Shopify Inc. (NYSE:SHOP) Goldman Sachs 29th Annual Global Retailing Conference September 8, 2022 12:15 PM ET
Gabriela Borges – Goldman Sachs
Conference Call Participants
Harley Finkelstein – President
All right. Great. Good afternoon. Thanks so much to everyone for joining us at the Goldman Retail Conference. I’m Gabriela Borges, Head of the emerging software vertical here at Goldman on the research side. I’m delighted to have Harley Finkelstein on stage with me; President of Shopify. Thank you so much for joining us.
Thank you for having me. Thanks for joining us, everyone.
So I want to start on the longest term vision that Toby and yourself have articulated since the time of the IPO on a 100-year company. And this idea that Shopify is more than just an e-commerce application, but actually the central nervous system or the operating system as mentioned of the style customers. And so when you think about what you’ve built and what’s made you successful to date, coupled with that 100-year vision, what do you identify as the core competency or the key competitive differentiation of your business model?
Yeah. It is a good question. In fact, if you look at — if you review the IPO roadshow deck, you will see that the ultimate goal was to become, we were calling the retail operating system for merchants and for brands. And I think, we’re as close to being there as we’ve ever been right now.
And just to define that, because I think it’s kind of nuanced, we want to be the most important piece of software that our merchants use every single day. What we mean by that is like when they say they’re going to work in the morning, what we want them to do is open up the Shopify admin and run their entirety of their business. So that means whether they’re selling across online or offline or they’re selling on Instagram or YouTube or Google or in person at a popup, that is their central view of the entirety of their business.
If they need payments, they use payments with us. If they need capital, they use us for capital. If they want to do shipping logistics, they can do all that from one centralized place, which effectively runs the entirety of their business.
And I think the core competency that we bring to the table is twofold. One is if you are a brand or a business or a retailer and you want to take advantage of someone else’s economy, a scale you can sell across the marketplace. Amazon’s a great place to do so. If you sell on Amazon, you absolutely can have economies of scale.
But if you want to own your own individual business, historically you had to build your own tech stack. And a lot of great companies had done that. Whereas on Shopify for a moment that we were a single retailer, we would be the second largest online retailer in America.
So with that, we’re entitled to all these incredible things like rates and payments and ability to give you capital and shipping rates and all those sort of solutions you might need. But at the same time, you’re able to build your own actual brand and your own business. The relationship you have with your customer is direct. There is no intermediary. And I think those are I think it’s that ability to build your own brand and your own relationship with the customer. And at the same time, be able to leverage mass economies of scale that I think makes us quite unique.
And when you about the scale and the visibility you have as part of having the second largest footprint of brands and retailers, when you look at the data that you’re getting out of that merchant face, what is it telling you about the health of the consumer today? And I think for a lot of us in the audience, one of the things we’re trying to figure out is, is this stabilization, or is there potential for another step down in consumer spending would love to hear your insight?
I think there’s stabilization and I can — I’ll sort of — I’ll provide you two examples of that. The first thing is I think what happened as inflation increased was the consumer tended to start buying more things like the discount retailers did very, very well. The commodities, the sort of staples did really, really well. And so there was a little bit of a pullback earlier this year, I think, around purchasing things that you want as opposed to things that you need.
And actually one thing that I don’t think people understand or recognize is that the direct-to-consumer model — I think my friends from Warby are speaking right after, but they’ll tell you the same thing I will, which is that fundamentally, when you’re a direct-to-consumer business model, you have obviously less intermediation, that means you’re not sharing the profit merger along the way.
So one of the things that we saw across — we have millions of merchants on the platform on Shopify. We saw they were able to handle things both inflationary and supply chain in a way that larger retailers could not. One of the companies we totally admire is Costco. I mean they operate on about a 10% gross margin.
When things get compressed both in supply chain or just inflationary on inflationary side of things, there’s just not that much room to — there’s not much room to go. Whereas with the direct-to-consumer business, you have enough margin built in that even though you may not want to, you’re able to absorb the shock for a period of time. That’s the first thing.
The second thing that we’ve also recognized is that on the consumer side of things, one of the things that was set during the pandemic was this appetite to buy direct wherever possible, that it wasn’t just something that was happening in a bit of a fad where consumers began to want to buy from their favorite retailers or businesses. But actually, the idea of direct-to-consumer shifted during the pandemic from a fad to more of a steady-state thing. And I think going forward, you’ll see a lot more of the most successful brands decide to go direct to consumer.
