Shopify – a moat widening story

Wednesday 12 April 2023

Portfolio insights

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At Swell, we spend a considerable amount of our time and energy searching for companies with a sustainable competitive advantage. It’s called an economic moat. And we look for it for good reason. In a perfectly competitive market, a company’s profit margin will approach zero, and the only thing stopping the slide to zero is the moat.

Moving moats

Complicating our search is the fact that moats are never static. They expand and contract daily due to competition, government regulation, management decisions and other factors. Wide moats are rare, so it is always rewarding to identify one in a business which meets our investment standards. Building a moat takes time and the daily battle is relentless, but the long-term opportunities for winners are significant.

Moats can be fabricated from anything of value. Holding an exclusive patent is useful. Alternately, supply or distribution advantages, lowest cost production capacity or significant market intelligence could create one.

Shopify’s advantage

Shopify is the world’s largest retail platform with more than 2 million merchants. It serves over 14,000 enterprise customers generating in excess of $32 billion revenue. Around 10% of all US ecommerce sales in 2022 were transacted through its merchants.

This scale has allowed them to create a thriving partner ecosystem which includes developers, designers, marketers, accountants, logistics providers and other experts. And it is this unrivalled partner ecosystem that forms Shopify’s economic moat.

Deloitte’s Global Economic Impact Study of Shopify in 2021 observed the Australian arm of Shopify produced US$29.6B in business activity. Moreover it had a job impact of 154,200 and 3,500 partners. Not bad for a country of 25 million people.

Partner value

Partners are drawn to Shopify’s platform to access its large merchant base. It’s a concept Microsoft and Apple know all too well. In fact, Bill Gates once remarked that a platform is “when the economic value to everybody that uses it exceeds the value of the company that creates the platform”.

Or as Tobi Lutke, Founder and CEO, wrote in the 2015 Company Letter:

“App developers, design agencies, and theme designers have built businesses of their own by creating value for merchants on the Shopify platform. Instead of stifling this enthusiastic pool of talent and carving out the profits for ourselves, we’ve made a point of supporting our partners and aligning their interests with our own.”

True to his word, in 2021 Shopify doubled down by removing the revenue share on the first $1 million made by an app developer in the Shopify App Store annually. Obviously by doing so, negatively impacting the company’s earnings in the short term.

The Shopify App Store is home to more than 7,000 apps. Encompassing functions from store design to product sourcing, SEO, marketing and shipping, most are created by third-party developers. Developers are incentivised through the generous revenue sharing model which fosters more developers and more apps.

Partners receive 100% of revenue earned through app sales until their apps each $1 million annually then they receive 85% of revenue. This compares favourably to Google and Apple which both charge 15% revenue share for developers earning less than $1 million annually, and 30% on revenue earned above that. Today Shopify counts more than 8,000 apps in its app store. Peers are well below this level, with Big Commerce at 1,200, Adobe Commerce (previously Magento) at 3,500 and Salesforce Commerce Cloud at 250.

One partner, Triple Whale, recently raised $25m in a Series B funding round. It plans to build a data platform to give sellers greater insight into how their marketing campaigns are performing. The investment is a vote of confidence for Shopify, its platform and app store, and deepens the connection to all partners.

Enterprise value

And its not just partners taking note as large system integrators have also announced partnerships with Shopify. EY, Deloitte and KPMG have all inked deals in the last 12 months to help enterprise merchants transition their operations from a legacy player to Shopify. This endorsement significantly enhances Shopify’s ability to expand its offering and scale their platform.

In January this year Shopify launched its latest product, Shopify Commerce Components for enterprise merchants. Components is a composable stack for enterprise retail which allows large merchants to use specific modules of the Shopify service and integrate them with their own systems. Large merchants can now choose among storefronts, cart and checkout, core commerce, data and compliance, shipping and logistics.

Harley Finkelstein, Shopify President:

“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 customise, differentiate, and scale.”

The rapid pace of technological innovation together with the fragmentation of sales surfaces is driving this trend. Shopify helps merchants to do this in real time while ensuring the integrity of infrastructure. And system integrators are experiencing this first hand.

Sam Roddick, Global Deloitte Digital Leader notes:

“In challenging times, we have seen best-in-class alliances between our clients and their platform partners unlock these opportunities. That’s why 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.”

With a leading product, a sustainable competitive advantage and management focused on the long term, we see more opportunity for product and geographic expansion for many years to come.

About the Author
Lachlan Hughes, CFA

Lachlan Hughes, CFA

Chief Investment Officer

Lachlan founded Swell Asset Management in 2014, wanting to create a unique investment offering – a global portfolio with a genuine long term focus. He is the CIO, with responsibility for all investment decisions of the Swell Global Portfolio. Previously he was a Senior Analyst with NovaPort Capital, a boutique fund manager owned by Challenger Limited. Prior to that, Lachlan was a corporate lawyer working with King & Wood Mallesons, The Bank of New York (London), and Allco Finance Group.

Lachlan earned the right to use the CFA designation granted by the CFA Institute in 2010. His professional qualifications include a Bachelor of Commerce (Finance) and a Bachelor of Laws.