Shopify: With the shell of Youzan and the core of Alipay, how can it grow freely?

In our in-depth research series on Shopify, in the previous article "Seemingly Taobao, Actually Alipay", we initially discussed the company's development history, business composition, as well as the true sources of revenue and profit. The core viewpoint we reached is that Shopify is a fintech company with a core business in payments disguised as an "e-commerce independent site operation service provider", positioning itself as a merchant acquirer in the payment chain. In other words, Shopify's advantage lies in building e-commerce independent site storefronts, operating SaaS tools, and related business ecosystems as a fintech company to acquire customers and create differentiation barriers.

This article, as the second part of the series, will delve into the industry from the broadest payment industry, to the fintech sub-sector characterized by "payment + technology", and further to the precise sub-track of "e-commerce SaaS + payment" where Shopify operates. It will explore the development direction, competitive landscape, and Shopify's position in different levels of the industry from broad to precise. Below is an overview of the conclusions we have drawn:

The role of merchant acquirer that Shopify plays is currently dominated by banks and traditional large payment institutions (accounting for 70%~80% of the payment share), while the market share of emerging payment institutions like Shopify is still small and scattered, with their main customers generally being SMEs and small businesses.

Although small and medium-sized enterprises (with annual sales of less than $1 million) that Shopify and other fintech institutions mainly serve only contribute 20% of the total U.S. payment volume, these small companies actually contribute nearly 60% of the payment processing fees, as payment institutions charge small businesses payment processing fees close to 4~5 times that of large enterprises. In other words, the revenue and profit potential from serving small businesses is not low.

The main evolution direction of the merchant acquirer sector in the past has been internal consolidation within the industry (major banks or intermediary clearing institutions integrating merchant acquiring functions and acquiring independent merchant acquirers). This process has largely concluded. One of the current main development directions in the industry is "payment +", integrating various additional services outside of payment functions (such as store management, online operations, customer marketing, etc.) to attract merchants differentially. In the future, as "payment +" captures more market share from traditional institutions, although the long-term growth center of the payment industry is slightly higher than nominal GDP growth, "payment +" is expected to grow at a high double-digit rate, with a more optimistic outlook.

Within the "payment +" sector, players generally have more differentiation, with their own advantages in services and customer base (unlike traditional homogeneous payments). Shopify's main advantage lies in independent e-commerce merchants. That is, they are not attached to e-commerce platforms, but are responsible for customer acquisition, operations, and fulfillment for online businesses on their own. However, unlike in China, in the United States, independent e-commerce merchants almost occupy half of the e-commerce industry, making them the mainstream shopping channel.

The biggest difference between independent e-commerce merchants and platform-based merchants lies in the source of consumer traffic, with the former mainly obtaining traffic directly from search, social, and entertainment platforms, while the latter mainly rely on platform distribution. With the changing habits of residents in online content consumption, currently, obtaining traffic from social and other platforms is the most popular growth direction in the e-commerce industry in both China and the United States. (In China, live streaming e-commerce, which accounts for over 30% of the market share, is essentially social e-commerce.)

The more open traffic ecosystem of overseas social platforms, and the ability for consumers to easily shop directly from third-party merchants on social platforms, make the independent e-commerce model more profitable and autonomous for merchants compared to joining platforms. This also means that Shopify actually lacks the ability to drive traffic to merchants, a fatal flaw in China but not a problem overseas.

In China's relatively closed traffic ecosystem, there is almost no room left for independent merchants to survive. WeChat and Yun, both e-commerce service providers, have a market value of less than 5 billion. In the United States, independent sites are mainstream formats for both merchants and consumers, allowing Shopify's business model to thrive and prosper.

Therefore, seizing the future directions of "payment +" and "social e-commerce," Shopify, despite a significant drop, still has a market value of over 500 billion, a hundred times that of its counterparts in China. It can be said that a slight difference leads to a huge loss.

The following is the detailed content:

I. Trillion-dollar payment track, where does Shopify fit in?

Following the research order from broad to specific in the previous section, the first issue to be explored in this article is, from the perspective of the entire payment industry, the role of the acquiring bank to which Shopify belongs in the entire payment chain, the types of players in the industry ( and which category Shopify belongs to ), the market position and share of different types of players, and the current development direction of the entire acquiring bank sector?

1. Acquiring Bank (Merchant Acquirer) - Shopify's Role in the Payment Chain

In general, payments are a 2B industry with a long chain, specialized division of labor, and numerous participants. Combining our previous introduction to the payment industry, the service providers involved in the entire (non-cash) payment chain can be broadly divided into three categories. The first category is the acquiring institution (Merchant Acquirer). The first category is the "front office" department that directly contacts, solicits, and serves merchants in the entire chain, with Shopify belonging to this category and being the main focus of our study in this article.

