For a long time, it looked like no one would touch Amazon's (AMZN 2.61%) e-commerce dominance. But over the past five years, Shopify (SHOP 3.33%) has emerged as a thorn in the company's side.
Shopify doesn't have a marketplace like Amazon, but the software-as-a-service company helps anyone establish an e-commerce website. It has grown from hosting 140,000 merchants in 2014 to over 820,000 today. The stock is up 1,400% since going public four years ago.
On the surface, it looks like things could only get better. Some in the American public are calling for a breakup of Amazon. Shopify investors should be cheering, right?
Not so fast. Depending on how a breakup of the e-commerce giant happened, it could create a long-term problem for Shopify. Investors in the company should keep their fingers crossed it doesn't come to that. Let's investigate why.
Image source: Getty Images.
Breaking down Amazon's dominance
Amazon is protected by multiple superwide moats.
Low-cost production is the widest moat. The company's network of 162 fulfillment centers inside the United States -- and another 193 abroad -- is an advantage that's impossible to match. Amazon can ship packages quicker and cheaper than anyone else.
Its marketplace (read: website) is also buffered by the network effect. As more people visit the site, third-party merchants are incentivized to list their products on Amazon and use Fulfillment by Amazon to send packages. As more merchants list, more buyers flock to the site. It's a virtuous cycle.
And the amount of stuff Amazon sells that comes from third-party merchants (Amazon doesn't make the products, it just ships them) has ballooned over the years. CEO Jeff Bezos recently revealed that 58% of the $277 billion worth of stuff sold on the site was from third parties.
While Amazon doesn't normally disclose such numbers, one look at the growth in revenue from simply listing and fulfilling those third-party orders puts things in perspective.
Data source: SEC filings. 2019 figures are for trailing 12 months ending Sept. 30, 2019. Chart by author.
Amazon's revenue from simply helping others sell stuff has increased 35% per year.
Where Shopify shines
But for all of the advantages of Amazon's distribution network -- millions of visitors, lightning-fast delivery -- there's a dark trade-off.
Let's say you offer a new product -- a specific type of battery, for instance -- that's very popular. Because Amazon collects all of the data on your sales, it sees that you're raking in the money. It then uses its vast war chest to create a slightly cheaper version of your battery and sell it as its own. All of a sudden, your sales dry up.
Bezos has often said, "Your margin is my opportunity." That seems like great news for consumers -- and it is -- but it also means power being concentrated in a single entity.
To that end, Shopify's CEO and founder Tobi Lutke sees an opportunity. This past summer, he announced Shopify would be offering its merchants their own fulfillment network. Here's the key quote from Shopify's Chief Product Officer: "We're not interested in competing with our merchants. So we're not going to take their order volume and create knockoff products at lower prices and lower quality to compete directly."
Amazon's ambition to seize all of those opportunities highlights the appeal of Shopify's agnosticism. And it is a key force driving merchants toward Shopify.
What could a breakup mean?
There are lots of ways a regulatory breakup of Amazon could go down. It could simply be a split between Amazon Web Services (AWS) and Amazon's e-commerce platform (though I doubt that would be of interest to most lawmakers).
For the purposes of this article, a breakup between Amazon's marketplace and manufacturing is what Shopify investors need to look out for. What would this mean? Here's one scenario:
- Amazon's marketplace: This would essentially be the company's website. Customers can type in an address, search for stuff, read reviews, and click "buy."
- Amazon's manufacturing: Amazon doesn't actually "make" its branded stuff. But this is where products are made under the Amazon umbrella that try to knock off popular products.
We can even forget about the fulfillment capabilities. If Amazon's "manufacturing" had to be separate from its marketplace, it would no longer have access to data on what's selling well. Sans that data, it would make little sense for Amazon to make anything that wasn't original.
That would be great news for third-party merchants. But it could spell trouble for Shopify. It would nullify that appeal of Shopify's agnosticism and potentially shift advantage back to Amazon.
But don't overthink this
Investing is a mental exercise. You try and play out different scenarios. But it's crucial to keep this in mind: You have no idea how things will go down. I've learned this the hard way time and again over the past decade.
At one point, it was a major source of stress. Today, I take a more Zen approach and acknowledge that I can't know it all. I play out different scenarios in my head -- as a mental exercise to prepare me -- but don't give it too much credence. This helps me to know what to look for, while not overreacting to potential outcomes that may never come to pass.
As such, I think Shopify and Amazon are both worth owning. Together, they account for a whopping 28% of my real-life holdings. Keep an eye on how these tensions play out, but don't let it stop you from buying shares of either.
