What you need to know before investing in Shopify

Shopify (NYSE: SHOP) is a leading provider of an internet platform for commerce, offering trusted tools to start, grow, market, and manage a retail business of any size.

Shopify’s software enables merchants to easily display, manage, market and sell their products across over a dozen different sales channels, including web and mobile storefronts, physical retail locations and social media storefronts. More than two-thirds of Shopify’s merchants have installed two or more channels for their business.

For example, Shopify has recently enabled merchants to connect their Spotify and TikTok accounts with their Shopify online stores.

To make it easy to use, Shopify software provides one single integrated back end that merchants use to manage their business and buyers across these multiple sales channels. Merchants use their Shopify dashboard to 

• manage products and inventory, 
• process orders and payments, 
• fulfil and ship orders, 
• discover new buyers and build customer relationships, 
• source products,
• leverage analytics and reporting, 
• manage cash, payments and transactions, and access financing. 

Shopify continues to add more value-added services that it can cross-sell to its merchants, making the platform even “stickier” by providing a full suite of e-commerce solutions.

To make sure that its software is up-to-date with the era, it also focused on making it mobile-friendly. Just as Shopify’s tools enable retailers to sell directly to their buyers through online stores, the Shop mobile app provides merchants with that same direct sales power through an app. Buyers use the Shop app to track packages, discover products from their favourite merchants, and engage with brands directly. This helps merchants increase the loyalty and lifetime value of their buyers. Shopify’s mobile capabilities are not limited to the front end: merchants who are often on the go find themselves managing their storefronts via their mobile devices, and Shopify continues to strive to make it easier to do so all from their phones.

Shopify is also a great way for merchants to go global. Shopify Markets, a product introduced in 2021, enables merchants to manage localized storefronts in different countries through one global store, making cross-border commerce easier for entrepreneurs. With Shopify Markets, merchants can easily set up market-specific buying experiences, enabling buyers to shop in their local currencies, languages, domains, and payment methods. Shopify Markets complements its partnership with Global-E, an offering for merchants who want to fully outsource their cross-border business with an approved third-party partner.

Merchants

As of 2021, Shopify had approximately 2,063,000 merchants from approximately 175 countries, geographically dispersed as follows: 55% in North America, 25% in Europe Middle East and Africa, 15% in the Asia Pacific, Australia and China and 5% in Latin America.

When merchants grow their sales and become more successful, they add on to their Shopify’s merchant solutions, upgrade to higher subscription plans, and purchase additional apps. 

The strength of Shopify’s business model lies in the consistent revenue growth coming from each cohort: the increase in revenue from remaining merchants growing within a cohort offsets the decline in revenue from merchant leaving the platform.

Our offerings

Shopify’s business model has two revenue streams: subscription solutions – a recurring subscription component, and merchant solutions – a merchant success-based component.

Subscription Solutions

Shopify generates subscription solutions revenues primarily through its subscription plans, as well as through the sale of subscriptions to its POS Pro offering and the sale of themes and apps. There are a few tiers to Shopify’s subscription service. At the low end are the Shopify Lite ($9 per month), Basic Shopify ($29 per month), Shopify ($79 per month), and Advanced Shopify ($299 per month) tiers.

While most merchants subscribe to the Basic and Shopify plans, the majority of GMV comes from merchants subscribing to Shopify Plus plans, which were created to accommodate larger merchants, with additional functionality, scalability and support requirements. Merchant retention rates are also higher among merchants on higher-priced plans. 

POS Pro enables brick and mortar merchants to seamlessly bridge online and offline commerce operations and offer their buyers a smooth shopping experience through features such as smart inventory management and buy online-pickup/return in-store or curbside.

Shopify’s App Store offers about 6000 apps, most of them being subscription-based products offered by full-time third-party developers. These apps provide a variety of functionalities such as UI enhancements, dropshipping apps and customized inventory management.

To attract the best developers in the world, in 2021, Shopify changed its revenue share model with app and theme developer partners to offer a zero per cent revenue share on the first million dollars that they make annually on the Shopify App Store. App and theme developers pay a 15% revenue share on earnings after the first $1 million, a threshold that resets annually, down from the previous 20% revenue share on their overall revenue.

This reflects the long term vision and mindset that Toby Lutke, the CEO of the company, has. Here’s what he said in Shopify’s IPO Prospectus, “Instead of stifling this enthusiastic pool of talent and carving out the profits for ourselves, we’ve made a point of supporting our partners and aligning their interests with our own. As a result, today thousands of partners have built businesses around Shopify by creating custom apps, custom themes, or any number of other services for Shopify merchants.”

Merchant Solutions

Shopify offers a variety of merchant solutions to augment those provided through a subscription to address the broad array of functionality merchants commonly require, including accepting payments, shipping and fulfilment, and securing working capital. Shopify believes that offering merchant solutions creates additional value for merchants, saving them time and money by making additional functionality available within a single centralized commerce platform, and creates additional value for Shopify by increasing merchants’ use of the platform.

Shopify principally generates merchant solutions revenues from payment processing fees and currency conversion fees from Shopify Payments. 

Shopify Payments is a fully integrated payment processing service that allows merchants to accept and process payment cards online and offline. Today, more than two-thirds of Shopify’s merchants have enabled Shopify Payments, which is available in 17 countries. 

