Quality of Revenue

Over the last three years, Shopify has shown gross margins in the mid-50% though we can see a small decline over this period. When we examine the revenue segments, it is evident that Subscription solutions contributed ~59% of 2019’s gross profits despite accounting for ~40% of sales. 

The three-year average gross margin on Subscription solutions and Merchant solutions segments were ~79% and ~37%, respectively. The Subscription solutions are arguably the more profitable component of Shopify. The cost of revenue for both segments include compensation and data infrastructure costs as a major expense item, but the Merchant solution also incurred additional fees (i.e., interchange, network) related to processing payments. 

There is also a consideration of the nature of the transaction as well. Subscription revenues are paid upfront for monthly, yearly, or multi-year plans. This upfront payment means Shopify receives money before rendering the service. Compare this to Shopify Payments, where they are paid after a transaction happens. The upfront cash payment can be considered similar to ‘float’ that Warren Buffett commonly uses when referring to insurance companies as they also receive payment upfront before processing any insurance claims.

The implication of this ‘float’ is that Shopify is able to use the funds from its higher-margin Subscription solution business to invest in other areas like Shopify Fulfillment Network that make up Merchant solutions. This cycle of reinvesting their float may already be showing up as Merchant solutions went from representing ~35% of gross profits in 2017 to ~41% in 2019. 

Management has noted the importance of Shopify Payments in creating higher retention with merchants. The expansion of more services like Shopify Payments to help merchants may lead to higher GMVs over time to propel further the growth of revenues from Shopify Payments over time. As of Q2, 2020, Shopify Payments processed $13.4b of GMV from $2.2b in Q2 2017.