Essay | Rex Woodbury | The Wild West of E-Commerce

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The word commerce has its origins in the Latin word commercium. “Com-” = “together,” and “-mercium” = “merchandise.” Together, merchandise. The Merriam Webster Dictionary defines “commerce”—somewhat hilariously—as “social intercourse.” That’s effectively what commerce is: people coming together to trade goods and services.

One of the earliest recorded forms of commerce was cattle trade around 10,000 B.C. Cattle had a fixed value and were exchanged for goods and services. The Latin word for money, pecunia, comes from pecus, the Latin word for cattle. Nowadays, commerce involves less cattle and more Apple Pay—which it turns out is more convenient—but continues to power the economy.

In the early days of the pandemic, this chart was all the rage:

I trotted it out in early Digital Native essays alongside a Vladimir Lenin quote: “There are decades when nothing happens, and there are weeks when decades happen.” The quote was fitting: in spring 2020, long-marinating trends were suddenly microwaved into a handful of weeks. Few trends accelerated faster than e-commerce penetration: it took 10 years for e-commerce to grow from 6% to 16% of retail sales, but it took just eight weeks in March and April 2020 to gain the next 10 percentage points.

The story ends, though, with this chart:

Source

E-commerce penetration has reverted to its long-term growth curve. As of this writing, about 20% of commerce happens online; that percentage will continue to tick up at a steady rate throughout the 2020s.

When you zoom out, commerce is still in the early innings of its digital transformation. This is a decades-long shift, and building in the commerce space can be incredibly lucrative. I chose to write about commerce this week after reading through Klaviyo’s S-1.

Most people probably haven’t heard of Klaviyo, but this week the company ended a nearly two-year drought of SaaS IPOs. Yesterday, Klaviyo began trading under the ticker KVYO and it’s currently trading around $9B. I’ll start this piece by geeking out for a minute about Klaviyo, then get back to innovation in commerce writ large.

1. Klaviyo & Commerce Infrastructure
2. Commerce Platforms
3. Innovation in the Lifecycle of Commerce
4. Final Thoughts: Ads & AI

Let’s jump in 👇

Klaviyo providers small- and medium-sized businesses (SMBs) with a platform for personalized marketing automation. That includes email, SMS, and push. In other words, Klaviyo is software that helps businesses acquire, retain, and grow their customers through marketing.

Here’s a visualization of the Klaviyo platform from the company’s S-1 filing; Meritech has a great S-1 breakdown here:

Klaviyo is a good example of e-commerce enablement software—infrastructure that’s invisible to most, but that undergirds the complex world of online shopping. Most of us have probably received a promotional email, text, or push notification powered by Klaviyo.

Klaviyo is also an impressive business. The company doesn’t report annual recurring revenue (ARR), but has $658M of implied ARR, calculated by multiplying last quarter’s revenue by four. ARR is growing 51% year-over-year, and the business has 118% net dollar retention; in other words, even without acquiring a single new customer, revenue would compound 18% annually. That’s impressive for an SMB-focused business (Klaviyo’s average annual contract value is just $5K).

Revenue growth over time

Net dollar retention hovers around 120%

Gross margins sit at 77%, and free cash flow margins are a strong 24%. Klaviyo even hit GAAP operating profitability the last two quarters.

Klaviyo’s cohort curves are a thing of beauty

Stunningly, the company has accomplished all of this by spending only $15M of the ~$450M in primary capital it’s raised through venture capital. Talk about efficiency. *chef’s kiss*

There are many “invisible” companies that act as engines powering how we shop.

Most people don’t realize that Amazon is now largely built on third-party sellers. In other words, when you’re buying from Amazon, you’re often not buying directly from Amazon itself; nowadays, you’re more likely buying from a seller who uses Amazon’s aggregated customer base as a demand funnel (when a Prime member visits Amazon.com, they end up buying something 74% of the time.)

This chart is dated, but it gives a sense of how third-party sellers began to dominate on Amazon during the 2010s. There are now about 10 million third-party sellers accounting for 60%+ of all products sold on Amazon.

Or take Shopify. To most people, Shopify is invisible; though Shopify boasts a $73B market cap, I’d venture that most people on the street couldn’t tell you what the company does. Yet nearly all of us buy from one of the four million stores powered by Shopify. Big brands like SKIMS, Gymshark, and even Sephora use Shopify these days.

