The necessity of Shopify Audiences

Shopify announced Q4 2022 earnings on Wednesday: while the company’s revenue grew by 26% to $1.7 billion on a year-over-year basis, its gross margin declined to 46.0% from 50.2% in Q4 2021, driven by significant increases in Research and Development (+61%) and General and Administrative (+111%) expenses. The company booked a $188.7MM operating loss in the quarter, compared to $14.4MM in operating income in Q4 2021. Shopify’s subscription revenue grew by 14% on a year-over-year basis, although, curiously, Monthly Recurring Revenue grew by only 7%. And the company’s merchant solutions revenue stream grew by 30%, owing in large part to the company’s integration of Deliverr, the eCommerce fulfillment platform that Shopify acquired last summer.

Shopify offered soft guidance for Q1 2023, with revenue growth in the “high-teens” and gross margin slightly higher than in Q4 2022, implying an operating loss. While Shopify’s gross merchandise volume (GMV), gross payments volume, and revenue metrics were all up for Q4 — with revenue beating consensus estimates — the company’s creeping cost base and light guidance for the current quarter apparently startled the market, with Shopify’s stock trading down by roughly 16% yesterday.

Last May, I wrote about Shopify’s then-newly-announced advertising targeting product, Shopfiy Audiences. From With its Audience product, is Shopify creating a Content-Fortress-as-a-Service?:

Effectively, with its Audience product, Shopify is operating a Content-Fortress-as-a-Service: it is aggregating first-party data and utilizing it on behalf of its customers (retailers) for ad targeting, but those ads are being served on a separate property…I imagine, as everything becomes an ad network, that productive partnerships between first-party data aggregators and the properties that service owned-and-operated inventory proliferate where that makes more sense than the alternative.

I include more detail about the product in the piece, but at a high level, Shopify allows retailers subscribed to its Shopify Plus program to target relevant users on external ad platforms using purchase history data aggregated from the Shopify network. Shopify Audiences essentially provides its retailers with lookalike audiences that are deployed on their behalf but not owned by them; Shopify maintains custody of the targeting data and transmits it to merchant accounts on external ad platforms directly, without merchants taking ownership of it. Shopify initially launched Audiences on Meta properties and, in October of last year, expanded the product to Google-owned properties across YouTube, Google Search, Google Display Network, and Gmail. And, according to Shopify’s Q4 2022 earnings call, on February 9th of this year, Shopify Audiences was extended to Pinterest.

The Audiences product received very little attention in the Q4 earnings call, but the company provided more color on its performance last quarter. From the company’s Q3 earnings call:

Another way that Shopify is enabling merchants to build buyer relationships is through Shopify audiences, our new tool that helps Plus merchants find high-intent customers. Since launching in May of this year, audiences is significantly improving conversion rates, return on ad spend and other important metrics for those Plus merchants who have opted in… Fast-growing home furnishing brand, Nathan James, attributed over 500 new customers to their use of Shopify audiences. They also saw a 200% increase in purchases, a 5.6 times return on ad spend on the targeted campaign, over $100,000 in new revenue, all while customer acquisition costs declined by over 50%. Examples like these fuel our excitement about how audiences can drive merchant growth, especially going into the upcoming holiday season. 

The crux of my Everything is an Ad Network thesis is that, as a result of Apple’s App Tracking Transparency (ATT) privacy policy and other impending platform and legislative privacy restrictions, any company with a large, proprietary first-party data set can manifest a high-margin advertising business because the social media platforms no longer crowd them out of the advertising market. Uber is a perfect example: the company launched an in-app advertising product, Journey Ads, last October and attributed strong performance in its Delivery business unit in Q4, in part, to advertising. The company’s advertising run rate doubled from Q4 2021 to Q4 2022 to $500MM, against a goal of $1BN in 2024 (Uber had an existing advertising business before Journey Ads was launched).

The type of advertising network captured by the Everything is an Ad Network phenomenon — often called a retail media network — is attractive to retailers because it allows them to monetize an existing asset, data, with a relatively low investment. Shopify likely can’t launch an ad network, given the nature of its relationship with retailers. But it did the next best thing by creating an audience network: monetizing the data it owns by empowering retailers to find and advertise to known, relevant customers. While Shopify doesn’t charge retailers for use of its Audience product, since it’s included with the Shopify Plus subscription, the company benefits when its retailers are able to efficiently target new customers and drive incremental sales. I outline the mechanics of an audience network in this piece.

Shopify can drive topline growth without attendant increases to its cost base by aggressively expanding its Audience Network: not only to new platforms but to more retailers within its network, possibly by making the product available to merchants outside of its Plus platform. I’d argue that Audiences likely isn’t a compelling enticement to SMBs to upgrade their Shopify merchant stores to Shopify Plus: with advertising performance, seeing is believing, and an SMB can’t know what effect Shopify Audiences will have on their business a priori to justify the $2,000 monthly expense. Similarly, counterfactuals related to advertising performance can also be unconvincing (eg. “You would have generated 30% more sales last month had you used our advertising technology”).

Expanding Audiences to all retailers could potentially grow GMV and revenue by activating more incremental sales, arguably without cannibalizing Shopify Plus recurring revenue. There are obviously other considerations, and Shopify hasn’t fully made public the details of the Audience Network (ie. which and whose data is input into Audience segments), but the opportunity seems attractive.