The second category is the middle clearing service institutions, including processors and card organizations, which connect the "front office" acquiring institutions with the "back office" banks. They are responsible for aggregating merchant payment instructions, processing them, and transmitting them to the banks for execution. In the entire chain, the number of middle clearing institutions is the least and their share is relatively concentrated. The third category is banks (issuing banks and acquiring banks), the actual fund managers responsible for completing the fund transfer between the two parties in a transaction.

However, even within the merchant acquiring institution sector, there are various types of participants, broadly categorized into 4 types:

The first type is the banks' own business development teams or dedicated subsidiaries at the bottom of the payment chain, directly performing merchant acquiring functions and soliciting merchants, such as JP Morgan & Chase, BofA, etc.

The second type is the intermediate level processors that consolidate acquiring functions upwards, providing services to third-party acquiring institutions and directly soliciting and connecting terminal merchants.

The third type can be classified as traditional acquiring institutions, solely responsible for merchant solicitation and service, while the actual payment instruction processing is handled by cooperating "middle and back office" intermediaries and banks. They mainly acquire merchants through traditional channels such as offline visits and "street sweeping."

The fourth type is the "payment +" acquiring institutions that combine other technological products with payment functions. Apart from payments, they also provide software tools for store management, marketing, or offer value-added services such as business loans, BNPL financial lending, entering the payment industry through cross-industry technology. Popular examples include Square, PayPal, and Shopify, which are part of this category.

In terms of market structure and market share distribution, currently in the entire U.S. acquiring system, approximately 70% to 80% of the market share is still held by banks and large integrated institutions, while independent acquiring institutions and fintech payment institutions only have a market share of around 20% to 30%. Apart from the top 8 large banks and acquiring institutions affiliated with large intermediaries, the market share of acquiring institutions in the industry's midsection and below is less than 1% From this, it can be seen that the "technology + payment" fintech companies, whether viewed as a whole or individually, still hold an absolute minority share in the entire acquiring market, and the market share is quite dispersed. Even fintech leaders like Square and Shopify are still considered insignificant players in the overall payment industry (classified as others).

However, from another perspective, even without considering the industry's own growth, if the current market share ratio of traditional institutions vs. fintech companies, which is approximately 7:3, evolves into 5:5, the size of fintech payment institutions could increase by nearly 70%, with the potential still being considerable.

Internal consolidation within the industry has come to a halt, while cross-industry integration is on the rise.

From the previous discussion on the types and shares of traditional acquiring merchants, we can see the development directions of the payment industry in the past and present at two macro levels: in the past, downstream banks and intermediary service providers with larger scales generally integrated the functions of acquiring merchants along the payment chain (there are also a few cases of upstream acquiring institutions integrating intermediary merchants, such as Adyen), which is vertical integration within the industry. By integrating multiple functions into a single entity, these leading players not only retain more value/profit internally but also, with higher economies of scale and lower internal communication costs, help improve industry efficiency.

However, after large banks and intermediaries through integration have occupied 70-80% of the acquiring market, internal vertical integration within the industry has come to a halt. The current trend is mainly driven by technology companies, which, by providing various software products or services, in addition to payment functions, also offer merchants comprehensive solutions for opening stores, acquiring customers, financing, and management. With homogeneous payment functions, differentiated value-added services, and cross-industry entry into the payment industry, is currently one of the hottest industry trends.

Therefore, although there is not much room for imagination in the overall payment scale growth of the payment industry in the future, at around 6%-7% (roughly equal to the growth rate of household consumption, or GDP growth rate + inflation rate), the general industry consensus is that fintech players are expected to significantly outperform industry growth in the acquiring market in the future, with an expected growth rate of around mid to high double digits in the next 3-5 years. Banks and large intermediaries will maintain a growth rate similar to the industry, while traditional independent acquiring institutions (lacking the ability to provide additional services and not having economies of scale) will lag behind the industry and continue to lose market share

4. SME Companies - Small Share of Payment Volume, but Large Contribution to Revenue

Similar to traditional payment institutions still occupying 70-80% market share in the acquiring market, medium and large enterprises with annual payment volumes exceeding $1 million or higher mostly still collaborate with traditional payment industry players. Therefore, the customer base left for fintech payment companies is generally small and medium-sized businesses (SMEs).

