Shopify Flexes Moat On Rivals

Shopify (NYSE:SHOP) has become a force to be reckoned with in the retail industry, powering 10% of US e-commerce activity today. Over the past several years, the Ottawa-based giant has been developing various solutions targeted towards serving the needs of larger enterprises, such as the Global ERP Program. Business from large-scale merchants brings higher-quality revenue for the tech giant, which is why it is unsurprisingly going hard after these corporations, encouraging them to leave their legacy providers for Shopify's industry-leading platform.

Shopify stock has strived to build a moat through its extensive suite of world-class commerce solutions, and now it is leveraging its moat to acquire merchants from rivals, kicking off 2023 with the launch of Shopify Commerce Components. While Nexus Research continues to maintain a 'hold' rating on the stock given the risks from Amazon's (AMZN) 'Buy with Prime' on Shopify's revenue growth and profitability, the launch of Commerce Components fosters Shopify's revenue growth potential.

Shopify Commerce Components

Shopify Commerce Components is a composable stack of enterprise solutions that allows large-scale retailers to selectively choose from 30 different Shopify Components to be integrated into their own systems, without needing to subscribe to a Shopify subscription plan bundling all its services together. The list of Shopify Commerce Components includes an online checkout system (Shop Pay), Point-of-Sale solutions, and Shipping & Logistics services.

'Commerce Components' enables Shopify to attract enterprises that are on the edge of deciding to migrate to Shopify, or at least away from their legacy providers. Legacy systems tend to be well-imbedded into corporations' core operations, resulting in high-switching costs if an enterprise decided to migrate to another commerce platform. In the interest of overcoming this hindrance, Shopify's Commerce Components allow enterprises to choose specific commerce solutions to integrate with their existing systems, and also offer component APIs to ease these integrations.

Not all enterprises are ready to migrate immediately, hence the Commerce Components service helps facilitate a step-by-step migration process over time. When enterprises use Commerce Components, it opens the opportunity for Shopify to demonstrate how their commerce solutions are superior to the firms' legacy systems. The goal is to upstage the legacy provider and subsequently cross-sell more of Shopify's Commerce Components to eventually induce the enterprise to migrate to Shopify completely.

If these large enterprises indeed end up migrating, they would become Shopify Plus members, which is the premium subscription plan aimed at large-scale businesses, costing $2000/month or variable platform fees for higher volume businesses. In Q4 2022, "Subscription solutions revenue was $400 million, up 14% over Q4 of 2021, driven primarily by an increase in the number of plus subscriptions, higher variable platform fees from plus merchants". If Shopify's Commerce Components strategy is executed successfully to eventually induce complete migrations to Shopify Plus, it could further accelerate growth in Shopify's subscription solutions revenue over time.

Shopify's Growing Enterprise Ambitions

Shopify has been working up to this strategy for several years. In October 2021, it had launched the Global ERP Program, partnering with large software companies like Microsoft and Oracle to make their Enterprise Resource Planning (ERP) services available through the Shopify App Store. This is a great strategy to ease the migration process for large enterprises, which are more likely to need ERP services. For instance, Microsoft's ERP client base could become more inclined to migrate to Shopify knowing that they will be able to easily maintain their access to Microsoft's software services through Shopify, thereby smoothening the migration process.

In 2022, Shopify partnered with various large consultancy firms, such as Ernst & Young and Deloitte, which act as system integrators for the Shopify platform. This strategy is meant to augment Shopify's sales strategy, as consultants advise their large enterprise clients to incorporate Shopify solutions into their firm-wide tech systems. Now Shopify is building upon this strategy through the introduction of Commerce Components, further smoothening the ability of large enterprises to adopt Shopify's solutions.

Industry-leading professional services firms like EY also act as system integrators for other commerce platforms, which compete aggressively against Shopify's solutions to be integrated into clients' tech stacks. Therefore, Shopify's new Commerce Components service is in fact essential to stay competitive against its competitors, as the easier integration should help incentivize consultants to promote Shopify's solutions over products/services from their other partners.

In fact, consultancy partners have already exhibited great eagerness to facilitate Shopify integrations through their services, as they have been quick to build and train large teams to develop their skills in/knowledge of Shopify services. For instance, on the Q3 2022 earnings call, Shopify President Harley Finkelstein proclaimed that:

EY will be training an initial cohort of 500 technical professionals across their EY Wavespace network at 50 locations globally on Shopify. And we'll further support those professionals by enabling up to 10,000 consultants through exposure to the Shopify platform.

Unsurprisingly, these consultancy partners have expressed similar enthusiasm to incorporate Commerce Components into their services. Amid the launch of the service, Sam Roddick, Global Deloitte Digital Leader acclaimed:

We're thrilled to work with Shopify to bring Commerce Components by Shopify to enterprise retailers globally. Shopify is an industry leader in commerce, and we believe Commerce Components will be the advantage in helping propel the world's largest retailers into the next era of commerce.

Improves Shopify's Revenue Growth Potential

Shopify is also using this new service as an opportunity to encourage enterprise use of its own checkout solution, Shop Pay. Given the tight competition in the payment gateway market with so many payment options already available, including PayPal (PYPL) and Google Pay (GOOG) (GOOGL), enterprises may not feel the need to add one more checkout option to their web stores.

To overcome this issue, Shopify is going as far as guaranteeing that "Shop Pay will improve [their] checkout conversion by 5% over [their] standard checkout, or [they] get 5 bps back". Shopify is indeed pushing aggressively to induce businesses to accept Shop Pay. More transactions being processed through Shop Pay would augment merchant solutions revenue, which comprised around 73% of total revenue in 2022.

