Roske Speaks: Redfin Should Be More Like Costco

Chris Roske, Redfin’s director of finance, recently sent me a letter explaining how Redfin should be more like Costco. I think the letter’s pretty good even though I disagree with a few points (Costco does send a ton of direct mail and I think its overhead costs for website development should actually be higher because this will deliver more customer value over time).

I asked Chris if we could publish his letter and he said yes. With his permission, we are removing one sentence about Redfin’s high-end listing business just because it has a lot of inside baseball, and another sentence about Costco’s supplier relationships that is probably sensitive to Costco.

When I asked for a picture of Chris to accompany this post, he said he doesn’t have one of just himself, without the kids. So you’ll have to take my word for it that he’s a very handsome man. Other facts to know about Chris:

  • He told me when my first child was born that I should get pictures of him with Santa every year until we are 18. When my second child was born, he made a comment about the child’s name that persuaded us to change it.
  • Even though Chris is our top dog in finance, he reviews phone bills, expense reports, invoices for unreasonable charges.
  • Chris makes 100 suggestions per month about how Redfin could be better, and just about all of them are right on. He travels around the office with binders of materials that have every known fact about our business since inception, and shuffles through them to make his points. Often, the first premonition that I have said something wrong in a board meeting is the sound of Chris rifling through his binders. Do you know how rare it is to find someone nitty-gritty and strategic at the same time?

In short, we would be lost without Chris! I hope you enjoy hearing what he has to say about Redfin’s strategy.

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From: Chris Roske

Sent: Wednesday, March 21, 2012 4:43 PM
To: Glenn Kelman
Subject: FW: Costco note

Glenn, I enjoyed your blog on Costco. I am somewhat passionate about Costco (my wife would not use the word somewhat) and feel in many ways that the more Redfin is like is Costco the greater our ultimate success will be. I think Costco goes beyond the customer experience. I think the key to their success is value and the trust that is developed by putting the customers interests first. I think Redfin shares many of these same traits and certainly is the standout leader in the Real Estate Industry and can be just as successful as Costco. I think the market value of both Redfin and Costco is based on the customers trust that has been earned and potential to earn it in the future. I apologize if this rambles but I love the fact we have a lot in common with Costco and I think we can still learn from them. I also appreciate the opportunity to share my thoughts with you and take this with a grain of salt as I have a bias (likely irrational bias) to how Costco operates. You do not have to reply.

 

My passion for Costco:  We own some Costco stock, first buying more than 20 years ago, and are a loyal customer. Because their value proposition is so strong they have insulated their business from the competition by keeping their business simple and their focus on value for the customer, I am confident the business will continue to create great value for shareholders.

 

Value: The reason I do not sell Costco stock is exactly the same reason I bought it back then.  It’s simple.  There is simply not a more efficient way to sell goods than their model and other retailers cannot match their ability to provide superior value to their customers.

 

Costco’s profit is basically its membership fees, as it essentially breaks even on the sale of goods. Thus, competitors who make their profit on the sale of goods always have to charge more in aggregate. Costco also has great purchasing power in that it limits the number of goods in a store.  This provides greater  leverage with supplier pricing as there is competition to get products into a warehouse.

 

Redfin perspective: We offer great value with the team approach and agents spending time working with customers, not marketing. This is a core value proposition and it is clearly a huge differentiator. The team approach is more efficient and gives us a huge advantage in the market.  Our ability to make our agents much more productive is the same advantage Costco has with its efficient warehouses. Redfin Open Book is another great opportunity to leverage our buying power with service providers to provide a benefit for our customers from both a quality and pricing perspective.

 

Trust: Costco strives to earn customers’ trust and all actions align with this goal. Costco does not sell anything unless it can offer a better value. It never markups any national brand more than 14% and limits the private label markup to 15%. Customers also can return anything. This provides customers with great confidence in purchasing at Costco. They may find an individual item less expensive somewhere else, but on a cart full of items, you are almost always going to be better off buying at Costco. Costco values customers’ trust so much that it is incredibly resistant to raising prices. If it raised prices just 2.5%, its profits would double and result in short-term increases in the stock price. However, if Costco had done this 20 years ago, I doubt the company would have the market value it has today.

