My Wayfair IPO breakdown. Sometimes an S-1 doesn’t tell you everything.

First things first. I am not a Wall Street analyst. I am neither long nor short Wayfair or hold any direct equity position in a comparable company that trades in the Wayfair competitive set. Lastly, for this post, I did my best to make some educated assumptions about the Wayfair business that have not been publically made available by the company. If there are any meaningful data inaccuracies, please know that they are not with specific intent.

wayfairLogo

  • Company: Wayfair Inc.
  • Founded: 2002
  • Location: Boston, MA
  • Employees: 2,104 FTEs w/ 125 open positions
  • Leadership: Niraj Shah (CEO, co-founder), Steve Conine (CTO, co-founder). 3.1 of 5 stars and 80% approval via Glassdoor Ratings)
  • Investors: Battery Ventures, Spark Capital, Great Hill Partners, HarbourVest Partners and T-Rowe Price.
  • Revenue: My estimate is $1.325B for calendar 2014
  • Market Cap: $2.8B (at $35/share)
  • Ticket Symbol: $W (great ticker symbol!)
  • Expected IPO Trading Date: Now trading.

Business and Category Overview:

Wayfair is an incredible ecommerce story. The business was founded in 2002 by Niraj Shah and Steve Conine in Boston as a website called RacksAndStands.com (yes, they started by selling speaker stands and TV stands online). Eventually, the business became known as CSN Stores which was a collection of ~240 niche commerce sites focused on furniture, home furnishings, decor and goods with web domains that included porchgrills.com, bathmats.com and bedrooms.com. Wayfair was bootstrapped until 2011, with business growing to >$500 million in sales. At that time the still founder led ecommerce pioneer took its first outside capital and made the strategic decision to rebrand and permanently redirect all of the sites into Wayfair.com. Leading to what is today Wayfair, a billion dollar plus pure-play ecommerce business with a collection of five home related sites — pretty much a one-stop shop for furniture, home furnishings, decor and goods.

W_IPO_Overview

Wayfair offers the world’s largest collection of online selections of furniture, home furnishings, décor and goods. I would best describe Wayfair as an ‘inventory lite’, Amazon like, online seller of home related goods connecting 7,000 third-party suppliers representing 7 million products with millions of buyers. Wayfair’s has built two clear “unfair advantages” relative to the competition that have enable them to have great success.

1) Complex and sophisticated supply chain, operations and production capability which can efficiently and effectively coordinate the listing, production, presentation, transaction, fulfillment and support for what are literally thousands upon thousands of smallish sellers who have millions of product type available for sale. As you can guess, logistics, fulfillment and customer support for home goods products are challenging given the various categories, shapes, sizes, weights and price points in the home market. Large bulky items, such as living room sofas, dining room tables and bed frames, are particularly challenging and costly to warehouse, ship and deliver. One of the reasons Amazon is not really in this business.

As Alex Finkelstein from Spark Capital an investor in the business said, “In my mind, that’s the secret of the business—teaching thousands of small, mid, and large manufacturers how to do drop-ship so well. That’s what really enables the engine behind the engine to work.”

2)  Successful three pronged demand generation mechanism that includes:

  • sophisticated online marketing capabilities, specifically homegrown tools that support paid search advertising and search engine optimization.
  • robust utilization of ‘success based’ third-party seller network, including the likes the Amazon, eBay and Walmart and an internally managed affiliate program.
  • aggressive television advertising initiative in support of the Wayfair.com and Joss & Main businesses that kicked off in a big way in late 2012.

A key investment theme of mine focuses on the fact that the pure play ecommerce businesses (ie: product is shipped to customers) that have created the most shareholder value all have two specific characteristics.

  1. Incredibly compelling value proposition to consumers.
  2. Differentiated and unparalleled back-end fulfillment, operational and production capabilities.

Companies like Gilt, HauteLook, Quidsi (Diapers.com), Yooz, Zappos and Zulily all fit such criteria. This is the reason I recently led a large investment at Upfront Ventures in ThredUp, a leading online shop for buying and selling like-new women’s and kids clothing and accessories and will someday become the largest “modern day consignment store” in the world. Wayfair obviously fits into this category as well.

In the world of retail, home goods are similar to fashion.  You rarely see couches, chairs or tables in people’s homes that look similar to yours.  Just like fashion products. As a result, consumers love to be able to have large selections for inspiration and purchase choice. With limited square footage in retail stores, and the required floor space need to exhibit such product, one sees why the Wayfair value proposition is so compelling.  While I do love my Ikea, it is an event in itself to visit a store like that. Quite simply, “home does not work well with a search box”. In addition, there are no real brands in home goods categories. Can you name the brand of your bed sheets (unless it is Parachute Home)? Can your son tell you the name of the manufacturer of his bunk bed? Exactly. Unlike fashion these are categories heavily influenced by who sells the product versus the brand of the product maker. Another reason why Wayfair is so uniquely positioned.

Like I said before, Wayfair works with thousands of third-party supplier partners including makers of furniture, home decor, lighting, kitchen, bed and bath, outdoor, home improvement, travel products and many more product categories. It is about more than the 7,000,000 product number, but about the fact Wayfair carries 800 types of bunk beds, 17,000 accent pillows, 4,000 chandeliers, 5,000 barstools and 10,000 table lamps. And customers can actually find them in their sites! This is a scale that traditional offline retailers just can’t match. You might have 1/100 of these quantities at an Arhaus, Restoration Hardware or Target store. On top of that, the home goods market is F’in huge, reportedly over $233B in North America with only about 7% ($16B) actually transacted online. While this category has significant ecommerce friction (shipping price, selection, lack of capability for consumers to return product, etc), it is still large and fast growing.  With Wayfair growing their top-line revenues between 45%-50%/year, they are clearly taking share in a category that is most likely growing ~20% YoY.

