Why Amazon Can’t Beat Shopify
Two of the most basic questions in business are: Who is your customer? How will you keep your current customers buying from you?
These questions come to mind in considering Amazon AMZN and its competition with Shopify. The answers to those questions are particularly challenging for Amazon.
If Amazon’s customer is the merchant who sells goods to consumers — which is the customer of its Marketplace business, then Amazon is losing ground to Shopify. That’s because Amazon keeps its eye on its most successful merchants and often introduces its own similar products — at a much lower price — to compete with the merchants.
Depending on the quality of Amazon’s version, that knockoff could be good for consumers and bad for the merchant.
By contrast, Shopify’s sole customer is the merchant, according to the New York Times Magazine. And merchants are leaving Amazon for Shopify.
Now, the Wall Street Journal, reports that Amazon is seeking to neutralize Shopify.
Sadly for Amazon, the ambiguous definition of its customer means it can’t wipe out Shopify unless it stops using its market power to raise the fees it charges merchants while knocking off the products of its most successful third-party sellers.
MORE FOR YOU
Amazon’s Third Party Marketplace Business
Since 1999, when Amazon — whose stock had risen 69% in 2020 as of December 22 — first opened up its marketplace in 1999 to third-party sellers, 1.7 million of them have signed up — attracted to Amazon’s huge base of consumers, high sales volumes and its ability to fulfill orders.
Amazon’s Third-Party Marketplace enables third-party sellers to display their products and prices on Amazon’s website. Once a consumer places an order, Amazon handles the delivery and after-sales customer service.
Amazon charges merchants a high price for these services. A clothing merchant that lists an item on its Marketplace for $50 could cede as much as $20 of the proceeds to Amazon. How so? According to the Times, $8.50 worth of the proceeds go to Amazon’s sales commission, $6.50 to advertising, and about $5.00 to its delivery service — Fulfillment by Amazon — which stores, picks and packs the merchant’s inventory.
This has become an increasingly important business for Amazon. Between 2015 and 2019, revenue from the marketplace increased from 14.9% to 19.2% of Amazon’s total revenue, according to MarketPlacePulse.
The third-party seller services revenue grew faster than Amazon’s retail operations taking over a bigger share of total revenue. Third parties paid Amazon $53.7 billion in fees in 2019 — nearly 26% more than the year before. Indeed, by November, the Times estimated that 60% of “commercial activity” on Amazon came from third-party sellers.
In addition to giving up some 40% of their revenues, third-parties cede to Amazon strategic assets that could endanger their survival. By far the most important of these is the third party’s relationship with the consumers who purchase their goods.
Merchants have little brand recognition and weak bargaining power against Amazon. For example, Amazon ships the third party products in its own envelopes or boxes, highlights rival vendors on its site, and extracts extra fees for early reviews and dedicated account managers, noted the Times.
Moreover, Amazon monitors and collects pricing data and until 2019, blocked merchants from offering their goods at a lower price outside of Amazon. The company told the Times its current policy is intended to prevent “practices that harm customer trust.”
How Do These Practices Threaten Third-Party Sellers?
If you’re wondering why this is a bad deal for merchants, consider the case of Pirate Trading. According to the Journal, around 2010 Pirate’s owner Dalen Thomas said that his company sold over $3.5 million worth of its Ravelli-brand camera tripods on Amazon.
In 2011, Amazon launched competing products under its AmazonBasics label. Specifically, Thomas said that Amazon launched its own versions of six of its most popular tripods. He ordered one of the Amazon tripods and found that it employed Pirate Trading’s design, had the same components, and used the same manufacturer, according to the Journal.
Thomas decided it was time to exit the tripod business. How so? Amazon set its price for the tripod clone below what Thomas paid his manufacturer to make Pirate’s version.
He told the Journal that decided to exit the business when he calculated that it would be cheaper to purchase Amazon’s clone tripod, repackage and resell it than to pay its manufacturer to make it.
Amazon cited authenticity issues as the reason it stopped selling Pirate Trading tripods that competed with the AmazonBasic clones. In 2015, Thomas said, Amazon suspended all Ravelli products. Amazon told the Journal that “AmazonBasics tripods don’t violate any intellectual-property rights.”
What Propels Shopify’s Growth
Stories like this create an opening for services aimed at merchants that don’t want to suffer Pirate Trading’s fate.
That’s where Ottawa, Ontario-based Shopify comes in. It’s clearly doing something right. Since going public in May 2015, Shopify shares have risen 42.7-fold to $1,237 apiece and they’ve outgrown Amazon stock so far in 2020 — rising 203%.
About a million small- and medium-size businesses pay Shopify $29 a month for the basic software plus a 2.9% per-transaction credit-card processing fee. 7,100 Shopify merchants pay thousands of dollars a month to subscribe to Shopify Plus — a customizable version that makes up a quarter of Shopify’s monthly recurring revenue, according to the Times.
Shopify has been expanding its so-called back office services —including logistics, shipping and fulfillment. In 2019, it launched Shopify Fulfillment Network by partnering with “seven existing third-party logistics providers” and upgrading their computing resources to work with the Shopify platform.
Shopify revenue has grown speedily. In the third quarter of 2020, Shopify’s revenue nearly doubled to $767.4 million — $104 million more than analysts had been expecting, according to DowJones.
With a 109% increase in gross merchandise volume to $30.9 billion, $522.1 million worth of that revenue came from its merchant-solutions while $245.3 million came from subscription revenue driven by new merchants joining the service, noted DowJones.
