What If Shopify Isn't An AI Winner?

The internet - including Shopify's success story - shows that new tech paradigms develop in surprising ways. Incumbents might not adapt, and premature predictions about the winners might fail.

Amazon.bomb

From Why Barnes & Noble May Crush Amazon (Fortune, 1997):

Anything Amazon.com can do on the internet, so, too, can Barnes & Noble. Once you look beyond the Website you begin to see why, in this battle at least, the odds favor the $3-billion-a-year Goliath.

In May 1999, Barron’s editor published Amazon.bomb, arguing that Amazon.com did not stand a chance once traditional retailers build their own websites:

In the retail drug area, traditional players such as CVS and Walgreen are boosting their online efforts. Earlier this month CVS, the country’s largest drugstore chain, announced it will purchase the internet’s first online drugstore, Seattle-based Soma.com , for $30 million. Walgreen plans to launch its Website in August. All manner of other retailers can be expected to follow suit.

“Once Walmart decides to go after Amazon, there’s no contest,” declares Kurt Barnard, president of Barnard’s Retail Trend Report. “Walmart has resources Amazon can’t even dream about.”

Soon Amazon will be encountering competition on the internet from even the nation’s mom-and-pop bookstores. By August, the American Booksellers Association will launch BookSense.com, a program that will let local stores launch individual Websites with their own logos, designs and book reviews. The association will provide back-office support, including credit-card processing for internet sales and an online catalogue of 1.6 million book titles.

[...][ “The first mover does not always win. The importance of being first is a mantra in the internet world, but it’s wrong. The ones that are the most efficient will be successful,” says one retail analyst. “In retailing, anyone can build a great-looking store. The hard part is building a great-looking store that makes money.”

While the prediction ended up hilariously wrong, Walmart indeed had “resources Amazon couldn’t even dream about”, having built a massive and advanced infrastructure throughout the 1980s and 1990s, as MBI Deep Dives quoted in a recent post:

“…you’re at the register at your neighborhood Walmart location: you scan the toothpaste, the barcode beeps. Within seconds, a satellite dish behind the store sends that transaction to the sky and over to Bentonville, Arkansas, where they’re hosting their mainframe computer to record the sale.

A few minutes later, a massive data warehouse would update how many tubes of toothpaste you had just bought. Then, perhaps before the end of the day, Procter & Gamble’s factory would receive an update that they needed to make more toothpaste.

This was the cutting edge of retail in the late 80s, and Walmart made a massive decision to take this a step further, truly driving innovation across the retail industry. They invested $24 million to build their own private satellite network linking all Walmart stores to headquarters. This was fairly unprecedented at the time…It was the largest private satellite network.

So any single event that happened within the Walmart ecosystem rode on this private network, enabling them to mine their data in a way that was unheard of before.

By mining their sales data – which could now be collected in real time across all Walmart stores over their private satellite network – they discovered that when hurricanes approached, the sale of Pop-Tarts increased 7x over their normal rate.”

In Amazon.bomb’s defense, how could a website compete with all that? The answer is provided by Ben Thompson, who explained in a 2016 Stratechery article what everyone – from the editor of Barron’s to executives at Walmart – got wrong:

[...] All of those analysts who assumed Walmart would squish Amazon in e-commerce thanks to their own mastery of logistics were like all those who assumed Microsoft would win mobile because they won PCs. It turns out that logistics for retail are to logistics for e-commerce as operating systems for a PC are to operating systems for a phone. They look similar, and even have the same name, but require fundamentally different assumptions and priorities.

The internet didn’t turn out to be a sustaining innovation for Walmart; as Thompson explained, the optimal logistics infrastructure for an e-commerce home-delivery operation required a fundamentally different architecture than one optimized to place items on physical shelves in stores across the country. The incumbent retailers – from Barnes & Noble to Walmart¹ – were trapped by the innovator’s dilemma, beholden to logistics that weren’t built for an internet-first retail operation.

Shopify and the Internet World Order

The most humbling example, however, is Warren Buffett’s 1998 “the internet isn’t going to affect how people shave“ prediction. “5 or 10 years from now,” the Oracle of Omaha announced in 2002, “I would be amazed if Gillette has lost market share”; and yet, this is exactly what happened after Dollar Shave Club was launched with a viral video a decade later, shaving 16% off Gillette’s market share!

What Buffett missed was that Gillette’s moat, similar to Walmart, was rooted in the post-WWII world order: people watching TV at home, seeing a product in a commercial, and then picking it up when it was prominently displayed in the big department store. Ben Thompson referred to this moat as “The P&G Formula”:

Branding and Advertising: As inspiring as that McDonald quote may be, P&G also dominates advertising: in 2014 the company spent $10.1 billion in global advertising, 37% more than second-place Unilever. This is hardly a new trend: the company invented soap operas in 1933 to help hawk the cleaning products it was built on, and invented the idea of a brand manager who had a holistic view of products from research to creation to advertising to distribution.

Distribution and Retail: P&G’s huge collection of brands and products not only gave the company massive scale efficiencies in manufacturing, but more importantly led to a dominant position in retail. P&G built strong relationships with retailers that let them dominate finite shelf space, the scarcest resource for an industry producing relatively bulky inexpensive products.