According to Credit Suisse's estimation, the total payment volume of large enterprises in the United States with annual revenues exceeding $1 million amounts to $9.3 trillion, accounting for approximately 80% of the total payment volume. On the other hand, small and medium-sized enterprises (SMEs) with annual revenues below $1 million contribute only 20% of the total payment volume in the U.S. However, large enterprises have strong bargaining power, resulting in very thin margin space left for acquirers (e.g., 10 basis points or even lower). Acquirers can charge payment fees ranging from 40 to 140 basis points from numerous small and medium-sized enterprises with weak bargaining power, equivalent to 4-5 times that of large and medium-sized enterprises. Therefore, although small companies hold around 20% of the payment share, they contribute nearly 60% of the payment processing fees.

In other words, despite the clear advantages in the collaboration between traditional acquirers and medium to large enterprises, fintech acquirers, even when mainly serving small businesses, can actually generate revenue/profit margins comparable to traditional payment institutions serving large enterprises.

In summary, Shopify's position in the "payment +" (or fintech) sector is currently one of the fastest-growing segments within the payment sector, with a relatively optimistic outlook.

II. Both Fintech Payments, What Sets Shopify Apart?

1. Both Fintech but Different

As the hottest development direction in the current payment industry, within the single segmented track of "payment + X" (X representing various types of additional services), there are numerous fintech players, such as Block, PayPal, Shopify, etc., all born in this wave of "payment +" with market values ranging from billions to tens of billions of dollars.

Compared to the almost homogeneous payment functions and the scale-centric competition logic between traditional payment institutions, different fintech companies mostly have very clear advantages in customer base and segmented tracks, naturally following a path of differentiated competition. Therefore, most fintech companies do not engage in fierce direct competition with each other. Taking Block vs. Shopify covered by Dolphin Research as an example, although both companies provide payment functions + customer management (such as membership management, marketing), store management (order, fulfillment management), back-office management (human resources, wages, taxes), business financing, etc., at first glance, there seems to be no obvious difference.

For example: ① Target Users: Shopify mainly serves independent online store merchants, while Block mainly serves offline small and medium-sized stores, restaurants, etc.; ② Payment Scenarios: Shopify mainly adapts to online e-commerce payments, while Block is more focused on offline POS payment scenarios; ③ Software Service Functions: Shopify is mainly oriented towards online stores, with functions such as store building, order management, package delivery tracking, etc.; Block, on the other hand, has unique features such as store ordering, reservation, inventory management, etc.

In summary, Shopify is suitable for the operation and online payment of online store merchants, while Block is more focused on the operation and payment scenarios of offline stores, almost perfectly positioned for operational and competitive differentiation.

Of course, as mentioned earlier, the momentum of leading fintech companies expanding into omnichannel payments is still strong. For example, Shopify has also launched offline POS payment services, and Block's various store operation tools are compatible with online booking, ordering, and other scenarios. Therefore, fintech payment companies following the historical process of traditional payment companies, subsequent convergence competition, and integration are highly probable events. However, in the medium term, this trend will not yet become mainstream, after all, the market share of fintech companies in the payment field is still less than 1%~2%, and it has not reached the stage where they need to compete for merchants and market share.

2. What are the differences between independent e-commerce and centralized platform e-commerce?

Following our "traditional payment" - "payment +" - "pan-e-commerce payment" three-tier structure from broad to deep, in the above part, we focused more on Shopify's positioning in the payment industry. Below, we will focus on the perspective of the e-commerce market where Shopify operates (more precisely, independent e-commerce), discussing Shopify's business model strengths, weaknesses, and competitive landscape.

Firstly, it needs to be clarified again that Shopify is a service provider for independent e-commerce, which has significant differences from familiar centralized platform e-commerce like Amazon or Taobao. From the perspective of merchants, the main differences between the two e-commerce models include:

① Store Construction: Amazon merchant stores are built within Amazon's website or app, and merchants need to comply with the platform's standard specifications to build their stores; For Shopify merchants, they can build their own websites (addresses) and online store decorations almost without any restrictions using Shopify tools.

② In terms of traffic acquisition, Amazon acquires customer traffic as a whole through the platform, and then distributes the traffic to merchants on the platform through their centralized bidding and distribution logic (of course, merchants also have some natural traffic). Shopify merchants, on the other hand, acquire customers and traffic on their own through various channels such as search engines and social media, with a higher proportion of natural traffic.

③ Regarding payment and fulfillment, Amazon provides a one-stop payment and fulfillment service, and most merchants directly use Amazon's services. Shopify merchants, on the other hand, choose their own payment and fulfillment service providers, and Shopify does not interfere much in this aspect.

