Large Brands and New Verticals to Push Revenues Higher But Cheap Ecomm Software Risks Remain

Shopify Continues To Have A Robust Market Opportunity

In 2023 Shopify had millions of merchants distributed globally, with 54% operating in North America, followed by 27% in Europe, 14% in Asia, and 5% in Latin America. The number of merchants fluctuates and the company stopped publishing the statistics in 2022, but some sources indicate that it is 1.75M in 2024. The company has built a platform used by more than 700M customers with the top 3 categories consisting of clothing, home and garden, health and beauty.

The company's software enables merchants to run their business across all of their sales channels, including web and mobile storefronts, physical retail locations, social media storefronts, and marketplaces.

Shopify lowers the barriers to entry of merchants looking to create an online store by providing a “plug and play” online store solution. It also provides merchants with a single view of their business across all of their sales channels and enables them to manage products and inventory, process orders and payments, fulfill and ship orders, build customer relationships, source products, leverage analytics and reporting, and access financing. In short, Shopify enables merchants to sell products online and manage the full process from a central point.

Shopify is attempting to position itself in a relatively large base and estimates a total addressable market of $850B.

Shopify’s Estimated Addressable Market

While these values reflect what the company may ultimately be able to address in the future, a present value calculation leans towards what Shopify can reasonably achieve in the next few years. Because of this, I transformed the value of each segment into what I estimate that Shopify can reasonably service (SAM - Serviceable Addressable Market).

Here is my breakdown:

• Subscriptions: SAM $81B, market share 40%. This puts Shopify in a leading position whose main peers are WooCommerce, Amazon, and large enterprise shops. This implies a revenue target of $32B, with an upside potential of 17x compared to its 2023 subscription revenues of $1.8B.
• Payments total: compared to management, I expect that the SAM is closer to $22B. I estimate this with the assumption of a growing gross merchandise value of 12% annually for the next 10 years, and assigning an average take rate of 3%. By growing the existing GMV of $235.9B (p. 27) by 12% annually I arrive at a $730B GMV. I assume that Shop Pay will be able to take around 70% of the payments market share. This is because I expect large merchants to use their own solutions which will have a ceiling effect on the penetration of Shop Pay solutions. Given the SAM of $22B and 70% market share, I expect Shopify to make $15.4B ($9.1B in 5 years) of revenue from its payment solutions. Offline payments are included in this estimate via the 12% GMV growth rate.

I expect Shopify to be able to grow its merchant solutions by 12% in the next 5 years, leading to revenues of $9.2B, up by 76% from the $5.2B they made in 2023.

Likewise, I expect subscriptions to grow around 33%, to $7.5B in five years. In total, I expect Shopify to grow at an 18% CAGR, and make a combined $17B by 2029, up by some 120% from the $7.4B they made in the last 12 months.

SMB Merchants Are The Foundation Of Shopify’s Business

Most of Shopify’s merchant base is composed of small and medium businesses (SMBs), and solo entrepreneurs, which bring in at least 60% of subscription revenues.

Shopify’s quarterly GMV and revenue segments

Shopify is well positioned to retain and grow its SMBs given that it provides an easy way for them to establish an online store without relying on technical expertise. Additionally, Shopify enables customers to link up payment processing, marketing, and social media to a central system. The company cites around 5M new businesses being registered monthly in the U.S. (p. 22) and aims to provide a digital store for those that wish to sell online.

While Shopify is capturing a decent portion of these new SMB online businesses, their profitability potential is relatively smaller, as they tend to stick to lower-end subscription plans and use low-margin payment solutions. This segment of customers is still a net positive for the business as it contributes to revenues, strengthens the brand and acts as a sales funnel, but I don’t expect high profit margins soon.  

Large Brands Are A KPI For Investors

As it tends to be the case with software, the company generates most of its revenue from the enterprise customers that are served via the Shopify Plus plan (starting around $27,600 per year) and use the platform to run their e-comm store. 

Shopify’s subscription revenue breakdown

These large retailers are the key driver of profitability and are worth more to investors, which is why onboarding new large brands is a KPI that investors should keep track of. Shopify had a subscription gross margin of 81.4%, and large brands made $138M, representing 27% of subscriptions revenue.