With that said, offline home goods can still be a very good business.  Have you heard of the Nebraska Furniture Mart? Arguably the best retail business in America with locations in Omaha, Kansas City and soon Dallas. Supposedly, they sell over $500 million/year per store in boxes that are ~500,000 square feet.  And yes, Warren Buffet does own the business.

In addition, it will be interesting to see how Wayfair is impacted by the businesses of Houzz and Pinterest – both of whom are now valued at several billion dollars and are launching commerce applications for utilization by their rabid communities. Also, the online businesses of Arhaus, Pottery Barn, Restoration Hardware (even though they do send 30 pound catalogs, West Elm and many others are actually very good and well run ecommerce businesses. Obviously, venture capital has flowed to online pure-plays like One Kings Lane and Fab.

Breakdown of Business Segments

The Wayfair S-1 document that is published as part of the IPO process actually does a very poor job of explaining Wayfair’s different businesses.  This is where the whole story starts to get interesting and the tale of a business “in transition” begins to emerge.

Wayfair is currently three different businesses which I have ‘attempted’ to illustrate in the diagram below.

  1. Wayfair.com (plus AllModern, Burch Labe and Dwell Studio).
  2. Joss & Main, which is a flash-sale site that competes directly with One Kings Lane.
  3. An Indirect third-party marketplace business that is a huge seller on marketplace sections of Amazon, eBay and Walmart.com.

W_IPO_BizDiagram

Wayfair has a very large third-party business in which they sell product on sites such as Amazon.com, eBay and Walmart.com. In fact, it may be one of the largest third-party sellers across the major North American ecommerce marketplaces and is reportedly the largest seller on the Walmart.com. Despite selling almost $1B of product via these sites over the past five years, there is almost no mention of this business segment, its profitability or its future growth in the S-1. It is clearly a channel that is being deemphasized by the company and investment bankers to help drive valuation and perception of the business.

My analysis on the Wayfair Indirect Sales business:

  • E2014: $218.6M (16.5% of sales, -10.0% YoY growth)
  • 2013: $242.4M (26.5% of sales, 14.3% YoY growth)
  • 2012: $212.0M (35.3.5% of sales, 32.5% YoY growth)
  • E2011: $160.0M (30.9% of sales)

There are many “in the wild” examples of the Wayfair storefronts on various third-party marketplace sites. For these types of sales Wayfair pays a variable selling fee of ~12% of sales plus any net shipping costs (the 12% includes mostly fees to the marketplace and merchant processing fees).

Walmart.com marketplace – 393,767 current product listing – from Crayola markers to exercise equipment.

Amazon.com marketplace – 495,000 current listings – from nose trimmers to kids books.

eBay.com store – 409,000 current listings – from lounge chairs to wrist watches.

Also, listed products on Best Buy marketplace, Sears and Rakuten (former Buy.com)

As you can see in chart I created below (the blue numbers are my estimates), the growth of the Wayfair.com business and newer Joss & Main business has covered the short-fall in the Indirect business. This is probably a good thing, but at least one that should be better called out by the company.

W_IPO_RevenuebyBusinessUnit

Marketing 

The telling the Wayfair marketing story is going to sound very two-sided. On the one-side, as I mentioned earlier (which may have been yesterday, as I know this is a long post), Wayfair is an online marketing machine – truly best-in-class. They have a world renown online and now offline customer acquisition team and with complementary infrastructure. While I couldn’t find specific details, I would bet they are close to a Top 100 Google customer and have been on the forefront of paid-search and SEO optimization for the past decade. They have an incredible and proprietary data driven marketing capability, all of which is data driven built by top data scientist and online marketers.

However, on the other side they are currently spending more than 20% of revenues on marketing and those numbers have increased year-over-year in a meaningful way.  As seen in the chart below, you in effect have a 23.3% gross margin business (see more in a moment) that also spends about 20.7% on “true marketing”.

W_IPO MarketingSpendAnalysis

For clarity, advertising includes search engine marketing, display advertising, paid social media and television advertisements. Other Marketing includes search engine optimization, non-paid social media, mobile ‘‘push’’ notifications and email. Indirect Retail Partner Feed is the third-party marketplace fees paid to the likes of Amazon, eBay and Walmart. The rest should be pretty self-explanatory.

A huge question is whether the current marketing spend creates downstream lifetime value or simply drives near-term sales. Currently, 51.6% of buyers are are repeat buyers have bought before via Wayfair, but that doesn’t necessarily mean that such repeat purchases didn’t cost money or advertising to create. This is the bet that Wayfair is hoping potential future investors make.

Wayfair clearly makes the point that their ads (specifically TV) are doing a great job in reaching their target customer (a women ~45 years-old). As you can tell by looking at the spend numbers, they really started aggressively marketing the Wayfair and Joss & Main brands in 2011 and then launched an aggressive television campaign in late 2013 with large television buys.

As an example, over the past 30-days, Wayfair has probably spent $5 million alone is TV ads.

  • Wayfair – 2,187 national tv spots have run in past 30 days
  • Joss & Main – 249 national tv spots have run in past 30 days

As a comparison during the same period of time, Zulily has run 2,234 spots, HauteLook 1,641, Overstock 1,090, Fan Duel 4,370, Draft Kings 1,860 and Vista Print 4,136.

