Five months and $134 billion in market cap ago (before the stock slipped by 68%), Bloomberg Businessweek purported to explain How Shopify Outfoxed Amazon to Become the Everywhere Store. One of the key parts of the story was how Shopify pulled one over on Amazon seven years ago:

An even more critical event came a few months after the IPO. Amazon also operated a service that let independent merchants run their websites, called Webstore. Bang & Olufsen, Fruit of the Loom, and Lacoste were among the 80,000 or so companies that used it to run their online shops. If he wanted to, Bezos surely had the resources and engineering prowess to crush Shopify and steal its momentum.

But Amazon execs from that time admit that the Webstore service wasn’t very good, and its sales were dwarfed by all the rich opportunities the company was seeing in its global marketplace, where customers shop on Amazon.com, not on merchant websites…In late 2015, in one of Bezos’ periodic purges of underachieving businesses, he agreed to close Webstore. Then, in a rare strategic mistake that’s likely to go down in the annals of corporate blunders, Amazon sent its customers to Shopify and proclaimed publicly that the Canadian company was its preferred partner for the Webstore diaspora. In exchange, Shopify agreed to offer Amazon Pay to its merchants and let them easily list their products on Amazon’s marketplace. Shopify also paid Amazon $1 million—a financial arrangement that’s never been previously reported.

Bezos and his colleagues believed that supporting small retailers and their online shops was never going to be a large, profitable business. They were wrong—small online retailers generated about $153 billion in sales in 2020, according to AMI Partners. “Shopify made us look like fools,” says the former Amazon executive.

If only we could all make such excellent mistakes; Amazon’s move looks like a strategic masterstroke.

Shopify’s Revenue Streams

Three major things have changed, will change, or should change about Shopify’s business in the years since the company made that deal with Amazon.

What has changed is the composition of Shopify’s business. While the company started out with a SaaS model, the business has transformed into a commission-based one:

“Subscription Solutions” are Shopify’s platform fees, including the cost to use the platform (or upgrade to the company’s Pro offering), commissions from the sales of themes and apps, and domain name registration. “Merchant Solutions”, meanwhile, are all of the fees that are generated from ongoing sales; the largest part of this are payment processing fees from Shopify Payments, but other fees include advertising revenue, referral fees, Shopify Shipping, etc.

It’s the shipping part that is line for big changes: while Shopify first announced the Shopify Fulfillment Network back in 2019, it is only recently that the company has committed to actually building out important pieces of said network on its own, the better to compete with Amazon’s full-scale offering.

As for what should change, I argued back in February that Shopify needed to build out an advertising network; this recommendation is more pertinent than ever, in large part because the second item on this list might be in big trouble.

Buy With Prime

From the Wall Street Journal:

Amazon.com Inc. is extending some of the offerings of its popular Prime membership program to merchants off its platform with a new service that embeds the online retailing giant’s payment and fulfillment options onto third-party sites. Called Buy with Prime, the service will allow merchants to show the Prime logo and offer Amazon’s speedy delivery options on products listed on their own websites…

The company said the Buy with Prime offer will be rolled out by invitation only through 2022 for those who already sell on Amazon and use the company’s fulfillment services. Later, Amazon plans to extend Buy with Prime to other merchants, including those that don’t sell on its platform. Participating merchants will use the Prime logo and display expected delivery dates on eligible products. Checkout will go through Amazon Pay and the company’s fulfillment network. Amazon will also manage free returns for eligible orders.

This is a move that you could see coming for a long time; back in 2016 I wrote an article called The Amazon Tax that explained that the best way to understand Amazon as a whole was to understand Amazon Web Services (AWS):

The “primitives” model modularized Amazon’s infrastructure, effectively transforming raw data center components into storage, computing, databases, etc. which could be used on an ad-hoc basis not only by Amazon’s internal teams but also outside developers:

This AWS layer in the middle has several key characteristics:

• AWS has massive fixed costs but benefits tremendously from economies of scale
• The cost to build AWS was justified because the first and best customer is Amazon’s e-commerce business
• AWS’s focus on “primitives” meant it could be sold as-is to developers beyond Amazon, increasing the returns to scale and, by extension, deepening AWS’ moat

This last point was a win-win: developers would have access to enterprise-level computing resources with zero up-front investment; Amazon, meanwhile, would get that much more scale for a set of products for which they would be the first and best customer.

