I have to admit: writing about things like Shop Pay are a lot more fun than writing about potential regulation.
On to the update:
Shop Pay on Google and Facebook
Shopify Inc. will open up its e-commerce checkout system to all retailers selling through Google and Facebook Inc., expanding an existing collaboration with the two U.S. giants and marking the first time the Canadian technology company has offered a product to merchants that don’t use its platform.
Retailers who sell products through Facebook or Google properties such as Instagram, YouTube or Google Maps will be able to offer shoppers the chance to pay for their purchase using Shop Pay, starting in July for Facebook and later in 2021 for Alphabet Inc.’s Google. Shop Pay is a checkout product that stores users’ information, speeding up online transactions. Right now, retailers have access to it through those social media platforms, but they must be Shopify merchants to use it.
This is a big deal, and a big change for Shopify, but its useful I think to understand the long-term context of this announcement.
Shopify’s original core business is called “Subscription Solutions”; from the company’s annual report:
We generate subscription solutions revenues primarily through the sale of subscriptions to our platform, including variable platform fees, as well as through the sale of subscriptions to our Point-of-Sale (“POS”) Pro offering, the sale of themes, the sale of apps, and the registration of domain names.
We offer pricing plans designed to meet the needs of our current and prospective merchants. Offering different service and pricing levels allows entrepreneurs to scale without leaving the Shopify platform: as a merchant upgrades to the higher-priced options, they receive more powerful tools. We believe this ability to retain merchants as they grow is an important factor for our success in serving the SMB market. While most merchants subscribe to our Basic and Shopify plans, the majority of our GMV comes from merchants subscribing to our Advanced and Shopify Plus plans.
Subscription Solutions is what I imagine most people think of when they think about Shopify: you want to set up an e-commerce store on the web, so you go to Shopify.com and do exactly that with only the click of a few buttons. Obviously Shopify scales to far more complex operations, but the core idea of building on top of Shopify’s platform and paying on a subscription basis is consistent. At the time of Shopify’s 2015 IPO this was the lion’s share of the company’s business — $67 million in 2014 revenue out of $105 million total; it also, like most SaaS businesses, had high gross margins — 75% in 2014.
Subscription Solutions was Shopify’s only business for its first seven years of existence; merchants were responsible for acquiring and managing their own third-party payment gateways. That changed in 2013 with the launch of Shopify Payments, which fully integrated payment processing into the core Shopify Platform. Built on Stripe, Shopify Payments has always been optional (alternatives do incur a 0.15% processing fee), but also the obvious choice, particularly for merchants new to the platform.
Shopify Payments also justified a new entry onto Shopify’s income statement called “Merchant Solutions”, given that it was a completely new kind of revenue model: instead of being a recurring subscription fee, Shopify Payments was a success-based revenue model, which meant that Shopify’s Merchant Solutions revenue wasn’t based on the number of merchants using Shopify Payments, but rather on Shopify’s share of the Gross Merchandise Value (GMV) transacted via Shopify Payments. That share was 2.9% + $0.30 per transaction for merchants on the Starter plan, and 2.25% + $0.30 for merchants on the Unlimited plan (the current posted rate for the Advanced plan is 2.4% + $0.30, although Shopify Plus accounts can be lower).
Merchant Solutions is inherently lower margin: that 2.9% + $0.30 includes non-negotiable interchange fees paid to banks and non-negotiable assessment fees paid to credit card networks like Visa. The cost of these fees can vary — Visa publishes an interchange fee table here, and a list of assessment fees are here — but for a typical merchant the total cost on a Visa transaction is somewhere around 2% + ~$0.10 for a successful transaction. However, there are definite advantages to collating millions of individual transactions into one merchant account, including the ability to route different transactions into different buckets to achieve the optimal rate. The net result is that at the time of its IPO Shopify’s Merchant Solutions had 31% margins on $38 million in revenue — both worse numbers than Subscription Solutions — but the big difference is that Merchant Solutions, by virtue of being indexed to Shopify’s GMV, was growing far faster.
Six years on and the higher growth rate of Merchant Solutions means that Shopify’s business has flipped from where it was at the time of IPO: Subscription Solutions has grown 126% to $909 million in 2020 revenue, and as you might expect from a SaaS business, gross margin has increased with leverage to 79%. Merchant solutions, though, has grown 517% to $2.0 billion in 2020 revenue, and is up to 41% gross margins as Shopify has been able to negotiate increased volume discounts, and also added on higher margin products like Shopify Capital (as a side note, Stripe’s margins on Shopify’s business must be thin indeed). While Shopify started as an e-commerce platform company with a payments business tacked on, its financial results increasingly are that of a payments business with an e-commerce platform that functions first-and-foremost as a funnel to said payments business, even as it still pays its own way.