In summary, centralized platforms like Amazon provide merchants with more convenient and one-stop services, making it easier for merchants to operate, but at the cost of losing a certain degree of autonomy and having to pay higher commissions or service fees. Shopify mainly provides tools related to operations to merchants, and the actual operation processes are fully completed by the merchants themselves. In a figurative sense, for merchants, Shopify is like an assistant that needs to be paid a fixed salary and bonuses, while platform-based e-commerce is more like a shopkeeper that requires a significant share of the profits.

3. Is independent websites the mainstream format of e-commerce in the United States?

In China, independent website e-commerce seems like a "negligible" niche track. After all, the three major platform-based e-commerce platforms plus Douyin and Kuaishou collectively occupy over 90% of the domestic e-commerce market share. The situation where merchants operate independent websites is basically limited to Apple, Xiaomi, top fashion brands, and some individual sellers, with their combined market share almost negligible.

However, in the United States, the total GMV of independent website merchants served only by Shopify in 2023 reached $235.9 billion, with about 64% in North America, accounting for 13.5% of the total online retail sales in the United States, ranking second in scale among all e-commerce platforms in the United States. Therefore, what factors have led to the success of the independent website model in the United States while it is not feasible in China is an important reference for judging whether Shopify's business model can continue to be successful.

From the perspective of results, apart from Amazon's dominant position in the U.S. e-commerce market with nearly 40% market share, the market share of the second-largest individual e-commerce entity, Walmart, has plummeted to 6.4%, and players ranked 5th to 10th have market shares of only 1% to 2%. It can be seen that the U.S. e-commerce market is a fairly decentralized and long-tail market, which is different from the highly concentrated situation in our e-commerce market To put it more vividly, the e-commerce market in China can be described as "Taobao + JD + Pinduoduo + Douyin + Kuaishou ≈ everything", while in the United States, Amazon, the top 2~4 players, and others hold market shares of 40%, 10%, and 50% respectively. Many others with individual shares of less than 2% actually account for the majority of the market share at 50%. Even among the top 10 players, Apple, Kroger, as well as Walmart and Costco, belong to brands with their own online sales channels. In other words, the independent platform model is indeed the main business format of e-commerce in the United States.

4. Social e-commerce is the trend in both China and the United States

As seen from the previous content, the independent platform model can be said to be the mainstream business model in e-commerce in the United States. From the perspective of results, does this mean that the independent platform model is a better choice for merchants than joining platforms? What are the advantages and disadvantages of each model?

In the previous second section, we have mentioned that there are differences between independent platform merchants and platform-based merchants in terms of store opening, customer acquisition, and fulfillment. However, we believe that the most fundamental difference lies in where the traffic comes from during the customer acquisition phase, as the essence of e-commerce business is to first acquire traffic and then "sell" the traffic in the most optimal way and price.

In reality, since Shopify basically does not provide merchants with the ability to generate traffic, lacking this crucial value point in e-commerce operations, we (based on domestic experience) once thought that its business model had significant flaws when we first learned about Shopify. It was not until we discovered that many American merchants do not actually rely on e-commerce platforms to obtain traffic that the business model of Shopify made sense to us. In other words, we believe that whether merchants have the ability and feasible ways to bypass centralized e-commerce platforms and directly acquire traffic is the fundamental reason why the independent platform model thrives in the respective environments of China and the United States.

This then evolves into the question of what are the advantages and disadvantages for merchants in acquiring traffic from e-commerce platforms compared to social, entertainment, search, and other channels?

Although this may be a subjective question without a precise answer, first and foremost, from the perspective of traffic scale, social, entertainment, and search platforms clearly have a significant advantage over e-commerce platforms. Taking China as an example, from 2019 to 2022, the share of total online time spent on comprehensive e-commerce platforms fluctuated between 4% to 5% among the national internet users, while the combined share of time spent on short videos, instant messaging, long videos, comprehensive information, and other entertainment platforms in 2022 has already exceeded 60% and is likely to continue rising in recent years From the perspective of company factions, by the end of 2021, the market share of users of various apps in the largest domestic e-commerce platform - Alibaba's ecosystem is only 6.7%, while the remaining over 70% share belongs to companies like Tencent, ByteDance, Kuaishou, and Baidu in the "social, entertainment, search" category, which is consistent with the data shown by industry segmentation.

Although we have not seen similar data on the overall online time allocation of American residents, from the chart below, American residents spend around 80-90 minutes per day on platforms like Youtube and Tiktok, and around 40-60 minutes on platforms like Facebook and Instagram. It is reported that American residents spend an average of about 8 hours online every day. This means that just one social media platform + one video platform can occupy nearly 30% of American residents' time, not to mention that in reality, people generally use multiple social and entertainment platforms simultaneously. Therefore, in the overall online traffic market in the United States, the traffic scale of social and entertainment platforms >> consumer shopping platforms is a highly probable scenario.