The most likely result of the dramatic increase in marketing spend over a short period of time is that orders from active customers has increased from 37.4% of orders delivered in 2012 to 47.2% of orders delivered in 2013. Note – Active Customers are the number of individual customers who have purchased at least once directly from sites during the preceding twelve-month period. This is a meaningful increase in net revenue/active customer, % orders from repeat customers and active customers. All very positive trends.

Two key drivers of these changes in engagement are most likely from a) the rapid growth of flash-sale site Joss & Main which inherently has more engagement and activity from a smaller group of very valuable customers and b) a >3x increase in marketing spend between 2012 and 2014 which has helped drive sales and engagement, but adversely impacted profitability.

W_IPO_EngagementTrends

One of the largest and most important questions about Wayfair is whether the rapid ramp-up in marketing spend is creating loyal, long lasting customers or will Wayfair have to “reacquire” customers downstream. To add some details, in the IPO Roadshow presentation management stated that in 2013 it took 123 days to reach contribution break-even for new customers (I am assuming this is blended cost of customer acquisition) compared to 77 days for the same break-even point in 2011. In short, Wayfair is now spending 2x more to acquire new customers than they did just two years a go. There is no data that highlights how marketing performance is doing in 2014, but clearly spend rates are way up.

Competitive Comparison (where the investment bankers make their money)

In reality, I believe the closest public company comp to Wayfair is actually Overstock.  However, to my surprise, Overstock is not even mentioned in the entire S-1 document. As you may know Overstock materially has shifted their business to be a dropship model where they now dropship 90% of their orders via their own fulfillment partners.  The Overstock market cap is currently about $400mm.

This is not intended to be a negative review of the business or S-1, but I do find it incredibly interesting that there is NO mention of Overstock in the entire document.  While I do think there is some difference between the Wayfair and Overstock business, they are close enough to compare.  Obviously, Overstock has it own issues and the brand feels for closeout than full price, but with the success of Joss & Main for Wayfair, the comparison is warranted.

From a late Saturday PM, Coors banquet beer induced tweet storm, I sort of went off…

1) Deep into Wayfair S-1 IPO analysis. Most interesting element so far is there is NO mention of Overstock.com in entire document.

2) A lot of ecommerce pundits mention the two of them in same breath. It’s almost like company + bankers don’t want any company association.

3) Wayfair is ~95% home/garden, 95% drop ship w/ 7,000 merchant partners. Overstock is 75% H&G, 90% drop ship w/ 2,400 merchant partners.

4) Wayfair sales in past 6 months $574mm w/ -$50mm operating income. Overstock sales in past 6 months are $673mm w/ $8mm operating income.

5) Wayfair is growing top-line revenue ~45% YoY compared to ~12% for Overstock.

6) Wayfair looking to price PO at ~$2.5B market cap (2x 2014 revenues). Overstock’s market cap is $425mm (~0.35 2014 revenues). 5x premium!

Listed online competition (two of which Wayfair is probably the largest seller on the site): Amazon, eBay and One Kings Lane.

W_IPO_PurePlayEcommercePeerGroup

As you can see, Wayfair is sitting between two very different comps. Zulily, which is trading a huge premium of ~4x revenue and Overstock which is trading at a huge discount of .3x revenue. Which would you rather have? Exactly. In addition, if you look at the PnL for the first six months of this year, Wayfair has lost >$50mm while both Overstock and Zulily have made money. In relation to growth, Zulily is growing at 92% YoY while Overstock is growing at 11.3%. In short, you now see why Wayfair is spending boatloads on marketing (24.1% of revenue fully loaded vs. less than 10% by the other two companies). The public markets want growth and will pay a huge premium for it. Wayfair probably should be compared to Overstock, but they and their investors might not be able to have it that way.

This will be very interesting to watch over the next several quarters. Is Overstock undervalued? Is Zulily overvalued? Is Wayfair valued just about right? Honestly, I am not sure.

W_IPO_ProformaFinancialData

Other Interesting Wayfair S-1 Tidbits

Is there tech platform risk at Wayfair? I tweeted earlier today that Glassdoor has become a key tool for me when researching private and public companies. Obviously, the reviews and posts on the site will most likely be more negative than positive, but one can gleam interesting nuggets of information.

There is a question about whether Wayfair has an “aging platform”.  Reading a few hundred employee reviews on Glassdoor, there are quite a few comments about frustration working with the current codebase. This is not surprising considering the business is now 12-years old (we dealt with the same thing at eBay) and I am sure it is something the company is keenly aware of, but definitely worth watching.

From a detailed post created on Glassdoor just a few weeks ago – 

“Wayfair’s ecommerce engine is a hard-to-maintain agglomeration of half-baked features stuck together with chewing gum. Code quality is pretty bad and there are no department-wide initiatives to improve it. The focus is on adding new features as fast as possible, the goal often being to make the site look and work like Amazon (this is openly admitted). In general minimal time is alloted for improving architecture and performance until things get so bad it’s an emergency.

Churning out code like this worked great when Wayfair was tiny but the company is now large and complex enough that the legacy codebase has become an impediment to progress, and management’s attitude towards software engineering is an impediment to improving the codebase. Many top people do not have formal training in software management and/or have only ever worked at Wayfair and are not acquainted with modern practices in the field. They are perfectly nice and well-intentioned but don’t “get” how to build great software.”

Capital Efficient Business: Wayfair is very capital efficient business as they collect payment for purchases from customers when items are shipped (usually about 2.5 days after order) and then don’t pay their 3rd party suppliers for more than a month (35.1 days). This has been a huge advantage for Wayfair as the business grows (similar to businesses like StubHub and Zulily), as a substantial amount of business is actually funded by the sellers thru beneficial payment terms. A lot of investors call this a negative working capital model.

