The Shopify initial public offering (IPO) was announced April 14, 2015 and now investors are wondering how does Shopify make money? Rightly so, as Shopify is entering a highly competitive battlefield, with no profits in the tank.
How Does Shopify Make Money?
How Shopify makes money is through several areas of its business. But before we get into its revenue streams, it’s important to first understand what Shopify does.
Shopify allows prospective merchants to set up an online storefront. Online sellers are able to set up a shopping cart, accept credit cards and more than 70 other payment methods, determine shipping rates, and automatically calculate taxes based on jurisdiction. On top of that, Shopify provides web hosting services, optimizes webstores for search engine results, and provides the needed business analytics.
For these services, Shopify charges a subscription fee ranging from $29.00 to $179.00 a month. Shopify also generates additional revenue from the sales of storefront themes, apps that the company claims increase functionality, the registration of domain names, and processing payment fees. Shopify’s merchant software model allowed the business to grow total revenues from $23.0 million in 2012 to more than $100 million for fiscal year 2014 (ended on December 31, 2014). (Source: “Shopify F-1,” Securities and Exchange Commission web site, April 14, 2015.)
Remarkable growth, but no profits for shareholders. In fact, the absence of Shopify’s profit for the three months ended March 31, 2015 added to a string of losses dating back to 2012. Total retained Shopify earnings now stand at a loss of $34.0 million, yet shareholders continue to sponsor unprofitable growth.
Shopify’s Revenue Forecast
The wall blocking Shopify from squeaking out a profit is its inflated operating cost structure. For example, in 2014, Shopify’s revenues grew at 109%, but costs related to promoting its business through marketing efforts also jumped 97%.
The only way Shopify can become a viable investment is if it can continue to grow revenues, while decreasing its outlays on marketing and research and development.
Promises of rising revenues can rescue any stock; let’s focus there.
To date, revenue growth has been impressive. Monthly recurring revenues, which track average monthly subscription fees from merchants, grew 72% in 2014 and another 12% in 2015. Moreover, the dollar volume of transactions on Shopify webstores grew 132% in 2014 and is on pace to add another 40% in 2015. (Source: Ibid.)
Shopify’s traditional avenues of increasing revenue are sure to lose steam. Future growth must come from increasing the functionality of its webstore platform. A big boost came, near the end of 2013, with the introduction of “Shopify Payments,” which allows merchants to accept credits and track all money flows on their web site.
New improvements could mean more Shopify apps to increase the flexibility of webstores, more business analysis tools, and better platform scalability to suit larger businesses. On top of that, global expansion is a must, as 69% of revenues in 2014 came from the U.S.
However, sustainable expansion runs Shopify into more trouble, as it must compete with other merchant software providers and giants of the e-commerce industry.
Shopify’s Earnings Potential
What is quintessential about Shopify is that it combines all parts of an online merchant account, including a shopping cart and payment gateway, into one easy-to-use solution. But other merchant software providers aren’t far behind.
Square, Inc. out of San Francisco allows sellers to accept offline debit/credit transactions and seamlessly connect with small business applications, like “Intuit QuickBooks.” While Amazon.com’s webstore service is no longer available to new sellers, there is an uncountable amount of e-commerce software firms that provide the same service as Shopify. E-commerce software is just part of the story; there are countless online marketplaces on which merchants can sell their goods.
For example, sellers can open a shop on Etsy, Inc. (NASDAQ/ETSY), sell goods on Amazon.com, Inc. (NASDAQ/AMZN), auction their merchandise on eBay Inc. (NASDAQ/EBAY) without a webstore, or for international retailers, Alibaba Group Holding Limited (NYSE/BABA) is a likely online storefront. Another clear alternative, for larger merchants especially, is to set up an online storefront through GoDaddy Inc. (NYSE/GDDY).
Shopify IPO Investment Thesis
How does Shopify make money? Well, it currently doesn’t and it is competing in a cutthroat industry. A competitive environment will benefit online merchants looking to get a great platform for a low cost, but it is likely to hurt the company’s IPO prospects.
According to the IPO filing, Shopify issued shares to insiders at $10.12 a piece at the end of 2013. Shopify’s stock may IPO in a similar range and the company is looking to receive gross proceeds of $100 million. That would value Shopify’s net worth at above $700 million.
Whether investors fork up this amount of cash and whether Shopify establishes a long-term defensible position is yet to be seen. Those looking to jump on for the ride shouldn’t expect profits right away, but the best surprises are always the ones you least expect.