Almost every company out there… I would say a lot of companies, at least the companies of my friends, they all use this company to build their e-commerce store and all the backend support is amazing. This company has also went on to develop their own capital ecosystem, where they provide capital to its community and also their developer ecosystem where there’s just a lot more features being developed by open source developers so that it’s not just them developing softwares. There are a lot of these guys that are also developing additional features and softwares on their platforms are very powerful growth engine for features and all that. 

I’m curious, how far can this company go? Joining me today to geek out on this company which is e-commerce giant Shopify is Ser Jing. All of you are familiar with him. He’s from The Good Investor and CompounderFund.com. Once again, if you want to read his research, just go to CompounderFund.com. 

Shopify is a company that constantly pushes its limits. What started as just services and software has come so far and Ser Jing has a lot of praise for Tobi, which is the founder of the company.

He believes that this guy has great execution, keep pushing boundaries, keep developing new stuff and founder-led. Founder-led is always a very interesting view of companies, so I think that is the focus for today to try to understand what is Shopify’s business model? How far have they come? They’re no longer just software and where can they go into the future? 

For your reference sake, this episode was recorded on the 26th of August 2021. Our discussion today is solely for education and entertainment purposes only. It does not serve as any form of advice or recommendations. Thank you for loving what we do and empowering us financially to do more for you. Join our Telegram group for a continued discussion. Let’s geek out!

Okay, so we back again today with Ser Jing in the house. Yo, how have you been?

Ser Jing: Thanks Reggie for having me again. Doing great, can’t wait to get started. 

Reggie: Yeah. We’re going to be doing this quite often so it’s going to be a recurring thing. I mean, in your portfolio, there’s so many interesting companies and everybody can actually find all your writeup and your research and all that jazz at CompounderFund.com so you should definitely check it out if you have not.

Today, we’re going to focus on this company called Shopify. But why Shopify, Ser Jing? 

Ser Jing: Why Shopify? It’s actually one of the… as of the point of recording which is 26 August, it’s actually one of the largest companies in our portfolio.

It’s a company that that I am very… that I like a lot. What I also find super interesting about Shopify is its co-founder and leader, current CEO. His name is… I hope I’m pronouncing it correctly because it’s a German word. It’s Tobi Lütke. I find him to be an incredible entrepreneur and in fact, I think in my opinion, one of the best young business leaders in the world today. That’s what really fascinates me about Shopify. 

Reggie: Did Shopify become your largest position because of the tenbagger situation that it had went through? 

Ser Jing: No. Just to clarify things a little bit, I invested in Shopify with my family’s money, I think sometime in 2015 or 2016 and that has done really well. I think it has gone up more than 30 times. If I compare Shopify’s current share price to the time when I first invested in it, but we… or rather my family actually liquidated most of that portfolio in the middle of 2020 so that the capital could be used to invest in Compounder Fund.

In the fund itself, that position is definitely not a tenbagger but it’s still a fairly large position within the portfolio, somewhere between 4-5% simply because it’s a company that we think has a lot of room to grow and also partly because the share price has done pretty well since we first invested in it sometime in July 2020. 

Reggie: Yeah, and I know Shopify has went through a lot of changes. When they first started, they were just doing this whole web commerce platform. Essentially, it’s a software. That’s kinda how they started. Over time, they’ve added a lot of features: dropshipping, they have built up their own supply chain. They have done the whole capital thing that they’re doing, so providing… there are people that use Shopify with capital. Can you walk us through what is Shopify at this moment in time? 

Ser Jing: Yeah sure. I think that’s a really interesting question. You’re absolutely right that Shopify kind of started with a web commerce kind of solution and over time just slowly diversified its business, but it’s still very much focused on e-commerce or rather, enabling businesses to sell online. I think Shopify basically sees itself as the operating system for e-commerce for other businesses to use so that’s how the company sees itself. 

What is Shopify today? You can split its revenue into basically two sources. The first would be subscription solutions and then the other would be merchant solutions. As of 30th of June 2021, Shopify had trailing revenue of about US$3.85 billion and 31% of that connection actually came from subscription solutions.

These are effectively software subscriptions that Shopify sells to merchants and these merchants use this solution to track inventories, set up an online store, manage the online store and so on. The prices there range from US$9 per month to more than US$2,000 per month. 

There are a wide variety of subscription solutions that Shopify sells. The US$9 per month subscription goes for very simple solutions and for very small merchants and of course, when you talk about the $2,000+ solution, that’s Shopify Plus and that applies to really large organizations.

I think it’s also very interesting that Shopify’s subscription solutions business actually serves all kinds of businesses of all sizes, from the smallest one to two man type of SME (Small & Medium Enterprises) all the way to the largest multinational conglomerates like Nestle or Heinz. It’s all across the spectrum of corporate sizes. That’s what Shopify serves. 

The other part of the business of Shopify would be merchant solutions, so that’s where Shopify provides other value-add services for merchants. These include things like Shopify Payments which is the payment processing platform. 

There’s also Shopify Fulfillment Network which is Shopify’s logistics services. It essentially acts as an outsourced fulfillment service for merchants. If you’re selling, say, glasses online, spectacles online and you’ll like to deliver your product to customers who buy from you, you can actually utilize the Shopify Fulfillment Network to help you fulfill that order.

