In part 1 of our series on Shopify and embedded finance, we analyzed the Shop Pay’s potential for growth and how it can be the groundwork for Shopify’s consumer ambitions. I wanted to look at Shop Pay first because generally, consumer facing products are easier to explain since  they’re more relatable. I also wanted to highlight how the potential of additions like installment loans can dramatically improve adoption and increase LTV. 

Today, we’re going to focus on the merchant side. There’s a ton to cover here: because Shopify’s been so focused on merchants as a business, they’ve been quietly developing merchant-focused fintech products for years. In Q2, Shopify processed $13 billion through Shopify Payments, a 132% increase from the quarter before and more than 40% of Shopify’s total GMV. To date, Shopify Capital has processed over $1 billion in capital advancements to merchants. So fintech isn’t new to Shopify by any means. The reason “Shopify and fintech” has become a trending topic recently is because the flywheel is now firing on all cylinders. 

Before we get into how that works, let’s start off by explaining what exactly Shopify offers merchants now. 

What Is Shopify Capital?

Shopify Capital is a lending product through which Shopify provides capital to merchants to help grow their business (much like Square and PayPal have as well). For Shopify, the loans are structured in two ways: a more traditional loan, where Shopify lends from $200 to $1 million to merchants with a fixed payment structure, or a merchant cash advance, where payback is a bit more flexible based on your sales. 

The distinction is key because the two products cater to two different merchant types. A straightforward loan has a 12-month lifecycle, and Shopify schedules 6 milestones (once every 2 months), where a minimum must be paid back. Shopify gets 10% of your daily sales, but if the minimum isn’t met, Shopify deducts the difference from your account. Since these loans are longer and have a more rigid payback structure, they’re most likely for merchants that have a stable business and revenue. 

Merchant cash advances seem more flexible, and are probably better for merchants just getting started but who need capital to take things to the next level. There’s no deadline, and Shopify just takes a percentage of your daily sales to pay it back. Shopify actually says the cash advance isn’t a loan—Shopify purchases your future revenue at a discount, and you give a larger portion of your revenue to them until Shopify’s received the full amount back. There aren’t any interest rates or terms, so it's simpler than a loan, but also merchants aren’t locked into any amounts—they’re only paying what they can afford. 

How Shopify Payments Fits In

Shopify’s platform has inherent benefits that enable the company to add fintech products that scale with low customer acquisition costs, add value over time, and are better products for merchants than traditional banking solutions. Yes, Shopify’s relationship is a plus here but the true asset is Shopify’s use of payments data to finetune financial products for merchants. Shopify’s ability to process, analyze, and leverage the data creates a lending product for merchants that’s simpler and more competitive than traditional loans. 

Shopify already has millions of merchants selling on its platform so it has a ton of sales data, which provides the payment processor with a ton of insights around how merchants sell. Historically, that data hasn’t really been accessible. In theory, if you can see how much a merchant is selling, how fast sales are growing, and reference that data with your own internal benchmarks across similar products, you can pretty accurately assess that merchant’s ability to repay a loan. Traditional payment processors have this data and haven’t innovated fast enough to start using that data to offer loans; tech-forward companies like Square pioneered this model of data-driven merchant lending, and others like Stripe have recently launched similar products too. Data around how much merchants are selling is incredibly valuable for a lender, and Shopify has years worth of insights to leverage. 

One of the first moves Shopify made was to create incentives for merchants to use Shopify Payments, like only making Shopify Capital available for merchants with Shopify Payments turned on. Why? While Shopify probably gets similar kinds of data from payment processing partners like Stripe, the flexibility and fidelity of that data is more refined when payments are going through your system. If you’re going to build a data-driven underwriting program for capital lending, then you’re going to want to own the data as well. While Shopify allows “eligible merchants” that use third party payment processors to apply for Shopify Capital, the company states it prefers merchants to use Shopify Payments as it is “designed to help you succeed through a powerful view of your performance, custom analytics, and access to other Shopify financial solutions.”