Kim K’s SKIMS, recently valued at $4B, runs its store on Shopify

One final example: Faire, which I wrote about in last year’s The $100 Trillion Opportunity in Marketplaces. When you or I shop from a mom-and-pop store on Main Street, we might not realize that the merchant is probably sourcing all her products through Faire’s wholesale marketplace.

This is Giselle Gyalzen, the owner of a boutique gift shop in San Francisco called Rare Device. Through Faire’s marketplace, Giselle can source new products with net-60 payment terms, helping her manage her cash flow. Over time, Faire begins to underpin a boutique merchant’s entire business: personalized product recommendations; inventory management; returns.

Giselle Gyalzen runs a boutique shop in SF called Rare Device; Source: Faire Blog

What Amazon, Shopify, and Faire have in common: they’re commerce platforms.

“Platform” is a word that gets overused in startups, but I like how my friend Rick Zullo puts it: “a software system that generates increasing returns to scale via proprietary Data, Distribution or Development.” Here are the 3 D’s:

Data — Companies achieving data network effects via 1st party and/or UGC, enabling services with monopolistic information rights

Distribution — Companies achieving customer network effects via the networks of their stakeholders, enabling monopolistic discovery and transaction efficiencies

Development — Companies attracting 3rd party developers to create and market services within the platform, enabling services with monopolistic capabilities and cost structures

For data network effects, think something like TikTok: your TikTok feed gets better with every video posted and viewed, as they fine-tune the For You Page’s algorithmic recommendation engine. (More on TikTok’s move into commerce later.) Google is another good example of a data network effect: the more searches, the better the search quality. Or take Google-owned Waze—each Waze user benefits from data being ingested by every other user on the road.

For distribution, Amazon’s third-party seller network is a good example. Many third-party sellers rely on Amazon for fulfillment, using FBA (Fulfillment By Amazon). FBA covers inventory storage, returns, and occasionally customer service.

For development, think Roblox’s developer ecosystem, now 10M+ strong. We don’t think of Roblox as a commerce company, but users spend billions a year on digital items. This visual from June’s deep-dive into Roblox explains the third-party developer network effect.

Many commerce companies are products, but the most valuable are platforms that become robust, expansive ecosystems.

Innovation in the Lifecycle of Commerce

When I think about innovation in commerce, it helps me to envision the flow of commerce.

Here’s an oversimplified visual. First, we have customer discovery—people finding the products they want to buy. Then we have the customer experience—think, the product images and reviews you look at during the purchase decision. Finally, we have the actual checkout experience—when money exchanges hands. Underneath it all are the broad infrastructure players.

This is an imperfect diagram, but it helps me think through the different facets of commerce. Brief notes on each:

Customer Discovery 🔎

Acquiring customers is a perennial challenge for brands and retailers. There are the old-fashioned tools—Google Search and Facebook Ads, for instance. Amazon, as we discussed, has aggregated tremendous demand that it lends to third parties for customer discovery. But there’s another player, one that also has a lot of attention that it hopes to mine for shopping.

TikTok is attempting to go head-to-head with Amazon this holiday season. TikTok will fund heavy discounts—up to 50%—to siphon off customers from Amazon. TikTok launched TikTok Shop in the U.S. just last week, offering to use its own fulfillment centers to help sellers reach customers. (Sound familiar?)

TikTok Shop; via TikTok

Globally, TikTok expects to do $20B in GMV this year; about $15B of that will come from Southeast Asia. In China, TikTok’s sister-app Douyin did $208B (!) in GMV last year. Over the past five years, China’s e-commerce landscape has shifted from an Alibaba-JD duopoly to a more crowded market with “social shopping” up-and-comers like Douyin, Pinduoduo, and Kuaishou.

Social shopping platforms have taken market share in both Southeast Asia and China over the past few years; Source: Freda Duan

On the startup front, new companies continue to find new paths for customer discovery. Whatnot leverages livestream shopping. Minoan lets you discover products in short-term rentals and boutique hotels, then shop them (ever want to buy the mattress topper or towels from your hotel room?). I’ve written in the past about Flagship, a company I work with. Flagship powers creator storefronts and uses the creator as the acquisition engine for brands; a creator posting on Instagram, TikTok, or her blog can drive traffic to her storefront and subsequently drive new customers to her partner brands. CAC-stricken brands are thrilled to have a scalable, economical channel.