My favorite — and I talked to this all morning long. My favorite T-shirt company is James Perse. I mean James Perse has had this incredible multichannel business for many, many years. I think they make the best T-shirts, just to say.
But now their focus is really on the direct-to-consumer business, not the wholesale business. They want to own the profit margin. They want to have direct relationship with people like me that love their products. And we’re fortunate that they’re using Shopify both online and also in store. And so I would say that I believe we are coming back to a rebalancing in terms of consumer spend and consumer behavior.
The other thing I just want to point out is that there is a bit of a mean that I think needs to be corrected, which is that e-commerce is going through kind of a weird time right now. And I think what happened during the pandemic is there was a metric that everyone really, really cared about, which was e-commerce penetration as a percentage of total retail.
What happened during the pandemic was the numerator, which is e-commerce penetration, it obviously went up because physical retail shut down. But the denominator in that equation, which was total retail, also went down because you pulled out physical retail entirely from it. And now that retail is beginning to rebalance, and you’re actually adding back in physical retail, it’s kind of a scary graph. But if you just look at e-commerce growth by itself, we’re going to hit $7 trillion by 2025. The e-commerce growth curve is back to where it was in 2019, but on a much higher base. And I think that gets lost a little bit in some of the graphs and the noise.
It leads nicely into a question on the longer-term health of the e-commerce market. So the idea for trend line. We’ve heard debate around could the trend line actually be more like 5% longer term, could it be more like 15%. How do you think about that normalization? Where do you think it settles? Do you think it’s a double-digit growth rate? Help us understand that.
I think it’s going to settle closer to where it was in 2019. I think that it’d be great if it — I think there was some suspicion that it would settle somewhere between the 2019 growth rate into 2020 or 2021 growth rate. I think it’ll look closer to 2019, but on a much higher base.
The other thing I think that is just important to just say out loud is 75% of retail is still being done in the physical world. And that is obviously shifting. Now you have countries like China, which is the first country on the planet that actually eclipse the 50% mark in terms of commerce happening more digitally than in person. But I think if you look at the U.K., they’ve had an increase that is larger than the U.S. Canada is still below the U.S. But I think where it’s going to settle is around the 2019 mark, which is still a massive growth rate.
Let’s segue a little bit into the physical world. So as the pieces of the SFN — Shopify Fulfillment Network strategy have come into place, I think you’re able to be a little more articulate about how the plan fits together. And so maybe we could take a moment to level set on how the strategy is playing out and how the integration of Deliverr is going.
Yes. So those of you that know the company or of the company, you’ve seen effectively since the IPO, a couple of things have changed on Shopify. Our history was really to help great brands and merchants start online stores and then scale. And some of those stores that start on the platform have grown to become very large, very publicly traded companies. Allbirds, for example, or FIGS or Oatly.
But if you look at companies like Gymshark and Fashion Nova, these are companies that started on Shopify at their mom’s kitchen table that are now category leaders. And that if they’ve been able to scale entirely on shop, there’s no graduation of Shopify, which is great. We love that.
But around the IPO time, we began to leverage the economies of scale that we were talking about to do things like payments and then capital and shipping labels. And more recently, things like audiences, which is our take on how to improve return on ad spend for our merchants, but really leaning in on this idea that what if we provided those economies of scale that we’re entitled to every single merchant on the platform. We think that would level the playing field for all small businesses and all brands.
But there was one piece of the business building process that was not helped by the introduction of the Internet, and that was the shipment of actual goods. And so we didn’t really want to go into shipping. That wasn’t really the goal that we want to come as a big logistics provider.
What happened was as we became more and more of that center of business for these millions of merchants on the platform, they ask if we can help them with more things. And so we began to think about, well, what if we were able to find a way in a very software asset-light model to help these merchants to fill their orders, ship their orders? And what we realized was there was sort of this natural glass ceiling on businesses once they got to the point where they acquired a 3PL.
Most 3PL — third-party logistics companies have massive minimums. They’re still expensive, even if you’re shipping tens of thousands of orders, and they’re not really optimized for software. So in a world where omnichannel is steady-state, where omnichannel is like talking about omnichannel, I’m talking about the color TV, it’s everywhere, we felt that merchants needed a single place where they can see the entirety of their inventory from factory to port, right to porch to the end consumer.