There’s also things like Shopify Capital, which is a kind of financing arm of Shopify. This is where Shopify provides capital to merchants. There are quite a number of other services as well that Shopify provides and all these services basically help merchants better able to conduct business online.

Everything is done with the idea of how can Shopify help merchants better do business online. When we look at these merchant solutions business… okay, the subscription solutions business is a subscription service. That’s where Shopify charge its merchants monthly. 

With merchant solutions, Shopify earns revenue from a few different ways. Some of the services are charged as a percentage of the amount of commerce activity that a merchant conducts through the Shopify platform. Some of these are based on different types of fees that Shopify actually charges the merchants. 

All in all, as I mentioned earlier, Shopify pulled in about US$3.85 billion in revenue in the 12 months ended 30th June 2021. Based on the latest numbers that Shopify has released, the company has about 1.75 million merchants from 175 countries that use its services. 

Reggie: Interesting! Interesting (that) Shopify managed to scale beyond where they started because there are a lot of tech companies that… you always find a corner, right? Tech companies always do that. They find an under-served population and then you create a solution for this under-served population. 

Shopify also started the same way: e-commerce, very under-served. They build a solution but not many people managed to scale beyond to such a size, beyond their original community and just keep growing, keep growing. Their solution has gotten so far that a lot of big boys are using them, right? That’s pretty interesting. 

Ser Jing: Yeah, I think what’s really interesting as well which I think it’s also a very positive sign on the management team, which we can talk about later, and that is… Shopify actually started off as a business to sell snow… I think it was snowboards online. They wanted to sell snowboards online. That was Tobi Lütke and his co-founder. They wanted to sell snowboards online. 

Reggie: They got the vibes lah. 

Ser Jing: Yeah, pretty cool dude, yeah. They realized that “hey, it’s so difficult to sell a product online” and so they thought “okay, let’s just build some things so that we can sell our snowboards online. But what they found was that the thing that they built to sell their snowboards online ended up being a much more attractive business than just selling snowboards and so that was how Shopify basically came about.

Reggie: Yeah. Interesting, and you specifically said that people should be very cognizant that Shopify is different from Amazon…

Ser Jing: Yes. 

Reggie: … in your thesis. Can you help our listeners understand the fundamental difference? 

Ser Jing: Yeah, sure. I think the fundamental difference is that Amazon is an e-commerce company. Amazon has both first-party e-commerce as well as third-party e-commerce. First-party e-commerce will be where Amazon is the one buying the inventory… buying the products and selling it to consumers. Third-party will be where Amazon acts as a marketplace to connect merchants with consumers. 

Shopify does neither of both. What Shopify is doing is to provide services and solutions for merchants who want to sell online. Shopify itself is not really involved with the actual selling process. What it does is to help the merchants better be able to manage their inventory, better be able to target or find their customers, better be able to fulfill the orders that they have received from their customers and so on. That is the role that Shopify is playing which is very different from an actual e-commerce company like Amazon. 

Reggie: Yeah, so fundamentally, Shopify is not responsible for traffic in that sense, right? 

Ser Jing: Ya, that’s correct. 

Reggie: They are not responsible for your traffic. They give you all these resources to set up your e-commerce store and then you can sell it on your own.

Ser Jing: In fact, what Shopify really wants to do is to help merchants to build a strong, direct relationship with consumers. Actually, another kind of difference between Amazon and Shopify… this is somewhat meta… is that Amazon can be seen as an aggregator. What Amazon does is to aggregate consumer demand. 

Say, if somebody wants to buy toothpaste or toilet paper, they will not go to the producers of toothpaste and toilet paper directly. They will go to Amazon and purchase that so that’s how Amazon kind of aggregates that consumer demand.

But in the case of Shopify, it really wants to help merchants build that kind of very strong, direct to consumer relationship so that’s another difference, But this difference is more about business philosophy. 

Reggie: Interesting. Definitely interesting. But I don’t think people should set up a toothpaste e-commerce store, just saying, but anyway… 

Ser Jing: Aye, you never know! *laughs* 

Reggie: Okay, you never know. Mybe you should set up like a super… what do you call that? Made to measure kind of thing, right? If you give me your saliva composite (or) whatever, we give you the best… but okay, that’s a story for another day. What is so interesting about Shopify for you as a business, knowing that this is the business model and what are some core ideas around this?

Ser Jing: Yeah, sure. I think what is really interesting for me, first and foremost, would be I think the quality of the management team. As I said earlier, I think Tobi Lütke is in my eyes, one of the best young business leaders in the world today. He’s still really young. I think he’s only in his early forties or late thirties… still tremendous amount of gas left in the tank for him to continue to lead Shopify. 

A few things that I saw in Shopify that made me think that he is somebody special… when Shopify got listed, I think sometime in 2015 or 2016, Tobi Lütke wrote a letter to shareholders that was published in Shopify’s IPO prospectus.

In it, he said a few very unique things in terms of the business. One of the very unique things he said was that they have an idea of wanting to build value for all the partners that they have, or rather they want to build value for all the constituents that they serve. 