Investment Capital to get this far: Despite my last comment, Wayfair has lost an accumulated $277.1 million since 2002 (building big businesses is not cheap!) They have raised a total of approximately $363.1 million from the sale of preferred stock, including $160 million in secondary sales by founders and early investors.

Sales Tax – Based on the location of the Company’s current operations, it collects and remits sales tax in only four states.  I have little doubt that this will change sometime soon. As a result, consumers are getting a 10% discount vs. other retail competitors. Current states where sales-tax is collected include Kentucky, Massachusetts, New York and Utah. It appears several states have already presented Wayfair with assessments (alleging that it is required to collect and remit sales or other similar taxes) in the amount of $11.7 million.

Employees: 2,104 full-time equivalent employees, 440 customer service reps (at a cost of ~$40k/FTE), 300 engineers and data scientists, others including marketing, category management, supplier management, finance, photo/design and production.

Significant employee count growth over the past three years.

  • as of 12/31/12: 1,169
  • as of 12/31/13: 1,558
  • as of 8/31/14: 2,104 w/ 125 current open positions.

International Sales: Today Wayfair delivers products to customers outside the US including the United Kingdom, Canada, Australia, Germany, France, Austria, Ireland and New Zealand. This represents about 4.5% of sales and held pretty consistent over the past couple of years.

Dwell Studio Acquisition: In July of 2013, Wayfair acquired DwellStudio for $6.4 million.

Founder Control Post IPO: – The co-founders, through a vehicle called SK Retail will have 56.6% of the voting power and 49.8% of the economic interest in Wayfair.

Ecommerce Unicorns lining-up at IPO starting gate. How to identify one early.

In the spirit of an overhyped Cyber Monday and blown-out of proportion mobile ecommerce statistics, I felt it was time for a little unicorn titled link baiting around the topic.  After all, I am a marketing guy and I wanted to show my eight-year-old daughter that the talk of unicorns are cool even with grown-ups right now as well! Special thanks to @AileenLee, @FredWilson and @CBInsights for making the dinner conversations around the house more interesting the past month.

  1. An authentic founder/team
  2. Early organic growth
  3. Proven/potential operational excellence
  4. Attractive market and margins
  5. Companies that are in a position to excel in a changing world

If you are an early-stage company and fit such a criteria, please reach-out to me directly!

Now for those with some time to read…

I was lucky enough to attend the Goldman Sachs Private Internet Company Conference earlier this month in Las Vegas.  It was a fabulous event showcasing some of the most dynamic and scaling private companies with most of ‘Tech’s Big Hitters’ in attendance (still trying to figure out how I got there). Besides the obvious media conversation about the recent Twitter IPO and the reports about Los Angeles based Snapchat turning away several acquisition suitors (good for you Evan, I am #LongSnapChat and #LongLA), the topic of Zulily’s incredible IPO had the attendees buzzing ($ZU has a market cap of over $4B as of today).

It is interesting that ecommerce related businesses always seem to be either very hot or very cold in the eyes of both private and public company investors.  There are many cases of companies getting lots of props and then all of sudden as soon as you turn around the haters jump-on. Over the past few years we have seen the likes of Gilt, ShoeDazzle, Groupon, Living Social, Fab and many more go from the ‘floor seats’ to the ‘cheap seats’.  The reality is this shit is very, very hard and usually takes a lot of time to prove-out success with many ups and downs.  The ecommerce and retail world changes quickly and the larger players and incumbents are not your typical sleepy bunch. You see the likes of Alibaba, Amazon, eBay, Google, IAC, Rakuten (to name a few) move fast, retain talent, play in big markets, have large balance sheets and can afford to make mistakes and place big bets (ie: invest in drones that can do same-day delivery).

So with all that it is easy to ask “why bother” building a company in/around ecommerce?  That is the easiest question – the answer is according to ComScore in the US alone online sales will grow about 15% increase this year and over the next four years will grow from ~$260 billion to this year to ~$370 billion in 2017. Sales over the long weekend (Thanksgiving to Cyber Monday) grew >20%, but even with all that, according to Forrester online retail sales will only grow from 8% of U.S. sales  to 10% in 2017 (thanks @JessicaLessin).  It is very early and many new companies will play large roles in the future of ecommerce and at the same time those playing leading roles now will play even larger rolls in the future.

Back to the Goldman Sachs event, the question coming-out was whether the Zulily IPO has opened the door for everyone else and is ecommerce ‘cool again’ in the minds if investors? The answer is yes.

Well, yes IF:

  1. You are an incredibly well run company (been there before at BlueNile)…
  2. That is growing a rapid rate (think >100% YoY)…
  3. In a very attractive market (mom’s spend money and kids grow)…
  4. With a pathway to longterm profitability (margins are good enough and pointed in the right direction)…
  5. And have a defensible market position

You see it is easy.  The reality is the reason Zulily has the market drooling is the fact that the public markets have only seen a few companies at that stage in the US that have been able to create something so incredibly special.  Zappos and Quidsi and Shopbop never got a chance (Amazon bought them-up). StubHub was purchased by eBay (I got that one right).  Richemont bought Net-A-Porter. The PE guys have their hands on Getty Images and Go Daddy. Asos and Yoox are in Europe.  I would put Groupon (you can knock it, but they are worth $6B) HomeAway, OpenTable, Shutterfly, Shutterstock and Vistaprint on a short list list of public companies that fit the criteria (I am sure I am missing some while obviously excluding Amazon, eBay and all the great travel, real estate, financial and payments companies).

