Jay Torres/The Globe and Mail
Few firms preach investing principles quite like Mawer Investment Management. For nearly 50 years, the Calgary-based company, which oversees $79 billion for individuals and institutions, has deployed a very specific strategy: Ignore market fads, buy stocks that trade at noticeable discounts, and invest for the long term. So when the money manager sank $44 million into Shopify shares in late 2017, the decision was, in many ways, a radical one. Mawer’s marketing tagline is simple: “Be boring.” Shopify was anything but.
At the time, Shopify had the potential to be the next Canadian gem. As a software company that helps merchants set up e-commerce stores, it benefitted from the tech boom that propelled the likes of Netflix and Facebook to fame, and it was a hit with the millennial crowd because the company’s founder, Tobias Lütke, had a vision: Shopify was a platform for democratizing commerce. In the digital world, Amazon was a giant that charged merchants usurious fees to sell through its ultra-popular site. Many small and mid-sized business owners, meanwhile, were barely literate with the internet, and there was a big chunk of people who wanted to make money selling their side projects online. Shopify was there for the little guys. In its early days, an average customer sold about $13,000 worth of products each year.
Editor’s Note: Is Shopify sunk or just growing up?
For Mawer, the tough part was swallowing the valuation. Shopify wasn’t profitable, yet its shares had climbed 500% since its 2015 initial public offering. The business model was compelling, though. At its core, Shopify was a subscription business just like Netflix—merchants pay monthly fees—and its bottom line got a bit of extra juice from clipping a small percentage of each transaction it processed. Think of it like Microsoft Office, but for the web—a utility that was becoming a regular part of business life.
It also had quite the upside: E-commerce penetration was still low, Shopify had the potential to expand globally, and the company could keep branching into other areas, such as payments. “We saw massive growth potential,” says Mark Rutherford, co-manager of Mawer’s Canadian equity strategy.
Mawer was right. Over the next two years, Shopify’s share price tripled. And then the pandemic hit. “COVID-19 essentially poured gasoline on the growth,” Rutherford says. With everyone trapped at home, e-commerce sales soared, and a special aura surrounded the company. Shopify was seen as central to the new economy. The company says it accounts for 10% of all U.S. e-commerce, and it handles US$47 billion in gross merchandise volume a quarter, predominantly for apparel, cosmetics, beauty and home goods. From the first lockdown through November 2021, when Shopify’s stock hit its peak, the shares jumped another 300%. For a while, it was Canada’s largest company by market value. Mawer trimmed its position during the rise to cash out gains, but because Shopify’s shares had soared so much, its stake was still worth $377 million by late last year.
And then the tech sector crashed. No one was safe, but Shopify was one of the worst hit, with its shares plummeting 84%. Mawer waited it out for a while, but by the spring the firm had had enough and sold what remained of its stake.
To outsiders, it may seem like Mawer simply couldn’t stomach the tech wreck. That’s partially true, but the portfolio managers were also spooked by something else. For all the hype, explosive e-commerce growth has stalled out, and the market is now much more competitive. Shopify has also morphed into such a giant that it’s starting to clash with Amazon a little too often. Instead of sticking to his lane, Lütke’s gone all in on assembling a delivery, fulfillment and logistics business, just like the incumbent heavyweight.
In a way, the investment resembles Facebook’s pivot to the metaverse. The giant dominated for a decade, but the digital world is changing so quickly that it worries about remaining relevant. Shopify’s shift isn’t as drastic, because it’s mostly building a complementary business. But like so many tech stars, it’s wrestling with its identity. Netflix, for one, recently lost subscribers for the first time in a decade and modified its business model to allow ads—something it swore it would never do.
The struggle for Shopify is that it’s making this pivot with an almost entirely new management team following an exodus over the past two and a half years. Rank-and-file employees are also uneasy after 10% of staff were let go this summer. Despite the tumult, Shopify is still hell bent on building something Canadians are proud of. “We’re going to build one of the most durable companies on the planet,” says president Harley Finkelstein. “I want Canada to be really proud of the long-term story of Shopify.” But layer in the market crash, and it’s enough to make you wonder: Is there a way out of all this trouble?
