Shopify (SHOP 0.29%) has big plans to help its merchants make more sales and get items to customers faster and more easily. It's investing $1 billion to set up a network of fulfillment centers in the United States for its merchants. The company aims to use the network to help merchants cut down on their fulfillment expenses and generate a new stream of revenue through its Merchant Solutions business.
But $1 billion might seem like chump change compared with Amazon.com's (AMZN 0.83%) investments in its fulfillment network. The online retail giant invested about $800 million more than it had originally planned in the second quarter alone to speed up its transition from guaranteed two-day shipping to one-day shipping for Prime members. The company's Fulfillment by Amazon service has become a dominant force in order fulfillment for small merchants like those using Shopify's platform.
Shopify's budget might be minuscule compared with Amazon's, but it presents a significant competitor in a space where Amazon has been able to run the show.
Room to compete
When it comes to third-party fulfillment for small online merchants, Amazon is at the top of mind and the top of the pile for most. That includes merchants that don't even sell items on Amazon's marketplace.
But Amazon has come under scrutiny lately for its pricing policies. It charges merchants one price for orders that come through its own online marketplace and a higher price for orders coming from competing platforms. The same item can cost 126% more to fulfill by Amazon if sold through a competing marketplace, compared with the fulfillment cost when sold on Amazon's marketplace, according to tech news website Re/Code.
That kind of anti-competitive pricing is only possible because merchants don't have many options -- certainly none as reliable and fast as Amazon. Shopify's Fulfillment Network will look to change that. And Amazon's relatively high pricing gives it room to undercut the incumbent despite not having nearly the same scale.
If any company can compete with Amazon, however, it's Shopify. It has over 800,000 businesses on its platform selling over $40 billion worth of goods. For comparison, Amazon is still much bigger, selling nearly $300 billion in merchandise last year.
But Shopify carries considerable heft in the industry, and it's growing quickly. It also doesn't have its own retail operations like Amazon, which compete directly with third-party merchants. Some merchants even accuse Amazon of copying its products if they sell well on its marketplace.
Shopify has room to scale its Fulfillment Network with demand practically built in. That's the same way Amazon came to dominate the market.
Building out an ecosystem
The Shopify Fulfillment Network ought to make its other products more appealing to merchants, improving customer acquisition and reducing churn. Shopify's entire value proposition is that it makes starting and running an online storefront easy. A fulfillment network taking care of inventory management and getting orders to customers makes running a store even easier.
The Fulfillment Network might also drive gross merchandise volume higher. Merchants should be able to guarantee faster shipping by using Shopify's service, which has become increasingly important in today's online retail environment. That could help it complete more sales compared with competing marketplaces or retailers that offer faster shipping, including Amazon.
So, not only will building out a fulfillment service help Shopify attract more merchants, it should also help those merchants attract more customers. That's a network effect that should produce significant growth for the company as it scales.
While the opportunity is great for Shopify, it needs to be vigilant. It's going to go head to head with Amazon, which is a ruthless competitor. While it could put pressure on Amazon's pricing, the online retail giant has never shied away from reducing its margins to shut out competitors. Fulfillment by Amazon is a big profit center for the company, but the scale of its third-party marketplace and the number of sellers on it gives it a lot of pricing flexibility if it needs to check Shopify.