The E-Commerce Shift
At the same time as Merchant Solutions has grown to become the primary driver of Shopify’s business, there has been a concurrent revolution in e-commerce. Shopify came up in a world where individual websites, powered by Shopify or not, were viable entities thanks to the open nature of the web. Merchants could do targeted advertising on Facebook or Google or any number of 3rd-party advertising networks and, thanks to cookies, track that advertising to conversions on their website. A combination of regulations and Apple-driven initiatives, though, has made this model increasingly unsustainable: 3rd-party cookies no longer work in many browsers, most importantly Safari on iOS, and Google is following suit in Chrome. iOS 14, meanwhile, makes it much more difficult to link advertisements in apps to conversions on websites. Going forward the only approaches that will be competitive will be those that rely primarily on first-party data.
This is great for fully integrated operators like Amazon: the company collects user data that it funnels into advertising on its own platform, the performance of which it measures through its own merchant solutions. Participants in the open web, meanwhile, are at a disadvantage, which is why Facebook has been moving towards the Facebook and Instagram Shop model, where advertising and conversion happen on the same platform. Shopify has, smartly, worked closely with Facebook and Google on this shift, powering Facebook Shops for Shopify merchants and making it easy to list Shopify-powered products on Google Shopping.
At the same time, this shift has accentuated the extent to which Shopify’s business has become a bit of the tail wagging the dog: if the commerce platforms that matter are Facebook and Google, and the key point of integration is payments with advertising, then why is Shopify’s business still anchored on managing a website? Shop Pay is a truly great product — it’s the best checkout process on the web, even better than Amazon’s — but to use it merchants have to run their store on Shopify. To put it another way, Merchant Solutions, despite being a bigger and more strategic business, is still downstream from Subscription Solutions.
Or rather “was”.
With this announcement any merchant, whether on Shopify or not, can avail themselves of Shop Pay. This means that said merchant could run a store that doesn’t exist anywhere but Facebook or Instagram, for example, while still using Shop Pay for payment processing. The reason to do so is what I said above: Shop Pay is a great product that converts well above average — Shopify claims that Shop Pay checkout “is 70% faster than a typical checkout, with a 1.72x higher conversion rate” — that gives access to a plethora of other products, including financing, order tracking, and more.
What is particularly interesting is why Facebook and Google would agree to this integration: at first glance, surely it makes sense for them to own payments on their own platforms? In a vacuum I suppose the answer is yes — all tech companies want to control everything — but this announcement isn’t happening in a vacuum. Both Facebook and Google are advertising businesses, not payments businesses, and more importantly, both were built on assumptions that undergirded the open web, including easy sharing of data, cookies, and the idea that it is easier and more efficient to build modular ecosystems with competition at every complementary layer of the stack. Those assumptions are being invalidated rapidly, and neither company has time to rebuild their entire value chains into an integrated model in the face of Amazon in particular.
Shopify, meanwhile, reportedly powers nearly 10% of e-commerce in the U.S., which means that a huge number of customers are already familiar with and have their payment information stored in Shop Pay; that means better conversions and higher CPMs on the advertising that led to them, and that advantage will only compound with time. Add in the fact that Shopify is likely doing some sort of revenue share with Google and Facebook, and this integration formalizes Shopify as the linchpin of The Anti-Amazon Alliance.
The most important impact, though, is on Shopify itself. First, the company’s financials — and the driver of its sky-high valuation — have long reflected the reality that Shopify is first-and-foremost a payments platform tied to the GMV of e-commerce, but this change makes that shift a reality from a product perspective. Merchant Solutions is its own independent product line.
Second, this also inverts Shopify’s funnel; from the Bloomberg article:
Shopify sees little risk that opening up Shop Pay will cause some retailers to cut their ties to the company in favor of doing all business through Google or Facebook — “just the opposite, in fact,” Finkelstein said. Shopify is convinced that e-commerce merchants will want to maintain bespoke websites at the core of their businesses. But many of them will opt to sell across multiple platforms, including social media, and that increased complexity should make Shopify’s system even more valuable, he said.
“You now need to reconcile inventory across eight or nine channels. You now have to handle shipping and fulfillment across eight or nine channels. And so as the complexity increases, the value of using Shopify as the central retail operating system also increases.”
This is the argument I was making last month in Market-Making on the Internet: there are huge opportunities to operating orthogonally to demand-owning Aggregators, particularly making it easy to operate businesses that function across multiple Aggregators. Shopify’s bet is that offering payment solutions will not simply drive more business for Merchant Solutions, but also be an on-ramp to Subscription Solutions as well.
Third, this — not the Shop App — is Shopify’s true coming-out party as a consumer brand. Facebook and Google are counting on the fact that consumers know and like and trust Shop Pay to drive more conversions than they could drive on their own, not simply because it is easy to use, but also because it is familiar.
All-in-all, everything about this announcement is very impressive. It is wise of Google and Facebook to recognize what is their core business, what isn’t, and to act accordingly in a way that is mutually beneficial; even more impressive is the way that Shopify has not only laddered up from a SaaS business to a payments business, but also its willingness to recognize what is the dog and what is the tail, and put each in its proper place.
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