And so the approach we took was very different than most traditional logistics companies. When a good is being made in the factory, there’s — the first phase is from the factory to the port. And we’ve announced a partnership with Flexport, which allows us to do that for our merchants very effectively.
Flexport leverages software and works with pretty much every shipping container company to get it from factory to the actual port. Once it gets to the port, and it’s in their shipping container, then it needs what’s called balancing. Someone needs to anticipate where those actual packages go where those products go to — and what warehouse they go to, to eventually get closer to the end consumer.
And so that second phase, which we call balancing, we ended up buying a company called Deliverr. And Deliverr was this company that we had been — we’ve been hearing about from a lot of our merchants. And it was just obvious they were so far ahead of everyone else on that balancing aspect. So that balance in the second phase is really when it arises in a port to where it goes to the fulfillment ever.
So we acquired them a couple of months ago, and they were handling that piece. And then once a get to the fulfillment center, one of the other observations we had was there are thousands — about tens of thousands of these third-party logistics companies — warehouses all over the world that are sitting empty because companies, Forever 21, for example, or Barney’s, for example, use them and are no longer using them at the same level anymore, and they were empty.
And so we went to these third-party business companies and said, we want to create a network, third-party fulfillment centers. We’re going to build our FMS, our fulfillment management software. And we’re also going to — if you’re ambitious, we’re going to give you these checks from a company we acquired called 6 River Systems, which optimized your inventory and your warehouse management. And we are going to give you as many customers as you need to fulfill orders and send to the consumer.
And so the first piece is Flexport. That second piece is Deliverr. And the third piece is really driven by the Shopify Fulfillment Network, which is powered by these third-party partners. And it’s taken some time. It’s not as easy as just releasing Shopify Capital, which we can announce on a Monday. And by Friday, it’s up and running. But we’re at a really good place right now.
And we can do in a way that is not capital-intensive, but we think can actually create huge value add for the merchants on Shopify. And it’s just one more piece of the business that we’re able to democratize for them, and it means we’re even more important in their life.
A little bit of a question on scale. If you think about the customers that would most benefit from SFN, I would imagine naturally, the smaller the customer, the more they benefit from Shopify economies of scale. For Shopify to be successful with SFN, do you need larger customers in order to make up the volume? How are you able to serve both the smallest customers but at a very small scale and also be successful?
Yes. That’s actually the best part of the Fulfillment Network story is that we can serve merchants that are doing 10 orders a day or 10,000 orders a day. Now the initial grouping of merchants that are using the logistics work right now tend to be larger merchants just because we wanted to get some merchants going, want to understand the data, get some good feedback. But ultimately, we think this will get to a point where, again, if you’re selling 10 orders of tea or you’re selling 10,000 orders of shoes every single day, you should be able to leverage this thing.
And the way to think about it is it’s because if you combine a lot of tiny little lights together, it becomes the sun. That’s kind of the way we think about a lot of our scale, is that these — the logistics system is — can work for all of Shopify. And most important thing is it’s not necessarily to give them some optimization in one particular part of that journey. It’s really so merchants on Shopify don’t have to think about logistics anymore. It’s just one of the things that kind of disappears, and it just kind of works. And because we go from factory right to porch to the end consumer, it means that a merchant can track that order as the entirety of the journey.
What we also know is that the consumers don’t actually — at least our merchant consumers, and again, these are brands that they love. I mean the majority of all of your favorite brands, we feel very lucky, are powered by Shopify. So what that means is we understand the consumer behavior because the merchants speak to the consumer fairly regularly. And what they tell us is that it’s not about one day cheap delivery. It’s about expectation management.
It’s about telling the consumer when they buy that this order will be at your door within 3 days, and here’s when you can expect it. And that anticipation of when the order comes in is more important than this race to the bottom to do 1-hour delivery. So the goal is to do two-day affordable delivery across 90% of the U.S. consumer base. That’s sort of phase 1, and we’re about to get there. Then to continue on, we don’t think we’ll ever have to get to 1 hour because that’s not what’s important. From a conversion perspective, the most valuable thing is for our merchants to tell the consumer, this is when you can expect your order.
You’ve touched on this a little bit, this idea of building a capital-light fulfillment network. Help us understand, when you think about the $1 billion commitment that Shopify has talked about relative to someone like an Amazon that’s spending order of magnitude $100 billion, compare and contrast for us the difference in the models. And is there a risk that we get to 2024 and there’s another $1 billion that needs to be spent on [indiscernible]?