As I noted in that article, the AWS model was being increasingly applied to e-commerce as Amazon shifted from being a retailer to being a services provider:

Prime is a super experience with superior prices and superior selection, and it too feeds into a scale play. The result is a business that looks like this:

That is, of course, the same structure as AWS — and it shares similar characteristics:

• E-commerce distribution has massive fixed costs but benefits tremendously from economies of scale
• The cost to build-out Amazon’s fulfillment centers was justified because the first and best customer is Amazon’s e-commerce business
• That last bullet point may seem odd, but in fact 40% of Amazon’s sales (on a unit basis) are sold by 3rd-party merchants; most of these merchants leverage Fulfilled-by-Amazon, which means their goods are stored in Amazon’s fulfillment centers and covered by Prime. This increases the return to scale for Amazon’s fulfillment centers, increases the value of Prime, and deepens Amazon’s moat

My prediction in that Article was that Amazon’s burgeoning logistics business would eventually follow the same path:

It seems increasingly clear that Amazon intends to repeat the model when it comes to logistics…how might this play out? Well, start with the fact that Amazon itself would be this logistics network’s first-and-best customer, just as was the case with AWS. This justifies the massive expenditure necessary to build out a logistics network that competes with UPS, Fedex, et al, and most outlets are framing these moves as a way for Amazon to rein in shipping costs and improve reliability, especially around the holidays.

However, I think it is a mistake to think that Amazon will stop there: just as they have with AWS and e-commerce distribution I expect the company to offer its logistics network to third parties, which will increase the returns to scale, and, by extension, deepen Amazon’s eventual moat

Today Amazon’s logistics is massive and fully integrated from the fulfillment center to the doorstep, even though it only serves Amazon; the obvious next step is opening it up to non-Amazon retailers, and that is exactly what is happening.

Beyond Aggregation

At first glance, this might seem like a bit of a surprise; after all, Stratechery is well known for describing Aggregation Theory, which is predicated on controlling demand. In the case of Amazon that has meant controlling the website where customers order goods — Amazon.com — even if those goods were sold by 3rd-party merchants. Why would Amazon give that up?

The reasoning is straightforward: while Amazon has had Aggregator characteristics, the company’s business model and differentiation has always been rooted in the real world, which, by extension, means it is not an Aggregator at all. I noted in 2017’s Defining Aggregators that Aggregators benefit from zero marginal costs, which only describes a certain set of digital businesses like Google and Facebook:

Companies traditionally have had to incur (up to) three types of marginal costs when it comes to serving users/customers directly.

• The cost of goods sold (COGS), that is, the cost of producing an item or providing a service
• Distribution costs, that is the cost of getting an item to the customer (usually via retail) or facilitating the provision of a service (usually via real estate)
• Transaction costs, that is the cost of executing a transaction for a good or service, providing customer service, etc.

Aggregators incur none of these costs:

• The goods “sold” by an Aggregator are digital and thus have zero marginal costs (they may, of course, have significant fixed costs)
• These digital goods are delivered via the Internet, which results in zero distribution costs
• Transactions are handled automatically through automatic account management, credit card payments, etc.

This characteristic means that businesses like Apple hardware and Amazon’s traditional retail operations are not Aggregators; both bear significant costs in serving the marginal customer (and, in the case of Amazon in particular, have achieved such scale that the service’s relative cost of distribution is actually a moat).

Amazon’s control of demand has been — and will continue to be — a tremendous advantage; Amazon not only has power over its suppliers, but it also gets all of the relevant data from consumers, which it can feed into a self-contained ad platform that is untouched by regulation from either governments or Apple.