Shopify Payments also give merchants access to Shop Pay, an accelerated checkout, which has been proven to improve speed-to-checkout and sales conversion rates for merchants, as well as Shop Pay Installments, a ‘buy now, pay later’ product, which has been proven to boost repeat purchases among first-time customers, benefiting merchant solutions revenue.

Advertising revenue is earned on the Shopify App Store as merchants click on the apps being advertised by our partners.

Shopify Capital helps eligible merchants secure financing and accelerate the growth of their business either through loans or purchasing receivables from merchants at a discount. The merchant then remits a fixed percentage of their daily sales until the outstanding balance has been remitted. 

Shopify Shipping allows merchants doing their fulfilment and shipping to select from available shipping partners to buy and print outbound and return shipping labels and track orders directly within the Shopify platform. 

In 2019, Shopify Fulfillment Network was launched for merchants looking to outsource fulfilment. Leveraging a network of fulfilment centres dispersed across the United States, Shopify Fulfillment Network is designed to help ensure merchants’ orders are delivered to buyers quickly and cost-effectively by leveraging Shopify’s scale with deep machine learning tools.

To accelerate the growth of Shopify Fulfillment Network, and to participate in the rapidly growing warehouse automation space, Shopify acquired 6 River Systems, a provider of collaborative warehouse fulfilment solutions. Shopify Fulfillment Network partners leveraging 6 River Systems’ cloud-based software and collaborative mobile robots can increase the speed and reliability of their warehouse operations by empowering on-site associates with daily tasks, including inventory replenishment, picking, sorting, and packing.

Shopify Balance offers merchants a no-fee money management account, providing merchants with fast access to their cash, a card for spending online, on mobile, or in-store, and rewards featuring cash back, perks, and discounts on everyday business spending. While Shopify earns a small fee upon the use of its card, Shopify expects to use Shopify Balance primarily as a way to introduce and centralize more financial services to simplify its merchants’ financial lives.

Investment thesis

1. Strong adoption of Shopify’s products and services

Over the years, Shopify has amassed a huge following from both small-medium businesses (SMBs) and large merchants alike, who wish to engage in omnichannel commerce while maintaining a strong brand presence. 

The demonstrated success of Shopify’s business model has seen it move into the number two position in market share for e-commerce in the US, behind Amazon.

From $119.50 billion in 2020, Gross Merchandise Volume (GMV) on Shopify has increased by 47% to $175.40 billion in 2021.

There is significant optionality that the business has developed over the last few years, such as payments, fulfilment and logistics, financing and other needs.

From $53.80 billion in 2020, Gross Payment Volume (GPV) has increased by 59% to $85.80 billion in 2021.

Meanwhile, Shopify Capital has increased its advances to merchants by 43% YoY. And Shopify has committed to owning more of the fulfilment experience and bringing this in-house compared to logistics via third-party providers. 

From $269.40 million in 2020, Shopify’s Monthly Recurring Revenue (MRR) has increased by 43% to $385.80 million in 2021.

2. Tailwinds with a large total addressable market

Ark invest estimates that e-commerce will reach 60% penetration by 2030 with two-thirds of that coming from drone deliveries. And this is not just Ark with another one of its bold predictions; Nasdaq also estimates that 95% of purchases will be facilitated by e-commerce in 2040.

Shopify estimates that its total addressable market is $153 billion, implying that they’ve conquered less than 2% of it so far.

Furthermore, the international expansion represents new growth areas for the business. 

One way the company is looking to continue growing rapidly is by expanding into China. The company partnered with one of China’s biggest e-commerce brands,  JD.com, to allow Shopify merchants to sell products in China. Additionally, Shopify’s investment in Global-E also allows merchants to use its services, which makes it easier for companies to expand internationally by breaking down international payment, logistics, and language barriers.

3. Platform “Stickiness”

Shopify benefits from high switching costs. Most merchants who gain any success of reaction with their e-commerce offering tend to stick around on the same platform. It’s typically not worth the pain and the hassle to move around e-commerce platforms if everything is working. 

Moving platforms introduces unnecessary integration risk with a new vendor and loss of stats combined with potential downtime. 

Financials 

Revenue

Revenue for Shopify has grown at a rate of 79.4% CAGR since 2012 and an average of 64.0% over the last 5 years.

Shopify recently turned profitable in 2020, with a current operating margin of about 10%. However, Shopify’s seemingly low-profit margins are not due to an unviable business model but instead are because of its heavy reinvestment of earnings in an attempt to aggressively capture more market share. In 2021, sales and research expenses constituted about 20% of Shopify’s revenues each. This percentage was even higher in the past.

Risks

Shopify competes with other e-commerce enablers that provide similar services, such as Adobe’s Magento, Wix.com, and BigCommerce. Then there are also the e-commerce players themselves, such as the juggernaut that is Amazon. Shopify has been facing intense competition for a long time, but that has not stopped the company from growing. 

Moreover, Shopify has the most complete solution for merchants who want their online storefront and end-to-end service from building the site to last-mile delivery. 

Summary

Shopify is driven by its mission to “make commerce better for everyone, so businesses can focus on what they do best: building and selling their products”. For every $1 of Shopify’s revenue, its merchants generate $40.82. Helping its merchants to sell better is central to everything that Shopify does. 

The company is operating in the large and growing market of e-commerce and could potentially expand its market opportunity in the future because of its keen ability to innovate.

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