What's Behind the Shopify Effect

Alex Danco's Newsletter, Season 3 Episode 12

Each year, Shopify releases a report with Deloitte called our Economic Impact Report, in order to highlight and celebrate some bigger-picture impacts of Shopify merchants around the world. This past year was obviously a critical period for our merchants, who thrived during an absurdly challenging time. It’s really meaningful that they did: Shopify merchants now represent 3.6 million jobs around the world, and every 28 seconds, a new entrepreneur makes their first sale on Shopify. 

All together, we’re very proud to help support this enormous, growing global community. This year we’re wrapping it up in some deliberate storytelling, called The Shopify Effect. 

There’s clearly something important happening at scale here. It’s not just the numbers that impress; it’s the depth and distribution. Merchants of all sizes are thriving on Shopify, and if anything, the small merchants are outperforming the larger ones in relative impact and growth this past year. The most impressive part of the “Shopify Effect” is that merchant’s aren’t just starting businesses; they’re building good businesses that really work, and sustain healthy gross margins, that support employees and suppliers and communities around them. 

There is something special going on here, which has to do with friction and the internet. But it isn’t what you think. 

Opt-In Commerce

A big part of the Shopify story is, “We help get rid of friction in commerce." This is certainly part of it: there is a lot of friction we try to remove with our product for both merchants and buyers. Merchants shouldn’t need to bear the agony of setting up a payment processor, dealing with cross-border taxes, syncing inventory, or having slow-loading checkout. There’s a lot of unnecessary struggle in entrepreneurship and in commerce we can help get rid of, and we’re proud of doing that. 

But getting rid of friction is only half of the battle. There’s another aspect of commerce that we need to understand too: challenge. They might seem superficially similar, but they’re not.

Commerce is not one homogenous activity; there are two distinct kinds of commerce that are effectively opposites. One kind of commerce is oriented around opting in to a challenge; the other kind of commerce is oriented around opting out of a challenge. 

Imagine you’re going to the store to buy a nice bottle of wine. You’re headed to a dinner party with friends, so you care about this purchase. It says something about you. Successfully finding and bringing a nice bottle of wine is a challenge. You are opting into this challenge; and so is the winemaker and merchant on the other side. They’re putting effort into this sale - not just growing and making the wine itself but how it’s presented, how they tell a story around it, and what the wine says about you.

This purchase challenges you, and that’s important. You and the merchant build a relationship with each other, in overcoming the challenge together. You’re likely to remember them, and buy from them again next time.  Notice how important it is that you consciously opted in to the challenge of buying this wine; so that you can take pleasure in knowing you fulfilled the challenge. 

There are all sorts of purchases we make that fall into this category, where we’re consciously opting into a challenge. A sneaker drop; a cosmetics line; local healthy food; collectables; art; a snowboard; for all these purchases, the challenge isn’t incidental. It is the point. Without it, the purchase has less meaning; and the meaning is really what we’re after - being beautiful, being smart, being an athlete, being someone with great art. We have a name for this kind of commerce, where people eagerly hunt for challenges to find joy in overcoming them: it’s called shopping. 

This kind of commerce sustains a healthy ecosystem behind it. There’s room for sustainable gross margin here, which in turn can support a lot of effort on the merchant’s part to make this purchase really special. That’s how you pay designers, and sustainable suppliers, and good wages to happy employees, with room left over to grow your business and reach financial independence. Gross margin matters; and that’s why these challenges and the stories around them matter.

Opt-Out Commerce

Of course, not everything we buy has this kind of meaning. There’s also the other kind of commerce, where we opt out of challenges. 

This is anything we buy at a convenience store, or any kind of purchase that honestly doesn’t say anything about us at all. There’s no greater meaning here; no challenge to overcome that speaks about us as a person; we’re just buying toilet paper, or picking up stuff at the corner store. The point here is convenience. We want to opt out of any difficulty whenever possible - it does nothing for us. 

The same is true on the merchant side of the table. It makes no sense for them to craft a meaningful challenge for their buyers. Buyers aren’t looking for a challenge to overcome; they just want to complete a transaction without any friction involved. The less of a direct relationship the merchant has with the buyer, the more certain that this’ll be what kind of commerce is happening. So the merchant is denied something too: they can’t create and overcome those challenges alongside their buyers. Both the buyer and the merchant opt for convenience instead. 

If we get rid of all the friction, all the challenge, every obstacle and inconvenience, what do we get? We get Amazon. It’s clear what kind of commerce happens here. A lot of it, for sure - convenience attracts a lot of customers, and a lot of buying does in fact take place. But without a challenge to overcome, nothing meaningful gets created. No buyer loyalty or retention gets established; gross margins continually face pressure. So it’s harder to pay good salaries to employees; it’s hard to reinvest into good design, or good craft. You’re stuck in this low-challenge, low-margin, low-breathing-room kind of commerce, where everyone’s going through the commercial motions but no one is deriving much joy or self-expression from it. This kind of commerce is called consumerism. 

I bet if you asked, “what’s the relationship between shopping and consumerism”, most people would tell you they’re overlapping concepts. We don’t think so. We think that shopping and consumerism are opposites. One opts into challenge. The other opts out. 

Gaming and friction

Speaking of narratives, here’s one you’ve heard before: “Over the long run the internet moves in one direction and that’s getting rid of friction.” There are two compelling reasons behind this argument. One is empirical; it’s what we see happening, all the time: both the companies making these great breakthroughs in eliminating friction, and the world-beating business models they create. The second is just common sense. Users don’t like friction; so when you get rid of friction, they’re happy, and in the long run, we’re good at building stuff that makes users happy. 