However, the next wave of great companies is lining-up.

Continuing the “is ecommerce back” theme – Andy Dunn, the co-founder and CEO of Bonobos, tweeted recently about whether an Ecom 2.0 IPO wave was beginning.


I agree with Andy. IF you are an incredible company doing special things. There are probably just a handful of companies getting close to such rarified air in and around pure-play ecommerce. I can think of Airbnb, Etsy, Eventbrite, Fanatics, TrueCar, Uber and Wayfair. I am very bullish on all of them and wish I had direct investments in each.  There are many great companies behind them, but I think those are first to go out. The bigger point is that of the thousands of ecommerce, marketplace and transactional businesses that have been funded, maybe 20 have gotten to this level. An interesting point about the 2014 list is only one of them is a pure ecommerce play that “puts stuff in boxes” (Fanatics) and honestly I don’t know enough about their business to know how much inventory they take.  I think Net-A-Porter, Quidsi and Zappos were the last ecommerce businesses at this level involved in a “financial event” that actually take inventory positions (that is a blog post for another day).

You see, it gets back to point that making money and building long-term value in and around ecommerce is really hard.  Only a few have done it and those that figure it out get huge credit and the market responds with extra special love.  All this is a perfect tie to what I think are key areas that investors (private company investors like me and even public market investors) look for when considering backing such commerce related business. I believe these are also some things you should evaluate when you consider working for earlier stage commerce related businesses).

So, what does it take to be an Ecommerce Unicorn?  Here are a few keys that I look for and try and extrapolate forward when looking at deals. Full disclaimer, I have never been luck enough to invest in one, but I hope to!

1) Authentic Founder/Team. A team whom understands the brand they want to build, their product relevancy, their customer, their industry and how what they are going to build is going to create an unfair advantage in the market.  Think about businesses like Amazon, Lululemon, Nasty Gal, Net-A-Porter, Nordstrom, Spanx, Tory Burch, Uniqlo and Zappos.  They share most of these characteristics, starting from the top when it comes to fully understanding why they are building it, what they are building, then positioning it with consumers, employees and partners and then creating something that others cannot replicate.  In Amazon it all about scale, for Lululemon, Spanx and Uniqlo it is fashion-tech and lifestyle, for Net-A-Porter, Nordstrom and Zappos it is about experience.  All of them are different, but all are clearly company defining and very differentiated in the marketplace.

2) Early Organic Growth. Other than using Arial font in a presentation, one-way to get on my bad side early in a discussion is to start talking about marketing ROIs and LTVs.  Simply said, I do not believe customer acquisition capabilities are a defensible tool in a competitive marketplace.  Remember, I am marketing guy and am sure as hell not a marketing hater, but paid acquisition is a commodity business.  Top performing customer acquisition is table stakes to win in ecommerce, but it can’t be the only thing you are good at.  Branding, efficiency, experience, loyalty, point-of-view, product, scale, technology – those are things that make companies special and defensible.  Have you ever heard Etsy, Net-A-Porter and Uber talk about LTVs?  Sure they spend money to acquire customers, but the money they spend is to put fuel on the fire of being great at other things that customers love to talk about.  I like to see business who are growing early by accident.  The accident is the result of something special being created and the market (even early) responding.

3) Operational Excellence. Ecommerce is all about execution.  With inherently low margins, a boat load of competition and everyone using pretty much the same marketing tool-kit and transactional platforms, there is very little margin for error to make ecommerce work and work profitably.  This is usually not something companies in their earliest stage are working on 100%, but I do think it is important to be thinking about it planning for it.  When considering an investment, I usually will look for examples or signals that the team is organized with operational excellence in mind.  For example, at HauteLook, Terry Boyle who is now the President of the business was keenly aware very early that we had to do operations and fulfillment ourselves because no one in the market could do what we needed at scale (from taking pictures of dresses on models to handling/shipping merchandise to consumers less than an hour after after receiving from our brand partners).  If you have never visited a Yoox site, you need to.  I think they are the best globally about getting lots of products produced and published to the site at the highest quality with the lowest cost.  Quidsi is incredible with Diapers.com (and has been for a long-time).  I remember ordering something in 2009 on a Sunday and receiving it on a Monday.  They were Amazon before Amazon and are now Amazon :)

4) Attractive Margins.  I talked about this at length in my Zulilly IPO post, but product margin and gross margin are incredibly important when it comes to evaluating ecommerce businesses.  Zulily’s gross margins (pretty much dollars left after you pay for the product you are selling and the cost for it to be shipped) are just under 30%.  This means for every dollar collected in sales, $0.70 is gone before any expenses such as fulfillment centers, business operations, merchandising, employee salaries, marketing spend, office space, etc.  As a comparison, Lululemon has 56% gross margins while Nordstrom has 39% gross margins.  The difference in margins is primarily the difference between vertical retailers (Lululemon) and horizontal retailers (Nordstrom) in the physical world and Bonobos and Fanatics in the virtual world.  Right now, I am a pretty quick pass on any ecommerce business with less than 40% gross margins (but the IPO success of Zulily has caused me to at least rethink this hypothesis).  When it comes to marketplace businesses, @BillGurley has written the defining piece on marketplace pricing.

