daily so prices can, theoretically, change every day. In practice, in pricing, we have a lot of conversations about how frequently we want to change prices. We have to balance that with how disruptive it is to customers. Let’s say they look at that sofa one day and it’s $143, and they come back the next day and it’s $148 and then the next day, $138. There are thresholds for that. Wayfair will not change prices unless it passes a certain threshold, in terms of time or dollar value. There are also certain big time markers, such as if a product in entering or exiting a promotional period or there has been a major update to the algorithm.

{audio:0:24:44} The algorithm is running every day and I know that millions of product prices are changing every day, but not every product is changing every day for the customer.

{audio:0:24:53} More conceptually, if Wayfair is updating the pricing, based on the fully-loaded cost and these variables, to optimize for that target contribution margin, does this not create a much more stable gross margin, comparing Wayfair to a more traditional retailer, where they own the inventory. Traditional retailers start at full price and then get down to discount so they can clear the inventory. It’s completely different for Wayfair. If they are pricing programmatically, on a real time basis, how does this impact the volatility of the gross margin?

{audio:0:25:46} Wayfair, obviously, doesn’t carry a lot of inventory so they don’t have that same traditional sales cycle for a product, where it ends up being discounted over time, to make room for new product. But, as we talked about, there is still a lot of room for volatility in the algorithm. Any of those components can change and, in practice, there is a tremendous amount of pricing volatility.

{audio:0:26:10} In terms of gross margin, if we look at what has happened over the long term, it also depends on what one considers to be volatile. When Wayfair IPO’d, they had a gross margin profile of around 23%, 24%. At the end of 2020, they had a gross margin profile of around 29%. We’ve seen 500 basis points of gross margin expansion, capturing the inelasticity in price as well as capturing all the wholesale efficiencies and supply chain benefits, that have come in.

{audio:0:26:51} Overall, the trajectory has been positive, in terms of expanding gross margin. I think there will be continued opportunity to expand gross margin but that doesn’t mean there won’t be volatility. A great example of volatility, when I was there, was the China tariff situation. When tariffs were put on a bunch of Chinese products – I believe in 2018 – that was a little bit of a shock to the system because Wayfair doesn’t hold inventory, so we didn’t actually benefit from the price protection of having inventory and we were more susceptible to changing product prices.

{audio:0:27:32} Does the executive management team just make a business decision? Do they price and keep the margin the same or do they actually price similar to competitors?

{audio:0:27:43} Those were the kind of discussions we were having, at that time.

{audio:0:27:47} How does Wayfair approach discounting?

{audio:0:27:50} As you can tell, I’m a little bit of a pricing nerd so I love these types of questions. In short, inside the pricing algorithm, discounting is considered a discount or investment off the optimal margin target or profile, for a given product. It is actually considered a sub-optimal pricing strategy.

{audio:0:28:12} That said, Wayfair obviously does discount and does offer promotional pricing, especially during these highly promotional periods. The scientific rationale for this is around future value. The basic idea is that customers like low prices and, if they see low prices, they will more likely to come back in the future and they will repeat more frequently. There are other strategic business benefits, such as the fact that lower prices also allow for building scale in logistical operations and a host of other rationales for discounting.

{audio:0:28:52} That is at the high level but, more specifically, to answer your question, the optimal promotional price is calculated using the same principles we talked about before; you take the fully-loaded cost. You then calculate the optimal target based on how much of incremental lift, in volume and profit, you would expect by lowering prices for a product. What is the benefit of lowering prices, in the short term and the long run? In practice, note that the discount doesn’t necessarily have to come out of Wayfair’s margin. It is often a supplier-funded discount. In the case of the sofa we were talking about earlier, with a fully-loaded cost of $100, let’s say Wayfair’s supplier relations team convince the supplier to provide a $20 wholesale discount on that product. That means that Wayfair can then decide to pass that discount through to the customer and charge something like $123 for that product, whilst maintaining its full profit margin.

{audio:0:29:57} And the supplier just takes the hit on their wholesale profit?

{audio:0:30:02} They would take the hit on the wholesale, but they would probably generate more turns.

{audio:0:30:11} I guess this can work on products that are maybe sitting in CastleGate and not moving much or have low turns? The supplier relations team can go to the supplier and suggest it is discounted to get it moving?