Overall, an increase in the use of Shopify Commerce Components by large enterprises would bring major new business to Shopify, given the size of these corporations. For instance, a giant enterprise interested in Shopify POS solutions would need multiple Shopify POS Pro subscriptions ($89/month per location) for their numerous store locations, augmenting Shopify's recurring subscription solutions revenue, which comprised around 27% of total revenue in 2022. Additionally, it would also bring in great payment processing revenue, boosting Shopify's merchant solutions revenue.

More business from large enterprises can also be considered higher-quality revenue than business derived from smaller, nascent merchants that incur higher risks of failure. Therefore, the Commerce Components venture can improve the quality of Shopify's topline growth, bolstering the Price to Sales (P/S) ratio the stock is able to command over the long term. Currently, the stock trades at a P/S ratio of 9.44x, after having peaked at around 64x in September 2020.

Counteractive Factors

Competition is tough in many of these commerce components markets: Shopify has not disclosed how much it charges for each of the commerce components and advises enterprise personnel to 'contact sales' to learn more about pricing. Nonetheless, pricing power is likely to be subdued to a certain extent due to the intensely competitive landscape for each of these components.

For instance, there are numerous market participants present in the payment gateway market, including PayPal, Google Pay, Apple Pay (AAPL), and Visa Checkout (V). All of these competitors will be fighting hard for business from large enterprises given the amplified payment volume potential. Consequently, Shopify will need to offer extremely competitive prices to successfully win over the business from these enterprises, which undermines the revenue/income potential from these deals.

That being said, Shopify offers an extensive stack of e-commerce solutions. Not all competitors may be able to supply these solutions aggregately. Shopify can leverage this factor through prudent cross-selling, whereby an enterprise using one or two Shopify components can be induced to use several other Shopify components through promoting synchronization benefits. As Shopify deeply integrates more of its solutions into enterprises' core operations, it would improve the tech giant's pricing power.

Persuading enterprises out of building their own in-house systems: A key selling point of Shopify Commerce Components is mitigating the need for enterprises to invest heavily in building foundational infrastructure, as Shopify President Harley Finkelstein proclaimed amid the launch:

Commerce Components by Shopify opens our infrastructure so enterprise retailers don't have to waste time, engineering power, and money building critical foundations Shopify has already perfected, and instead frees them up to customize, differentiate, and scale.

Nevertheless, large enterprises may often prefer to build in-house systems to reduce reliance on third-parties and gain better control over their cost structures over time. This again could potentially require Shopify to offer very competitive prices for its commerce solutions, in order to successfully convince decision-makers at enterprises to opt for Shopify's Commerce Components over investing in in-house systems.

That being said, developing and continuously advancing in-house systems through constant R&D is highly capital-intensive that can pressure enterprises' operating margins. Given that Shopify has already built highly-scalable infrastructure supporting millions of merchants across the globe, the tech giant should be able to develop and innovate commerce solutions more efficiently than individual enterprises.

Furthermore, the fact that behemoth corporations like Netflix (for online merchandise stores) and Heinz trust Shopify's infrastructure to be the backbone of their operations substantially augments the Shopify brand value. As a result, this increases the opportunity cost of not using Shopify's Commerce Components, as enterprises would want to avoid missing out on best-in-class commerce infrastructure that is constantly evolving and utilized by some of the world's top brands. Therefore, Shopify's brand power could help uphold its pricing power for supplying Commerce Components.

Overall Thesis

Nexus Research previously covered the risks from Amazon's 'Buy with Prime' on Shopify's revenue growth and profitability. Amid the release of Shopify's latest quarterly earnings report, Shopify projected that revenue would grow at a rate "in the high-teen percentages", coming in lighter than analyst forecasts of 23% revenue growth. The tech giant did not offer guidance for the full year. Furthermore, when asked about 'Buy with Prime' on the earnings call, President Harley Finkelstein did not offer too much detail in how Shopify is perceiving/dealing with the threat, and simply disclosed that they are in talks with Amazon regarding the issue of data security. Given the lack of revenue guidance (and weak guidance for Q1 2023), combined with the lack of clarity on Shopify's counter-strike against 'Buy with Prime', Nexus Research maintains its hold rating on the stock.

Nevertheless, the launch of Commerce Components fosters Shopify's revenue growth potential. The higher quality of revenue from larger enterprises improves the P/S ratio the stock is able to command going forward. The tech giant is well-positioned to penetrate and capitalize on the growing commerce market, both online and offline, with favorable growth trends over the long term.

Summary

Shopify's Commerce Components allows enterprises to choose specific commerce solutions from Shopify to integrate with their existing systems. The goal is to upstage the legacy provider, and subsequently cross-sell more of Shopify's Commerce Components to eventually induce the enterprise to migrate to Shopify completely.

Commerce Components should help incentivize consultants at EY and Deloitte to promote Shopify's solutions over products/services from their other partners. In fact, consultancy partners like Deloitte have expressed great enthusiasm to promote Shopify Commerce Components to their retail clients. More business from large enterprises can also be considered higher-quality revenue than business derived from smaller, nascent merchants that may witness higher risks of failure.

While Nexus Research continues to maintain a 'hold' rating on the stock given the risks from Amazon's 'Buy with Prime' on Shopify's revenue growth and profitability, the launch of Commerce Components improves Shopify's revenue growth potential over the long term.