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Is Shopify’s Dual Business Model the Future?

As we posted a couple of weeks ago, Shopify is on a tear. In that post, we said that we’d cover the launch of their fulfillment network and discuss the company’s revenue mix. So here goes.

At its investor event earlier this summer, the company announced plans for its new fulfillment network. Bloomberg reported that Shopify plans to spend up to $1B on the network. The plan is to help their large merchant base – estimated at around 800,000 and nearly 90% SMBs – reduce overall shipping and logistical costs. They play to leverage machine learning to help their merchant base optimize choices such as the best warehouse location to store goods.

Think of Shopify’s fulfillment network initiative as bringing the same kinds of logistics tech that Amazon, Target, and WalMart rely on to the SMB market. According to a recent Barron’s article, Thomas Epting, a Shopify executive, says the company is driven by its mission to help entrepreneurs. He cites three reasons why merchants choose Shopify over Amazon: Stores want to maintain a direct relationship with their customers, they want to create unique branding experiences versus shipping Amazon-cloaked boxes, and businesses worry that Amazon will one day create lower-priced knockoffs of their products.

Epting goes on to say in the same Barron’s piece that “Shopify’s merchants want to compete on the same service level [as Amazon], but do not want to give up their buyer data, their branding experience, or ultimately their business.”

“Shopify is now part-Square, part-Amazon, part-back-office operations, and part-financial services.”

So in theory, the launch of the fulfillment network should provide a big boost to Shopify’s merchants and could, probably should, accelerate Shopify’s customer acquisition. This assumes the network delivers on its promise to reduce logistics complications and costs while allowing merchants to devote more time to delivering high-quality customer experience. It appears Shopify will take a measured approach to the rollout as it accepts merchants into the network. As written in the July 5 Barron’s piece on Shopify, “it is now part-Square, part-Amazon, part-back-office operations, and part-financial services.”

An interesting aspect of Shopify is its “dual” business model, combining SaaS and transaction revenue model. In the company’s filings, it refers to these as Subscription Solutions and Merchant Solutions. This “dual” model creates some interesting business challenges and opportunities. According to the company’s recent filings, its transaction revenue has grown to 56% of total revenue and continues to grow faster than its subscriptions revenue.

On the one hand, there is a very significant upside for the transaction model. With eCommerce representing just under 10% of global commerce (outside of China according to eMarketer), Shopify merchants stand to grow robustly over the next decade. And as they grow, so should Shopify’s Merchant Solution revenues.

However, as Morgan Stanley analyst Brian Essex pointed out in a May 2019 research briefing, the increased reliance on transaction revenues could have a negative impact if the global economy eases into a period of a mild recession. The same analyst suggests that more reliance on a SaaS model would help Shopify weather any downward economic trends. But his analysis is based on comparing enterprise SaaS (e.g., WDAY or VEEV) to SMB SaaS. We see these two as fundamentally different animals.

Our viewpoint is that SMBs are considerably more sensitive to usage and value than enterprise companies. As such, relying wholly on a SaaS model is in our view riskier than “dual” models like Shopify. “Dual” models can better link usage to value than conventional SaaS models. This is why we anticipate that companies operating in the SMB SaaS space will slowly move toward “dual” models where they get the financial advantages of SaaS and the benefits from usage or transaction models, which do a better job of linking usage and value. Time will tell if we are right. In the meantime, please let us know what you think.

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