Shopify: Disrupting Salesforce, not Amazon (Part 2)
Enterprise: 15% Revenue CAGR over the next 15 years, even before AI
Part 2: A Data-Driven Approach to Analyzing Shopify's Future
1. Measuring Merchant Satisfaction and Innovation To Estimate Enterprise Conversion Potential
2. The Enterprise Growth Formula
3. SHOP 3-Statement Model (updated)
Disclaimer: The contents of this document are NOT meant to serve as investment advice. Read our full disclaimers below.
The quote above by Jeff Hoffmeister, Shopify’s CFO, was given at the recent Morgan Stanley TMT Conference 2024. As you can tell, he doesn’t describe Shopify like other marketplace platforms do, which tend to boast about setting terms of engagements at their merchant’s expense (e.g. Amazon’s 50% take rate).
Rather, he describes Shopify as being in servitude to its merchants — by anticipating problems that they face and utilizing the platform’s aggregated economies of scale to create otherwise unattainable solutions for their merchants. In other words, “how do we add value to our merchants, instead of taking advantage of them?”
Reading this really put a smile on my face.
Shopify is one of the more inspiring stories of innovation in modern American capitalism. Typically, you’d only accord such praise to legends like Herb Kelleher of Southwest, John Malone of TCI, Henry Singleton of Teledyne or Steve Jobs of Apple. I have a feeling that Tobias Lütke of Shopify will one day leave a legacy in an adjacent zip code, if not a similar one.
Shopify has come a long way from simply being the digital shopfront of small businesses. Nearly 3/4 of their FY23 revenues came from Shop Pay, which charges a 2.9%++ take rate on all GMV processed on the Shopify platform (orange):
As alluded to above, such a business model ties Shopify’s incentives to that of its merchants, i.e. what’s good for them is good for Shopify. This has resulted in Shopify bringing significant innovation to the small & medium e-commerce space, including:
Shopify Audiences: Treats the entire Shopify platform as a single giant merchant, and shares customer data between all merchants who opt-in to inform future growth strategy and ad targeting.
Shopify Plus: Full stack turnkey solution which bundles Shopify’s entire product suite into a single package for larger merchants.
Hydrogen and Oxygen: “Headless” e-commerce which decouples the front-end shopfront from back-end infrastructure. This allows merchants who have customized back-end needs (e.g. Dollar Shave Club’s paused subscriptions) to access Shopify’s benefits if they don’t want to give up their existing e-commerce setup.
Commerce Components: Modularizes any component of Shopify’s business integrations, thus allowing merchants to onboard on a piecemeal basis. Particularly attractive to large Enterprise customers who are entertaining joining Shopify, but don’t want to risk transitioning cold turkey away from their existing partners (e.g. Salesforce).
Shopify has since graduated well past its small business roots and is now focusing on attracting Enterprise accounts, which involve lower margins but much larger GMV. While they still remain in the early innings of Enterprise, they’ve already managed to gain some legitimacy by attracting relatively large accounts, including Overstock.com ($600M market cap), Everlane ($500M valuation), Carrier B2B ($50B market cap), and Coach (parent: $9B market cap).
In the recent Morgan Stanley TMT Conference 2024, Shopify’s management explained what their on-ramp formula for the Enterprise market looks like. The reason why Shopify waited until now to pursue Enterprise is because the e-commerce needs of Enterprise are very different from SMBs (small & medium businesses) — e.g. SMBs might be fine with adapting to Shopify’s existing offerings, while Enterprise might need more customized solutions to accommodate their legacy setup.
As a result, Shopify has been very deliberate about innovating new solutions, in order to better appeal to Enterprise customers. For instance, Hydrogen’s “headless” integration allows Enterprise customers to attach their existing back-end infrastructure to a Shopify shopfront — allowing them to enjoy Shop Pay’s famous 36% higher conversion rates without having to fully transition to Shopify. Similarly, Carrier and Everlane can use Commerce Components to bolt-on Shopify’s integrations on a piecemeal basis, without the risk of adopting a full-fledged turnkey transition. This ultimately reduces cost and risk for potential Enterprise clients, with the goal of eventually encouraging them to fully move their back office e-commerce functions over to Shopify.
The formula is to first use these solutions to on-ramp Enterprise customers, by giving them access to Shopify’s industry-leading “just better than everyone” merchant solutions (e.g. significantly boosted conversion rates, longer sales cycles). Once they’re in the funnel, Shopify can then upsell ancillary offerings like Payments, Logistics or Audiences which adds incremental value to them — some of which are absent at Enterprise competitors. This gradually increases the stickiness with the Enterprise client, which reduces friction to try even more bolt-on solutions with Shopify. Before you know it, they’ve fully made the transition over to Shopify.
