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After my last article on Shopify Inc. (NYSE:SHOP), the stock has bounced a little bit thanks to the recent rally of the overall market. Although the Q2 results missed the expectations, I remain optimistic about SHOP’s long-term prospects. In this article, I would like to dive into SHOP’s strategic ambitions of offering full logistic support for merchants. I believe SHOP’s investment in logistic networks will offer huge opportunities for long-term growth.
Business updates in Q2 2022
SHOP’s 2022 Q2 total revenue grew 16% YOY to $1.3B (three-year compound growth 53%). Subscription solutions revenue grew 10% to $366.4M and merchant solutions revenue grew 18% to $928.6M. Although both EPS and revenue missed Street expectations, they are mostly affected by macro headwinds. SHOP GMV growth still outpaced the growth of broader US retail markets (both online and offline). The company expects continued pressure from inflation in 2022’s second half. However, we may see higher user growth and merchant solution revenue growth in the coming quarters.
Why invest in fulfillment and physical asset?
Developing a fulfillment business is a huge step for SHOP. It is not an easy thing to do since SHOP has been a pure software company before and has never dealt with physical logistics assets. SHOP is a customer-centric company. The Shopify Fulfillment Network (‘SFN’) offers huge benefits with port-to-porch 2-day delivery. A big deal. They want to do fulfillment because they know customers want it. Especially for small merchants who do dropshipping, delivery is always a headache. SHOP does charge a subscription fee for fulfillment and storage, but the prices are very competitive compared to Amazon (AMZN).
The acquisition of Deliverr makes lots of sense
Deliverr is an E-commerce fulfillment company that adopts a software-driven and asset-light approach to fulfillment. It doesn’t own warehouses but operates a warehouse network which is a more flexible and adaptable model than Amazon. In fact, Deliverr sees large retailers like Amazon and Walmart as partners. SHOP already does a good job on the inbound freight side by partnering with Flexport. The Deliverr acquisition connected all missing links needed for SHOP SFN to work, as Senior Manager Ana Raman stated:
Deliverr is really helping to accelerate a roadmap that we already had planned. Now they’re just helping us get there faster.
With their smart inventory placement, we’re going to be able to really effectively allocate inventory through the channels and then get to the third leg with fulfillment and with SFN to intelligently route inventory close to the ultimate buyer as possible.
The fulfillment business may not make money at all, but that is fine
Because the fulfillment investment is a customer-oriented move, it is very likely that SHOP will not make much money from it. In fact, Amazon barely makes money from their logistic systems either, even with the large scale they have. Especially for SMB merchants, I don’t expect SHOP to make money from them, given their low volumes. However, having fulfillment services will boost trading activities which will lead to more revenue from GMV. According to the latest 40F filing:
During the year ended December31, 2021, merchant solutions revenues accounted for 70.9% of total revenues (69.0% in the year ended December 31, 2020). We principally generate merchant solutions revenues from payment processing fees and currency conversion fees from Shopify Payments.
Our merchant solutions revenues are directionally correlated with the level of GMV that our merchant’s process through our platform.
Therefore, all SHOP wants are higher GMVs, which is exactly how fulfillment services can help.
Amazon is not going to be a serious threat to SHOP
Recently, Amazon has taken several actions to intervene in SHOP’s business, including having Prime payment available in SHOP stores. AMZN likely felt the pressures from SHOP since lots of their merchants are also opening SHOP stores and using more Shop Payments. However, I don’t think this will be a big issue for SHOP. If AMZN offers its services to the SHOP website, such as AMZN logistic capabilities for merchants (although at higher prices), merchants will be more successful and grow more GMVs which is what SHOP loves to see. More infrastructural services available on the SHOP platform will further strengthen the SHOP business and make it truly mission-critical.
In fact, SHOP wants AMZN to integrate with SHOP even more, as the management stated in a recent conference:
Because Buy with Prime is not integrated with Shopify, there’s also a bit of a disjointed experience for both the merchant and the buyer. So right now, if anybody has experienced it, if you do click on that Buy with Prime, it actually takes you off-site from a merchant’s store.
Bottom line
SHOP is an extremely innovative company. The CEO Tobi Lutke truly understands engineering, design, and eCommerce. His vision should unlock huge value for investors. While the existing SHOP store website builder and SHOP plus are already huge successes, new developments in POS, fulfillment, and payment are all going in the right direction in the early stage. I am sure they will make mistakes and have setbacks, given the huge scale and complexity needed. However, the management will gain valuable experiences along the way and adjust. The stock should do great for long-term buyers.
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