Shopify has built the online platform for businesses small and large to facilitate e-commerce. There are tools, services, and a third party marketplace for merchants to thrive with its online store.
Shopify has been an explosive growth story with no signs of slowing with the rise of e-commerce penetration globally.
To expand on its online payment network even further, Shopify introduced an ad-on called Shop Pay. It will continue to exercise optionality by providing e-commerce solutions to applications to facilitate shopping on-app through Shops.
The business trades at extremely expensive valuation multiples and multiple compression is a risk to returns moving forward.
Shopify's founder-led growth story brings significant upside as it expands its already enormous total addressable market.
Key Company Metrics
A set of metrics we constantly keep updated to monitor the investment thesis.
Shopify is widely considered the holy grail of do-it-yourself ("DIY") e-commerce services for businesses of any size. No coding or website-building experience is required to put together a highly aesthetic and functional website.
While Shopify is not the easiest to use nor does it offer a free version (besides the 14-day free trial), it ranks as #1 according to users. Shopify's main competitors, Wix and Squarespace, provide easy-to-use services and perform exceptionally well.
However, they are not quite as powerful as Shopify. Shopify is an e-commerce-first website host with plenty of shopping experience enhancing apps, third-party connections, and solid customer support. The platform is harder to learn and use, but once learned, it performs better for businesses looking to scale or already scaling. As many businesses look to scale in size, Shopify is an intuitive platform to scale with.
Wix and Squarespace can be considered "introductory" products for these types of scaling businesses. But, they work great for their specific niches - micro- to small-sized businesses and freelancers like Wix, and artists, creatives, and photographers generally go with Squarespace.
Shopify wins in the market for its powerful resources, connectivity, and support. The three price tiers presented above provide access to the foundational aspects of a website - the website, blog, support, shipping and payments capabilities, and basic POS services, among others. Above this, additional features and apps to enhance a website and tailor it to a business's specific needs are added costs.
Business owners can generate invoices and refund policies, ship through Shopify’s shipping service, and even create company logos, all from one place. Having a platform to access all your needs as a business owner is crucial. Shopify’s ability to capture mind share from new entrepreneurs trying open up a business is what allows them to perform so well.
At first glance, this may seem somewhat "predatory". However, these apps and features increase stickiness. For an affordable price, businesses can design their websites exactly how they want them to improve the customer experience and increase sales.
The company's monthly recurring revenue ("MRR") growth in the subscription solution segment is driven by increasing numbers of active merchants on the platform. As more businesses use Shopify, total recurring revenue increases. It has been evident Shopify is executing extremely well.
Since no other website host performs to this standard, and Shopify takes time to learn, we believe the Shopify business boasts high barriers to entry by focusing all investment dollars on being an e-commerce-first platform that customers love, and customers face high switching costs in terms of time and cost. It is no surprise that Shopify is the leading platform for e-commerce.
Shopify's platform and exceptional e-commerce capabilities cost large sums of money that translate into low profits, for now. However, the company has shown tremendous operating leverage with its three main expense line items:
sales & marketing ("S&M")
research & development ("R&D")
general & administrative ("G&A")
As the company grows, matures, and secures its place in the market, expenses in these discretionary areas decline as a percentage of revenue. Shopify has built a highly scalable product that can be iterated over and over again, regardless of how many customers sign up.
Additionally, Shopify has minimal capital expenditure requirements. The company is still in growth and spending mode to make sure it stays on top. However, its declining spending requirements as the company grows its top line is impressive and seemingly a sure path to massive profitability down the line.
A large portion of Shopify's successes to date - and source of future growth - is attributable to the massive growth in e-commerce. In 2021, the total addressable market ("TAM") for Shopify had reached nearly $153 billion. Shopify will continue to gain more popularity as COVID-19 spurred greater e-commerce penetration as a percentage of total sales, changing the way we view retail and shopping. Consumers can sit in the comfort of their own home and shop for all their needs, with the click of a button.
Even if the world reverts to the in-store / online shopping mix it saw pre-COVID, Shopify has seamless POS technology to run a great omni-channel business. Aside from the software that Shopify has built, it also offers POS solutions for physical stores. These devices include iPads and chip readers to help customers with ordering and item checkout. The POS system is well-integrated within the Shopify ecosystem. All transactions go through Shopify Payments and business owners get the same perks as those with online stores, with transaction history and sales tracking.
Many Shopify shop owners have brought up the concern that there is very limited creativity when it comes to building online stores. There are a set number of themes users can access to build their site, but after a while, many businesses will start to have similar-looking online stores. For many, brand recognition is vital for a successful online business, and a one-size-fits-all solution may not be the way to go.
Despite having the ability to add Shopify Plus, the most premier Shopify service, not all business owners can afford the service. With a $153 billion total addressable market in small- to mid-sized businesses, Shopify should be looking for new ways to allow businesses to keep their brands unique and creative.
Despite Shopify being a leader in this market and dominating market share, there are other competitors that may pose a threat to the company, such as Wix, SquareSpace, and BigCommerce.
With Shopify having a very broad business model, serving all kinds of customers, some competitors cater their services to specific target markets such as small businesses (Wix) or fast-growing businesses (BigCommerce).
This lack of focus could pose a threat to Shopify if they are not able to provide the best services to all segments of their target market accordingly. Shopify should strive to distinguish themselves as the best e-commerce store builder, in order to be appealing to more consumers.
Perhaps more opportunity than risk, but with every transaction made, Stripe takes a small portion of the total for allowing Shopify to run on its payment network. As Shopify’s total payment volume continues to grow, that small percentage will make up a larger portion of revenues, which may be troublesome in the future. Shopify should look to creating its own payment network to capitalize on the entire transaction instead of just a portion. Over time, we think this would improve margins and top-line figures.
Investors should be wary of Shopify's share price growth trajectory thus far. The stock has been on a tear, far outpacing its growth in income. The market is implying that Shopify will continue to grow at such rates, despite having limited insight into what its margins and growth will look like when it reaches a mature, steady state.
The business undoubtedly trades at extremely expensive valuation multiples and multiple compression is a risk to investment returns moving forward.