These constitutents are not just like Shopify the business, but Shopify’s customers, Shopify’s suppliers, the environment at large and also of course the partners that are building businesses on top of Shopify. 

What Shopify has is this App Store where third-party software developers can build software that serves merchants that use Shopify’s platform. In that 2015 or 2016 letter, Tobi Lütke said that “since the creation of Shopify’s business, we have always believed in building long-term value for our partners and people within our ecosystem.” 

They have not been trying to maximize short-term revenue gains. They see that if they can help deliver more and more value to the constituents within their entire ecosystem, the more valuable the entire ecosystem can be and the more valuable Shopify can be over the long run. That has been like a guiding principle for Shopify and I think that is a rare thing to happen in the business world.

I think maybe sometimes, a lot of people can pay lip service to that kind of message. But when I looked at the way Shopify has grown its business, especially in terms of the number of merchants that have been on the platform and so on, and the amount of gross merchandise value that has been facilitated through Shopify’s platform, I think that it’s very clear that merchants love what Shopify is doing and they have really gravitated towards the platform. 

When I look at that, I think this is a company that really believes in what it’s saying. It’s walking the talk and I think a really, really good example of this long-term long-term vision and long-term patience to building value… there’s a great example that really shines through and it happened sometime in… I think in June this year. 

Shopify announced that it will be completely removing revenue share for the first million dollars in revenue that third-party software developers would earn on the Shopify App Store. This first million dollars in revenue is something that resets every year.

Basically, every year, any the first million dollars or revenue that a third-party software developer earns through the Shopify App Store belongs fully to the third-party software developer. That’s a move that could hurt Shopify’s revenue in the short run but I think the value that could potentially accrue to the merchants that are using Shopify’s services would be immense because this move really incentivizes software developers to come and build on the Shopify App Store and it really just encourages a lot more innovation going on there. 

I think the more innovative and useful software services they are being produced by these third-party software developers, the stronger the entire Shopify ecosystem becomes and the more valuable the company will be. I think it’s not an easy move to want to cut off a part of your revenue source. I think this is just another great example of why I think Tobi Lütke is just such a special business leader. 

Reggie: Yes, and I think to put it in context, this was 2015. At that point in time, this idea is very revolutionary… where you have an ecosystem and then you open up for third-party developers to come in to develop in-house softwares that would then be sold to your same community to ensure that your in-house development CapEx (Capital Expenditure) is very low. Your OPEX (Operating Expenses) is very low, you don’t need to hire all these developers to build all these features. You have a third party to come in or you’re welcome all these other people that come in to build for your community. This is considered very revolutionary at that point in time. Now, it’s like every other software ecosystem has this. We have to be very clear about this. 

But definitely, I get what you’re saying and they have taken a lot of very revolutionary moves in how they view these kinds of third-party software developer ecosystem and (it) definitely helps them to build a lot of features in a shorter amount of time with lighter fixed costs. Yeah, that’s definitely good stuff. Yeah. But what about other people on their management? Do you have any other thoughts? 

Ser Jing: Yeah. Of course. I think another really important member of Shopify’s management team is the president of Shopify, a long time president of Shopify. I think his name is either Harry or Harvey Finkelstein. I can’t remember his first name, I hope I’m getting it correct. But let’s call him Harvey, right? Harvey or Harry… I can’t remember which one. Okay, let’s call him by his last name, Finkelstein, which I’m very sure I’m correct. 

He has been with Shopify for many years and I think what’s really funny though is how he entered Shopify. He was a customer of Shopify for a while and for a long time, he was a massive pain for Shopify because he kept complaining about the service and kept offering suggestions to the extent where Tobi Lütke was like “hey, you know what? Let’s just give Finkelstein Shopify for free so that he will stop bugging us.”

It turns out that Finkelstein did not stop bugging Shopify and he kept badgering the company. There came a point in time where Tobi Lütke realized that “hey, I think I need a more diverse set of leaders around me as well to help lead the company.” 

That was when he decided to bring on Finkelstein and I think he, together with Tobi Lütke, have been instrumental in leading the growth of Shopify since Finkelstein joined, which I believe was sometime in 2010. 

Reggie: I love how he hired his most annoying customer because they want you to succeed, because they really like the product and then they keep disturbing you to want to make it better so that’s a very interesting way to look at it. 

Ser Jing: Yeah, so I think Finkelstein has been another very important part of Shopify’s success. 

Reggie: Cool. Do you have any thoughts about their compensation structure? In, in, Because it’s a tech company, it’s growing very fast so sometimes com(pensation) can be a bit complicated. What are your thoughts on their com(pensation)? 

Ser Jing: I think Shopify has a really good compensation structure. The company has no short term incentives. It pays its executives only a base salary and long-term incentives that come in the form of stock options or restricted stock units. 

In 2020, Tobi Lütke’s base salary was reduced from about $600,000 in 2019 to just $1. Tobi Lütke now belongs to the $1 club, and his total compensation… 

Reggie: Dollar club CEO. 