We’re pretty much there ready. We think an additional $1 billion to 2024 gets us the entire fulfillment and logistics network complete — end-to-end logistics network that’s built specifically for modern brands. So there’s no risk there. But the Amazon model was totally different. The Amazon model is a race to get it as cheap and as fast as possible. They own all their warehouses. All their staff is on their payroll.
And we just don’t think — in our model, that’s not necessary. What’s more important for us is actually to leverage the fact that there are these thousands of warehouses all over the world that are sitting empty that have staff that are looking for customers that we have for them. And by unifying them with this really smart intelligent software, it means that they all can be part of this network.
And as demand increases, we have a lever to add more partners. And if demand decrease, we can also pull that back. That to us is a much better model for our merchant base.
Leads nicely into a question on Amazon as a partner. And so Shopify has talked publicly about wanting to integrate with Prime, and that being a net positive for your customer base at the same time has been media reports debating to what extent that actually is.
I don’t know what you’re talking about.
We’d love to get your updated to you. What are your plans and how does that help your customer base? What does it mean for the economics of Shopify?
Yes. The theme of pretty much everything I’ve talked about is around the same concept, which is that it is — our entire mission is to democratize this idea of building great business from scratch, and then those businesses are growing really large to be category leaders. The fact that these businesses — I don’t know this for a fact.
Some of you in the room may know this spend than I do. But I suspect at some point in a Nike board meeting, they were talking about Gymshark. That is unbelievable, that a company that was only built 7 years ago is now, whether or not it’s a major threat or a small threat, is an actual topic of conversation in a board meeting at Nike. To me, that is wild. And the reason these companies can grow at this pace and this velocity is because of technology. .
So I’m bullish on any technology that makes the business building and the business scaling process better. If big companies are going to open up their infrastructure to make it easier for small businesses to leverage that infrastructure, we think that’s great. Buy with Prime, we said this on, I think, the Q1 earnings call, would be a great addition to Shopify. And we’re talking to Amazon now about how we actually integrate those things. But it has to be in the right way. And if it’s going to be done in a hacky way where merchants lose or they — or the customer information is obfuscated, that’s not the right way to do it.
And if you look at all of our partnerships, whether it’s powering live shopping on YouTube or Google Shopping or Instagram Commerce or Facebook Commerce or TikTok or Snapchat, across every one of these major commerce partnerships where Shopify is powering that new social media surface or that service in general, it is because we are coming in, in a way that actually allows the merchant to keep control of their customer. And we think we can probably get there with Buy with Prime, but we’re talking now about that.
Let’s talk a little bit about the building and scaling of Shopify as a business. So the leadership changes, new COO, new CFO, this morning. Why is now the right time to make those transitions? And what should investors be expecting in terms of [indiscernible] going forward?
Yes. I mean, look, Shopify has become a much more difficult company to articulate. If I was sitting here in 2015, you said what does Shopify do, I’d say we’re an e-commerce provider. And then 2 years later, I’d say we’re multichannel. And 3 years later, I’d say, well, we’re also doing some payment stuff and a little bit of capital. But more and more, we are taking on a larger piece of the needs of the businesses and brands on our platform. .
So with that, we sort of view Shopify as like these sort of tours of duty. And sort of this new tour of duty where we have millions of merchants where we’re powering 10% of all e-commerce in the U.S., in some countries, even more than that. We want to always make sure that we’re set up to execute on that ambition.
And in terms of both those changes, I mean, Amy has grown — our current CFO has grown the company from I think $600 million in revenue to almost $5 billion in revenue. She’s been with us for 5 years. She did an amazing job for us. And so this new CFO is coming in, Jeff Hoffmeister; we worked with him. He was the banker during the IPO.
He helped us do a ton of financing. He’s been an adviser and sort of Tobi and I for many years. He’s incredible. We think that he, coming from banking and understanding, has taken perhaps most of the — not all of them is Goldman Sachs, a lot of the lead left up here. But a lot of the major tech companies public. He understands something that he brings in the table that we currently don’t have.
And then interesting on the COO side of things, Toby Shannon, who started the same day that I started about 13 years ago, Shopify, he’s retiring. He’s much older than I am, and he’s going to be joining our Board. But we’re actually — we promote [indiscernible] who has been running products for Merchant Solutions to Chief Operating Officer, and we’re actually bringing product and revenue in commercial together.