It’s obviously anecdotal, but I know a lot of smart people who understand the internet well, and have effectively concluded: this is how the internet works. There’s an arrow of progress that moves in one direction - towards getting rid of friction - and a corresponding rise in internet-native businesses, especially the aggregator and platform models, that support and monetize that. On today’s internet, it can be hard to imagine that it might work any other way.

Meanwhile, there’s another industry next door that has a very different philosophy about friction. That industry is gaming. 

The gaming industry understands that friction isn’t something to blindly get rid of. Friction is challenge, and for them, challenge is the product. That is the point of gaming: crafting and hosting challenges that intrinsically motivate people to go after. The gaming industry understands the distinction between bad friction versus good challenge, so much better than anyone else. 

Josh Buckley, the CEO of Product Hunt, had a great interview on Colossus the other day where he shared some of the common principles of game design. It’s worth listening to, for two reasons. One, because he clearly explains some fundamental rules of how friction and challenge works, and how to craft them so that they’re intrinsically motivating. And two, because it might be the best articulation of how D2C works that I’ve ever heard. 

There are four more-or-less universal principles for designing intrinsically motivating games. All four of them are about challenges. And all four of them apply directly to commerce.

First, there needs to be a meta-narrative for why you’re participating, that makes you feel a certain way. If you’re buying sports gear, that meta-narrative is the challenge of athletics. If you’re buying old records, that meta-narrative is the challenge of cultural fluency. If you’re buying cosmetics, the meta-narrative is the challenge of beauty and self-expression. For one of my favourite Shopify merchants, RedOne Music, the meta-narrative is the challenge of being a musician. 

Second, you need a variable reward mechanism. This is really important: if it’s pre-ordained that you are going to succeed, there isn’t a real challenge. When you go to the convenience store, you know you’re going to buy a couple things; there’s no uncertainty to it, and there’s no challenge you overcome. But when you go shopping there’s some real uncertainty when you set out, and that’s why conquering that challenge has meaning for you. Some of the most fun commerce experiences on earth, like sneaker drops, take this to its limit. 

Finally, you need tight feedback loops and a sense of control. These two go together, and they’re really important for creating experiences where people enjoy the challenge, rather than dread the challenge. Sense of control doesn’t mean “pre-ordained outcomes”, it means, “Do I feel like I’m in the driver’s seat of something.” 

Think critically about this, juxtaposed against that earlier assertion: “The internet gets rid of friction, and that’s what people want.” There’s obviously such a thing as bad friction to get rid of, but the people who really get it - like the gamers - understand the importance of challenge. And so do Shopify merchants. 

Nowhere is this more apparent than in the economics of ecommerce. 

The Shopify Effect

One of the biggest consequences of the direct-to-consumer resurgence in commerce is the total focus on customer loyalty it demands. The internet is a wide open playing field. You can reach any customer, anywhere - but anyone can reach your customer. The cost of reaching new customers, seen in the average CAC spend that merchants must invest into their customer base, relentlessly goes up every year as a consequence. 

If you’re doing Opt-Out commerce, this is just a death spiral for you. When you compete on the basis of eliminating friction and challenge, you’re just signing up to pay market rate to reach buyers, and buyers will evaluate you on the same playing field as your competitors. It’s hard for you to establish any kind of sustainable gross margin that way, let alone contribution margin. It’s tough to build a business that way, or to support a community around you. 

But if you’re doing Opt-In commerce, which is what D2C really means, something else happens. The amplifier of the internet works for you: if buyers identify with the challenge you’ve created with them, and if they’re intrinsically motivated to go conquer it with you, then that accomplishment will propagate virally. If you’re good, something astonishing happens: the more CAC you spend, the lower your incremental CAC becomes. That’s magic for a consumer business.

When I think of the most successful Shopify merchants and the kinds of brands they’ve built, every single one is explicitly doing this. Their buyers come back to them, again and again, because they’re intrinsically motivated to participate in something meaningful. That retention and LTV helps support really strong businesses, and they also demand a lot of reinvestment too - the good kind of reinvestment, like reinvesting into really well-crafted products, high-quality materials, and loyal employees. 

To me, this is the real “Shopify Effect”. Our merchants can have such massive global impact (3.6 million jobs! $307 billion in 2020 economic contribution!) not only because they’re able to start and scale businesses, but also because those businesses are good businesses. They have strong fundamentals, powered by healthy gross margins that can support huge communities around them. The fundamental reason why they can do this isn’t only by getting rid of all the unnecessary friction. It’s by creating really expressive challenges, and helping their buyers become someone through conquering that challenge.

Sure, there’s a lot of unnecessary friction that doesn’t help, and Shopify is eager to help get rid of that. We’ll never get tired of speeding up page load times or streamlining complex registration forms. But the real Shopify effect that I’m really proud to help build is in the Opt-In part of commerce. 

You probably know that famous Jeff Bezos line, which goes something like, “I don’t want to build a business on what will change in 10 years; I want to build a business on what will be the same in 10 years. And buyers will always want more choice, they’ll always want more convenience, and they’ll always want lower prices.” Well, we have our own version: “People will always be motivated by challenge. We always want to become someone. Challenges are how we do that. Great commerce celebrates those challenges.” That’s what our merchants do every day. And I think we’re figuring out how to help. 

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And before we go, here’s this week’s Tweet of the Week, the tweet that made me laugh the hardest:

Have a great week,

Alex