Ser Jing: Yeah, the dollar club CEO. His only compensation came in the form of long-term incentives. In his case, they were stock options and they vest over a three-year period. 

I like seeing companies give either stock awards or stock options that vest over a number of years because I think that multi-year vesting period helps align the incentives of a company’s management team with the company’s other shareholders.

In Shopify’s case, that was what happened. I think it’s a very well-designed compensation structure. It’s a company that pays a decent base salary. It’s not very high… paid to its managers, but at the same time, really tries to incentivize them towards long-term performance by these stock options and awards that vest over multiple years. 

Reggie: So you like this kind of vesting structure? 

Ser Jing: Yeah. I typically like seeing companies that pay their management teams over a multi-year period or based on performance… either business performance over a multi-year period or based upon the share price changes of a multi-year period.

When your options or your stock awards vest over multiple years, the monetary value of these options and awards are in the end tied to the changes in the company share price, right? If this change in the company share price takes place over a few years, it’s very likely that the change in the company share price is then influenced by the business performance.

Now, of course, if these options or stock awards vest over, say, a one month period, then I think that doesn’t make any sense at all. But if it vest over 3, 5, 7, 10 years or just a long multi-year period, then I think that makes a lot of sense because then the management’s compensation is actually heavily linked to multi-year changes in the company’s share price which is then in turn linked to multi-year changes in the company’s underlying business performance.

That is ultimately what I want to see. I want to see a management team that is paid based on the company’s long-term business performance because that is how I think the incentive will be well aligned and as a shareholder, ultimately, what I want with a company (is to see the) business be able to do well over a long period of time.

Reggie: Yep. Good… fair, fair. It’s already very common in the tech space where more and more techies are being paid these kind of long-term four year vesting period of options. But I also like it that more management are moving to this kind of structure where the management… the top 9 management are also vested with the shareholders. Actually we’re aligned with our interest, so I think that’s very good. 

But Shopify is no longer a small company. They’re already racking in billions and and billions of dollars and they have gotten to a situation where even Amazon pulled out of the e-commerce business a few years ago, They already said that “we’re not going to do the e-commerce solutions. We’re just..” 

It’s a big win, right? It’s a big win in the tech space where Amazon said “oh, we’re not gonna play this game already.” That means Shopify already run so far ahead. What is their future growth and how is their financials looking like? 

Ser Jing: Sure. I think in terms of their future growth, one thing that I often like to look at companies is to look at the total addressable market that a company has.

I think in Shopify’s case, the total addressable market is still huge. Recall earlier, I mentioned that Shopify’s trailing revenue, it’s about US$3.85 billion. At the end of 2020 globally, there are about 68 million merchants with less than 500 employees. That is kind of like the Shopify’s sweet spot where it wants to target these smaller types of merchants and then hopefully grow along with it.

68 million merchants… and then in 2020, the average revenue per user on the Shopify platform was about US$2300. When you multiply these two numbers together, you arrive at a total addressable market of more than US$150 billion and then when you compare it to where Shopify is today, I think that just shows the tremendous room for growth.

I think there’s another important dynamic that’s related to the total addressable market of Shopify and that would be the fact that the average revenue per user is likely going to increase over time because of the way Shopify could layer on more and more new services to users over time.

As an example, in 2019, the average revenue per user on Shopify was about US$1600. In 2020, that’s nearly US$2,300. A significant jump in the average revenue per user, and I actually can see that increasing as well because e-commerce today, on a global basis, the penetration rate is at best, I think, in the mid-teens range, so e-commerce as a whole has a lot of room for growth. 

That will also mean that the merchants that are using Shopify’s services, not all of them will grow, but at least there’s a strong tailwind backing many of these merchants that are on Shopify’s platform and that could potentially lead to an increase in the amount of services that they use on Shopify as well as increase the amount of gross merchandise value that flows through Shopify platform.

Because the company also charges for some of its services based upon the amount of gross merchandise volume that flows through its platform, that’s just another way for Shopify to really increase its average revenue per user as well. 

So I think that when we look at the total addressable market, where we look at the global e-commerce penetration and we look at where Shopify’s revenue is currently today, I think it’s just very clear that there’s just tremendous amounts of room for growth. 

Another important statistic… the total global e-commerce market was about US$3.9 trillion in 2020. That’s US$3,900 billion. When we look at the projected total addressable market that Shopify thinks it can get and compare that to the global e-commerce market, we can see that the take rate is actually a very sensible number that is somewhere in the low single digit percentage range. 

If Shopify thinks that its total addressable market is going to be like this massive double digit or 20%, 30%, 50% kind of take rate, then I think that’s not very sensible. But then when you compare its potential total addressable market and you look at that as a take rate of the overall e-commerce market, I think the numbers still look very much sensible to me and so I think it’s just… to me, at least very clear that there’s still a significant amount of room for Shopify to grow. 

But just having the room for growth alone is not enough. Another important part of the equation is that you also must… or rather, in my point of view, the company must have a high probability of being able to take advantage of that growth. 