Gillette’s strengths stemmed from the same characteristics². In a commerce world governed by TV advertising and large retail chains, it was hard to imagine how anyone – let alone a website – could pose a threat to Gillette’s market share.

Except that the internet completely undermined that entire world order.

Similar to how Google had enabled the long-tail of online content in the early 2000s – blindsiding the big web portals that were busy building walled gardens inspired by cable TV – the internet gave rise to the long-tail of e-commerce in the 2010s.

Dollar Shave Club’s success opened the door to the direct-to-consumer wave: Casper’s mattress in a box, Warby Parker’s home-mailed $95 prescription glasses, Allbirds’ environmentally friendly footwear, Bonobos’ well-fitted khakis, and a plethora of e-commerce upstarts taking on the big brands of the baby boomer era³. Ben Thompson came up with the perfect name when he called it the Disruption of Everything.

The mobile internet created a new world. One where – rather than everyone watching the same TV shows and commercials at the same time – millennials spent more and more time scrolling through Instagram, watching personalized ads (that even tiny merchants could afford), clicking on them and making a purchase, directly on a storefront powered by Shopify. Alongside Google and Meta, Shopify was both a major enabler, and beneficiary, of this new order.

No wonder Warren Buffett, who came of age in the post-WWII environment – dominated by TV networks, mass-market advertising, and scarce shelf space – couldn’t imagine the internet changing how people shave. But the new internet order did exactly that, eroding Gillette’s market share and profit margins.

What Ben Thompson Could Be Missing About AI

This is why I was surprised to read a Stratechery update last week that ended with this:

There will be losers from AI, but there will also be winners, and Shopify is very much poised to be the latter.

While the article did a great job highlighting Shopify’s different strengths – such as its payment infrastructure, proprietary data, interaction with the physical world, and horizontal coverage for all aspects of the merchant’s business – I can’t help but think of Walmart’s strengths circa 1999. The thought that a mere website could compete with Walmart seemed as ridiculous back then, as the idea of merchants vibe-coding their own storefronts may seem today.

I agree that this, specifically, isn’t a credible threat to Shopify.

But that doesn’t necessarily mean that Shopify is poised to be an AI winner.

We’re still at the early stage of the AI paradigm shift. It’s been less than four years since ChatGPT launched. That makes today roughly the equivalent of 1997 in World Wide Web terms. Back when Barnes & Noble still seemed like a Goliath, about to crush Amazon.com with its own website!

It could take another decade for things to play out, but a new world order would emerge. Consumer behavior would change. The main thing we can learn from history is that it will all seem obvious in hindsight, yet probably impossible to know at this point (despite the abundance of X and Substack articles going viral with predictions about the future).

What happens when the demand gets aggregated by AI chatbots and agents? When consumers make better informed purchase decisions, after conversing with AI (rather than typing a few keywords, getting the Meta pixel cookie, and being bombarded with ads on Instagram)? What is the right platform to power purchases made by AI agents, who are already informed about the individual users’ preferences? Would commerce – much like what happened with text and content – shift from matching a user’s intent with the best existing product, to generating demand signals (based on users discussing their issues with chatbots) and contracting merchants to produce new products?

I can probably tease out a whole article from each of these questions and make predictions about the future. They will all likely end up wrong in hindsight (though some may go viral in the meantime). That’s the thing, though.

What history mostly teaches us is that it’s very hard to predict the steady state on the other side of a major paradigm shift. We don’t know how the value chain is going to shape up, what role Shopify will play, and how much of the value it could capture. What seemed like strengths in the previous state, might end up a liability.

Declaring that Shopify, built and optimized for the “disruption of everything” era, is a likely AI winner so early, might end up the equivalent of assuming that “Walmart would squish Amazon in e-commerce thanks to their own mastery of logistics” or “like all those who assumed Microsoft would win mobile because they won PCs”.

This all may still take a decade or more to play out. Even Amazon.bomb held up well for several years. Shopify could do well in the short-to-medium term. But at a ~$150B market cap, it still trades at ~13x LTM sales (and a p/e ratio of well over 100, as it still invests in future growth). While the stock has fallen ~35% in four months – and despite how unhinged the recent AI Scare Trade may seem – the valuation still embeds very high expectations regarding future growth and profitability.

While many doom takes go viral, and some professional analysts ask silly questions, there’s humility in being confused. And this is exactly the part of the cycle where one should be confused. Prematurely declaring which incumbents stand to win in AI ignores the lessons of past paradigm shifts – particularly the internet – and runs the risk of bombing.

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Disclosure: not financial advice, this post is for educational and general purposes only and should not be relied upon for investment decisions.

1. Walmart eventually found its footing in e-commerce (as Stratechery later noted), but Amazon never “bombed” and its e-commerce GPV has surpassed Walmart’s.

2. There was also a cultural element that helped winning over the consumer mind share: buying the same razor blades or carbonated drinks used by the American soldiers who won the war and shaped the postwar world order.

3. That’s part of the reason How I Built This became so popular in the late 2010s: the D2C wave created interest in entrepreneurial stories, and many episodes documented the internet success stories.