Shopify’s Top Brands

Growth in large brands represents higher revenue per customer potential, and improves Shopify’s profitability. If the company can offer a sustainable value proposition to large brands, then I expect continued growth in the B2C segment as it provides companies with a stable e-commerce solution while being a neutral platform. Conversely, neutrality is a key benefit for merchants that are successful on Shopify, as they never have to worry about the company becoming a competitor, which may happen to successful merchants selling on Amazon.

Great Funnel, High Risk: Celebrity Brands And Solo Entrepreneurs 

Shopify appeals to solo entrepreneurs and individual sellers who are looking for a platform to sell niche products, handmade goods, or dropshipping items. Like SMBs, these merchants benefit from the ability to quickly set up an online store. However, these businesses have the highest risk, as they tend to attract entrepreneurs chasing trends with a “get rich quick” mentality that has a higher failure rate.

On the other hand, celebrities have a better chance of transforming their ideas into a business, as they are able to leverage a personal brand.

Shopify has indeed made barriers to entry fairly low – especially for drop-shipping, which is why the market is saturated with product discovery arbitrage by dropshippers, leading to a decrease of profitability margins for merchants which extends to Shopify. Dropshippers tend to use Shopify as a front-end for rebranded wholesale products from marketplaces like AliExpress, which may be an unsustainable model for stores that bring little to the table other than product discovery. Dropshippers also take a significant amount of product quality risk (will products arrive as described from wholesalers), and inventory risk by betting that they can sell enough product with enough liquidity left over after a sales cycle.

Shopify is still catering to this demographic, and we can see that their main content revolves around helping small merchants become successful and minimize risk. The company promotes business models for stores that target smaller items, aimed at impulse buyers, and educates merchants on increasing profitability with up-selling. Shopify’s outreach programs to SMB and solo entrepreneurs indicate the growth constraints the company is dealing with in this highly competitive landscape. For investors, it is far more important to get a sense of how the marketing budget is being allocated on larger brands, rather than on SMB’s and solo entrepreneurs.

New Verticals Will Maintain Growth

Shopify is constantly working to expand its market opportunity. Recently, the company started targeting brick-and-mortar retailers with their payment solutions and offering them a quick way to set up their online distribution. A large portion of retail is still being done in physical stores, and smaller shops have a difficult time competing with giants like Walmart and Costco. By expanding their online presence for items with a high return, these small owners may be able to carve out more market share for themselves and allow Shopify to benefit in the process.

Shopify’s product development and TAM expansion

Shopify is also developing their B2B platform, which allows a more streamlined approach when negotiating quotes between businesses, as well as a place for wholesalers to set up distribution. The B2B approach is a good vertical for Shopify, which will allow them to leverage their existing software infrastructure to serve an additional customer segment. The privacy and neutrality benefit applies especially for B2B merchants, as they will be able to develop their business away from Amazon.

E-commerce Software Will Continue To Get Cheaper

Shopify’s largest competitors are WooCommerce and the decreasing cost of technology to create e-commerce stores.

WooCommerce may offer competitive rates for small businesses and may increase in traction as it reaches higher awareness among SMBs, while e-comm shop technology has the potential to entice larger customers that want to lower the costs of ownership.

In other words, Shopify must be a more appealing solution for customers, versus the option to hire a team of developers to create their e-comm store in-house. In the past Shopify had a higher value proposition, given that creating e-comm software was more difficult, however, as the technology gets streamlined and cheaper, merchants will increasingly look to alternatives. This means that software improvements and cloud providers will entice large customers and successful SMBs to create their own e-comm solutions, which will impact Shopify’s market opportunity.

The chart below displays an estimate of the share of e-comm platforms ex. Amazon. Keep in-mind that these are presented as a % of the total number of sites which have some e-comm functionality, which means that the chart doesn’t distinguish between small passion projects from revenue-generating sites.

Yaguara.co: Total Market Share of The Top 10 E-commerce Platforms

We can see that while Shopify has lower tier competitors, other than WooCommerce, these do not seem to present a significant risk to its market share.