When I studied Shopify’s historical financials, I think that this is a company that executed tremendously well. Just for some perspective, in 2012, Shopify’s revenue was just below US$24 million. Today, on a trailing basis, it’s at US$3.85 billion and if you look at Shopify’s revenue from 2012 to 2020, the company ended 2020 with about $2.9 billion in revenue. That’s an annualized revenue growth rate of about 83%, so very strong growth.

I think also interestingly, when you track its take rate, that means revenue over GMV (Gross Merchandise Volume), you can see that it has remained very much constant, somewhere between 2.4% to 2.6% over those number of years. 

I think it just shows that this is a company that has been able to provide a lot of value for its merchants and it’s just growing simply because more and more merchants (are) just happy to come onboard the Shopify platform. I think this is a company that is executed really well and so I think chances of it being able to continue growing in the future, taking advantage of that big total addressable market that it has, I think the chance is very high. 

Of course, it also helps that Shopify has this really, really good, entrepreneur at its helm, which is of course Tobi Lütke, like I mentioned earlier. Just the fact that he has this very staunch belief in building long-term value, I think that will be tremendously helpful in terms of Shopify’s future growth. 

Reggie: Yeah. It definitely helps that he’s a snowboarder… but yes, that’s just disturbing here. He’s done a great job. Can you help me expand a little bit on the idea of take rate? Why is it important to keep it stable and consistent, like revenue divided by GMV? 

Ser Jing: Right. I think at least for now, keeping an eye on the take rate is important because I think it also gives us a window into how Shopify is thinking when it comes to building long-term value. I think in the next few years at least, if I were to see Shopify’s take rate increase significantly, then I would be a little bit worried. 

The increase needs to happen for a good reason because I think that, at this current stage, it makes tremendous sense for Shopify to just try to build as much value as it can for merchants that are using this platform and for all the other partners within this ecosystem. 

If Shopify’s take rate is high, it means that the amount of value that it’s providing to its merchants, all else being equal, is actually lower, so I would want to see that take rate kind of being constant. Another thing of course is that if the take rate is currently low, then the chances that it can increase in the future is definitely higher whereas if let’s say the take rates is already currently, say, 20%, then it’s very hard to envision a future where this take rate can continue to increase and so the company’s overall business growth then will have to rely nearly solely on just winning more merchants to its business and to a much lesser extent, in terms of layering on new services. 

But in this case, because the take rate is still so low, I think there is the potential for just two powerful tailwinds to help power the company’s growth in the long run in the future, which is an increase in the number of merchants that are using the service as well as slowly increasing that overall take rate which can then lead to much higher revenue growth.

Reggie: In other words, a lower take rate means it’s cheaper for enterprise to use their ecosystem. If it becomes higher and higher, then it becomes too expensive then it slows down the acquisition, it slows down the… it reduces their value to customers which are enterprises trying to set up e-commerce shop, right?

Ser Jing: That’s right. That’s right. 

Reggie: Yeah, good. But later about 2019, 2020, that period of time, Shopify was toying with setting up their own logistics network which is super heavy because in a sense, all their business from the start to then, was all very light… very software subscription services, payments, capital. They were all very light businesses in terms of asset-light businesses. There’s no big costs that is ongoing. 

But they had decided to go into logistics, doing the shop, doing dropshipping, doing this kind of logistical services to support their merchants. What are your thoughts on it? Are you concerned? 

Ser Jing: I think it’s a really great move. I don’t… I’m not adverse to investing in businesses that are capital heavy. The capital heaviness has to be for good reason and in the case of adding Shopify, I think investing in logistics is a very natural and very smart move to make because if you want to be the central operating system for commerce activity for your customers, then I think it’s just very natural that you want to have a solution that is as comprehensive as possible.

When it comes to e-commerce, a very important part of the entire e-commerce… what do you call it… interaction between merchants and consumers will be that last mile fulfillment, meaning to the point where the consumer actually gets the product. That is a very important point of interaction between the merchant and the consumer.

I think that in Shopify’s case, if it really wants to be the central operating system, then it will need to provide a really robust logistics solution as well. There’s also value in Shopify providing such a service. Currently, the Shopify Fulfillment Network, which is the logistics service that it provides, is still quite young, relatively young. The company is still figuring out how it wants to build it and so on. 

But one important thing that it’s currently doing with Shopify Fulfillment Network is really trying to aggregate a lot of these fragmented third-party logistics services providers and bring them all into the Shopify platform.

And so what happens is you have Shopify just kind of aggregating all of the logistics demand that its small merchants are looking for and then try to connect them with all these fragmented third party logistics services providers. Shopify can then become a very valuable service provider for not just the merchants, but also the logistics services providers because it’s just completely inefficient and not possible for these, logistics services providers to knock on the doors of each small merchant asking “hey, do you have a packet to ship today?” 

It’s just not something that is economically feasible and so by having Shopify be that connective layer, I think that can be tremendous economic value that can be unlocked for the logistics services providers. That’s something that Shopify is investing in to do as well. 

Reggie: Okay, great. I just want to clarify that… that sounds like they’re not planning to actually own the logistics network. They just want to build the layer of matchmaking platform for the last mile logistics provider and the merchants. Is that the situation or going forward, they are planning to even bite into this last mile logistics, to in-house their own logistics infrastructure?

