Shopify’s investment in fulfillment can deliver tremendous value

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After my last article on Shopify Inc. (NYSE: SHOP), the stock rebounded slightly thanks to the recent global market rally. Although second quarter results fell short of expectations, I remain optimistic about SHOP’s long-term prospects. In this article, I would like to dive into SHOP’s strategic ambitions to offer comprehensive logistics support to merchants. I believe SHOP’s investment in logistics networks will provide tremendous long-term growth opportunities.

Q2 2022 Business Updates

STORE Q2 2022 total revenue increased 16% year-on-year to $1.3 billion (three-year compound growth of 53%). Subscription Solutions revenue increased 10% to $366.4 million and Merchant Solutions revenue increased 18% to $928.6 million. Although EPS and revenue missed Street’s expectations, they are mainly affected by macro headwinds. The growth of SHOP GMV again outpaced the growth of broader US retail markets (both online and offline). The company expects continued inflationary pressure in the second half of 2022. However, we may see higher user growth and merchant solutions revenue growth in the coming quarters.

Why invest in achievement and physical assets?

Developing a fulfillment business is an important step for SHOP. This is not an easy thing to do as SHOP used to be a pure software company and never dealt with physical logistics assets. SHOP is a customer-centric company. The Shopify Fulfillment Network (‘SFN’) offers huge benefits with 2-day port-to-porch delivery. A big deal. They want to do the fulfillment because they know the customers want it. Especially for small merchants who dropship, delivery is always a headache. SHOP charges subscription fees for execution and storage, but the prices are very competitive compared to Amazon (AMZN).

The acquisition of Deliverr makes a lot of sense

Deliverr is an e-commerce fulfillment company that takes a software- and resource-driven approach to fulfillment. It does not own warehouses but operates a network of warehouses which is a more flexible and adaptable model than Amazon. In fact, Deliverr considers major retailers like Amazon and Walmart to be partners. SHOP is already doing a good job on the inbound freight side by partnering with Flexport. The Acquisition of the delivery person connected all the missing links needed to make SHOP SFN work, as Senior Director Ana Raman said:

Deliverr is really helping to accelerate a roadmap that we had already planned. Now they just help us get there faster.

With their smart inventory placement, we’re going to be able to efficiently allocate inventory through channels and then take it to the third step with execution and with SFN to intelligently route inventory as close to the end buyer as possible.

The fulfillment business may not make any money at all, but that’s fine

Since investing in fulfillment is a customer-driven decision, it’s very likely that SHOP won’t make a lot of money out of it. In fact, Amazon barely makes money from its logistics systems, even on a large scale. Especially for SMB traders, I don’t expect SHOP to make money from them given their low volumes. However, having fulfillment services will boost business activities resulting in more GMV revenue. According to last deposit 40F:

During the fiscal year ended December 31, 2021, merchant solutions revenue represented 70.9% of total revenue (69.0% during the fiscal year ended December 31, 2020). We primarily generate merchant solutions revenue from payment processing fees and currency conversion fees from Shopify Payments.

Revenue from our merchant solutions is directionally correlated with the level of GMV that our merchant process goes through our platform.

Therefore, all SHOP wishes are higher GMV, which is exactly how fulfillment services can help.

Amazon will not be a serious threat to SHOP

Recently, Amazon has taken several steps to intervene in SHOP’s business, including offering Prime payment at SHOP stores. AMZN has probably felt the pressure from SHOP, as many merchants are also opening SHOP stores and using more in-store payments. However, I don’t think this will be a big deal for SHOP. If AMZN offers its services to the SHOP website, such as AMZN logistics capabilities for merchants (although at higher prices), merchants will be more successful and develop more GMV, which SHOP likes to see. More infrastructure 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 even more with SHOP, as management stated at a recent conference:

Because Buy with Prime isn’t integrated with Shopify, there’s also a somewhat disjointed experience for merchant and buyer. So right now, if anyone has experienced this, if you click Buy with Prime, it actually takes you off site from a merchant’s store.

At the end of the line

SHOP is an extremely innovative company. CEO Tobi Lutke truly understands engineering, design, and e-commerce. His vision should unlock enormous value for investors. While the existing SHOP store website builder and SHOP plus are already huge successes, the new POS, fulfillment and payment developments are all heading in the right direction at an early stage. I’m sure they will make mistakes and suffer setbacks given the scale and complexity involved. However, management will gain valuable experiences along the way and adapt. The stock should do great for long-term buyers.

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