It's been a little over a year since Shopify (SHOP 2.60%) announced a $1 billion investment to create a smart fulfillment network in the U.S. This move was intended to deepen the breadth of merchant offerings and provide even more services for its customers.
Let's look at what's happened since this Canadian multinational e-commerce platform announced its massive investment, and what it means for the stock going forward.
Building a $1 billion fulfillment network
In June 2019, the company announced a comprehensive plan to build a network of fulfillment centers backed by its smart e-commerce operating system with an easy on-ramp for customers, called Shopify Fulfillment Network (SFN). The SFN was met with enthusiasm from customers and partners, and thousands of merchants signed on to be part of the early access program beta phase. The plan was to ramp up over four years and scale into profitability by 2023.
Image source: Shopify.
In October 2019, the plan was augmented with the $450 million acquisition of 6 River Systems, a fulfillment center-focused robot company. This move further showed the company's commitment to building a state-of-the-art service for merchants.
Shopify has always been focused on the success of its merchants, and SFN is no different. It has numerous merchant-friendly features that are attracting more customers to this new offering. Smart stocking algorithms put products closer to customers while reducing inventory requirements, helping merchant cash flow. Automatic integration with an existing Shopify store enables an easy on-ramp for customers. And its use of merchant brand packaging, informational material, and a merchant-specific invoice put the merchant's brand front and center for their customers.
So how are things going with the project?
It's a work in progress
From the latest earnings report, management shared that the network now has nine centers run by third-party partners across the U.S. with four of those operating 6 River Systems robot picking solutions. Additionally, the company has a warehouse in Ottawa it uses for development and testing purposes.
That being said, our focus in 2020 around SFN is to achieve product-market fit, which we plan to continue into 2021. We want to ensure that the foundation of the fulfillment network is strong and the merchant's experience is outstanding before we enter sort of the scale phase.-- Shopify President, Harley Finkelstein
A Wall Street Journal interview with Thomas Epting, Shopify's director of its fulfillment network from October, indicated that its network had increased its shipping volume by 2.5 times since the first quarter. Although detailed performance information isn't available for investors, it's clear the network is becoming a bigger contributor to the overall business, and it certainly has helped fuel the company's recent record performance.
What this means for the stock
The financial impact of the fulfillment center is typical of any long-term investment. Startup and building investments upfront result in a decline in margins in the short term until the investment is able to scale up to full volume. As more customers use the SFN, revenue is captured in its merchant solutions segment. Last quarter revenue from this segment was $522 million, 68% of the total.
But the service is just part of this business segment, which includes payments, use of its shipping network, and Shopify Capital. For investors, what's more important to remember is that SFN is just one of the company's efforts to improve its platform (see graphic below), which drives its flywheel of growth.
Image source: Shopify Q3 earnings presentation.
Management explains its growth flywheel like this. As more merchants become more successful in generating revenue for Shopify and its partner network, it allows them to invest more in platform innovation. As the company improves its ecosystem of services on its platform, it makes it more attractive for even more merchants to sign on, and the growth flywheel spins faster. For investors, more growth means the stock should respond positively over time, but you should remain patient.
The road ahead
We are committed to building a reliable fulfillment solution so our merchants can focus on building a successful business. -- Amy Shapero, Shopify Chief Financial Officer
SFN is just one way the company makes it easier for merchants to be successful. As merchants grow their business on the platform, Shopify and its shareholders will share in that success. This is a quality business that is being propelled by tailwinds of e-commerce and a renewed acceleration of new business formation. Its fulfillment network is just one of the many reasons that investors should be a part of this long term growth story.