 

Redfin perspective: Our 100% guarantee and no-commitment stance on working with us is similar to Costco. Our incentive pay does align the agents’ interest with the customer. However, our ability to create trust is much more difficult than Costco’s because it depends on individuals providing a service that is personal in nature. Our employee model gives us a great opportunity to be better than our competition by our ability to standardize best practices and not accept anything less to create this trust.  You have recognized that this can be a huge differentiator for us and the emphasis on training will help.  However , we need to commit to consistency of quality service across all markets. On the pricing aspect, no business is as disciplined as Costco and long-term Costco has certainly benefited by keeping price increases to a minimum. Costco also benefits from a pricing philosophy that is simple, consistent and transparent and it is important that Redfin remain committed to this.

 

Marketing: Advertising does not provide any benefit to the customer so Costco does not do it. It is a cost that needs to be passed onto the customer. Costco’s  marketing is usually limited to contacting employers to encourage employees to sign up for Costco memberships.

 

Redfin Perspective: This is a hard one because we originally adopted this stance but competition has forced us to use marketing and it makes sense for us. The event marketing is incredibly consistent with Costco because it does provide a benefit for our customers. I understand we need to let marketing do what marketing does but it is a different philosophy than Costco’s and can even reduce the customer or potential customer’s trust if this is abused.

 

High-end Customer: I think it has been very key to Costco’s success that it  was accepted by the high-end customer first. Costco got lucky in that they originally appealed to small business owners and once it was acceptable for them to shop for values in warehouse, it was acceptable for everybody and even became trendy.

 

Redfin Perspective: We have made some inroads but in my opinion, Redfin could learn from what I think has been a key part of Costco’s success. I know Redfin wants a standard level of service that is high for all customers, but let’s make it higher for higher-end buyers. A home-run customer experience gets shared and the power of our brand grows. If it can be cool amongst high-end buyers to use Redfin, we will find it easier for moderate-priced buyers to follow suit. It is much harder to go from the low-end market to the high-end. As you know, the Japanese auto companies created different brands because this is such a challenge and Windermere’s local significant market share can at least partially be attributed to the fact they started off serving expensive neighborhoods.

 

Expansion: Costco has always had a conservative approach to physical expansion. It typically owns rather than leases, looks at demographics and has a bias toward lower-risk infill over new markets. It also only goes into markets where the cost of building a warehouse is low enough to support its business model. It also often goes in to new markets with more than one warehouse or at least plans for more than one, to leverage its marketing efforts. Finally, when Costco goes into a market, it engages in pre-marketing with free memberships. It has also had success introducing ancillary businesses like travel, pharmacies and gas that encourage more visits and are consistent with its value proposition

 

Redfin Perspective: Redfin has followed Costco’s strategy of selecting markets and done a good job in going after more desirable markets first. The new strategy of ramping up our PR and Marketing campaigns as we enter new markets in order to make a bigger splash is consistent with what Costco has done. Redfin’s consistent value approach into ancillary businesses is similar to Costco’s.

 

Perspective on Overhead: Costco focuses on keeping costs to a minimum. It has modest headquarters, low marketing and basically tries to minimize costs that do not directly benefit the customer.

 

Redfin Perspective: Redfin does a good job on this  because you think it is important, however it is becoming more difficult as we grow. I am conservative and am concerned as overhead costs increase more than transaction growth.  I believe Costco would argue that despite its size ($89B), the business  is pretty simple and does not require huge overhead to manage.

 

Perspective on Customers, Employees and Investors: Costco values its customers first, followed by employees.  Its strives to deliver stockholders a attractive but not fantastic return. Everything flows from the customer value proposition. It takes care of its employees with higher pay and benefits, but expects more out of them than other employers. This higher pay makes it a desirable place to work. Further, there is a culture of hard work that permeates the organization and it rewards that hard work. Also, the lack of turnover is a huge competitive advantage in an industry that has high turnover. Finally, the goal for stockholders is a strong, consistent annual return which Costco achieves by growing profitability and revenue.  Given the loyalty of Costco’s customers, I am confident they will continue to deliver a strong return.