{audio:0:30:26} When you see a discounted price on Wayfair, because of the fact that Wayfair doesn’t really own much inventory, often, it is not really Wayfair taking much of a hit?

{audio:0:30:38} I think that’s a really great point you are making which is that, sometimes it is but Wayfair entirely controls the markup. Wayfair gets to decide the markup it charges on a product and, going back to what we talked about earlier, it’s not the supplier relations team and it’s definitely not the supplier that sets the price. This gives Wayfair a tremendous amount of flexibility and latitude in controlling its destiny, in terms of gross margin. Wayfair can decide where it needs its gross margin to be and what trajectory it wants that number to be on.

{audio:0:31:10} Obviously, Wayfair would prefer that discounts come out of supplier-funded pockets, as opposed to their own pocket. But in reality, a supplier-funded discount may be shared with the customer. Wayfair can choose to keep a certain portion of that and pass a portion onto the customer. That creates a win/win/win situation. The customer gets a lower price, Wayfair gets to keep margin and the supplier gets increased turns.

{audio:0:31:35} As you said, if you look at the fully-loaded cost, they are targeting each component of that? In the long run, ideally, you wouldn’t want to move the price too much for the customer, because then you get the best of both? You can have a higher margin from lower costs and also turn more, because it’s good value for the customer?

{audio:0:32:03} Yes; I think you’ve hit the nail on the head. One of the key reasons the pricing model is the way it is, is because it really aligns incentives with the different pieces of the cost structure. Teams at Wayfair can go out and tackle different components of it. The supplier relations team can go and tackle product costs; the shipping team can go out and negotiate better shipping rates and get suppliers into CastleGate. That is all part of the recipe.

{audio:0:32:28} It is so fundamentally different from a retailer. They will have a buying and merchandising team that will work very closely together and they would, effectively, have some kind of intake margin – COGS plus a fully-loaded margin – and then just try and shift it as quickly as possible because it’s burning cash on the balance sheet. But Wayfair is completely different.

{audio:0:32:52} Yes; when you get into the details of it, it is a very different approach. Ecommerce and pricing are still relatively new areas in retail. I think people are still figuring it out and exploring different ways of doing it. There is a lot of flexibility because it’s still a new business model.

{audio:0:33:14} What was the biggest challenge in optimizing price at Wayfair?

{audio:0:33:18} I know it can sound simple, from the outside, and one might be tempted to think, it’s just pricing; how complicated can it be? I think we’ve actually talked about a lot of the extremely challenging and complicated nuances and getting to that fully-loaded product cost. Estimating each of the components of those costs can be a really tough data science problem to solve. We talked about getting and scraping competitor prices for every product and, for a really big portfolio, that’s a very big data problem.

{audio:0:33:52} Lastly, actually calculating the price elasticity of demand itself and, consequently, the target margin. There are a lot of mathematical challenges to deal with. They can be as simple as, how do you incorporate seasonality into the model, to more complex things such as, what is the shape of the demand curve for a given product? How do we incorporate cross-price elasticity? How do you price a product that has thin sales data? It is all really challenging and interesting and I think pricing strategy is often an under-invested and under-resourced area of a company. It is somewhat rare to find pricing departments such as the one at Wayfair, from what I’ve seen. But it can be a huge strategic lever because of the direct impact that pricing changes can have on improving your bottom-line profitability.

{audio:0:34:39} Did the system get materially better over time, as more data was collected?

{audio:0:34:42} Yes; definitely. I think that is also part of the strategy; Wayfair is constantly collecting data over a really long time period about how customers are interacting with the products on its platform; how competitor prices are changing over time; how elasticities are changing over time. One of the questions I get is, how unique is this and how difficult is it for someone else to copy or replicate? I think the data advantage is a really big one that Wayfair has over a lot of other competitors that are trying to do ecommerce pricing, especially in the home goods space.

{audio:0:35:21} The strategy itself has evolved quite a bit. When I joined Wayfair, this evolution to value-based pricing was just taking place. Wayfair was coming off a more elementary approach to pricing, like many others; a more simple cost plus pricing model than incorporated a lot of competitor matching. Looking out and seeing what the prices were somewhere else, and copying that price. The model has evolved over time and got better because of all the incremental data that has been collected and because of the changes to Wayfair’s business.

