If we look at it from a narrows lens, Shopify is in the business of making it easier for people without coding skills to launch an online business. But if we zoom out, we could classify Shopify as an upstart in the broader retail market.
Yes, it is primarily in the business of internet retailing. But retail is not limited to the internet. Selling online is a sister distribution channel to the traditional offline channel. The whole point of commerce is to be present where the customer is, be it online or offline, or both, in an integrated fashion.
Shopify now describes itself as “The all-in-one commerce platform to start, run, and grow a business.” on its about page. The word “online” appears on the about page only twice, referring to the first Shopify Store, launched by Shopify CEO Tobi Lutke, himself. Nowhere else, on the about page, does Shopify associate itself with online commerce, which is telling that Shopify no longer sees itself as a pure-play e-commerce software.
What then is Shopify? Let’s circle back to this question at the end. By then, we’ll have learned enough to be able to answer.
Shopify’s Founding Story
At the time of writing, Shopify is used by more than 1M businesses worldwide. But surprisingly, the two founders, Tobi Lutke & Scott Lake, never intended to build an online commerce solution for other merchants. They wanted to sell snowboards, initially taking the less-capital intensive online route, with plans of launching an offline store later.
Being snowboarding enthusiasts themselves, figuring out the business’s product and branding was easy. The challenge presented itself on the technology side.
In an interview with Basecamp, Tobi explained,
“I set up our online store based on a variety of different systems such as Miva, OsCommerce, and Yahoo stores. Truth be told, all those systems made my skin crawl because of how bad they were. The final straw was when I got a custom design made for my snowboard store and I couldn’t get it to work in Yahoo stores. We had this great CSS-based layout done with all these new fanged ‘web standards’ and the customizability of Yahoo Stores barely allowed me to change the background color of the top frame.”
The bright side of the problem, though, was that Tobi had worked as a programmer and could develop a custom store. After two and a half months of work, the snowboarding store was up and running.
To get the word out, the founders used Google AdWords, a lesser-known marketing channel, in 2004. Minimum bids for clicks were cheap because Adwords operated, as it still does, on an auction-based model, and there weren’t many businesses bidding back then.
AdWords marketing, coupled with the Winter launch, helped make enough sales to recover their seed investment and make some profit. When sales dipped in Spring, the two founders contemplated adding skateboards, surfboards, and kiteboards to the product mix as a workaround. But an unforeseen opportunity came knocking.
Other netizens with e-commerce ambitions began inquiring if they could license the snowboarding store software since it was built on a solid foundation, better than the existing solutions of the time. The founders now had two choices — either expand their store or turn it into a software solution for other aspiring merchants. Choosing the latter, said Tobi, was an obvious decision.
Around that time, Tobi brought in a friend, Daniel Weinand, to help build Shopify. During the development phase, the team kept collecting the email addresses of people interested in the solution. After a year and a half of work, Shopify launched in 2006. Until then, approximately 4000 or 5000 had signed up on the waiting list, a sizeable number considering the size of the target audience pool. When the Shopify team informed those people about the launch with an email blast, some became customers.
In those early days, merchants had to pay around 3.5% commission per sale. Shopify did not have subscription tiers for different customer segments like it has today.
The commission model failed because stores with no or low sales volume preferred it, but stores with high sales volume found the 3.5% commission per sale high. Stores with higher sales volume were likely to have better retention, so they switched to a subscription-based model. When Shopify made that switch, in 2007, the company had around a few thousand merchant accounts, of which only 100 were active. Merchant growth, post making the switch, became steady.
When the financial downturn of 2008 began, Tobi thought the company would die, but people who had lost their jobs began using Shopify to set up online stores in large numbers. Surprisingly, the crisis accelerated growth to the extent that Shopify turned cash flow neutral for the first time in 2009.
Shopify’s Business Model
Since its early days, Shopify has expanded beyond its primary merchant software subscription offering. It now even offers merchant solutions, an umbrella term that houses multiple offerings like Shopify Payments, Shopify Shipping, Shopify Capital, referral fees from partners, point-of-sale (“POS”) hardware & Shopify Fulfillment Network.
Merchants Solutions, in fact, now generate more revenue than merchant software subscriptions. But the solutions offering comes into play only when merchants subscribe to the primary software subscription offering, meaning merchant solutions revenue is indirectly dependent on the number of merchants that can build a sustainable business using Shopify.
Merchant subscriptions have three different tiers: Basic Shopify, Shopify & Advanced Shopify.
Most merchants, being small & medium-sized businesses, subscribe to the two lower-priced plans. But the majority of the GMV comes from merchants subscribed to the Shopify Advanced & Shopify Plus plans.
Launched in 2014, Shopify Plus was the company’s attempt to move upmarket. Over the years, both established offline brands like Heinz & Nestle looking to migrate online, and digital-first brands like Allbirds, Gymshark have subscribed to Plus. At the time of writing, over 7000 stores subscribe to Plus, paying a minimum of $2000 per month or a variable fee for higher sales volumes.
Besides the three-tier subscriptions & Shopify Plus, the company also offers a $9/month Lite subscription targeted at the lowest end of the market — blogs looking to sell limited products rather than building a full-fledged online store.
Merchants originally ran stores using Shopify but used third-party payment gateways to collect customer payments.