 

Redfin Perspective:  Redfin leads the industry in watching out for our customers. Our customers recognize that. I do get concerned when we spend time and resources on initiatives that don’t deliver value to our customers. As far as employees, like Costco, Redfin does a great job of providing benefits to a class of employees who normally don’t get them, of promoting from within and you clearly have the employees’ best interests at heart. The stockholder comparison is irrelevant because of our maturity, investors… but I think the fact the value of the company is based on customers trust that has been earned and potential to earn it in the future is a common trait between Costco and Redfin.

Thanks again,

Chris

 

 

Discussion

  • Robert

    The problem with high end property and RedFin is that a lot of high end property is difficult price based purely on traditional comps. Also many properties will list some sort of square footage in the description but omit it from the sq. ft. line, which makes it more complicated because then the end user has to calculate the $/sq ft. If you can encourage real estate agents to actually list features of the home (i.e., in SF bridge views, or what direction the home faces) then it will be easier to perform “meta” searches.

    Why does my real estate agent send me a list of properties via sfarrmls? At least for me it would be nice if they could send me a list directly to redfin as it is much more enjoyable to use. But obviously redfin is missing or hides a lot of data that is available through a sfarmls link. Maybe you can provide a way either for real estate agents to send a proxied link to sfarmls through redfin or for me to enter an sfarmls link in redfin, and redfin will load a custom page with data mined directly from the sfarmls search with all of the additional information filled in.

  • Yamil Hernandez

    Also, Costco profits handsomely from its supply agreements.  AFAIK Costco as close to 0 days of AR aging (you pay cash/or AMEX which settles in a day or two), yet costco has 90+ days on its AP.  Additionally, they turnover their inventory very quickly and therefore have a nice “float' of money that earns a return for them.

  • Wrharper

    As a buyer, I think using Redfin for “high end” or near high end properties is a no brainer.  As a seller, I think the FUD from traditional agents about the value of their marketing is a significant barrier.  I think pricing could also be a challenge for higher end properties, unless the Redfin agent has very specific neighborhood knowledge.  Full disclosure – I bought my house using Redfin.

  • Paul Swegle

    Great insights Chris.  Companies that lose sight of providing value to and building trust among their customers rarely become household names.  Measuring every initiative against these goals is a great way of keeping them front-of-mind throughout an organization.  The idea of providing a higher level of service for higher end customers, however, might risk alienating more potential customers than it attracts.  Better, I think, to continue your successful efforts to continually enhance service across the board.  The company's sophisticated online and mobile tools and intelligent pro-consumer advocacy already provide a solid base for attracting higher end consumers.

  • http://www.facebook.com/cynthianowak Cynthia Pang Nowak

    Dying to know what Chris said to change your mind … I can imagine it being a financial reference.

  • http://www.brickandgarden.com/ Reuben Moore

    It does seem that certain people develop an irrational bias towards Costco.  My folks are in that category.  They raved about the place.  So much so, that I said, okay, take me.  And they did.  We drove an hour (an hour!) to the nearest Costco.  Worth the trip they said – Just wait you will see.

    Well we got there around 10am and there were surprisingly few cars in the parking lot.  Turns out, the store was closed for the Labor Day holiday.

    I am sure that Costco does value its customers – at least more than most firm's its size.  But not on that day.

  • Investor

    There's a problem with high-end customers.  They expect high-quality, professional, value-add service.  They don't always buy the most expensive house.  Many buy multiple properties.  I started with Redfin during a relocation, trying to buy a future rental to live in while we looked for our forever home.  Redfin treated us like un-valued customers.  So we bought with a traditional agent (TA), and now we're building our book of rental properties with that TA.  Why?  The TA does what he says he will, when he says he will, and he does legwork before showings to save us time (like calling the LA, finding out if a property is already finalizing a contract, finding out if a property is in far worse shape than advertised, etc).