SHOPIFY, THE DARLING OF CANADA’S TECH INDUSTRY, HAS WATCHED ITS FORTUNES SINK OVER THE PAST YEAR. IS THERE MORE TO IT THAN THE MARKET ROUT? AND IS THERE A WAY BACK TO THE SURFACE?Jay Torres/The Globe and Mail
First things first: Shopify is not on the cusp of crumbling. Unlike the scores of unprofitable tech companies that soared during the pandemic, Shopify has a fairly sound balance sheet and a solid base of recurring revenues. It’s a real business with devoted clients.
Based in Ottawa, Shopify’s co-founders bootstrapped the business in its early days—the other two co-owners left early on—and its first round of venture capital funding raised a grand total of $7 million in 2010, a pittance compared to what it could have hauled in if it had been created a decade later, at the height of the VC boom. “Very few VCs believed that software businesses targeting SMBs were good investments, let alone ones that could deliver venture returns,” Bessemer Venture Partners, the firm that led the funding round, said in a post-mortem on the investment.
Shopify had a few things going for it. Crucially, there was a massive tailwind from the digital revolution, and Amazon wasn’t really focused on the SMB market. But Shopify didn’t have the market to itself. It had a number of rivals, like BigCommerce, Volusion and Magento—the latter of which was purchased by eBay, then flipped to Adobe. To stand out, Shopify courted developers to build add-ons for merchant stores, which meant customers had access to a bunch of drag-and-drop applications offering, for instance, shipping labels and automated orders whenever inventory got low. Another crucial feature: tiered pricing for merchants of all sizes, so as clients grew, Shopify could offer them more services.
But none of it was rocket science; Shopify’s product was simply more elegant. “There have been many tools that launched before Shopify and after Shopify,” says Juozas Kaziukenas, a consultant for e-commerce marketplaces. “In many ways, Shopify didn’t invent this or materially disrupt it. They just made a much better interface and network of partners.” If that sounds dismissive, it’s not. He deeply respects the company. Elegant design is how Apple defined itself under Steve Jobs.
Eric Fuller has run his wooden-puzzle business, CubicDissection, based in Raleigh, N.C, on Shopify since late 2017. He used to use Volusion. “Before Shopify, there were only a couple of large hosting companies, and they generally focused on large clients. It was clear they didn’t care about the little guy,” he says. Shopify’s product adapted to all sorts of sales styles. “Our website sees 80% of its business during a six-hour period every four to six weeks when we release new work. It’s mostly crickets, then it gets slammed. Shopify handles it with ease.”
Shopify also expanded with its Merchant Solutions division. One major project was mini-lender Shopify Capital. Instead of turning to a bank, merchants can sell Shopify their receivables at a discount in exchange for access to funding. Customers also needed a way to collect credit and debit payments online, and instead of forcing them to add on an external tool, Shopify built one that processes the transactions through Stripe. Each transaction costs the merchant about 2% to 3%, a good chunk of which goes to Stripe. But a small amount falls to Shopify’s kitty.
This all meant that for many years, Shopify’s strategy was pretty simple: Sign up more merchants, process more transactions, and revenues would grow. Investors were fixated on potential—profits didn’t really matter as long as the company was bringing in more merchants. That might seem easy in retrospect because e-commerce growth was so high. But Volusion, for one, filed for bankruptcy protection in August 2020. Shopify found a way to remain at, or near, the top of the class, depending on whom you ask—its market value hovers around US$40 billion, while BigCommerce’s is US$1.2 billion. Lately, though, Shopify’s narrative has changed because the pandemic boom has disappeared. Sales are still elevated relative to 2019, but it turns out in-person stores still matter—a lot. E-commerce as a percentage of retail sales has plateaued around 15%, a stall that has hit everyone, including Amazon.