The bigger issue is the mentioned decline of software development costs  - my assumption is that this is on a trajectory that is inverse to Moore's law. This is important because Shopify’s product is considered to be a cost center for its larger customers, which tilts the decision-making toward elimination down the line. However, as Shopify adds ways to stimulate customers’ growth, it will increase its product’s staying power.

The Early Stages Of Shopify’s Business Cycle Allows For Some Optionality Value

While Shopify may not create a high value business based on the subscription model (their highest margin segment), the platform may have optionality value given that it’s a home for millions of merchants. This means that the company may be able to offer these merchants a valuable product down the line.

Unlike Amazon, Shopify doesn’t have a customer-facing marketplace, however it does connect merchants to white-label distributors, this is one potential vein that management is drilling on with their B2B platform, as wholesalers rarely have an established market presence and merchants have difficulty finding them when starting new operations. The company may even be able to allow wholesalers to advertise to Shopify and gain a cut from connecting them to merchants.

Optionality refers to the possibility of a platform to transform into something more valuable and use its existing user-base to sell that new product. The famous example of this is Amazon, which was an online retailer that became much more valuable once it launched its AWS cloud and offered a new platform supported from its recognized brand name.

In my view, Shopify is not directly comparable to Amazon as its key customer are merchants (stores), while Amazon’s key customer are end-consumers, and optimizing for the consumer is the superior model, while Shopify is put in the position where it hopes that the interests of merchants and end-consumers are aligned. However, the wholesale to merchant connection presents a competitive edge for Shopify, as it has the potential to directly cut into the margins of Amazon.

These are just some examples of optionality for the products that Shopify could build down the line, it may be the case that the company can take a completely different direction, or that no large-scale optionality materializes, however should investors find themselves entering Shopify in what is a reasonably fair price, then the optionality may be an additional reason to extend the investment horizon.

• Revenue: I estimate that Shopify will grow total revenue at an 18% CAGR from $7.4B in the last 12 months to $17B by 2029. I expect subscriptions to grow 33%, contributing $7.4B in five years, while the merchant solutions segment grows at a 12% CAGR to $9.2B in 2029.
• Profitability: I expect gross margins to remain at a stable 50%, with operating expenses stabilizing at 25% of revenue over the next 5 years. This leads to an operating profit of 25%, or $4.25B. I expect stock based compensation to keep impacting the bottom-line at 6% of total revenue, leading to an expense of $1B. In order to account for further growth investments, I will round down the net profit margin to 60% of the operating margin, leading to a final net profit estimate of $2.6B for 2029 (15% net profit margin).
• Multiple: I estimate that Shopify will have continued growth opportunities well beyond my 5-year forecast period. For this reason, I am attaching a forward PE of 30x in 2029.
• Share count: Shopify’s SBC is its main source of dilution, and I expect that the company will continue its share dilution in order to fund growth projects. I estimate a stable 2% reduction of the share count per year, in-line with past practices. For 2029, I expect the share count to converge on 1.42B, up by 10% from the latest value.

• Shopify may have a larger market opportunity than I forecast in my narrative. Due to the nature of software, the company may be able to rapidly scale up revenues if they manage to onboard more subscription customers.
• The company may be able to develop an enticing B2B platform that converts into a high margin segment as the type of customers it targets have higher budgets than its present core customers.
• Shopify’s sale of its logistics business indicates a failure of planning on the company’s ability to grow. Similarly, I expect that not all of the currently presented management initiatives will be successful and Shopify will have to divest some projects.
• By offering a standardized e-comm solution to large companies, Shopify may become a serious competitor to Amazon and entice sellers to initially use both platforms and exclusively switch over time.
• While Shopify doesn’t have a marketplace app, it may opt to create one and leverage its large number of partners to offer a centralized channel that will increase merchant distribution and allow Shopify to take a portion of the turnover.
• While Shopify’s software is cutting edge, further improving their infrastructure may serve to reduce complexity as well as reduce barriers to entry for new merchants.

While I believe that I have balanced out future potential and the verticals that are likely to be fulfilled, should one or more of my cited risk factors materialize it may have a positive effect on the value of Shopify.