Shopify: Simplifying the Future of Retail

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REVIEW OVERVIEW
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Shopify is a leading cloud-based, multi-channel platform that aims to enable and improve e-commerce for merchants globally. At its core, Shopify allows users to bypass technical, operational, and financial barriers by providing clients, entrepreneurs, small to medium-sized businesses, and large enterprises with an easy and intuitive way to establish an online goods store. The company also offers a variety of other services that range from processing payments to facilitating inventory. This value proposition has resonated strongly with customers, as demonstrated by Shopify’s rapid 90-per-cent revenue growth. However, the company continues to incur annual net losses of $35 million in 2016 and $37 million in the first nine months of 2017.

As a company at the forefront of e-commerce, Shopify has the opportunity to revolutionize the retail industry. By moving toward a proposed Simplex Retailing concept—where retailers become curators of showrooms and suppliers ship directly to end consumers—Shopify will be able to distribute associated financial rewards among itself and its merchants.

Digitizing the Shopping Experience

Shopify’s current business model is supported by two main revenue streams: subscription solutions and merchant solutions. Subscription solution revenues are primarily comprised of monthly fees charged for Shopify’s core offering: an online storefront and an easy-to-use digital store management platform. Sales of features such as themes, apps, and domain name registrations also contribute revenues to this segment. Subscription solutions have historically allowed the company to enjoy high gross margins of approximately 80 per cent. In 2013, Shopify also began to establish additional revenue streams with an expanded merchant solutions product suite, including Shopify Payments.

Merchant solutions are a supplementary part of the business that provide additional value to the core experience of Shopify’s merchants. Potential add-ons include transaction fees, shipping and financing services, and point-of-sale hardware. The company’s payment gateway, Shopify Payments, is responsible for a significant portion of this segment’s revenues and costs. As opposed to the fixed nature of Shopify’s subscription solutions, revenues and costs for merchant solutions are variable: the success of merchant solutions services is directly correlated with the success of Shopify’s merchants themselves. This creates an incentive for Shopify to maximize merchant success and fully reap the benefits of its merchant solutions segment.

Despite the supplementary nature of merchant solutions offerings, this segment has recently constituted a greater portion of Shopify’s total revenues compared to subscription solutions, generating 52 per cent and 48 per cent of revenues, respectively. Furthermore, the merchant solutions portion of the business is the faster growing of the two, growing by 115 per cent in 2015 compared to 68 per cent for subscription solutions. However, despite this positive outlook, Shopify’s merchant solutions segment lags behind its subscription solutions counterpart in terms of profit. This is due to the high costs associated with providing merchant solutions, which constitute 64 per cent of revenues, compared to those of subscription solutions, where costs constitute only 19 per cent of revenues.

Customer Process

These lower margins are mainly driven by the need for partnerships with third-party organizations, such as Stripe, which provide ancillary services that Shopify does not offer. These partners take a cut of Shopify’s profits; for example, payment processing through Shopify Payments requires credit card fees. Ultimately, Shopify must focus on optimizing merchant solutions to better take advantage of the segment’s high growth.

Shopify can seek two primary methods to achieve future growth: obtaining customers in new markets and driving more revenue per customer. Currently, the company’s strategy is focused on growing its merchant base. Fortunately for Shopify, e-commerce is still projected to grow more than eight per cent in the U.S. until 2020, largely due to a major shift from traditional to online retail. By taking advantage of the Simplex Retailing method, Shopify can further capitalize on both growth drivers.

Catering to the New Consumer

In a post-Internet society, consumers have access to an immense amount of information on the availability, prices, and quality of products. Increased product diversity and information transparency have resulted in more selective and price-sensitive consumers. Customers are often willing to give up instant gratification and in-person service for a chance to receive lower prices, with more than 75 per cent of consumers willing to wait two or more days for items to be shipped. Online retailers generally have an advantage over brick-and-mortar stores in this regard, as they have greatly reduced overhead costs, particularly in rent and utilities.

However, 85 per cent of consumers still prefer being able to physically see and handle a product prior to purchase, indicating that brick-and-mortar stores still provide significant value in the purchasing process. Unfortunately, physical retailers often fail to capture this value due to the phenomenon of “showrooming”—browsing at a brick-and-mortar retailer, and subsequently shopping for the best price online. Access to information is highly valued by consumers in their purchasing journey, and even with access to sales associates and physical items for inspection, 82 per cent of consumers still consult their phones for additional information. As illustrated by the recent bankruptcies of Sears Canada and Toys “R” Us, physical retailers must adopt new strategies to adapt to increasingly dynamic consumer purchasing habits. Shopify, as a platform provider that focuses on growing small and medium businesses, is strongly equipped to aid retailers in this process.

Simplex Retailing: A New Way to Buy and Sell

Consumers’ preferences toward showrooming allow brick-and-mortar retailers to embrace drop shipping, a business model in which retailers have suppliers directly ship products from their warehouses to the end consumer. The Simplex Retailing model allows retailers to sell products without having to carry inventory, eliminating the need for stockrooms and creating significant cost savings in rent, storage, and shipping expenses. This model is most impactful for small and medium-sized businesses with relatively linear supply chains and products that customers feel the need to see before purchase.