At the same time, rising interest rates have taken a sledgehammer to tech valuations. Growth stocks flourish when rates are low, because endless expansion is cheap and easy to finance. But they get pummelled when rates rise. The fear now is that rates will need to go even higher, because inflation is quite stubborn and won’t fall quickly. That could put the global economy into a coma, which means consumer demand will drop. Shopify’s subscription revenues are heralded for being sticky—the service is arguably akin to a utility at this point—but its payments business would certainly feel the pain, and that’s what’s been driving revenue growth.
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That’s the simple version of what’s gone wrong, and it’s the most widely accepted narrative. But it’s only part of the story.
What made Shopify stand out for so long was that it was the anti-Amazon. The U.S. retail giant loves to be front and centre, making sure everyone knows they’re buying something through one of its portals. Shopify’s mantra, meanwhile, was to stay out of the way and let entrepreneurs be entrepreneurs. It worked for so long because the direct-to-consumer business model was a dominant one online. The likes of Facebook and Instagram had boatloads of data on their users, and they made it easy and affordable for merchants to buy cheap ads that micro-targeted niche audiences. Those users would eventually find their way to stores run by Shopify.
But then Apple made privacy a core tenet of its business model. Social media companies were so effective at selling ads because they tracked you across the entire internet—and even in some private chats. In April 2021, however, Apple rolled out a software update for iPhones that allowed users to opt out of being tracked. It was a hit. Now when merchants buy ads, it’s a bit more like throwing spaghetti at the wall.
Digital commerce is also in a different place. When Shopify was a baby, it was able to grow quickly because it was one of the first movers. Then it was perfectly situated when COVID-19 hit. “For them to sign up merchants, it was almost like shooting fish in a barrel. People were desperate to get their stores online,” says Desmond Lau, an analyst at independent research shop Veritas. Now that the world has re-opened, it’s pretty clear a lot of demand was pulled forward, so it’s slimmer pickings for new signups.
All this means Shopify has to work harder to attract new clients. In 2021, it spent 21% of its revenue on sales and marketing, Lau notes. That has jumped to 25% this year. In consulting terminology, this means Shopify now has a higher cost of customer acquisition, a crucial metric for tech companies. Across the sector, one ratio is held sacrosanct: the lifetime value of a client relative to the cost of bringing it in. Anything above three times is good—that is, if you spend $1 to add the client, they should deliver $3 in value. Lau worries Shopify’s ratio is starting to drop, and rather quickly, but there’s no real way to know. It’s impossible to know what Shopify pays the likes of YouTuber MrBeast, say, when he promotes the service. It’s all a black box—which is fine in an up market, but when investors are losing money, the knives come out.
Another financial threat: shrinking margins. Shopify is typically associated with helping small businesses set up online stores, but most of its revenue growth comes from processing payments. This unit has lower margins, primarily because it has to pay a good chunk of its fees to Stripe. This summer, Shopify disclosed that its gross profit as a percentage of total revenues dropped to 51.8% during the first half of the year from 56% a year earlier.
Nothing has flustered investors more than Shopify’s pivot to logistics and fulfilment. The company had been hinting at this expansion for years, and in 2019 it even bought 6 River Systems, which made cloud-based software and mobile robots for fulfillment centres, to take a stab at it. But it wasn’t a priority. Now Shopify is all in, spending US$2.1 billion to buy Deliverr in May, and telling investors it needs to spend $1 billion more to integrate everything and get it up to snuff.
It’s all so disorienting because Shopify is late to this game. There are already scores of third-party companies that handle warehousing and fulfillment, and the likes of FedEx are big in the logistics game. “The market is pretty well taken care of. There are unicorn-size companies and small startups,” says Kaziukenas. “It’s not really something Shopify can disrupt in any meaningful way.”
The investments also seem to put Shopify on a crash course with Amazon and its Prime delivery business. Amazon seems so rattled by the threat that it’s clapping back with a new program that allows merchants to use its delivery and fulfillment system even if they don’t sell through an Amazon site. All they have to do is add a “Buy with Prime” button to their website. In other words, they’re cutting Shopify’s grass.
