Welcome to Episode 4 of Beyond the Cart! In this episode, I highlight key developments in the Shopify ecosystem over the past year and their outsized impacts on the future of commerce enablement. I chose to write this blog about Shopify because they have considerable market influence and they have redefined the e-commerce category over the past decade. There is an impressive track record of value creation at the application level in the Shopify ecosystem which I expect to continue going forward.
It All Starts With The Shopify Effect
The Shopify Effect is the ability for anyone to stand-up an e-commerce store quickly, democratizing access to digital retail. While this first targeted entrepreneurs and SMBs, Shopify’s platform has become increasingly extensible to support merchants as they scale over time.
We are now seeing the second wave of the Shopify Effect: the evolution of Shopify’s platform towards more flexible platform architecture that enables third-party applications to emerge as significant standalone businesses. Along the way, Shopify is making venture investments to back winners in its ecosystem. The end goal is improving the merchant experience and further contributing to the proliferation of e-commerce and digital retail.
______________________
The Transition to Flexible Platform Architecture
Shopify’s Platform Progression
Merchants choose Shopify because they can launch an Enterprise-grade store in weeks, rather than months, with out-of-the-box products. The trade-off is less customization; historically, it was cumbersome to create custom integrations to third-party software, so Shopify products and apps had a natural appeal to merchants. Shopify has a similar unfair advantage to Apple with its app store, taking a 15-20% revenue share from developers as a fee to access users.
In the same vein of streamlining e-commerce sites, Shopify’s Merchant Services provide all the required ancillary services to be a one stop shop (eg. payments, fulfillment, financing/lending, etc.). Merchant Services are crucial to Shopify’s success – they accounted for 70% of revenues and ~60% of gross profit in 2022. With all this consolidation, the biggest threat to Shopify is getting unbundled and losing these profit pools to third parties.
Until recently, there was an organic attrition point in the Shopify framework as midmarket merchants achieved enterprise scale (~$1B of GMV), and bigger merchants wanted a more flexible e-commerce tech stack; this was the problem Shopify Plus was trying to solve. Plus offered more customizable features for merchants to tailor their e-commerce stack, but merchants still felt Plus was an out-of-the-box solution that didn’t give them enough flexibility to manage more complex needs.
Shopify realized the market pull for headless commerce required a strategic shift towards a more open ecosystem.
What is Headless Commerce?
Headless architecture means the ability for the front-end and back-end of a store to run independently.
Open-source software is the key to making headless commerce work because it allows developers to make modifications that meet their business needs. Previously, Shopify’s closed-ended software made this difficult as its backend code was off-limits for merchants (hence the need for custom integrations). The consequences of custom integrations are decreased site performance and the headaches of maintaining integrations over time. Shopify realized they needed to empower merchants with a more flexible tech stack, which led to open- source products.
Diving Head-First Into Headless Commerce with Hydrogen
Last year, Shopify made waves with the announcement of the Hydrogen framework – a react-based headless commerce stack. Hydrogen allows custom software development for storefronts (ie. the front-end) for merchants to create more dynamic and personalized user-facing experiences.
Hydrogen’s challenge is it requires a merchant who knows what they want to build and has the technical expertise to build it. But, because open-source code can be shared, I expect Shopify’s developer ecosystem to flourish. Developer communities for engineers will grow to exchange knowledge and improve their code. Merchants enhancing the shopping experience will ultimately trickle down to benefit the customer.
The first major e-commerce platform shift was the transition from monolithic to headless architecture. As we look to the future, the next wave of innovation will be centered around the concept of composable commerce and it’s about to take the market by storm.
Commerce Components by Shopify
Think of composable commerce as a customizable Lego set: you can pick and choose what bricks you want to use to build your e-commerce store – providing flexibility to get creative with it in the process. Whereas headless commerce decouples the front and back-ends, in composable commerce each component is independently strung together via API on a platform with modular infrastructure to enable microservices (Fabric provides more details on this infrastructure here and here).
Earlier this year, Shopify announced Commerce Components by Shopify (CCS) for Enterprise merchants. Merchants can now assemble the commerce experience of their choice at scale brick-by-brick. Shopify is doing all the heavy lifting, as there is no need to make remote API calls or manage your own servers as a merchant.
Arming the Rebels for a Composable Future
Merchants are empowered to create a future-proof tech stack with CCS, assembling the best-of-breed platform that best suits their needs with maximum flexibility. There is also an opportunity to customize the front-end with Hydrogen (hosted on Oxygen), make changes to the back-end with Functions, and utilize CCS to swap any other technology in and out, all with the vast array of apps in the Shopify app store at their disposal.