Success in e-commerce demands three skills:
- Marketing to get customers to the online store;
- Software to take payments, place orders, and monitor shipping; and
- Manufacturing, warehousing; and shipping to deliver the goods to the destination specified by the customer.
Shopify does not handle the marketing — which means that the merchant maintains control over the customer relationship. Shopify does provide the software and services for storage and fulfillment. If a merchant sells a product for $10 on a Shopify store, they pay 59 cents for payment processing and “maybe a few dollars more for storage and fulfillment,” according to the Times.
If a merchant is good at designing a product that customers want and marketing it effectively, Shopify is a better platform. Otherwise, merchants are willing to give up more to Amazon — which provides both marketing, store operations, and order fulfillment.
If you excel at either of two ways to reach e-commerce customers, Shopify could be a great partner for a merchant.
One way to reach consumers — particularly members of Gen Z and millennials — is to be an Instagram or Snapchat influencer. The Times reported that 86% of these generations would gladly post content for money and 54% would be social media influencers.
A case in point is Kylie Jenner who has turned her existing social media audiences into a “billion-dollar e-commerce businesses seemingly overnight.” Consumers are eager to pay for such brands as long as they confer the magic feeling of being linked to a celebrity.
Another way to market is to buy ads on social media. While that strategy worked well between 2015 and 2019, it has become too expensive for all but the most differentiated consumer brands.
As the Times noted, in the recent past, a merchant operating on Shopify could pocket a $50 profit on a sweater it sold to consumers for $80. The merchant would pay $15 to manufacture it and another $15 to market it on Facebook.
By 2020, Facebook raised its advertising rates to $75 — turning that $50 profit into a loss. Facebook also wiped out the profits for brands that could keep their customer acquisition costs under control. As the Times wrote, when such brands boosted their Facebook spending from $500 to $5,000, they lost money because the audience they were targeting remained about the same size.
Can Amazon’s Project Santos Nullify Shopify?
Despite the challenges of succeeding as a Shopify merchant, enough of them are growing to have put Shopify ahead of Amazon’s third-party business. How so? The Journal reported that over Black Friday weekend, Shopify’s small retailers sold $5.1 billion worth of merchandise — surpassing Amazon’s third-party sellers by $300 million.
While Amazon has dismissed its significance for years, in the past 12 months Shopify has been winning more of Amazon’s merchant customers. The reason? Amazon’s commissions have increased from 19% of sales in 2015 to 30%, according to the Institute for Local Self-Reliance.
The Journal reported that Amazon has created a “top-secret task force” dedicated to studying and copying parts of Shopify. Amazon appointed Peter Larsen, its vice president, consumer, to lead the initiative — dubbed Project Santos. In October, Larsen’s team presented its findings to CEO Jeff Bezos who was enthusiastic about the prospects for stemming merchant defections to Shopify.
Will Amazon wipe out Shopify? One canary in the coal mine is Shopify customer, Allbirds — a maker of “popular shoes using natural and recycled materials,” according to the Journal.
People who buy shoes from Allbirds are doing more than protecting their feet. As the Times wrote, they are making a statement to themselves and the world that they are “card-carrying member(s) of the technorati.”
In theory there are two ways to compete in an industry: be a differentiator in which you offer consumers more value for which they are willing to pay a price premium — or be a low cost producer — providing consumers a decent product at a much lower price.
Allbirds sees itself as a differentiator. Joey Zwillinger, Allbirds’s co-founder and co-CEO, told the Times that the company will not sell on Amazon or Foot Locker FL because that would damage “its brand and pricing power.”
Zwillinger sees Amazon as a low cost producer. “Amazon is designed to commoditize products to the lowest common denominator of what they stand for. They would love to devolve us into a feature-and-benefit set and then put every knockoff in the world next to us, and then just drive everybody down to the lowest price, even if you’re sacrificing quality,” he told the Times.
That is what Amazon did to Allbirds. In 2019, the Journal reported, Amazon launched the Galen — a shoe the looks the same as the Allbirds’ bestseller, lacks the environmentally friendly materials, and is priced over 50% below the Allbirds shoe.
An Amazon spokesman told the Journal that its Galen shoe “didn’t infringe on Allbirds’ design” and that “offering products inspired by the trends to which customers are responding is a common practice across the retail industry.”
What Amazon did to Allbirds makes it clear that it is not keen on allowing its most successful third-party merchants to survive.
Amazon delights in using merchants as an R&D outlet that helps identify successful products that it can clone and sell at huge discounts. If Amazon’s consumers lap up its merchant knockoffs and the merchant does not survive, so be it.
If consumers flock from the Allbirds’s $95 shoe to the $45 Amazon knockoff, then Allbirds is in trouble — and if such Shopify merchants are similarly targeted by Amazon’s low cost producer strategy, then Shopify is in trouble.
Are there enough consumers willing to pay a price premium for Allbirds’s shoes? If so, Allbirds should be fine.
As Geekwire wrote in November 2019, “You get what you pay for. If you want better materials, the brand name, and care more about sustainability, the Allbirds are for you. If you really just want that wool look, don’t want to spend an extra $50, and don’t mind some minor flaws, Amazon 206 Collectives are the way to go.”
Shopify’s customer is the merchant, Amazon’s is the consumer. The corollary is that Amazon will continue its shabby treatment of its third-party sellers. Therefore Shopify will keep growing faster than Amazon.