{audio:0:35:54} What exactly happens when you get it wrong? With the fully-loaded cost, if something changes, materially, and you get it completely wrong, does Wayfair have the decision to take the hit on the margin or just not sell the product, or go to the supplier and get a discount?

{audio:0:36:15} In some ways, I think that is the fundamental risk of pricing. What if Wayfair’s price on a product is wrong? That can be defined in a variety of ways. It could be the kinds of things that you just mentioned. When you talked about inputs changing, that is exactly what Wayfair is trying to do on a daily basis. Often, we don’t know. On a given product, we may not know if the price is wrong, but those are the variances that we are trying to minimize, over time, by having better and sharper estimates and more real time data.

{audio:0:36:48} At the end of a period, there are reconciliations that take place to see how good our estimates were and what can we learn from them to make our algorithm even better? Those are the types of enhancements that are being made to the algorithm. Those are some ways that the price could be wrong.

{audio:0:37:05} The other way the price could be wrong is in terms of how the consumer perceives the price. That is also very important. The key parts of the Wayfair thesis, that I’m sure you’ve heard Niraj and Steve talk about, are that, in home, it is not a branded category so it is hard to know what the price of that sofa should be.

{audio:0:37:26} You can’t price compare?

{audio:0:37:27} Correct; you can’t compare. There’s a great story about this exercise we did, in one of these leadership team meetings at Wayfair. We brought in a lamp and we asked everyone around the table to write down what they thought the price of the lamp should be and the prices were all over the board. It is so hard to know what the price of that lamp should be. Ultimately, it is the consumer that perceives the prices of Wayfair, relative to other retailers, in terms of what that means about price perception and shopper behavior. That is a really tough challenge, especially right now, as we are in this inflationary, price-raising period, as we have been for the last two years. With rapidly changing data and consumer behavior, it is really difficult to know what the right price is and when to stop raising prices.

{audio:0:38:14} How is the pricing set differently for CastleGate items versus the drop-shipped items?

{audio:0:38:20} The beauty of Wayfair’s pricing model is that it is somewhat naturally picked up in the algorithm, by the calculation of the fully-loaded product cost. The key distinction is that CastleGate costs are lower; that’s the whole point of having CastleGate. That naturally flows into a lower total cost profile and that should translate into a lower customer facing price, higher product velocity and better overall performance on Wayfair’s platform. More specifically, there are several elements of the CastleGate value proposition that contribute to this favorable flywheel effect and these include things like the customers being able to see the fast, one-day to two-day delivery badging on eligible products. NPS scores are higher; customers are more satisfied with their purchase. The reviews are better for the product; they are boosted further up the sort position on the product page. The damages are lower.

{audio:0:39:26} You mentioned how the CastleGate items are lower cost but are you also more certain on the costs?

{audio:0:39:40} I’m not totally sure how to answer that. My intuition says yes, since this is a Wayfair controlled platform so they would have a lot of visibility into that. But I also think Wayfair would have visibility into drop-ship costs, as well. The piece that Wayfair may not know as much about in drop-ship is the inbound shipping costs. How much does it cost to get that product into the country, in the first place? Now, with its Asia consolidation and ocean freight programs, Wayfair will have more visibility into that.

{audio:0:40:13} My understanding was that if a drop-ship product was coming from a 3PL or a third-party freight forwarder, the supplier may be paying spot ocean freight prices. Does that drop-ship item then get priced when it lands in the US? Whereas at CastleGate, it’s coming to the warehouse; it might go through ISC and Wayfair’s ocean program, so you should have a better understanding of the fully-loaded cost?

{audio:0:40:51} There are so many products and, for each category, some are more CastleGate and some are less. I think all of this would be handled within the pricing algorithm and the shipping algorithm and the estimates that they are creating. They will look at things like what proportion of this product is shipped through a Wayfair facility versus not, take the costs associated with that and incorporate it in and look at how it is changing over time. Those types of nuances are all taken into account in the algorithm.

{audio:0:41:25} How did you see the difference in the sales conversion between CastleGate and non-CastleGate?

Wayfair: Pricing Strategy & Gross Margin

Former Associate Director, Pricing Strategy and Analytics at Wayfair

inpractise.com/articles/wayfair-pricing-strategy-and-gross-margin

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Shaloo Savla

Former Associate Director, Pricing Strategy and Analytics at Wayfair

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Wayfair: Pricing Strategy & Gross Margin(January 26, 2022)

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