The heart of Etsy is as an enclave for artisans, which runs up against the site's need to grow, creating a conflict of visions. Photo: AIGA/NY.

"We have met the enemy, and he is us." That basically summarizes the challenge artisan crafts website Etsy (NASDAQ:ETSY) faces as it ponders where to go after its latest disappointing earnings report. Its troubles aren't so much from competition such as Amazon.com's (NASDAQ:AMZN) recently launched Handmade site, but rather it's an internal battle over how to grow beyond the confines of just being a niche retailer.

Since going public in April at an offering price of $16 a share, Etsy has lost 43% of its value, but it's down more than 75% from the highs it briefly hit soon after its debut, making it the worst-performing IPO of the year.

Growth at any cost
Part of its problem is needing to expand. While it reported a nearly 22% increase in gross merchandise sales in the latest quarter, its operating expenses outstripped that growth, widening at a 32% clip as marketing costs surged 88% higher, mostly from buying Google product listing ads. Marketplace revenues were up 19.7% year over year while seller services were almost 67% higher.

More worrisome, perhaps, is it sees the need for those expenses to grow even more for the foreseeable future while its revenues will get dinged by foreign currency exchange rates as it makes more sales globally.

Etsy's efforts to make itself more visible to more people does seem to be working to a certain extent in that it's witnessed a 25% increase in active buyers on the site to 22.6 million while experiencing a 20% increase in active sellers, whose numbers rose to 1.5 million. Yet considering the amount it's spending on marketing, the expansion is a bit disappointing, as it should have attracted more to the platform.

Even so, by helping its sellers meet the potential for increased demand, it has controversially partnered with mass manufacturers who will assist sellers looking to expand its stores. Although CEO Chad Dickerson maintains that Etsy Manufacturing "reimagines" production on a smaller, human scale, it's clear Etsy's path forward is expanding beyond its original handcrafted and vintage roots.

Competing visions
And not all artists and craftsmen support the change, though that's often a symptom of growing pains a company goes through as it necessarily adapts to changing conditions. Similarly, it updated its website payment options that forces buyers and sellers to offer Etsy's integrated PayPal account to make transactions as opposed to a seller's personal account, with the difference being in how quickly sellers are able to access their money.

Of course it's not just altruism pushing Etsy to help sellers expand, either, as it will translate into more revenues for it from the commissions it charges on sales made on its site. Etsy also has plans to eventually act as a middleman between manufacturers and sellers, collecting commissions for hooking up both parties.

Seller services revenue now accounts for almost half of Etsy's total revenues, up from 40% last year, suggesting its ability to upsell sellers is working and giving it more flexibility than just relying upon listing fees alone.

Homespun advice
Etsy's challenge is to take handcrafted mainstream without alienating those artisans who form the heart of the experience, a difficult task since almost by definition hand-crafted work is outside of the norm. At the same time, the site remains unprofitable and revenue growth is slowing, even as costs are increasing and margins are getting pinched. And on top of all that, yes, there is the elephant in the room, Amazon.com.

Although the e-commerce leader is making overtures to Etsy sellers in an attempt to poach them to its Handmade site, the terms it offers aren't nearly as generous as those made by Etsy, which partially neutralizes the threat.

That should give the artisan site a chance to further delineate its value proposition. Whether it can achieve it's goal of making Etsy an "everyday experience" as CEO Dickerson says is the company's goal remains to be seen, but that can only happen if it's able to get out of its own way.

Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Amazon.com and PayPal Holdings. The Motley Fool owns shares of Etsy,. 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.