In the fourth quarter of 2022 ended Dec. 31, Etsy's (ETSY 2.44%) revenue increased 12.6% year over year to $807.2 million, beating Wall Street forecasts. And for the full year of 2022, sales were up 10.2% to just under $2.6 billion. These impressive gains were on top of 35% revenue growth in 2021.
A double-digit, top-line increase is certainly positive news for shareholders, especially in an uncertain economic environment where many experts are predicting a recession in 2023. However, shareholders need to pay attention to what's happening beneath the surface.
Here's why this top e-commerce business's strong revenue growth might come at a real cost.
Look beyond the headline numbers
While Etsy's revenue was up meaningfully, the company's gross merchandise sales (GMS), which looks at the total amount of spending on the company's various marketplaces (Etsy, Reverb, Depop, Elo7) declined 4% year over year to $4 billion. Unsurprisingly, as more buyers transact on the platform, Etsy benefits with the potential for greater revenue. A softening macro-backdrop and a shift in consumer demand away from goods toward services could be pressuring GMS.
Shareholders are probably wondering how revenue rose at a time when GMS fell. It all comes down to the take rate, or the fees the business can extract from the sales volume on its network. In Q4, the take rate was 20% versus 17.1% in the year-ago period and 17.1% in Q4 2020.
In addition to offering optional services like advertising and shipping labels, Etsy charges sellers a listing fee, payment processing fees, and a transaction fee. And in April of last year, the business increased the transaction fee rate from 5% to 6.5% for the first time since 2018. The move wasn't well received by sellers, unsurprisingly. In fact, between March 31, 2022 (right before it was implemented) to Dec. 31, 2022, Etsy lost 184,000 sellers.
But to be fair, the leadership team did mention that the latest fee hike would be implemented to reinvest back into improving the seller experience. About a year ago, CEO Josh Silverman highlighted this new direction:
We're planning to invest even more in making Etsy the best place to run a creative business -- in fact, we expect to invest most of the incremental revenue from this fee increase in marketing, seller tools, and creating world-class customer experiences.
Looking at marketing, one of the areas of focus, it's interesting that the company's annual marketing as a percentage of revenue went from 29% in 2020 to 27.7% in 2022. I would have expected this to increase based on the CEO's comments justifying the move. To its credit, though, Etsy launched a new app for its sellers, with upcoming feature introductions that could be a major benefit to these small businesses.
Keep this in mind
While raising the take rate has been a successful strategy historically, management must be careful not to alienate its most important user group, which is its 7.5 million sellers. Obviously, Etsy needs to cater to them by providing a friendly experience that isn't prohibitively costly. Without sellers choosing Etsy to set up their digital storefronts to sell their goods, the business wouldn't be what it is today. Consequently, buyers would be less inclined to go to Etsy if the product selection were smaller.
It's critical that shareholders pay close attention to the relationship between GMS and revenue trends. If the former starts to increase at a faster pace than the latter, then this means Etsy isn't monetizing its network well enough. And if the opposite happens, where revenue outpaces GMS, like we saw in 2022, then Etsy could be taking advantage of its seller base, and that might end up hurting the business over the long term. While this could lead to a short-term bump in sales, it could drive sellers off the platform.
And that's the last thing Etsy investors want to see.