5) Positioned to Take Advantage of Changing World.  I needed a catch-all.  There is so much more that must be considered, but I think they can be put in a single bucket.   In short, a changing world providers opportunities for new companies and new types of companies to emerge and be successful.  For example, if you are selling commodity type of products that can be found at Amazon, Best Buy or Wal-Mart, don’t bother, even if you can deliver product via underwater sub drones with a reverse time machine.  However, if your business works dramatically better than what exists today because of things like local, mobile and social capabilities then you are in unique shape. All that needs to be said is Lyft and Uber.  In addition, recognizing a change in customer behavior before anyone else is incredibly important – short attention spans (flash sales), great design elements, desire for transparency, etc. are all examples of key behavioral insights that are impacting the ecommerce marketplace.

Side note:  A couple of blog posts that I think are very good are from Ajay Agarwal and Brian Garrett.  There are countless others, but those two came to mind.

My reaction to Zulily’s IPO filing and Flash Sales explained

This week Zulily, the ecommerce flash-sale site targeting moms with products for their kids and themselves, filed their S-1 to go public.   While I knew the filing was coming and I had an idea what would be inside, my first reaction was still……HOLY SHIT.  Without a doubt, the 179 SEC page filing is a must-read for ecommerce investors and entrepreneurs everywhere.  The reason: on one extreme it highlights how well they have executed on an incredibly tough business in just four short years, going from a zero to $600 million in annual sales (my estimates for 2013).  On the other extreme, they have limited profits and have lost $56 million to get to this point in their life-cycle.  In between, there is a ton of interesting and pertinent information.

The intent of this post is not to recommend whether I would invest in Zulily on a go-forward basis.  Regardless of what happens in the public markets, they must be commended on what they have built.  As someone whom competed against them while I was the CMO of HauteLook,  they have done an amazing job.  It does bother me that they tried to block HauteLook IPs and HauteLook employees from accessing their site for competitive purposes, but that is a blog post for another day!  Also, as a new investor for Upfront Ventures, I wish my early deals could end-up like Zulily did for my friends at Maveron (we are a co-investor in a different deal) who STILL owns 24% of this business prior to going public.  Maveron is not a huge VC fund, but this could be one of the great investments outcomes in the ecommerce era.

With all that said…..a little background.  I can remember when we first heard about Zulily in the fall of 2009.  It was four months into my job at HauteLook.  The head our kids business at HauteLook was talking about industry chatter about some Blue Nile guys trying to create “HauteLook for moms”.  The industry might have actually been saying “Gilt for moms”, but we at HauteLook would never say that because we always thought (and to this day believe) we had a better business than Gilt.  Regardless, then came the calls over the next 18-24 months from Silicon Valley VC friends asking me about Zulily (and OneKingsLane for full disclosure) and what I thought.  I always gave them the same honest answer re: Zulily: “love the target market, feel the kids/moms retail space lacks a dominant brand and think the value proposition will resonate.  However, have concerns what was assumed was low average order values and low product margins (a flash-sale problem), thus driving to lower than desired LTVs, high customer acquisition costs and eventually low net income margins”.

So right……..but also so wrong!

Zulily has done an incredible job of building a huge business in a very tough space, without blowing thru a ‘ton’ of money.  Don’t get me wrong, they have raised $137 million to date ($94 million primary and $43 million secondary) which is a lot, but to their credit they still have tens of millions in the bank.  While other flash-sale sites like Gilt and Fab have raised $221 million and $336 million respectively (thus far), Zulily has used a more balanced strategy in regards to investment growth and cost containment.  In addition, their non-inventory model has resulted in a negative working capital model which has set them up for long-term success.  Regardless, just as in other ecommerce businesses, the core data points that need to be looked at relate to a) Gross Margins, b) Operative Leverage, c) Marketing Spend as a % of Revenue and d) Customer Productivity Overtime.  These core data points are obviously in addition to things like team, brand, market size, competitive set, etc.

Let me dive in:

Gross Margins: Zulily’s gross margins — pretty much dollars left after you pay for the product you are selling and the cost for it to be shipped — are just under 30%.  This means for every dollar collected in sales, $0.70 is gone before any expenses such as fulfillment centers, business operations, merchandising, employee salaries, marketing spend, office space, etc.  Compare this to businesses like Lululemon with 56% gross margins or Nordstrom with 39% gross margins.  These two cases are the difference between someone who sells their own product (Lulu) vs. somewhere who sells someone else products (Nordstrom).  In short, this is not as high as most investors would like, but is the reality of being a seller of other people products and made tougher when selling other peoples product at low price points and at a discount.  Now you can see why businesses like Bonobos, Combat Gent and Nasty Gal all get such attention from investors as their gross margins are closer to Lululemon than Nordstrom (and Nordstrom is an AMAZING business) and also is a reason why from an early-stage investment perspective, I am a pretty quick pass on any ecommerce business with less than 40% gross margins.

Operating Leverage: Flash Sales are hard. The business is hard to scale and expensive to operate. Remember when there were several hundred similar businesses? Not only are you playing with less than desirable gross margins, you are effectively merchandising a new shopping experience everyday.  Zulily highlights that they are launching 250,000 product styles per quarter (2,777 per day).  That is A LOT.  Think about the production and operational work and processes that needs to get done every day to get all of these items live to the site.  From the coordination and storage of product samples, to scheduling of photo studio and photographers, to photo creation, selection and editing, to product measurement and product detail description writing, to the other ten or 20 steps in the sales creation process.  Also, that doesn’t include all the pre-work around setting-up the OTS (open to sell), vendor set-up and accounting, post-sale coordination, etc.  While someone like a ShopBop.com or Nordstrom.com might have 20,000 to 50,000 unique SKUs for sale at any one given time, such items on those sites stay-up for long periods of time (usually 3 months or longer) – maybe 200 to 500 new styles go live each day.