Ser Jing: No. I should clarify. Being that connective layer is something that Shopify is working on, but at the same time, it’s also trying to build its own in-house fulfillment capabilities so it’s kind of moving on two ends together. 

Reggie: Okay. They will build where they can, then where they cannot yet, they will direct to a third party? They will pass to the third party? 

Ser Jing: Yeah, that’s right. But I would say that I think trying to be the connective layer would… at least for now, be the easier path forward simply because you have companies like Amazon which is investing significantly higher amounts of capital, just strengthening its own in-house logistics capabilities so I think that is going to be very difficult to compete against. 

But then when you are able to aggregate a swarm of these fragmented players together, then I think collectively, they can be a force to be reckoned with as well so I think being this collector of fragmentation is perhaps the easier way forward for Shopify. 

Reggie: Great, good clarification. Thank you. I want to also dig your brains a little bit into the payment network that they’re building and also the capital network that they’re building because I think the base layer of subscription services, all those software stuff, people understand. It’s quite easy to understand that business.

But I do think some of their biggest growth engine will be in the merchant solutions layer of things and that is the part where payments come in. That’s the part where capital comes in. These two parts, could you expand for us a little bit? How does this business work? 

Ser Jing: Payments is where Shopify basically helps its merchants process payments. Basically, when a consumer purchases a product, it’s Shopify in the background helping to process these payments. Shopify is actually working with Stripe, this online payment processing company. Shopify has slapped its own logo and all that as well on top of the solution that Stripe has built. And so…

Reggie: White label.

Ser Jing: It’s this thing called…. yeah, yeah. Kind of, in a way. Effectively, what it’s trying to do is to minimize the friction that consumers face in e-commerce. Shopify claims… and I have good reason to believe what they say. They claim that Shopify Checkout, which is part of that payment solution, is actually one of the fastest in the online space. When it comes to making online payments, the smoother your overall experience is, the higher your conversion rate will be. There’s one value-add that Shopify provides to the merchants that are using this Shopify Payments. 

In terms of Shopify Capital, that is the service where Shopify distributes loans to merchants. I think in many parts of the world, even in developed economies, small/medium-sized businesses sometimes have difficulty accessing the capital markets. Sometimes, they have difficulty obtaining financing for their business needs. They go to banks and banks are not willing to lend to them. 

This is where Shopify steps in because Shopify… especially for merchants that have been on this platform for a long time, it can have a very direct view of how well this merchant’s business is doing and it can then assess the risk of lending money to these mature and in a very smart manner. 

This is where Shopify is, again, trying to provide a valuable service to some of its merchants. It says that “hey, I see that your business has done very well over the past few months or past few years and it seems that there’s a very good sales window coming up.” Let’s say it’s Christmas time and this small merchant is like “I have so much demand that I think I can fulfill but I just don’t have the working capital to purchase more inventory from my suppliers ahead of time.”

That’s where Shopify can step in. It says “oh, I can look at your numbers and know that the business you have is the real deal and I think that if you can find a financing partner, that will be very useful for your business. This is what Shopify Capital is going to provide: this solution to help finance very promising merchants that may have difficulty getting financing support from the mainstream financial market. 

Reggie: Yeah, and that forms an amazing flywheel if you think about it. The companies… they are not big enough to get financing, but because I am Shopify, you’re using my platform. I know when your money comes in, I know how much you transact. I know all the data. 

Ser Jing: Exactly. 

Reggie: So with all this data, I can build an algorithm to evaluate the risk of you repaying. 

Ser Jing: Exactly. 

Reggie: Yeah, and then with that, I give you money because I’m confident enough within my algorithm to know that okay, I can lend this person this amount of money whereas the bank does not have the information. They only see your balance sheets. 

Ser Jing: That’s right. 

Reggie: And then you grow, the GMV becomes bigger. Everybody’s happy and then the cycle keeps growing, keeps growing… 

Ser Jing: Yeah. The more GMV there is, the more revenue there is for Shopify Payments, the more revenue that could be for Shopify’s subscription solutions… if the merchant becomes larger and graduates to the more expensive subscription packages, for example. Yeah, you’re absolutely right that there’s this very strong potential for a positive flywheel to develop. 

Reggie: Yeah. Very wild, very crazy. When I first heard they’re doing this, I said “oh, that’s pretty cool”, okay, but also clarify… these days, more and more people are also doing it already. 

Ser Jing: Yeah, thats right. More and more companies are doing it. 

Reggie: Shopify… they always start this new random thing and then it proves that it works, then other people kinda copy and go along. That is pretty, pretty cool. 

Ser Jing: I would say that I think Shopify does have an advantage in there in the sense that because they already are a vendor or supplier that merchants are very familiar with and so I think that there’s just this natural kinship that merchants may have with the company that will perhaps make it easier for merchants to want to rely on Shopify for financing rather than third-party providers.

But of course, if somebody comes along and says that “I can provide you financing at much more attractive terms than what Shopify can”, then I guess it’s natural that merchants would want to move elsewhere. But if something like that happens, then I don’t think it’s beyond the ability of Shopify to be able to react and counter such moves.