Part of the thing that I think we have not been historically good at, I think we’re getting much better at is this idea of making sure the right merchants have the right products at the right time. So on one side, we have all these amazing merchant solutions that merchants need. On the other side, we have all these merchants. And I think that we have sort of — it’s previously merchants sort of beat a path to our door in terms of adoption. But now we really want to focus on how do we find — how do we ensure those merchants have it. And it’s already working.
I mean our attach rate is the highest it’s ever been in the history of the company. So we add more merchant solutions. More merchants adopt the solutions. They become more successful. We’re able to generate more revenue. And so we think bringing those 2 things together under him is just a great way to sort of go forward. And I would say that our leadership team now is about a stacked with, like, the best talent as ever.
It leads into a question around the cross-sell opportunity and some of the low-hanging fruit that you think is still an opportunity at your customer base. If you think through the impressive list of products that you’ve already talked about in Merchant Solutions, what do you think are the next two or three that can the needle? What are some of the early results coming through from being a little more focused on cross-sell? And how should we think about the implications to take rate [indiscernible]?
One that I’m especially excited about, it was sort of a good idea last year, but now it seems to be more of a great idea is audiences. Audiences is a product, which we enable merchants to have higher return on ad spend. So if you’re a Shopify Plus merchant and you have 15 SKUs, you select two SKUs that you want to sell more of.
You feed that into the audience’s algorithm. We give you back a sample audience or a look-a-like audience. And now when you’re buying ads in all the major ad platforms, you upload that particular sample audience or look-a-like audience, and we can pretty much guarantee you we’ll have a higher return on ad spend.
In fact, we now have about 7 case studies on our Shopify Plus vlog showing what the return asset has been. That’s another way where we can leverage our economies of scale to give merchants more value. And that was something we were sort of toying with about 12 months ago.
And then IDFA and ATC changes came out of Apple, I think, in January or so of this year, and it just became a lot more difficult because of the third-party data to really target — if you want to sell me skateboard — I love skateboarding, and I also love technology. And so the Venn diagram overlap made me a perfect customer for that skateboard.
But now when you’re buying ads, you have less information. And so you’re — it’s a lot more sort of spaghetti on the wall. And so that came out and then we really did throw some fuel on the fire of audiences in the last couple of months because we’ve noticed that a lot of our merchants are finding more difficult to acquire customers. And again, the more data that gets into that algorithm, the higher the return has been will be for other merchants as well So I would say that one is a big one.
The other one that I think it’s missed a little bit, what’s really important is this idea of international, but selling internationally, not necessarily international expansion. I mean we — international as a group of merchants is one of our largest growing segments of new merchants and platform. But one of the things that we’ve noticed is a lot of our merchants struggle with selling in multi-jurisdictions, language issues, tax issues, currency issues. And so we built a product for most merchants, most of the time called Shopify markets, which make it effectively every business default global. We think that’s a really big one.
And the other one is — I really like, too, is maybe not as sexy, but I think the point-of-sale product on Shopify is the best it’s ever been. We are now seeing merchants coming to Shopify for that point-of-sale product, not just for e-commerce. And I think previously, you came to Shopify for e-commerce, and there was sort of this appendage of point-of-sale.
What happened during the pandemic was when all the physical retailers shut down, those have never sold online before, for the most part, they came online using Shopify, and we built a lot of trust with them. And so now that physical retail is reopening, a lot of them are replacing their old legacy systems with Shopify point-of-sale. And what they’re realizing is that they no longer like — they have one centralized place to run the entire business.
Through that as well, we’ve announced some major upgrades to Shopify point-of-sale Pro, which is our enterprise product for physical retailers. So if you go to like an Allo Yoga or you go to James Perse or an Albert store, the physical retailers are powered entirely by Shopify, just like the online side of their business, too. And that is something that I don’t think we’ve been very well known for that is changing quite dramatically.
I want to touch on the audiences a little bit more. So the case sites that you have on the website, some of the numbers on return on ad spend are really impressive, I think north of 5x. Is there any reason those success stories couldn’t be replicated across multiple cohorts in your installed base?
No. In fact, over time, the expectation is that if we continue to execute in the way that I think we should and can, at some point, it should be a bad idea to buy an ad an app platform without first running it through the audience’s algorithm. It’s just one more — when you buy an ad on Instagram or on Google, any major digital platform, there’s a couple of key ingredients you have to input.