Compare this this large flash sale sites where more than a hundred new products go live to the site each HOUR.  To support the relationships with 10,000 brand partners and 1,000,000 product styles per year, Zulily will spend an incredible $100mm on SGA in 2013 (excluding marketing spend).  I would take an educated guess and say that most of their 811 non-fulfillment related employees work on this part of the business, including 302 in merchandising, 89 in technology and 39 in photo studios.  The Zulily reviews on Glassdoor and some of the notes in the S-1 (see page 58) would also suggest these numbers are correct as well.  Assuming $70k/year in fully loaded expenses for 500 people, one can assume they spend $35 million per year just to get those products to the site each year ($35/item). For full disclosure, Zulily reports to have 886 full-time employees, of which 75 are in in fulfillment, but not including the temp labor they use in the their fulfillment centers which I am sure is in the several hundreds.

In addition and amazingly, Zulily manages 1.1 million square feet of their own leased fulfillment space at facilities in Nevada and Ohio (size of almost 20 football fields). There they can handle over 100,000 items per day in volume per day which if you back of the envelope is about $750 million in volume/year (100,000 items at an ~$20 per item value times 365).  That might actually mean they need to soon add even more sq. footage for fulfillment, but this is not meant to be a takedown of their future cap-ex needs.  With that said, order-to-ship times for customers is 10.6 days down from 12 days just 18-months ago.  This is actually very good for a “pick, pack and ship” model.  The best-in-class flash sale providers like Gilt, HauteLook and Rue La La are all in the 10-11 day range for such deliveries.  Again, a long-winded way of saying that this is not a cheap business to execute on and not easy.

Marketing Spend as % of Sales: As a marketing guy this was very interesting. Zulily has been very aggressive on the marketing spend side of the business from the start. Out of the gate (2010) they were spending 27.8% of revenues on marketing and today spending just under 10% of revenues on marketing….wish I was at those Board of Directors meetings in the early days! In real dollars, they will have spent almost $120 million over the past four years to build-up their customer base, including what will be around $55 million in 2013 alone.  This may surprise you, but this level of spend sits between where Fab was spending (no comment) which was reportedly 35% of revenues and the other leaders in the flash-sale space whom are closer to 5-8% of sales.  The reality is while Zulily has shown incredible YoY sales growth, most of those gains are being driven by spending more money each year.  With that said, there is little doubt they are best-in-class marketers and you may even see their TV ads on the air today.  However, it is fair to say that Bill Gurley is probably not be a big fan of the flash sale category.

Customer Productivity: Zulily reported that average revenue per customer (defined as a buyer) per year is $210.  In addition, AOV (average order value) is $53 (which includes shipping cost charged to the customer).  Therefore, an average customers orders from Zulily four times per year.  Without divulging too much, the number of orders per buyer per year is similar to the other major flash sale sites.  What makes Zulily stand-out relative to others is that it appears (at least in the Q1 2011 customer cohort) that average spend per customer per year does not decline on an annual basis.  Like I said, this is a unique positive characteristic and one that is rarely seen in any ecommerce business, let alone a flash sale business.  Hopefully, you have read Jeremy Liew’s blog posts on LTVs, but an increasing annual spend curve does wonder to the long-term business value creation.  In the Zulily case, they have determined contribution margin per order to be 18% (meaning $18 of every $100 spent invariably drops to the bottom line).  In this case, in a single year a customer spends $210 with $37.80 “dropping to the bottom line” and they can afford to spend roughly $40 to acquire a buyer that is paid for in one-year.  At HauteLook we used to target a six-month payback period and were much more conservative on determining contribution margin.  Not saying what is right or wrong, but it there is no one way that all marketers define how to profitably acquire customer.

Other Zulily Data Tidbits and Conclusion:

  • Highlighted the recent changes to Gmail as a risk factor as it could hurt the ability to message to members.  This will be a future blog post and something that is keeping all Flash Sale CMOs up at night.
  • Only charge sales tax in Washington, Nevada and Ohio.  This will change, just not sure if this year or in three years.
  • 2.2 million active customers (customers who had purchased at least once in the last year), an increase of 93.1% from 1.2 million active customers during previous 12 months.
  • $214 of revenue per active customer per year, a 10.9% increase from the $193 of revenue per active customer generated during the 12 months prior. This is most likely due to improvement of shipping times, decline of shipping prices driving more sales and increase in the number of live sales per day and categories of those sales (ie: not just kids clothes, but also gear, apparel for moms, etc.
  • Approximately 42% orders were placed from a mobile device.  This is great, but pretty indicative of all flash sale sites (a great mobile commerce category).  With that said, Zulily has a great mobile app that consistently is a Top 20 Lifestyle App in the Apple Store.
  • $2.5 million of net income on $272 million in sales during the first six-months of 2013.
  • Class B investors have 10x the voting rights of Class A investors.
  • Zulily does not have meaningful inventory.  A huge plus for the balance sheet, but it creates a more difficult consumer value proposition (ie: items can take 10 days to get to buyers).   In addition, their choice of categories is not a big utilizer of returns. The end result is an attractive negative working capital model which has set them up for long-term success.

In conclusion, to go to the next level Zulily must a) continue to acquire new customers, b) attempt to maintain the wallet share and engagement from new customers and c) grow by introducing new categories and new markets (ie: international).  All this while the law of large numbers might say this will be difficult as the ability to continue to grow at that pace and the ability to maintain such loyalty to a single brand is getting more and more difficult.  Regardless, Zulily has emerged in a short-time to be a generational defining ecommerce business.  With well over a billion dollars invested by VCs in the flash-sale category over the past five years in the US, they are the ones that got public.  HauteLook and Rue La La were sold large nine-digit numbers and Gilt and One Kings Lane have built great brands and solid businesses, but it is Zulily who may be the company that defined the post Zappos/Diapers.com ecommerce market.

