How does Wayfair make money?

Wayfair uses a drop shipping model, where its network of suppliers ship directly to customers

E-commerce is having a second wave with companies like Flipkart, Delivery Hero, Snapdeal and LivingSocial leading the way to a huge amount of money being invested in the sector. One of the most successful e-commerce 2.0 companies is online home furnishing company Wayfair, which went public last year.

Wayfair uses flash sales to offer limited-time discounts on home goods in categories that include furniture,decor, kitchen & dining products, home improvement, patio & garden and baby.

It makes money through what is known as a "drop shipping " model, meaning that the company does not hold its own inventory, but instead relies on a network of suppliers to ship goods directly to the consumer. Wayfair itself never handles the majority of the merchandise sold through the site. 

Here is how the practice is described by Shopify:

"Drop shipping is a retail fulfillment method where a store doesn't keep the products it sells in stock. Instead, when a store sells a product, it purchases the item from a third party and has it shipped directly to the customer. As a result, the merchant never sees or handles the product," it says.

"The biggest difference between drop shipping and the standard retail model is that the selling merchant doesn't stock or own inventory. Instead, the merchant purchases inventory as needed from a third party –usually a wholesaler or manufacturer – to fulfill orders."

In its S-1 filing when it was going public, Wayfair described its business model like this:

"Because each of our customers has a different taste, style, purchasing goal and budget when shopping for her home, we have built one of the largest online selections of furniture, home furnishings,décor and goods. We are able to offer this vast selection of products while holding minimal inventory because we typically ship products directly from our suppliers to our customers," it wrote.

"This supplier direct fulfillment network is a key component of our custom-built and seamlessly integrated technology and operational platform, which also includes extensive supplier integrations, a proprietary transportation delivery network and superior customer service."

Once a product is purchased on one of Wayfair's five sites, its notifies the appropriate supplier, and that supplier then packages the item for them to ship directly from its facility to the customer. The company currently offers over seven million products from over 7,000 suppliers that is has a contract with.

Here is a graphic how it works:

The Wayfair family of brands includes: Wayfair.com, an online destination home designs; Joss &Main, an online flash sales site offering  home design daily; AllModern, for modern design; Dwell Studio, a design house for modern furnishings; and Birch Lane, a collection of furnishings and home décor.

There are both advantages and disadvantages to the drop ship model, as outlined by Shopify. On the one hand, it requires less capital, as the site does not have to supply its own inventory. It does not need to purchase a product until the sale has already been made, and the customer has already paid for it. The model also allows the company to drastically reduce overhead.

There are also risks that come it however, as it is predicated on maintaining relationships with suppliers, who may not want to continue doing business if Wayfair is not able to maintain sales levels.

"If we are unable to provide our suppliers with a compelling return on investment and an ability to increase their sales, we may be unable to maintain and/or expand our supplier network, which would negatively impact our business," the company wrote in its S-1.

So far, the model is working for Wayfair. Last week the company reported its Q2 earnings,during which net revenue from merchandise sales topped $490 million, an increase of 66% year-over-year. 

It also saw a significant increase in he number of active customers in its Direct Retail business, going up almost 54% year-to-year to a total of 4 million.  Orders delivered in the Second Quarter of 2015 were 2.0 million, an 80.7% increase year-over-year.

Founded in 2002, and headquartered in Boston, Massachusetts, Wayfair had raised $358.6 million in funding from investors that included Battery Ventures, Great Hill Partners, HarbourVest Partners and Spark Capital.

(Image source: wayfair.com)