In other words (perhaps common sense), even the top e-commerce platforms are at a disadvantage in the entire online traffic market, and they also need to obtain traffic from upstream social, entertainment, search channels and then distribute it to downstream merchants.

Therefore, logically, it can be said that independently obtaining traffic from social and entertainment platforms is a more efficient way . After all, social and entertainment platforms have larger traffic sources upstream and do not need to go through the secondary distribution of e-commerce platforms, making it easier for merchants to retain their own private domain traffic.

In comparison, the disadvantages of merchants within platforms include: most of the traffic has already undergone multiple layers of distribution upstream, and merchants have almost no autonomous control over the traffic, making it difficult to retain natural traffic. However, the advantage is that after the "filtering" by the e-commerce platform, the remaining user traffic has a clearer shopping intention, leading to higher conversion rates.

In simple terms, for businesses lacking strong brand effects or marketing capabilities, e-commerce platforms can provide traffic that is more "convenient" and more easily converted into actual shopping traffic. Conversely, for businesses with stronger brand effects, user loyalty, and self-traffic operation capabilities, the independent platform model gives businesses a higher ceiling Therefore, since bypassing e-commerce platforms and directly obtaining traffic from higher upstream sources is effective and feasible, for ambitious and capable merchants, being able to operate independently without having to relinquish a relative portion of power and profits to the platform, running a standalone business can be seen as a business model with a higher ceiling.

Moreover, the e-commerce model of directly obtaining traffic through social and entertainment platforms (referred to as social e-commerce) has been proven feasible in China as well, and is one of the fastest-growing sub-tracks. Examples include Taobao Live, Douyin & Kuaishou e-commerce, and WeChat micro-business. According to industry statistics, by 2023, the share of live-streaming e-commerce in the entire e-commerce market will be close to 38%, with the share increasing by over 7 times in just 5 years. In other words, social e-commerce is actually a major evolution direction in the e-commerce industry in China, the United States, and even globally.

The open traffic ecosystem has nurtured companies like Shopify

Although social e-commerce is a trend in both China and the United States, there are significant differences in the hosting models between the two countries. In the United States, social e-commerce mostly follows an independent site model, while in China, it is either live channels incubated by platforms like Taobao, or closed-loop e-commerce platforms built by traffic platforms like Douyin and Kuaishou themselves.

In other words, social e-commerce traffic in the United States is mainly open, while in China, it is mostly embedded within e-commerce or social platforms, leaving very limited space for independent merchants.

In actual daily use, there are also significant differences in the convenience of searching and shopping for consumers in China and the United States through open traffic platforms (those that do not have their own closed-loop e-commerce business). For example, when searching for the keyword "T-shirt" on the homepages of Baidu and Google respectively, Baidu's search results page does not directly display links related to products, at most showing related clothing matching images and text content, requiring consumers to go to other e-commerce platforms to make purchases even after showing interest. On the other hand, nearly 2/3 of the results returned by Google directly lead to related merchants or product links, allowing consumers to shop directly after clicking.

In addition to Google, major platforms like Facebook and Instagram also provide the function of embedding third-party merchants' shopping features on their pages. For example, in 2020, Shopify reached a strategic partnership with Facebook, allowing third-party merchants to easily set up online stores under their Facebook accounts through tools provided by Shopify

Due to convenience, in the main channels for American consumers to search for shopping, apart from Amazon and Walmart ranking first and third among platform-type shopping channels, most are independent shopping sites owned by search engines, social media platforms, or brand merchants themselves. It can be seen that searching for shopping on search engines and social media platforms has become a daily habit for American residents.

The difference in social e-commerce ecosystems has also led to a vast difference in the current situation of e-commerce service SaaS companies that rely on independent merchants between the United States and China. China tends to have a closed traffic ecosystem, making it difficult for independent merchants to survive, and the market value of two service providers, Weimob and Youzan, is less than 5 billion RMB each.

Meanwhile, Shopify's market value once exceeded one trillion US dollars, and even after a significant pullback, it still has a market value of over 500 billion RMB. A market value difference of 100 times can be the difference between success and failure.

Dolphin Research's previous research on Shopify

In-depth research:

First coverage on January 19, 2024, " Shopify: Looks like "Taobao," but is actually "Alipay""

Risk disclosure and statement of this article: Dolphin Research Disclaimer and General Disclosure