Online furniture seller Wayfair has been a hit in its first day as a public company, but the company’s future success will likely hinge on whether its large marketing expenses attract shoppers who continue to come back time and time again.
The Boston-based company raised $319 million in the IPO, after pricing its offering above its target range at $29 a share. It opened trading at $36 on Thursday morning and climbed past $37.50 in late trading, scoring almost a 30 percent gain and pushing its valuation above $3 billion.
One big reason for early investor interest is the company’s rapid growth in the still-nascent business of selling furniture and home decor online. Revenue grew 52 percent in 2013, from $601 million to $916 million. But that growth hasn’t come cheap. Instead, it has been fueled by rapidly increasing marketing expenses coupled with widening losses, raising the question of how sustainable this spending will be. Wayfair spent $177 million on sales and marketing in 2013, and has already spent $138 million in the first six months of this year alone. For those periods, the percent of revenue spent on sales and marketing spiked from 19 percent to 24 percent.
To understand why Wayfair thinks it needs to spend on marketing so aggressively, it’s helpful to know a little bit about the company’s backstory. Founded in 2002, Wayfair was originally known as CSN Stores, which grew to be a network of more than 200 disparate shopping sites. But in 2011 its founders decided to consolidate those sites under a new brand and site called Wayfair. The company raised several hundred million dollars between then and the IPO so it could invest heavily in advertising campaigns, including TV commercials, to build awareness for the new brand and attract new customers.
In the short term, that spending seems to be doing its job. The number of active customers, defined as customers who have made a purchase within the last 12 months, increased 75 percent in the 12 months ending June 30, from 1.5 million to 2.6 million, according to a regulatory filing. Lifetime net revenue per active customer also increased, but only slightly, by six percent.
But how do such high marketing spending levels lead to a fast-growth company that also makes money? Or will Wayfair put the brakes on the marketing outlay? If so, will growth tail off?
In an interview today, CEO Niraj Shah said he doesn’t believe the company will need to continue increasing marketing spending as revenue grows, meaning that the percent of revenue being spent on those costs should decrease over time. He also pointed out an analysis included in the company’s IPO filing that seemed to prove that its current group of customers is making repeat purchases more often than customers it acquired years ago.
“What we’ve been saying is we’re trying to build a really big business, and to do that with a big base of loyal customers that come back more and more often,” he said.
If that bet doesn’t work, one of two new realities awaits: Slowing growth, or a company operating in the red for longer than expected.
This article originally appeared on Recode.net.