______________________
The Evolution of Shopify’s Build vs. Buy Strategy
Build
Shopify Editions launched in June 2022, and includes 100+ first-party Shopify apps/tools. While there are established brands and network effects with companies that exist in today’s Shopify ecosystem, there is an all-new competitive dynamic at play where third-party companies on the app store may have to compete head-to-head with Shopify equivalents.
Shopify’s first-party apps aim to accelerate the launch of a barebones e-commerce store. The expectation is the adoption of more robust products as merchants scale and their needs become more sophisticated (eg. starting out with Shopify Email and shifting to Klaviyo down the road).
Nonetheless, Editions creates competition for the “cheap and cheerful” app segment. For larger, more mature merchants, Shopify’s corporate development team has been very busy lately making investments to help champion apps in its ecosystem.
Buy/Invest
Shopify makes three distinct types of app investments:
- Venture Investments: Minority equity investments in Shopify apps (~5-10% stake), including Inovia portfolio company Bench, Tapcart, Loop Returns, and Gorgias.
- Strategic Alliances: Larger-scale equity investments (~15-20% stake), forging a strategic partnership with recipients, such as Stripe, Yotpo, Klaviyo, and Flexport.
- Acquisitions: Acquiring businesses to be integrated with Shopify’s first-party offerings where there are functional/operational gaps, such as 6 River Systems, Deliverr, Remix, and Dovetale.
I am of the opinion that Shopify has good intentions with its investment strategy. In the long run, Shopify’s investments will help accelerate e-commerce adoption by creating superior products that improve the merchant experience. Venture investments are beneficial to help boost successful apps in the Shopify ecosystem that deliver value to merchants.
There is an argument that this strategy is an “expansive pie” activity that makes it easier for Shopify merchants to grow their business and increases e-commerce penetration. I agree with this framing at a high level. But, in order to remain intellectually honest, it’s also important to consider the second-order consequence of playing favorites when considering Shopify’s strategic alliances and acquisitions, which is that it disrupts the competitive landscape.
An example that illustrates this dilemma is the process of selecting the default 3PL for the Shopify Fulfillment Network (SFN). Since inception, Shopify has struggled to build market-leading fulfillment capabilities. There was intense competition between Shipbob and Deliverr as they jockeyed for pole position in the App Store as the top 3PL player.
Shopify acquired Deliverr for $2.1B to be fully integrated with SFN, signaling they are willing to pay up to compete with the likes of Amazon Fulfillment. Though this is a phenomenal outcome for Deliverr, it leaves Shipbob to fend for itself. The more SFN vertically integrates, the more difficult it becomes for players to compete as one link in the end-to-end supply chain.
______________________
Composable Future of E-commerce
At Inovia, we believe the future of commerce is composable. Given all the recent developments at Shopify, below is some food for thought on potential outcomes in the commerce enablement market:
Platform Agnostic Future
I believe there is a future of composable commerce that is platform agnostic. A catalyst to this transition is the emerging middleware category, with players like Rutter and Gadget, enabling merchants to create a custom composable stack. This can go either way for Shopify:
- Tailwind: Composable commerce enables more merchants to access Shopify’s products and apps from other platforms. There is also a lower switching cost of moving to Shopify from another headless platform (eg. BigCommerce, Magento).
- Headwind: Easier migration between platforms means Shopify will need to maintain a competitive edge to encourage retention. There is potential for a race to the bottom as platforms compete on price to attract new customers.
For apps, a platform agnostic future creates meaningful TAM expansion by removing the friction of integrating into another platform. This is going to be the purest form of best-of-breed, where the best applications will emerge as the category killer.
Shopify’s App Store Monetization Coming Under Pressure
An open source future with composable commerce could threaten Shopify’s 15-20% revenue share in its app store. More development outside of the Shopify ecosystem likely means fewer opportunities for monetization on apps. It would come as no surprise if Shopify finds new monetization opportunities for its app store, such as ads for preferred placement in search results (ie. paid search ads on Google).
Growing Shopify’s Developer Ecosystem
Shopify will need to bolster its developer ecosystem in order to survive. Forming developer communities will be crucial to accelerate product development. For reference, 460K+ developers and community members use Adobe Exchange to further extend the functionality of Adobe Experience Cloud. An open-source future puts more power in the hands of developers and Shopify needs to be in good standing with them to remain at the forefront of innovation.
Where Does That Leave Us?
With all that said, we remain bullish on e-commerce in the long run. Our view is that in ten years e-commerce will feel completely different than it does today. Although online shopping is becoming increasingly commoditized, successful brands will prioritize transparency to build trusting relationships with consumers.
That’s a wrap for Episode 4 of Beyond the Cart! Please see our website to read more about our commerce portfolio companies and more thoughts on the topics.