By processing payments, Shopify’s turned its Payments product into a massive revenue driver. It’s widely assumed that Shopify Payments revenue “accounts for the bulk of Shopify's merchant solutions revenue,” which was $517 million last quarter. The combination of owning the underlying payments layer along with the clear value proposition for merchants and consumers has turned Shopify Payments into a revenue generator for Shopify’s fintech ambitions while laying the groundwork for other products, like lending.

Shopify’s Distribution Advantage

While data is the main asset here, distribution is a massive advantage for Shopify too. Unlike fintech startups, Shopify isn’t spending insane amounts of money acquiring customers—they already have them. The platform already solves a problem for merchants by making it easy to sell stuff online; it just so happens that a lot of these merchants have problems with their banking as well. Because Shopify is helping merchants grow their business, there’s a ton of brand affinity and trust between the merchant and Shopify; a perfect ingredient for upselling users on financial services. Brand equity is an extremely valuable asset in financial services, and Shopify has it in spades.

The UX around Shopify’s lending products demonstrates the power of the company’s distribution combined with a frictionless experience. A merchant can simply access a Capital tab within the Shopify dashboard to see if they are pre-approved for a loan or merchant cash advance. It takes the burden of asking for money to grow your business off the merchants hands and moves the entire operation behind the scenes.

For a merchant, just the access to capital is incredibly valuable. Traditional financial institutions have never really catered to small businesses, and entire companies like OnDeck Capital and Funding Circle have been built on that premise alone. But, Shopify doesn’t use capital as a revenue tool—it uses access to capital as an incentive to drive merchant adoption to its revenue generating Shopify Payments product.

How Will Shopify Balance Fi In?

Shopify Balance, its new banking product, falls into the equation too. Small business banking is broken—there’s a reason there’s been a newfound interest from entrepreneurs and investors into the space. Anecdotally, when I started a business account for Fintech Today, I ended up sitting in a Chase branch for two hours…and 3 weeks later Chase shut down my account for no reason. A merchant should just be focused on one thing: growing their business. 

For Shopify, another part of the lending equation is how much merchants are spending, and on what. Because of the close relationship between Shopify and merchants, Shopify is in a unique position to offer a premium banking product that serves the merchant’s needs while also giving them a ton of data insights and access. Firstly, by learning about a merchant’s spending habits, Shopify can provide new data points to their lending algorithms while also adding value. If a merchant spends responsibly and has a certain balance in their account at the end of the month, Shopify might be more willing to lend them money, since they know they have the funds to pay them back. Shopify already knows the growth and revenue side of a merchant’s business; developing a banking product helps Shopify gain data on the costs and expenses side too. 

That full visibility into a merchant’s revenue and costs can make Shopify Capital an extremely powerful lending platform; one that can understand how much a merchant is growing, how much a merchant is spending, and making loans accordingly. 

How It All Fits Together

You can’t understand how Shopify thinks about fintech without understanding how it thinks about its core business. This flywheel taken from Shopify’s Q2 presentation does the trick: Shopify is all about getting more merchants on board and helping them sell more. 

Shopify Payments and especially Capital directly impacts the GMV side of this equation. Shopify Payments solves the issue large GMV companies run into around reducing payment processing costs at scale by turning payments into a revenue driver. Now, more GMV doesn’t have to equal increasing payment processing costs. Shopify Capital helps by providing capital at the right time to merchants to grow faster—increasing GMV for merchants.

It all works together, driving value for customers and revenue for the platform. Fintech products fit in seamlessly, like a jigsaw puzzle. They’re not band aid solutions, they’re fundamental solutions that affect every stakeholder in the ecosystem. I tweeted yesterday about why I’m bullish on Facebook’s payments and commerce reorg because Facebook has tried to solve problems by creating point solutions instead of holistic ones. Facebook should be thinking about how fintech can make the FB ecosystem more robust for everyone, instead of solving individual problems with narrow solutions.

In the next installation, we’ll be covering how Shopify can layer in the consumer side of this equation to continue amplifying its fintech flywheel. We’ll be wrapping up but talking about some key issues and concerns I’ve been thinking about in the embedded fintech sector.