Note:  I know there is a lot of material here and I know a lot of it is inside baseball.  I did my best to highlight the parts of the S-1 I personally thought were interesting.  I know missed things and didn’t go deep enough in some areas.  There will be more posts to come.  Hopefully, you get the idea.

First VC Investment: Deliv – Same-Day Delivery for Large Retailers

I am excited about my first investment with Upfront Ventures, leading a $6.85mm Series A financing in Deliv which was announced today.  Based in Palo Alto and founded by Daphne Carmeli, Deliv is a crowdsourced scheduled same-day ecommerce delivery service targeting large national multichannel retailers.  By integrating into a retailer’s ecommerce platform and leveraging specific omnichannel inventory management capabilities, Deliv enables real-time routing, scheduling and parcel pickup with managed local contracted and dedicated drivers to fulfill deliveries to consumers.

My early focus at Upfront Ventures has been focused on “retail innovation” with a significant interest on how the offline retail world is made better when fully integrated with the online experience.  The delivery and fulfillment experience around ecommerce is a great example of a segment of the market with large changes happening now.

Why Deliv and the Scheduled Same-Day Delivery Thesis

A few things we believe to be true………

1) If given the opportunity, at an attractive price consumers will gravitate towards a scheduled, same-day shipping opportunity with expanded delivery time option for ecommerce purchases. Whatever the category (entertainment, electronics, gifts, groceries, home goods, shoes, etc) who wouldn’t want to take advantage of getting that desk ordered from Ikea delivered to your home any time you want (say Sunday morning) for a lower price than UPS or Fed Ex charged for 2 or 3 day delivery?  Crowdsourced point-to-point delivery makes affordable same-day delivery possible.

Speaking of Amazon (I am playing both sides of the table),  I am reminded of a Jeff Bezos quote that has been recirculated recently.

….I almost never get the question: ‘What’s not going to change in the next 10 years?’ … [I]n our retail business, we know that customers want low prices, and I know that’s going to be true 10 years from now. They want fast delivery; they want vast selection. It’s impossible to imagine a future 10 years from now where a customer comes up and says, ‘Jeff I love Amazon; I just wish the prices were a little higher,’ [or] ‘I love Amazon; I just wish you’d deliver a little more slowly.’ Impossible. And so the effort we put into those things, spinning those things up, we know the energy we put into it today will still be paying off dividends for our customers 10 years from now. When you have something that you know is true, even over the long term, you can afford to put a lot of energy into it.

2) So long-term, retailers MUST try and “out Amazon Amazon.”  They simply cannot try and replicate the Amazon model, but instead must leverage existing assets and skill-sets to make their models work in today’s retail environment.  In order to do this, retailers must work together and pool resources to effectively compete long-term.  For example, in the US alone, the Top 100 retailers have well north of 150,000 unique points of distribution.  In the old days, we called them stores.  Today this real estate footprint also act as strategic transactional points used for consideration (trial), purchase and shipping (fulfillment). In addition, within the next few years, it will be table stakes for successful omnichannel retailers to have  “buy online, pick up in store” (BOPIS) and/or “buy online, ship from store” (BOSS) capabilities.  Currently, this number is closer to 50%.  If a retailer has can enable BOPIS or BOSS, they can ship to consumers same-day.

3) In order for a same-day shipping service to be attractive for, and utilized by, retailers it MUST be a) enterprise grade, b) vertically focused and c) relatively unbranded to the consumer.  I love the missions of the likes of Uber, Instacart and Postmates, but in the eyes of top retailers, these services need to be dedicated and focused on specific business partners, similar to how they view their current relationships with Fed Ex, UPS and USPS.  In addition, this has to be done in a cost effective and scaleable way.  What retailers cannot do is offer a value-added service to consumers and then take it away or dramatically change the costs because the long-term economics are upside down (see Kozmo, Webvan, etc).

Early Moves by Competitors and Different Approaches

Some would say while this could be a large market, it is already crowded with competitors.  Of today’s $70B delivery market, same-day is estimated to be just ~$500M.  Regardless, as consumers begin to experience cost-effective scheduled same-day delivery, and the retailers seek to leverage their recently built omnichannel capabilities while increasing brand perception and customer experience, the market will grow rapidly. By combining a dedicated and retail specific crowdsourced delivery network and the collective aggregation of retail locations, Deliv is quickly being positioned to become the enterprise grade industry platform for scheduled same-day delivery. By partnering early with a top mall developer and owner like GGP, they are well on their way building the blue-print for long-term success.

Deliv’s advantage lies in unique combination of a one-sided market (direct integration into retailers’ ecommerce experience) and mobile-enabled contracted deliverers (vs. expensive couriers).  We argue this provides superior economics (no margin-on-margin with couriers), greater appeal to retailers (own their data and experience), and faster ability to scale (only need to ramp up deliverer network).

All-in all, get ready for a wild ride. It won’t be long before same-day delivery is available to you as an option when you check-out from your favorite retail ecommerce site (especially, if you live in Chicago or the San Francisco Bay Area).  It won’t be long before you see your local mall and commercial retail super-center doubling as a localized ecommerce distribution center.  It won’t be long until you vehicles marked with the Deliv logo dropping off packages in your neighborhood.

Special thanks to my Upfront Ventures colleague Glenn Poppe for helping with this deal.