Shopify has promised investors its pivot to fulfillment won’t be too costly—nothing like Facebook’s spend on the metaverse. But it’s expensive enough that in the first six months of the year, the company reported a US$2.7-billion net loss, more than wiping out its total profit from the same period last year. It’s as if the pandemic boom never happened, and it was enough to spook Mawer. “We don’t know how much this is going to cost,” says Rutherford, the Mawer portfolio manager, “and what type of return they will get.”
Harley Finkelstein has heard this all before. Via video call from Montreal, where he grew up, Shopify’s president explains he hasn’t been back home to Ottawa in six weeks. Instead, he’s been on the road telling Shopify’s story again and again, and answering questions from confused investors and analysts. If Lütke is the shy and deadly serious brains behind it all—he once said his wife calls him “an immigrant to the human condition”—Finkelstein, a former DJ and T-shirt entrepreneur, is the marketer.
“If you had asked me 10 years ago what Shopify does, it’s really easy: e-commerce for small businesses,” says Finkelstein. But now it’s so much more, and the sheer breadth can trip up investors.
To help solve the conundrum created by Apple’s privacy changes, Shopify is leaning on something it calls Audiences, a tool that helps merchants find customers. Shopify’s clients can select the product they want to sell more of, and algorithms will build what the company calls “an audience of high-intent buyers.” That list is then shipped to whatever ad network the merchant chooses—though right now it’s only available on Facebook and Instagram. In a way, it’s an in-house advertising agency that’s free for Shopify Plus clients, the premium version of its e-commerce subscription package.
Another fix: an updated point-of-sale device. Shopify has long had checkout devices for brick-and-mortar stores, but they hadn’t been updated in a while. In September, the company rolled out a new version, arguing physical retail was rebounding in importance now that lockdowns had subsided. (E-commerce sales still make up roughly 90% of Shopify’s gross merchandise value.)
The largest source of uncertainty is Shopify’s logistics plan. Initially, there were fears management would spend recklessly to compete with Amazon on warehouse space, especially because it paid a hefty multiple for its acquisition of Deliverr. Finkelstein pushes back. “This is not a $10-billion thing. I know there’s been reports of that. It’s ridiculous. We don’t have to own the warehouses. We don’t have to own the staff. What we need is really great software. It’s a very different model.”
The way he explains it, Shopify isn’t suddenly going to become an owner of industrial real estate. The goal is to make software that can track a merchant’s order from the time it leaves the manufacturing plant, through the port to a distribution warehouse, and then on to the end customer. “We don’t want to do one-day cheap shipping like Amazon. That’s not the point,” Finkelstein says.
He offers more context: Shopify wasn’t really looking to get into shipping or logistics, but as its merchants got bigger, it became more of a priority because they were getting screwed by the massive minimum orders demanded by many third-party logistics providers. Shopify thought, What if we could build plant-to-porch software? It has since partnered with Flexport, whose clients are shipping-container companies that get goods to the port, and it bought Deliverr, which handles balancing, the term for getting stuff from the port to the fulfillment centre. For the last piece, it’s working with third-party fulfillment centres in the hopes of renting empty space and then deploying new fulfillment-management software (some of which came from its 6 River Systems acquisition).
The problem is that it’s going to take time to build all this out, and that investment will create substantial losses right when investors are increasing their scrutiny.
But there is a plan. Shopify is not an electric-truck SPAC that went public with zero revenue and is now scrambling to deliver its first-ever order. Its struggle is one of execution. Save for Lütke and Finkelstein, the entire executive team has turned over in the past two and a half years—sometimes in a pretty harsh manner. In the fall of 2020, Lütke announced that chief product officer Craig Miller was leaving and filled the hole with… himself. The reasoning for each departure has never been clear—some leaders seemed to burn out and were happy to enjoy their wealth. Others might have clashed with Lütke over time. Just when the turnover seemed to be slowing, in early September Shopify announced its CFO and COO were also changing. Even the Bay Street analysts who had been constant cheerleaders for the company finally admitted it was strange.