Reggie: Of course, yeah. That’s the cool stuff. Okay, so what are some of the… we talk about all these different products, features, the team, the finances of the company, and all that. Can we come together to talk about some of the moats of this company?

Ser Jing: I think the strongest competitive advantage that Shopify has would actually be Tobi Lütke because I think that he has a very unique point of view about the world. There was this really good essay written a few months ago or maybe a year ago, or something, I can’t remember. Sadly, I can’t remember the author but the essay was fascinating in the sense that it talked about…. it drew an analogy in Tobi Lütke’s business strategy with the game StarCraft. Are you familiar with StarCraft? 

Reggie: I won’t say I’m familiar, but I know got 3 races. They fight. Yes, I know. 

Ser Jing: Yeah, I think Protoss, Terran and Zerg. It’s what they call a real-time strategy game where you pick a race and then each game starts off as you just having a few small units and you’re supposed to build different types of structures and different types of units and go on to attack.

Reggie: Yes, but I have to say StarCraft is an amazing game in a sense that the three different classes of characters are very different. It’s not like other games where it’s like a different skin but the features are similar. No, this is three different class. They’re very different and the power balancing is done very well. Although I don’t play it, sometimes I watch it so I thought “wow, this is quite cool ah, this game.” 

Ser Jing: Tobi Lütke is actually a very avid StarCraft gamer. I think I have even read somewhere that he has hired somebody purely based on the person’s ability in the StarCraft game. He hired a StarCraft gamer just because he was this really, really good StarCraft player.

The favourite race that Tobi Lütke likes in StarCraft is Zerg. Zerg is a very unique race in StarCraft because early on, it’s quite weak. The individual units in the Zerg race is just weak. But what happens is over time, if you’re able to fend off your opponent’s attacks in the early game and you do this thing called a Zerg Creep, which is where you swarm the map with a lot of small units, then in the late game, the Zerg race is effectively unstoppable, right?

So this author drew this analogy and looked at what Shopify is trying to do and basically analogises it to the idea that Tobi Lütke is trying to Zerg Creep in the real world. He’s trying to really arm all kinds of small merchants, all kinds of small businesses give them… empower them with the tools to succeed and then go on to attack the world of e-commerce. I find that to be a very fascinating window into how Tobi Lütke thinks about the world of business.

I can’t say for sure if that is exactly what Tobi Lütke is thinking about but I think the author makes very compelling arguments and I kind of agree very much with what the author is saying. In fact, if you look at some of the moves that Tobi Lütke has made, like when Shopify made the announcement that it was going to remove all revenue share for third-party software developers on the Shopify App Store for the first million dollars in revenue, Tobi Lütke actually sent out a tweet. He made a tweet that says that… very interesting tweet. 

He says that “your (increased) margin is our opportunity” and this is actually a wordplay on a famous quote from Jeff Bezos, which is “your margin is my opportunity.” I think that is fascinating because I think it shows the belief that Tobi Lütke has in that if I empower all these small little so-called ‘Zerg units’, over time, I can do this Zerg Creep and just go to dominate the world. 

I just think that it’s just a fascinating business strategy and so I think that just having Tobi Lütke at the helm of Shopify, it’s just the biggest competitive advantage that a company has because with him at the helm, he is setting the tone for the company, setting the culture and what happens is then I think it flows down and employees in Shopify are just constantly thinking about what/how can we build long-term value for the company by empowering our partners, by empowering our merchants and so on.

I think that is a North Star that is very hard to replicate, right? If I were the one running Shopify and I had the opportunity to remove revenue share for the App Store, would I really do it? I might not because it also goes directly against the very human nature of greed. It’s just a very normal and human thing to want to be able to make as much money as we can. 

But in the case of Shopify, it’s very capable of being able to delay that kind of gratification over the short run and I think that just comes from Tobi Lütke. Having read interviews by him and so on, I just think that he’s just a very unique polymathic thinker as well about the world and so that helps also to create this very strong culture within the company. 

When people often talk about workplace culture, they have this idea that is something that is static; there are core values and so on. But in Tobi Lütke’s case, he has a firm belief that culture is actually something that is evolving all the time. What is important is to make sure that you do not disrupt the evolutionary process. Of course, you need to keep an eye to make sure that the evolution is happening in the right direction, but if it’s evolving, then it’s important to not break that. 

That is just something that I think is again, unique. I seldom come across business leaders who think about a company’s culture in this way and of course, when you look at the kind of success that Shopify has in the business, just tremendous revenue growth and in recent years, just this explosion in free cashflow as well, then I think that a lot of the unique things that Tobi Lütke is trying to implement within Shopify is working out, so I think he is the most important competitive advantage for the company. 

I understand that the answer may be a bit of a cop-out, right? When we talk about competitive advantages, people often think about things like intellectual property, they think about being a lowest cost producer and some other types of competitive advantages. 

But I think it’s also important for investors to realize that all of these competitive advantages that you see actually come from the company’s management’s past actions. It’s the past actions that have led to the current competitive advantages that you see so I actually see that ultimately, a company’s competitive advantage would be the management team and that is why I think in the case of Shopify, I’m very adamant that the real competitive advantage that Shopify has is Tobi Lütke. 