You have to put in the price, product description, product photography. There’s a bunch of meta tags you want to put in, like sizing and stuff like that. But now you have a fifth metric or fifth variable, which is a sample audience, a look-a-like audience. And over time, the more people that adopt audiences, the better that information becomes, the better we can predict what is the type of demographic or type of audience you should have for that product. And so I think that’ll just get better over time. .
We’re doing some other stuff around customer acquisition as well. One thing that I think is really cool is we have a lot of like these huge YouTubers on Shopify who have like tens of millions of subscribers, and they try to build a product, and they don’t really do it as well as they probably should or want to. On the other side, we have a bunch of great brands that try to build YouTube channels, and they kind of don’t do it as well as they should.
And so we created something called collabs, which is effectively a software-based match-making service, which says if you’re a YouTuber and you have a great — you have 1 million subscribers on your cooking show, [indiscernible] our place and you guys should do some sort of collaboration where they pay you an affiliate fee to promote their products. And so we’re trying to find new ways, not just on the backs of IDFA or ATT changes, but just generally help merchants become more successful. And those are 2 really good examples.
What are some of the key metrics you’ll be looking at internally to the time and when to switch on monetization of [indiscernible]?
Well, audiences is monetized. It’s just monetized indirectly. The more — obviously, the more advertising they do at a higher return on ad spend means the more customers come to their online store, more GMV. And obviously, we make money on GMV and on payments. But there is an opportunity at some point where we can move that lever on monetization to be more direct. So maybe start charging for a marketing module even if you’re not a Plus merchant. But right now, the goal is to get as many people using it because the more people that use it, the better it becomes.
Absolutely. I’d like to spend a few minutes on how to think about operating leverage in the model and your profitability profile. Last earnings call, Tobi and yourself talked a little bit about rightsizing some of the cost infrastructure that you have in-house. What are the implications for what that means for operating leverage for the next couple of years? How did you think about the right areas to maybe pull back on versus where you’re continuing to invest pretty heavily?
Look, Shopify is a company that very much likes being profitable. We were a boot company for a long time. We were not born on venture capital the way a lot of our peers were built. So that sort of bootstrap culture is very much baked into the DNA of the company.
If you look at — we went public in 2015. Since 2017, we’ve been profitable every year and growing profit. This year, we said in February, this will be an investment year, but the plan is absolutely to return to profitability.
In terms of some of those optimizations, when we — during the pandemic, we knew that the growth rate of e-commerce just by itself was not necessarily going to be what it was during the pandemic because you had effectively this massive shift over from physical retail to online retail pretty much overnight, but we suspect that it would be somewhere between 2019 rates and 2020 or ’21 rates. And it turned out it was closer to 2019 rates.
And so once we got that information, we simply said, we probably don’t need as many of these sales reps or support reps. And I think good companies make hard decisions in the face of new information. And we try to do that. And for anyone in the room that has run a company or run a team — layoffs, they suck.
And it was a difficult time for us, but I feel like we’ve now emerged from that sort of period, a better company, stronger company. We’re adding more value to the lives of our merchants. And I feel like that operational excellence lever, we have really good carriage of, and we can sort of play with that as needed.
It leads also into how you think about the longer term for gross margin, operating margin. We’ve had conversations about how Shopify is solving for gross margin dollar growth and not for gross margin percentage.
And I mean just to say the thing because I don’t want — I think that’s an important point. What we focus on, we optimize a company for is gross profit dollar growth. And the reason I say that is because we get a lot of questions — I get a lot of questions about our margin and where our margin is eventually going to kind of level out. Every merchant solution is going to have a different margin profile.
Obviously, we think fulfillment and logistics will be closer to sort of the payments margin profile. But obviously, capital is going to be a lot higher. And obviously, the SaaS margin is always going to be a lot higher than that as well.
And so if we were overly focused simply on gross margin, what we’d end up doing was we would never have done payments. We’ve never have done some of the other merchant solutions, which are a huge part of our business and allowing us to build a very long-term, very profitable, very large scale — large cap company. So the way we run our business has always been on looking at gross profit dollar growth.
Help us then think a little bit about the free cash flow margin line or the operating margin line. For us as software investors, we tend to look at LTV to CAC, and we underwrite a normalized software operating margin of 20% or 25%. How do you think about that for the Shopify business model? How is that going to be impacted by SFN?