Shopify used to have two great things going for it: a strong culture and a meteoric share price. Shopify really cared about its people, and its offices were inviting places to be. Free hot breakfast. Open beer taps all day. A corporate Soho House of sorts. It’s been hard to replicate that working remotely.
Worse, there are some concerns the company is starting to resemble an American tech giant—less soul, more cutthroat. Kaz Nejatian is Shopify’s newly appointed COO, and last fall he famously tweeted, “We should celebrate hard work more than we do,” adding that China’s growth was fuelled partially by 9-9-6 companies, where employees work 9 to 9, six days a week. (His tweet was in response to the Ontario Liberal Party’s idea to test a four-day work week.) It was the polar opposite of what Lütke used to preach, talking openly about being home by 5:30 p.m. every day, even as CEO.
As for the shares, no matter how much spin the executives put on it, the freefall is painful. Lütke and Finkelstein have tried to brush it off, saying investors are simply too short-term-focused. But try telling that to a Gen Z employee who feels they’ll never be able to buy a house. Shopify has had to modify its compensation structure—employees can now choose their mix of cash and shares, whereas it used to be a pre-set ratio—and this spring a number of top executives tweeted that they were buying the stock as it crashed. The sacred rule used to be that no one was allowed to talk about the stock at work because it sent the wrong message. Yet, here were the leaders doing just that, in the most public forum possible. (It didn’t help that Lütke quietly cashed out $623 million in 2021 as Shopify approached its record high.)
Finkelstein appreciates the concerns about Shopify’s executive exodus, but he stresses he and Lütke view leadership as a two- to three-year “tour of duty.” The rule doesn’t apply to either of them, though. “I just recommitted to another decade,” he says. Lütke, meanwhile, was just granted a special founder share that gives him 40% of Shopify’s shareholder votes, meaning he’ll essentially have control of the company in perpetuity. But Finkelstein pushes back on any slander about Shopify’s culture. “I reject the fact that we are becoming like some big tech company. There is a soul to this company,” he says. Shopify has an ethos, he swears: It is entrepreneurs building software for other entrepreneurs.
Every company faces tumult. It’s a function of growing up. The struggle for Shopify is that it’s going through it in the midst of a complete market reset. Valuing tech stocks used to be as basic as slapping a multiple on the sector—say, 20 times sales. And because Shopify was one of the beloved companies, it earned a premium valuation—perhaps 25 times. It really was that simple.
In a down market, investors go hunting for weaknesses, and Shopify’s margins are compressing. Software companies were so attractive for so long because they could be scaled—build the software, then sell it to as many customers as possible with minimal extra costs. But by adding so many divisions, including fulfillment, it’s hard to tell what’s worth what or even what an appropriate multiple should be. Microsoft, meanwhile, is minting US$16.7 billion a quarter, and it’s been around so long that it has very clear benchmarks. Facebook (now Meta) is often seen as the poster child for Web 2.0 companies—that is, those that came of age after the dot-com crash. For a while there during the pandemic, when Shopify was worth more than $200 billion, it seemed to be verging on this level of fame. Meta, though, reported US$39 billion in net income in 2021, the banner pandemic year. Shopify’s equivalent profit: US$2.9 billion, much of which will be offset by losses this year.
Shopify is living the age-old rule in real time: Success masks all sins on the way up, and the pain compounds on the way down. No one knows how long the market rout will last, but if its leaders are ever feeling particularly low, they can look to their chief rival for inspiration. Amazon’s stock lost 90% over two years after the dot-com bubble crashed, yet it was able to claw its way back.
In a letter to investors when Shopify went public, Lütke wrote about wanting it to be a company that sees the next century—not just for its own sake, but for Canada’s, too. He’s harped about how easy it is to turn into BlackBerry, which was hyped just as much as Shopify at one point, only to lose all relevance. When Shopify was soaring, Lütke could seem paranoid, never satisfied. But the current downturn makes his fears seem a little too on the nose. If Shopify truly plans to be around for 100 years, this is shaping up to be the ultimate test of its resilience.
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