In the past, I've talked about the importance of businesses sticking to their core competencies to thrive. Yet history is filled with stores of successful companies that ignored this fundamental truth. For example, Google's high-profile foray into gaming was a disaster. Amazon's Webstore couldn't hack it against Shopify and BigCommerce. And eBay has failed at practically every growth initiative it has attempted.
With Shopify Fulfillment Network (SFN), Shopify is now in danger of falling into this trap. Across the e-commerce landscape, the race to build best-in-class logistics infrastructure and faster fulfillment capabilities is heating up, and Shopify wants in on the action. But is entering a space that Amazon dominates and venturing away from its core competency (small business software) the best use of its resources?
Note: I originally published this post on LinkedIn.
How Shopify Fulfillment Network Stacks Up
Amazon’s economic moat is practically impenetrable. At its core, Amazon is a technology company that enables commerce in all its forms and invests tens of billions of dollars every year to expand its competitive advantages. For example, in its relentless pursuit of improving delivery speeds for its customers, Amazon dropped $52.3 billion over the last year and grew its fulfillment capacity by 50% to expand Fulfillment by Amazon (FBA).
In addition to adding fulfillment centers, Amazon vastly improved its middle-mile and last-mile capabilities with significant investments in sortation centers, airplanes, trailers, delivery stations, delivery service partners, and other CAPEX. As a result, 77% of the US population is within 60 minutes of an Amazon delivery station and 63% of a fulfillment and redistribution center.
Retailers like Target are starting to gain ground in the same-day fulfillment space as well. Target’s 1,914 U.S. store count is a significant competitive advantage even over Amazon, and the retailer has leveraged its strengths to create a “stores-as-hubs” model all across the country.
The company has also invested heavily in its rapid fulfillment and last-mile capabilities in recent years, including the acquisition of transportation technology company Grand Junction in 2017, the $550 million acquisition of same-day delivery platform Shipt the same year, and the purchase of proprietary technology from Deliv in 2020.
Target now has 46 distribution centers across 23 states and its massive chain of stores recently fulfilled more than 95% of the company’s second-quarter sales. And, according to their Q2 2021 earnings report, their same-day services (Order Pickup, Drive Up, and Shipt) grew nearly 55% on top of the record growth of 270% last year. In fact, customers chose same-day services for more than 50% of all the company’s digital sales during the most recent quarter.
And then there’s Shopify. In 2019, the company introduced the Shopify Fulfillment Network (SFN) to compete directly with Fulfillment by Amazon (FBA). But instead of building its own infrastructure, Shopify has partnered with third-party fulfillment centers around the U.S. to offer two-day shipping to its merchants.
The company also paid $450 million to acquire the robotics company 6 River Systems, saying it would invest $1 billion over five years to leverage its scale and technologies—collaborative robots, deep machine learning tools, demand forecasting, smart inventory allocation, and intelligent order routing—to offer faster and cheaper fulfillment services to its merchants.
If you’ve spent any time in logistics at all, you’re probably skeptical about Shopify’s plans to go head-to-head with Amazon. But even if you haven’t, all you have to do is look at Amazon’s fulfillment centers and compare them with Shopify’s SFN facilities. The differences are astounding, and Shopify is nowhere close to catching up. A billion-dollar investment over the next five years feels like a drop in the bucket.
Furthermore, it’s been over two years since SFN launched, and the service has yet to gain any real traction. As of this writing, SFN remains in the “product-market fit” phase, and the company has yet to announce plans to open up the network to its 1.7 million merchants. Does this mean that Shopify has bitten off more than it can chew?
Shopify Is Facing Real-World Struggles with SFN
There is no doubt that Shopify offers the world’s best e-commerce platform for SMBs. It has made sense for them to move into fintech with payment processing, small business loans, bank accounts, and installment payments. And even though Shopify is not the right choice for large businesses that want to scale, the company has found incredible success by focusing on what it does best: helping small businesses get started online.
But fulfillment logistics is an entirely different beast. Over the last nine quarterly earnings calls, no fewer than analysts were met with vague answers each time they asked important questions about SFN’s real-world progress. Similarly, a director at SFN recently declined to discuss specifics about the company’s logistics plans.
Even if their fulfillment service remains on track to accelerate growth in 2021, Shopify has now ventured into deep, uncharted territory, and SFN’s real-world struggles are beginning to show.
