Shopify (NYSE:SHOP) may be one of the fastest-growing companies you have never heard of. The company has developed an e-commerce platform that helps small businesses and entrepreneurs to get online, making it easy to set up a website, build a product catalog, track inventory, collect payments, and more. Shopify has been so successful with its platform that over 325,000 merchants depend on it every day. Even Amazon.com has ceded this business to Shopify.
The one number to watch
The merchant solutions business allows Shopify's customers to accept payments on its platform and has driven significant additional revenue, but it comes at a cost. The margins are much lower than the subscription business. As the merchant solutions revenue grows to be a larger portion of overall revenue, gross margins will continue to decline. But, this is good for Shopify.
Shopify says the payments business has two benefits. First, it will likely drive higher customer retention rates and second, it is beneficial to operating margins. Retention is important for any business and especially for Shopify. Since merchants dedicate time and energy to set up with Shopify, if they decide to leave, the merchant has to do all of this set up again. This is commonly referred to as switching costs. When this happens, it's very likely that Shopify has lost this customer forever.
In the most recent earnings call, management also brought attention to the importance of merchant sales when discussing retention of new customers on the platform.
...the thing we find is if there is going to be people leaving the platform, generally it's because they are closing their business. And that happens within that sort of first three to six months period. Once you as a merchant start getting some sales and so time to that first sale is something that we are always looking at how do we improve that for the -- or help the merchant to improve that, the churn potential goes down significantly.
In its most recent annual report Shopify disclosed that retention rates are best with its largest customers that sell the most -- those with the highest gross merchandise volume, or GMV.
While our Basic and Professional plans are our most popular plans, the majority of our GMV comes from merchants subscribing to our Unlimited and Plus plans. Also, merchant retention rates are higher among merchants on higher-priced plans.
The Foolish bottom line
Shopify's mission is to make commerce better for everyone. I love the fact that Shopify's business results are aligned with the success of its customers. Having Shopify's merchant solutions revenue grow means that Shopify customers are selling more -- and that's a good thing for Shopify.Shopify is exactly this: the only platform you need to build your empire. Shopify is the first thing our merchants log into in the morning and the last thing they log out of in the evening. It's at the heart of their business—a responsibility that we take very seriously.This is a prime example of how we approach value and something that potential investors must understand: we do not chase revenue as the primary driver of our business. Shopify has been about empowering merchants since it was founded, and we have always prioritized long-term value over short-term revenue opportunities.
Brian Withers owns shares of Amazon.com. The Motley Fool owns shares of and recommends Amazon.com and Shopify Inc. Class A Subordinate Voting Shares. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.