    Once we have a million+ in rental properties, we might be interested in a million+ residence.  I wouldn't buy it with redfin, though.  It's not enough to target high priced homes, you have to work in a way that is compatible with the higher expectations of the well-capitalized professionals who can afford such homes.  Save me time.  Earn my trust in your integrity, but also in your discipline, professionalism, and expertise.  Stay on top of things – the contracts, the paperwork, the communications, etc.  If you drop the ball, don't be rude to the customer for following-up; apologize, do better next time, and move forward.  Better yet, don't drop the ball.  Provide all relevant information that is readily accessible through MLS, but not accessible to the buyer.

    I guess I'm not your target demographic, anyway.  Your commission rebate wouldn't even pay my annual CPA budget.  Your agents don't seem to understand investors.  Costco doesn't just provide pleasant service, they strive to provide value.  Cut-rate service at a cut-rate price isn't value.

  • JL

    I normally don’t post but I feel compelled to given I just used Redfin and have some strong feelings about the last person’s comments.

    To “Investor” – yes, 100% client satisfaction is impossible to achieve.  As someone who recently used Redfin to sell my home, I disagree with your comments as an indictment of an institution.  If you are correct that it is an institutional issue, Redfin’s overall business results will reflect that and you’ll be vindicated.  As someone who used the high-end traditional agents twice over the past 6 years, my experience was one of complete disappointment and frustration.  It is a flawed system caused particularly by mis-alignment of incentives.  I’ll explain my point:

    Once you list your home for sale, all else equal, the traditional agent’s model provides more incentives for them get any deal done rather than the right deal for you. For example, say that my house hasn't sold yet and I'm faced with the decision of whether to drop the price.  In this example, the lower price has a material effect on me and marginal impact on the agent.  Our interests are not fully aligned and at risk of diverging.  The agent runs the risk of getting a slightly smaller commission, but presumably that's not enough to meaninfully change their incentives at this point in the process.  The concerning agency risk here is that a TA may actually have an incentive to push one decision over the other causing a divergence in our interests or an actual conflict.  Dropping the price effectively increases the likelihood that the agent gets $2700, whereas refusing to drop the price potentially decreases the likelihood that your agent will get $3000 or $2700 or any commission at all.  In a model where that commission helps pay for fixed costs let alone provide additional incentives (remember, they are independent contractors), there is no denying that the agent's priority is getting a deal done. 

    Acquiring you as a client and getting your house sold are the two primary motivations for TAs.  I realize that I am being overly simplistic and readily admit that some TAs are above this comparison due to personal morals and that some firms may admonish agents who act out of self-interest.  Nevertheless, it relatively straightforward issue in that the TA model does not mitigate this potential conflict and, I believe, gives it fuel to thrive.  This is clearly why Redfin has taken the employee / bonus approach.  Having agents as employees shifts the financial burden to Redfin, and having bonuses further mitigates these types of risks by trying to align agents to clients.  Commission payments are quantitative metrics that reward sales activity whereas bonuses retain the quantitative aspect and simultaneously focus on the qualitative features a company wants to reward. The risk to the company is that you get less sales activity but that tradeoff may be worth it in the long-run for the betterment of the enterprise (a bet Redfin is making). 

    My recent experience with Redfin completely supports the point I am making and so does my experience with TAs (incentives mattered and affected their actions).  It becomes incumbent on the client to be aware of the risks and incentives and be willing to act themselves to mitigate them them (as I did).  Most clients don’t need or want this hassle.     

    But, the original reason for my post was to address Chris’ point.  I am a huge fan of Costco as well but I think you’re stretching the analogy.  Redfin still has a foot in the old TA model whereby the primary revenue determinant is the sales price of the home.  For dramatic effect, if Costco had that model they’d charge Executive Members 2% more on every purchase (I realize I'm stretching a bit now).  If you really wanted to apply the Costco model, it seems to me you would have to move to a cost plus model – you'd give up some short term opportunity costs (2.5% in your Costco example) in exchange for potential long-term enterprise gain.  It’s a risky but interesting bet.  The biggest impediment may be the fact that buying / selling a home is an inherently emotional and rationale transaction that involves leveraging the better part of your financial future.  No matter how many unnecessary, high-quality, well-priced items I buy at Costco, their business model does not face that dilemma.