Customer Experience 🛍

When I think customer experience, I think of everything that happens between landing on a product detail page and checking out. This can be something like reviews, powered by startups like Okendo. It can be the product images you sift through, which startups like Treat are using generative AI to reinvent. And it can be Chrome extensions that allow for easier comparison and decision-making: Honey, for instance, for a prior generation (acquired by PayPal for $4B), or a newer product like Vetted.ai which gives you the TL;DR on customer sentiment and feedback.

Treat’s product uses AI to generate various creatives for a brand

Point of Purchase 💰

The point of sale is all about two (related) things: removing friction, and increasing conversion. Often, a single feature can do both; enabling shoppers to pay with Apple Pay, for instance, makes the experience easier and ticks up the percentage of shoppers who check out.

Players in this category the past few years include Buy Now Pay Later companies like Affirm, Klarna, and Afterpay—those companies say that including BNPL at checkout improves conversion 20-30%.

Earlier-stage startups are reducing friction and improving conversion in other ways:

Beam, for instance, introduces social impact donations at checkout, with the brand carrying the cost. Brands are happy to do so because it turns out that shoppers spend more, convert higher, and become more frequent customers when they feel they’re putting money toward an important cause.

Catch reinvents loyalty at checkout: shoppers can pay with Catch, earning store credit toward future purchases. In doing so, Catch incentivizes more people to purchase.

And Croissant gives guaranteed buyback value on what you buy—naturally, when you know you can resell something down the road for a good chunk of change, you’re more likely to buy it now.

Infrastructure

“Infrastructure” is a broad category. It’s really the plumbing that undergirds the entire customer shopping experience. Klaviyo and the platforms above are examples, though they also touch on multiple points of the customer journey.

In 2023, advertising is again the business model in vogue. Netflix launched its ad-supported tier which now represents over 25% of new sign-ups. Uber reported in its latest earnings call that its advertising business is at $650M in revenue; 400,000 advertisers now advertise on Uber’s app (look for it next time you order a car). And Amazon, of course, has quietly built one of the most formidable advertising businesses in the world. Amazon’s ads division brought in over $10B in Q2; if you apply typical advertising margins, that means Amazon is raking in more profit from ads than from AWS.

The other big IPO this week was Instacart—also a commerce company. As of this writing, Instacart is trading at $8.3B. Instacart’s success story is miraculous 1) given how many times grocery delivery had been tried in the past, yet failed (Webvan was a famous dotcom-era bankruptcy, for instance), and 2) given how many people predicted Instacart’s demise when Amazon bought Whole Foods in 2017. Instacart’s story should be inspirational to any startup taking on an incumbent.

Instacart is also raking in the ad dollars. Nearly a third of Instacart’s $2.5B in revenue last year came from ads. Brands can jockey for valuable real estate on the Instacart app:

“Paid placement” is high-margin; it’s a no-brainer for companies like Amazon, Uber, and Instacart that aggregate millions of eyeballs daily. I expect ads to continue to seep into commerce.

The other new “trend” in commerce (and in every sector): AI. How will AI reinvent commerce? A few ideas:

• LLMs trained on millions of frustrated customer service messages can deliver better chatbots that (hopefully) make customer service less painful.
• In the hype around generative AI, we forget about good old machine learning. More powerful machine learning can lead to more personalized recommendations for shoppers.
• On the generative AI side, I expect product images to be generated by AI—and perhaps shoppers can soon use image models to design their own products, which can then be manufactured and shipped to their door. (TBD on how economical this will be for brands.)

Only $1 in every $5 spent shopping lives online. And from customer acquisition through to fulfillment, the commerce landscape remains full of friction and in need of digitization. It’s still the Wild West in commerce. In the long run, this week’s blockbuster IPOs in Klaviyo and Instacart will still look like early winners; there’s still massive value up for the taking.

Sources & Additional Reading

• Meritech had a great S-1 breakdown for Klaviyo here; the S-1 itself is here
• In case you’re curious, Instacart’s S-1 is here

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