Drop shipping essentially shifts the retailer’s value generation from product provision to product curation. Instead of merely providing products, retailers should select particular products to show in a meaningful way, offering a distinct value proposition. Shopify has already begun to facilitate this paradigm shift through its 2017 acquisition of Oberlo, a dedicated drop shipping platform.

Retail stores that embrace the Simplex Retailing method will have the opportunity to radically redefine their customer experience. Take a small designer phone case store which has adopted the Shopify platform and drop-shipping methodology for example. When customers walk into the store, they enter a showroom adorned with designer phone cases on display, with each product sporting an individual “Shopcode”—Shopify’s QR code format—that directly takes the user to the product page on the retailer’s Shopify store.

Additional product information, reviews, and specifications can be displayed on the page, potentially eliminating the need for sales associates. In this model, customers are able to both physically examine products, as well as review detailed information online. If customers decide to purchase a phone case, they can do so instantly on their mobile device. This process is not only convenient, but potentially contributes to impulse purchases as well, which represent almost 40 per cent of all spending on e-commerce. The phone case is then drop shipped directly to the customer’s home a few days later.

The Simplex Retailing model should serve four main purposes to provide value to its merchants:
1) Host the retailer’s website and database so its products can be retrieved when prompted by a beacon or code.
2) Store user payment and shipping information to provide users with the convenience of one-tap purchasing.
3) Act as a central storage system for each customer’s purchase receipts and browsing history; and,
4) Operate as the link between retailers and its distributors, and automate dispatch of the products.

Shopify currently supports more than 500,000 merchants on its platform; as a market leader in the e-commerce space, Shopify is in a prime position to implement this unique retailing model.

Shopify’s existing business already fulfills the first and second purposes, leaving only the third and fourth to be implemented. Since Shopify already stores user information across its websites, it will be able to use its existing technology to eventually create universal Shopify accounts for these users. This will allow it to act as a central hub for customers’ browsing and purchasing history. Ultimately, Shopify should look to serve as the connection between all levels of the Simplex Retailing model.

Simplifying the Backend

When consumers purchase a product, the transaction is processed through Shopify’s proprietary payment gateway. After a successful payment, the order is sent to the distributor’s Shopify account; the account could connect with existing logistics software via an application programming interface (API), although Shopify could eventually move toward a fully vertically integrated solution by developing its own logistics software. Simultaneously, Shopify will automatically create a shipping label and tracking number based on the distributor’s API. This data is automatically sent to the consumer, as well as the warehouse for packaging. Shopify then forwards the payment to the warehouse and distributor.

In every step of this process, Shopify should charge a small percentage fee to use its network. Shopify posted a gross merchandise volume of $15.4 billion in 2016, which has historically doubled every year. If it charges a platform transaction fee of even two per cent—and assuming 25 per cent of merchants making up Shopify’s gross merchandise value use the platform—the company could receive $77 million in additional revenue, equivalent to roughly 20 per cent of total 2016 revenue. This model would also offer significant savings for small-to-medium businesses, given that existing marketplaces such as Amazon and eBay charge a rate of five to 15 per cent of net sales.

Retailers also benefit from significant operational savings, as they require fewer staff members while reducing inventory and storage space. For example, suppose a new business owner wants to assess the profit potential of starting a shop. In a traditional retail model, the entrepreneur would need to first rent a location, ideally in a trendy area. In 2017, a 500-square-foot retail location in downtown Toronto could rent for approximately $30,000 per year. Assuming in-store inventory of around $20,000, $50,000 for two minimum wage in-store representatives, and startup costs including leasehold improvements, an entrepreneur would require roughly $150,000 in the first year.

Under a Simplex Retailing model, the savings are immediately evident. With smaller inventories, less space is required for storage; reducing even 100 square feet of rented space translates into approximately $6,000 in savings. The entrepreneur is also able to avoid most of the $20,000 upfront investment in inventory, assuming around 10 per cent of inventory is maintained for displays. The business owner also benefits from time savings as a result of procuring inventory from a business-to-business marketplace, as opposed to forming and maintaining complex supply chain relationships. Also, the digital platform could reduce back-end labour by one minimum wage employee, saving an additional $25,000. In the Simplex Retailing model, assuming the same miscellaneous expenses, small-to-medium business owners can achieve total savings averaging almost $50,000 annually.

The Simplex Retailing model also attracts new merchants, who might otherwise have been deterred from starting a business due to inventory management costs and other logistical challenges.

A New Era of Commerce

In light of this new retail landscape, Shopify has an opportunity to revolutionize both its own business model as well as the retail industry. Not only does Shopify gain an additional stream of high-margin revenue through Simplex Retailing solutions, it also encourages a new customer base to engage in its existing subscription and merchant solutions segments. Using a Simplex Retailing model, long-term success can be found in reducing costs for merchants, as well as incenting end consumers and merchants alike to use Shopify’s services. Ultimately, this strategy will further Shopify’s mission of making commerce better for everyone.


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