Fulfillment capacity is shrinking
One of the most apparent signs that building a world-class fulfillment system is proving more difficult than anticipated is Shopify’s shrinking capacity. At launch, SFN promised to support merchants with less than 2,000 SKUs that sent out between 10 to 10,000 orders per day. That capacity was supposed to increase by the end of 2019 to accommodate merchants that shipped between 3 and 30,000 packages per day.
Today, SFN can only accommodate merchants with less than 200 SKUs that only ship between 3 and 200 packages per day. That’s not good. If Shopify is onboarding more merchants but has severely limited the volumes of their shipments, that means their aggregate fulfillment capacity hasn’t changed at all. This is a red flag that things aren’t going as planned for SFN.
Surprise: Logistics is hard
On Shopify’s Q3 2020 earnings call, CEO Tobi Lutke was asked about the biggest frictions he saw in the e-commerce landscape, and he responded by saying:
“Logistics is hard. I'm sure… you will hear it from everyone in the logistics world. But it's hard. And it's really, really, really, really harder… even [for] those who know that it's hard. So there's a lot of friction in this process. And a lot of that is hard to see right now how to avoid it. Like processes can only get you so much and software can only do so much.”
This points to a lack of faith in the success of SFN at the highest leadership level. Tobi has taken Shopify to extraordinary success as an SMB software platform, but now he needs a team at Shopify to guide SFN in the right direction. He can’t do everything. His specialty is entrepreneurship and software development, not logistics.
Further, Shopify is taking a notoriously tricky business and adding a layer of complexity by inserting itself between merchants and third-party logistics providers (3PLs). The economics of this approach are unproven at best. Even if machine learning and collaborative robots can dramatically improve the efficiency of these fulfillment centers, it speaks more to how poorly these facilities were run in the first place than to how great Shopify’s fulfillment technology is.
In contrast, Amazon executives famously subscribed to the theory of constraints to tackle bottlenecks in their fulfillment centers. They quickly realized that the equipment and software from third-party vendors simply weren’t designed to maximize the efficiency of their supply chain. As a result, Amazon eventually had to engineer its own solutions, resulting in one of the most innovative and dominant logistics systems this world has ever seen. These are challenges that will be extremely difficult (if not impossible) for Shopify to overcome.
SFN is losing its value propositions
If you’re a Shopify merchant and you want to offer the fastest available shipping to your customers, SFN simply can’t match FBA’s one-day and same-day capabilities. This is why Shopify offers an FBA integration to merchants. What’s more, Amazon’s multi-channel fulfillment program is now processing Etsy, eBay, and Shopify orders using blank, unbranded boxes instead of Amazon-branded boxes.
This latest move is a direct shot at Shopify’s fulfillment aspirations. One of SFN’s main selling features is that merchants can use custom packaging to promote their brand and deliver a better unboxing experience for their customers. But if the benefits of using blank boxes and FBA continue to outweigh the benefits of custom packaging and SFN, few merchants will likely choose Shopify over Amazon. This is yet another way that Amazon is exerting its control over its e-commerce competitors.
However, one advantage that SFN has over FBA is that merchants get to retain complete control of their customer, sales, and inventory data. As you know, Amazon has a history of developing competing products using data from sellers. But while this is a great advantage that Shopify has over Amazon, more mature 3PL providers offer the same value proposition.
SFN’s Only Chance for Success
Improve fulfillment and logistics
To create a holistic experience that benefits the end consumer, Shopify needs to make gains in both fulfillment and logistics. To clarify these concepts: logistics begins where fulfillment ends. Fulfillment is inbound order management, sortation, pick/pack/stow, and shipment manifestation while logistics is the first, middle, and last mile of delivery. Based on my points above, Shopify has not made meaningful strides in either of these areas.
Adopt a marketplace model
Before Amazon's marketplace ambitions, retailers optimized fulfillment and order systems by managing inventory levels and shaping demand. Similarly, logistics providers were busy optimizing routes and commingling inventory for the first, middle, and last mile to squeeze cost efficiencies through the network. Amazon's marketplace model allowed it to blur the lines between brands and create cost efficiency, arguably the only efficiency that matters besides time.