So SFN, again, will — where it’s going to net out will be — it’s going to make money. The unit economics are strong. The more people that are using logistics generally, the better the economics become because of those economies of scale. But even just at this particular point where we have — we don’t have thousands of merchants using it, but we have enough merchants to understand what are the puts and takes of that business. Human economics are already there.
In terms of sort of the funnel of Shopify, our funnel — our goal is really to create the widest top of funnel possible. We want anyone on the planet who thinks about starting a business to do so with Shopify. They’re in the shower, and they have an idea. The next step should be to go down to their kitchen, open their laptop and sign up for Shopify. We recognize that not all businesses are going to be successful, but what we know is that the ones that are successful more than offset the cost of the ones that are not.
And the really cool part about our business model is that we have this incredible stacking of cohorts, almost like an annuity. So the cohort from, I don’t know, Q1 2013, which FIGS as a part of, that cohort continues to send revenue to us every single quarter. In fact, the revenue keeps growing. And so you kind of have a wonderful stacking of revenue over time. But on the CAC to LTV ratio, we’ve always had a really healthy CAC to LTV ratio.
When one particular channel gets a little more expensive, we often look for others. Some of you may have seen more Shopify now on TV or direct mail stuff. That’s a new way for us to actually acquire customers, which we think is a great experiment. But we think whether it’s on unit economics or something like logistics or the CAC to LTV ratio, this is a company that has deep operational discipline baked into the business. We don’t do Super Bowl ads. We kind of know what works, and we like things we can measure.
Yes. It’s interesting because one of the comments around merchant ads numbers this year has been merchant ad stronger in the second half as first half. It leads to the question on is merchant ads a little bit number for us to be thinking about when we look at LTV to CAC, merchant ads then not all created equal and especially at Shopify’s winning larger and larger Shopify for customers, that metric perhaps becomes more to started a less correlated than it used to be. So last get your thoughts on the merchant ad spend.
I mean, look, if you look at like a merchant of ours like Mattel or you look at it, for example, I mean, obviously, those merchants are obviously worth a lot more than — an aspiring entrepreneur who is just getting started, and they’re not really sure whether or not the business — excuse me, will have legs long term. However, the cool part of the Shopify Plus business is that half of it is homegrown success stories.
The other half are existing enterprise merchants that have migrated either over from a homegrown system or they’ve migrated from an enterprise system. And so the unfair advantage we have by having merchants start with us and they’re very small and then growing really, really large is that the big — like if you look at our top 120 merchants, a big chunk of them started on Shopify and will never leave Shopify.
At the same time, we don’t really have this revenue concentration in 1 or 2 merchants in that if 1 or 2 merchants left the platform, it wouldn’t really affect the business too much, like there’s built in resiliency. And so I think we have to do both. But I think, to answer your question directly, I think merchant count is something that is important to look at. GMV is important to look at, and gross profit dollar growth is also important to look at. And those are 3 measures that we really care about.
And on the merchant ads side, is it fair to expect that post what we’ve seen in the near-term COVID normalization 2022, post this period of 2022, should we expect merchant ads to continue growing steadily?
Yes. I mean we have not — I think 30% of our revenue comes internationally. We have not penetrated all the international markets where we know there’s pent-up demand, where we have product market fit, where we have app developers and agency partners. I think in the last 12 months, 40,000 agencies and third-party freelancers have referred new stores to Shopify. I mean there’s a massive opportunity for us internationally even on the core merchant base.
I think things like B2B, which we just announced in the last couple of months, allows us to go after a completely new segment of the market who historically has never thought of Shopify because they’re B2B companies. They’re wholesalers. And now we think our product is not only good for them, but actually will absolutely improve their business on the back of the fact that a lot of these B2B customers or these B2B businesses are actually beginning to think about going direct to consumer as well.
And actually, you’re seeing manufacturing companies that are now branding their actual products and skipping over the retailers going direct-to-consumer. So I think there’s a lot of growth left in front of us, not just on GMV, but also on the merchant count side.
I’ll pick up on the international expansion part because we’ve seen a number of software companies that have done an excellent job scaling in the United States. And then they look to scale internationally, and they find that the same economies of scale maybe don’t apply because you need a more regionalized approach, more localized approach. To what extent is that true for Shopify? Compare and can trust what you’ve done internationally thus far with the scaling that you’ve seen in the U.S. and North America.