While the title of this article was “Disrupting Salesforce”, this narrative isn’t merely confined to Shopify disrupting Saleforce’s Enterprise CRM industry. Shopify can apply the same roadmap to make inroads into every Enterprise Retail-related market — I just used Salesforce since it’s more recognizable.
And while Shopify’s success in such an ambitious Enterprise endeavor has far from guaranteed, it’s worth noting what this narrative implies:
Shopify is still a startup relative to the humungous global Enterprise market, their $70B market cap notwithstanding;
Shopify’s growth runway is practically unlimited — the implied TAM here is pretty much the entire Enterprise Retail market (e.g. Salesforce, Oracle’s e-commerce segments, etc)
Shopify’s future growth isn’t contingent on beating Amazon at e-commerce.
While it’s true that their future margins will likely be compressed, it’s a worthy tradeoff for persistent double-digit revenue growth for the foreseeable future. This is something I’ve already more than accounted for in my Shopify Part 1 report, so click the link if you’d like to see the assumptions I used in their valuation.
Just imagine charging a client the size of Nike 1% of GMV — the growth potential is inconceivable.
But wait, there’s more.
While e-commerce has certainly kicked B&M in the face over the past decade, the future of Retail is undeniably Omnichannel. And while pursuing an Offline market is less exciting than Enterprise, it’s also a gazillion times bigger. 80% of US Retail remains B&M (China: 70%), offering enterprising Tech sector incumbents the opportunity to steal market share from the B&M Retail industry.
What do Shopify’s Offline solutions look like? In management’s own words, their Point-of-Sales (POS) solution has gone from being just an ancillary service (for e-commerce merchants who also want to sell in a physical location), to becoming a standalone product. As the US Retail industry gradually transitions to Omnichannel over time, the worlds of B&M and Retail will inevitably collide. And as one of the incumbents, Shopify will most assuredly be there to pick from the low-hanging fruit — enabling B&M giants to transition to e-commerce in India, China and Southeast Asia.
This brings us to International. While Shopify’s legacy storefront subscription industry (and future GMV potential) can no longer be characterized as being unlimited in the USA, it still looks to be that way in the rest of the world. As we shall observe below, Europe has been growing like gangbusters and key markets like APAC and India have barely gotten started. Once again, this implies that even Shopify’s original shopfront subscription business has plenty of legs underneath it.
There are not a lot of businesses with $70B market caps that one can truly say has practically unlimited growth — but Shopify is certainly one of them. As the famous Buffett quote goes:
“…the best business to own is one that over an Extended Period can employ Large Amounts of Incremental Capital at very High Rates of Return.’’
Shopify ticks all three boxes, and has a decade-long track record to prove it. It doesn’t get any more hardcore than that.
So now that we’ve established that they’re a wonderful business, is their valuation at a fair price? We’ve already explored this in Part 1, so click the link below if you’d like to figure out where the threshold for their fair value lies:
However, if you’d like to understand Shopify’s business better — as well as what their formula is for tackling the enormous potential in Enterprise — you’re in for a treat, as we'll discuss all this in this Part 2 report!
The objective of this SHOP Part 2 report is twofold:
Provide hard evidence using numerical data to support the narrative of Shopify’s immense future growth in Enterprise as described above, using both historical data and forward-looking estimates;
Justify the SHOP valuation as discussed in Part 1
A Data-Driven Approach
Measuring Merchant Satisfaction & Innovation To Estimate Enterprise Conversion Potential
This article describes how the best measure of performance for asset-light Tech companies is Revenue/Employee. Why?
Big Tech is notorious for publishing nebulous performance indicators, which cannot be objectively estimated since they tend to involve subjectiv estimates of long-tail events far in the future. Some of them are well-intentioned like LTV/CAC; but others like WeWork’s Community-adjusted EBITDA are straight up pure fantasy.
In any case, the road to hell is paved with good intentions — which is why it’s always better to observe the wisdom of Edwards Deming: “In God we trust. All others must bring data”.
In contrast, Revenue/Employee is a highly objective performance measure, as it uses historical and straightforward data to measure efficiency. Furthermore, it’s an excellent “no-bullshit” performance screener, since the largest cost base in most Big Tech companies is usually headcount.
Revenue/Employee is also a good proxy for measuring Shopify’s level of innovation, since developing new innovative e-commerce solutions requires incremental headcount; while incremental revenue measures how much merchants value those solutions. And by extension, how much incremental GMV merchants think they can generate, since buying those innovative solutions from Shopify incurs higher costs.
So how has Shopify’s Revenue/Employee performed over time?
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