Reggie: Fair, fair. I think I already see a pattern after doing this with you a few times. You are always very big on the management and I think it’s important because some of the best leaders will lead a company through all sorts of weird times so I think that is a very fundamental, important part. By recognizing that things are fluid, you know that you cannot just rely on the current advantage that you have but whereas a good team can keep meandering around and finally get it to wherever you want to go. 

Of course, specifically for Shopify, it sounds like they want to take on Amazon so you need some crazy guy to take on Amazon. It’s not so simple. 

Ser Jing: That’s right. 

Reggie: Cool. Okay, I think we all can agree that they are riding on tailwinds. It’s going to the future, so more and more e-commerce, digital interfaces and all that stuff… more reach, more accessibility. Those things, I don’t think we really need to expand, but what are some of the risk factors in closing for this company because we cannot like wah everything like very positive like that ah. So what are the risk factors? 

Ser Jing: Yeah, so I think the biggest risk factor for Shopify would actually be key man risk. Key man risk essentially means the risk that the businesses’ growth could be harmed if a certain or a few or one individual leaves the company and in this case, I think if either Tobi Lütke or Harvey Finkelstein leaves the company, then I think that can be potentially very detrimental to Shopify’s future growth because then the company could lose the North Star in terms of having that long-term goal of empowering merchants, building value for partners and so on. 

If you lose that kind of a leader at the helm, then that North Star could potentially disappear and I think that could be dangerous for the company so that’s my biggest risk. 

There are a few others. There’s also the risk of competition. Shopify is providing a software solution and other types of digital services to help merchants conduct businesses online and there is no shortage of competition. I mean, there’s always the chance that somebody would come up with a better mouse trap so I think there’s that. 

Of course, I think you rightly pointed out that Shopify sees Amazon as one of its biggest targets. Amazon is itself a very formidable company and in Jeff Bezos, and of course now Andy Jessie… it has incredible leaders at the helm. 

A full disclosure: my funds also own shares in Amazon. It’s also one of the larger positions that I have within the portfolio. So, yeah, I like both companies a lot but I think you can never really fully write off Amazon especially when it’s quite clear that Shopify wants to compete against Amazon’s aggregation efforts. 

I think another important risk is dilution. Shopify has over time been shown to have been issuing shares quite a bit. Just for some perspective, let me just pull up the numbers very quickly… In 2016, I think that’s when… or 2015, when Shopify IPO-ed (Initial Public Offering), its share count has actually nearly doubled from then till 2020 so that is like a mid-teens rate of annual increase in the share count so that is very high. 

But the good thing is that when I look at Shopify’s revenue growth, it has significantly outweighed the growth in the share count, meaning that on a per share basis, I think the company is still building value at a significant rate. But ideally, I wouldn’t like businesses that have such high dilution so that’s another risk I’m looking at. 

I think another important one would be, of course, the valuation. Shopify is not a cheap share. I think Shopify is… today trading about maybe 60 times trailing revenue so that is a very high multiple. Even if let’s say I assume that Shopify has a free cash flow margin of say 30% today, that 60 times revenue number would equate to maybe 190 times free cashflow, which is super high. 

That is of course a risk, when you pay very high valuations for companies and if the company does not deliver, then you’re in for a painful ride as a shareholder. But in this case, I’m just happy to pay up because I think that Shopify is just a very unique [indiscernible] business that likely has significant room for growth ahead. You can probably compile its top line anywhere from 30-50% easily over the next five to seven years and so because of that, I see the high valuation as a risk, but not something that would cost me to just completely stay out. 

To recap, I talked about key man risks, I talked about dilution risk, I talked about competition and I talked about valuation. I think these are the important risks that I see with Shopify’s business. 

Reggie: Cool! Good to know. Anyway, I just want to say that I am very okay with a company that is at a very high valuation to dilute its shareholders. I know it’s a very long discussion and we probably should organize it like a few people, online discussion. How do you evaluate growth companies, right?

Because at that stage, they’re land grabbing, they’re innovating. They need a lot of capital and you want them to keep growing so as long as the top line is running… there are top line running 2X higher than dilution, then you know that it may be a good move. 

Ser Jing: I completely agree with you actually.

Reggie: Yeah, so that’s a whole different discussion. We will do it another time. I think a lot of people are very interested in how to evaluate growth companies. It’s very different from all the value metrics and all those things that is being talked about. 

Ser Jing: I think we definitely should have that discussion because I actually don’t see that there’s a big difference in how you evaluate growth companies versus what people traditionally learn about investing. I actually don’t see big differences there. The biggest difference is just having that imagination or being able to think about how big a company could become. That is a discussion for another day but yeah, I’m definitely keen to have that. 

Reggie: Great! Okay, so I got one man in. We will organize something like that some time down the road. Okay. Thank you, bro. See ya! I hope you guys enjoyed. Good stuff. Take care! 

Ser Jing: Thanks for listening. Thanks for having me. Bye bye. 

Reggie: So I hope you learnt something today and definitely recognize that investing is a personal decision. We’re not here to give you any recommendations but we’re always happy to geek out with you on interesting companies and trends for the future. 

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