Amazon’s marketplace model was vital in supporting economies of scale that benefited both Amazon and its customers. And while Shopify has played around with this model by launching its “almost-marketplace” called Shop, it does not support economies of scale.
Consider buying shoes from Allbirds, socks from Bombas, and shorts from Chubbies (all Shopify merchants). You have one order but potentially three fulfillment centers for three different brands and the associated labor, packaging, and stowage costs. Unit economics do not work here.
Compare this to a marketplace model with unified fulfillment and logistics that offers the opportunity to load balance inventory at the square-foot level, shaping your inventory patterns based on broader customer behavior across different brands and verticals. Shopify talks about doing some of this on its SFN page; Amazon has already done all of it. Amazon serves 3P and FBA merchants, including Shopify merchants who use FBA!
That said, I don’t see a path for SFN where they even come close to offering a fulfillment service with costs anywhere near Amazon unless they spend 100x more than what’s currently planned for fulfillment and logistics. And even if they do this, a marketplace model that limits branding and data control goes against Shopify’s ethos of serving the merchant first and foremost.
SFN Faces Fierce Competition Beyond FBA
FBA may be the giant elephant in the room, but many smaller logistics competitors can give Shopify Fulfillment Network a run for its money. ShipBob is one example.
This cloud-based logistics platform also partners with 3PLs to provide sellers with supply chain and fulfillment capabilities. But, unlike SFN, ShipBob’s founders are logistics experts that built their own end-to-end systems from the ground up. As a result, they are attracting large investments and growing at an incredible pace. ShipBob currently has 24 warehouse locations versus SFN’s ten and has plans to reach 35 by the end of 2021. This makes me wonder why Shopify didn’t acquire ShipBob or a similar company over 6 River Systems.
Yet even with all of its growth and success, ShipBob only serves about 5,000 e-commerce businesses today. Shopify has nearly two million merchants. So if Shopify is serious about building SFN into a legitimate contender, it will need to allocate more capital than its paltry investment of $1 billion over five years.
Others believe that SFN will need 40 to 50 warehouses across the U.S. and an investment of several billion more dollars for it to scale. And it doesn’t end here. How do you meet the expectations that Amazon Prime and FBA have set for delivery speed without controlling the first, middle, and last mile? Is that the best use of money for a company that serves small businesses, doesn’t specialize in logistics, and has struggled for over two years to get its fulfillment service off the ground?
The shipping assistant feature inside the Shop app is the best Shopify currently offers related to fulfillment and logistics. But this feature seems to serve as an interim solution to what Shopify hopes SFN will be. The shoppers I know don’t want to download a separate app to track deliveries. They want to expect it in two days or less.
Lesson Learned: Stick to Core Competencies
As we saw from Tobi Lutke’s quote above, Shopify realizes that fulfillment is much more complex than they initially thought. And I believe this is because Shopify has deviated from its north star of serving merchants as fulfillment mainly focuses on the buyer. As a result, fulfillment probably feels awkward to them, but not in that good kind of way that often preludes success.
Deviating from ethos, north star objectives, and core competencies is rarely a good idea. For instance, Amazon shifted from focusing on consumers to merchants with Webstore, a failed software initiative that tried to compete with Shopify. And eBay shifted from focusing on consumers to businesses with its acquisition of GSI Commerce. a suite of e-commerce marketing services that formed eBay Enterprise. This happened around the time I joined eBay as director of global shipping in 2011 and I witnessed its fast demise.
If Shopify can learn anything from eBay, it’s about calling a misaligned initiative a failure early on. For example, after purchasing GSI Commerce, eBay divested it two years later (2011-2013). On the other hand, it took Amazon five years to divest Webstore (2010-2015). Either way, if you’re going to challenge companies that dominate a business area like fulfillment, you have to have genuine insights into the wants and needs of the customer, and you better play to win.
It looks like the strategy at Shopify was to find a shortcut into the fulfillment space without having to engineer solutions from the ground up. This approach is similar to how it hacked Shopify Plus and forced its way into trying to contend with e-commerce software providers serving mid-market and enterprise brands and retailers.
These are good lessons for other e-commerce providers to learn from as we continue to grow our e-commerce platform. During this time, we will remain focused on serving mid-market and enterprise brands with technology that supports scalable and customizable buying experiences. All new initiatives will align with this.
What is your company focused on? What is your north star? Let me know on Twitter.