There are markets where Shopify has 100% product market fit right now, whereby right now, as we sit here, everything they need to run their business is fully ready to go, and we simply need to turn on those engines. And we turn on those engines in a few ways. One is obviously spending money on marketing. Another way is to activate a large community of agencies and freelancers and third parties who refer us business.
By the way, there’s other markets where they just weren’t talking to us because they wanted to work with Deloitte and Accenture. And so the reason that we announced partners to Deloitte Digital and Accenture is because there are some merchants who fundamentally want to work with the systems integrator before they pick their commerce provider.
So the way we think about international is find places whereby the product has product market fit, where there’s existing pent-up demand, and we know we can go to market without any major changes to our business model. It’s the reason why Western Europe has been a big focus for us, and you’ll see that there has been a large part of our new merchant growth is coming from outside our core geographies.
But it’s also the reason why we don’t think we’re ready for prime time in Latin America. There’s a lot of work to be done there on the payment side, on the fulfillment side, on the app side of things. And so we’re trying to take a little bit more of a scientific approach to say this market, if you sort of quantify product market fit, pent-up demand, partner relationships, ability to execute, this is a 9 out of 10, let’s go there. That’s a 3 on 10, let’s actually wait for that one.
As part of your efforts to go international, there was a change in the pricing model in May, more localized pricing…
Yes. Not change on the pricing model, but there are certain places where you’ve all heard of the big MEK index. There are certain places where charging $29, turns out to be a great deal of it. And so we are now experimenting at certain places whereby if we reduce the cost of onboarding into Shopify, what ends up happening 12, 18 months later.
The goal, again, is to make it so easy, whether it’s the complexity of technology or it’s affordability to onboard to Shopify. And then we get effectively the ones that are successful, will take payments and take capital, they’ll upgrade to plus eventually. And so remember, every new merchant on Shopify from a marginal cost perspective is simply a line item of database. It doesn’t cost us very much once we acquire them. And in some places, there is opportunity for us to acquire them at a very low rate. And so we want as many people at the top of funnel as possible because we can mine the ones that will be successful longer term.
I’m curious, have you already seen an impact to uptake because of the more localized pricing strategy? Or is it more of an 18-month journey?
You will hear more about that.
Excellent. I think we’ve covered a number of topics. Thank you so much. Is there 1 or 2 things that you think are most underappreciated about the Shopify story that we heard today?
I mentioned this at the beginning, but I think it’s a really important point. This — like no one talked about Shopify as a retailer because we’re not really a retailer. But I think what gets missed often is that the scale of this business, the fact that we can walk into a shipping company and demand rates that Walmart is demanding or targets demanding and then give those rates to a small business and keep a little bit for ourselves as well.
At the same time that is happening, every 60 seconds or so are brand-new entrepreneurs in their first sale on Shopify. So it’s not just that we’re expanding our piece of the pie, we’re actually growing the pie itself by encouraging more people to try their hand and entrepreneurship.
Maybe the last thing is just maybe repetitively, every merchant needs something different from Shopify when they get started. So they come for one particular problem to solve. They want to sell online or they want to get access to Shop Pay or they want something that is particular to their needs. What’s really cool is that we see very quickly as they grow, we’re able to take on more and more of their business areas. And we’re able to do it in a way that is all centralized in one — like it’s a central nervous system of their entire business.
And there are competitors out there that take each of these pieces. There’s a lot of point-of-sale companies. There’s a lot of e-commerce companies. There’s lots of payments companies. There’s a ton of buy now, pay later companies. But bringing it all together into one centralized place where they have a single view of their entire business, I think that makes us really, really unique.
And I think the reason that you don’t see churn off the platform where you go into — you’re an online store and you’re browsing through and at the end of the check and you see Shop Pay, you’re like, wow, Shopify is actually powering my favorite brands, is because we make the important — really, really easy. And then everything else they want is also possible.
We didn’t talk really about the app ecosystem, but just as an aside, I mean, what Shopify also provides is 80% of what every merchant needs out of the box. And then if you have a particular need for your business, the reason we have 100% product market fit across the board is because we have these 8,000 app developers all over the world always thinking about how to make Shopify better.
So when you combine all these things, the 10% of e-commerce, plus the 60-second new entrepreneurs created, plus the fact that we have this incredible ecosystem and the centralized operating system model, I think you end up with a really, really compelling product. And I think that’s the reason why, hopefully, it will be around 100 years.
Thank you so much for your time. Thanks, everyone, for being here.