At the same time, limiting a business to customer touchpoints that you control means limiting your overall addressable market. This may not matter in markets where there are network effects (which means you appeal to everyone) and you are an Aggregator dealing with zero marginal costs (and thus can realistically cover every consumer); in the case of e-commerce, though, Amazon will never be the only option, particularly given The Anti-Amazon Alliance working hard to reach consumers.

A core part of the Anti-Amazon Alliance are companies that have invested in brands that attract customers on their own; these companies don’t need to be on Amazon fighting to be the answer to generic search terms, but can rather drive customers to their own Shopify-powered websites both organically and via paid advertising (Facebook is a huge player in the Anti-Amazon Alliance). Still, every customer that visits these websites has an Amazon-driven expectation in terms of shipping; Shippo CEO Laura Behrens Wu told me in a Stratechery interview:

Consumers have those expectations from Amazon that shipping should be free, it should be two days, and whatever those are expectations are, returns should be free. That is still carried over when I’m buying on this branded website. If the expectations are not met, consumers decide to buy somewhere else…Merchants are constantly trying to play catch up, whatever Amazon is doing they need to follow suit.

Now Amazon has — or soon will have, in the case of Shopify-only merchants — a solution: the best way to get an Amazon-like shipping experience is to ship via Amazon. And, in contrast to the crappy Webstore product, you can keep using Shopify and its ecosystem for your website. Amazon may have given away business to Shopify in 2015, but that doesn’t much matter if said business ends up being a commoditized complement to Amazon’s true differentiation in logistics. That business, thanks to the sheer expense necessary to build it out, has a nearly impregnable moat that is not only attractive to all of the businesses competing to be consumer touchpoints — thus increasing Amazon’s addressable market — but is also one that sees its moat deepen the larger it becomes.

Shopify’s Predicament and Amazon’s Opportunity

The reason this announcement is so damaging to Shopify goes back to the transformation in the company’s revenue I charted above: Amazon’s shipping solution requires the customer to pay with Amazon; I love Shop Pay’s checkout process, but it’s not as if I don’t have an Amazon account with all of my relevant details already included, and I absolutely trust Amazon’s shipping more than I do whatever option some Shopify merchant offers me. If I had a choice I’m taking the Amazon option every time.

Granted, I may not be representative; I’m a bit of a special case given where I live. What is worth noting, though, is that every transaction that Amazon processes is one not processed by Shopify, which again, is the company’s primary revenue driver. Moreover, the more volume that Amazon processes, the more difficult it will be for Shopify to get their own shipping solution to scale. This endangers the company’s current major initiative.

That is why I think the company needs to think more deeply than ever about advertising: the implication of Amazon being willing to be a services provider and not necessarily an Aggregator is that Amazon is surrendering some number of customer touchpoints to competitors; to put it another way, Amazon is actually making competitive customer touchpoints better — touchpoints that Shopify controls. Shopify ought to leverage that control.

That noted, there is a potential wrench in this plan: if Shopify doesn’t own payment processing, will they have sufficient data to build a competitive conversion-data-driven advertising product? Amazon — and Apple — would likely argue that that data is Amazon’s, but the merchant will obviously know what is going on (by the same token, will Amazon be able to tie this off-platform conversion data back to its own advertising product? It’s not clear what would stop them).

Shopify has two additional saving graces:

• First, the fact that Amazon will be able to collect data is a big reason for many merchants not to use Amazon’s new offering. Shopify’s offering will always be differentiated in this regard.
• Second, as the announcement noted, this is going to take Amazon a year or two to fully roll out, and lots of stuff can change in the meantime.

Moreover, while AWS has always been excellent at serving external customers — which it did before Amazon.com ever actually moved over — Amazon’s off-Amazon.com merchant offerings have never been particularly successful (including the aforementioned Webstores).

With that in mind, I think it’s meaningful that “Buy With Prime” is the first major initiative of new CEO Andy Jassy’s regime; I don’t think it’s an accident that it is so clearly inspired by AWS. AWS’s strength is its focus on infrastructure at scale; successfully moving e-commerce beyond aggregation to the same type of service business model would put his stamp on the company in a meaningful way, and, contra that quote in Bloomberg Businessweek, mark Jassy as nobody’s fool.