For the uninitiated, the payment gateway is the service responsible for the steps between when a buyer enters card information on the checkout page and the money getting transferred to the merchant’s bank account. Paypal, Stripe & Square are common examples of payment gateways.
Shopify Payments is the company’s attempt to play the role of payment gateway service itself. The service makes it convenient for merchants to track revenue within the Shopify dashboard itself, removing the hassle of logging into another platform to check income.
Merchant solutions revenue principally comes from the payment processing fees from Shopify Payments.
Businesses today have numerous ways of securing capital. But traditional options can, in many cases, be unnecessarily time-consuming & unfavorably structured. Shopify Capital fixes this shortcoming.
Under Shopify Capital, merchants using Shopify can borrow from the company itself, with the flexibility of returning funds as a percentage of sales and payment schemes suited to the individual business.
Since Shopify Capital’s launch in April 2016, the company had disbursed $885 million in cumulative cash advance until Dec 2019, with approximately $150 million outstanding until December 31, 2019.
That said, Shopify doesn’t give money to every merchant that applies to the Shopify Capital program. The company vets applicants and gives capital only to businesses graded a low-risk profile, having a minimum sales volume.
We can think of it this way — Shopify Capital is a growth hack designed to accelerate the growth of merchants most likely to grow. After all, Shopify grows when merchants grow.
Shopify launched its point of sales hardware solution in 2013, after online-first Shopify stores expanding offline started facing challenges in integrating both channels.
Even a 5-minute lag in synchronizing inventory between point-of-sale locations and the online store would lead to either overselling or underselling problems. A single database, with both the channels connected, was what merchants needed.
A futuristic solution, POS, also empowers merchants to upgrade from multichannel retail, where marketing is siloed, to omnichannel retail, where marketing is unified.
As per Shopify’s claim, businesses with unified in-store and online sales have seen a 30% growth in revenue year over year.
Shopify Shipping & Shopify Fulfillment
Shipping is self-explanatory. Fulfillment, a relatively broader concept, is defined as the process of storing, packaging, and shipping e-commerce products.
In the early days of setting up an online shop, a merchant only needs a third-party shipping provider. Once they get an order, they find the ordered product in their in-house inventory, put on their branded packaging, and hand it over to some third-party shipping provider, who then ships it to the customer.
But what do you do when you’re business is of the size that keeping inventory in-house is no longer feasible, but neither is buying a warehouse & hiring staff for operations. You outsource it to a fulfillment provider, who houses your products in its warehouse, packages them as per your requirements, and ships them to the customer. The fulfillment company provides this same service to many businesses, making the economics work.
In many cases, the same company provides both Shipping & fulfillment services. So, if third-part companies already provide shipping & fulfillment services, how does Shopify coming into the equation help merchants?
Due to the enormous aggregate order volume generated by its merchants,
Shopify can negotiate discounted terms with third-party shipping & fulfillment providers.
Under the Shopify Shipping program, the company passes on these discounted rates, mostly in the range of 20%-50%, at no extra cost to merchants subscribed to any Shopify merchant plan.
The Shipping program does contribute to Shopify’s bottom line, but it functions as a retention tool by increasing the platform switching cost for merchants.
Shopify’s fulfillment program takes it a step further. Shopify houses merchant inventory in partner fulfillment centers but technologizes fulfillment by using machine learning for demand forecasting, smart inventory allocation across warehouses, and intelligent order routing.
Pricing plans are customized to suit the unique needs of merchants interested in joining the Shopify Fulfillment network.
Shopify’s Fulfillment service optimizes operations & improves merchant businesses, positively impacting Shopify’s bottom line.
The phone operating system market, dominated by Android & iOS, is a quintessential example of how third-party armies working on your behalf can make the underlying offering incredibly valuable. Numerous developers work hard to develop apps to list their wares on these two app stores chasing the incentive of generating revenue from users.
But the more apps are developed, the better the user experience, and the stronger the moat gets for Android & iOS. Not only do these app developers make the ecosystem more valuable, but Google & Apple also take commissions on app sales, adding an extra line of revenue to their balance sheet.
Like Google & Apple, Shopify also has an army of third-parties working to make the platform more valuable. Shopify’s partner ecosystem mainly consists of developers & platform experts.
Of these three options, building and selling Shopify apps is the most lucrative option. As per the company’s claim, the top 25% of Shopify app developers have average annual earnings of $272K. Developers get to keep 80% of the app revenue, with Shopify taking 20% commission.
Shopify experts, on the other hand, are freelancers and agencies with expertise in setting up & marketing Shopify stores.
Shopify Developers & Platform Experts make the product better and the ecosystem robust, but in some cases, they also end up starting and growing entire businesses on top of Shopify.
One such example is Bold Commerce, which started as a four-person Shopify App development shop in 2010. By 2018, it had around 100,000 merchants using their apps & employed 270 people. With time, the company also began to build apps for Bigcommerce, one of Shopify’s competitors. In 2019, Boldcommerce raised 22 million CAD, intending to become a middleware solutions provider for all e-commerce activity outside of Amazon.
So what is Shopify?
Knowing what we now know about Shopify, it’s evident that it has outgrown being an e-commerce software solution. It is now an integrated omnichannel retail business solution used by merchants to manage online and offline operations. And the driving force behind everything Shopify does is its merchant focused business model. It’s the alternative merchants wanting to build a differentiated brand and going direct to consumers needed.
If you liked this piece, you might also like our article covering Google’s Business Model.