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Why Microsoft’s (NASDAQ:MSFT) E-Commerce Foray Could Cripple Shopify’s (TSX:SHOP) Growth

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Shopify (TSX:SHOP)(NYSE:SHOP) is the disruptive Canadian tech darling that’s become impossible for investors to ignore with the multi-bagger gains that have been posted since its IPO.

The Ottawa-based company behind the innovative and easy-to-use e-commerce platform catered to small- and medium-sized businesses (SMBs) has been kicking butt and taking names over the past few years. Not even Amazon.com, the biggest e-commerce disruptor of our time, had the desire to remain on Shopify’s turf in the midsized e-commerce market, as it turned out the lights to its competing product Webstore just a few years ago.

While it was encouraging that Shopify was able to give Amazon a taste of its own medicine by chasing it out of the SMB space and a sign that the company’s innovative technologies may have formed an actual moat around its circle of competence in the SMB space, investors have to be a bit worried about Microsoft’s (NASDAQ:MSFT) potential plan to enter the e-commerce playing field with a competing platform of its own.

In a recent interview conducted by The Information, Microsoft VP Shelley Branson stated that her firm is thinking about offering software tools to help digital retailers.

That’d have me a bit worried if I were a Shopify shareholder because when it comes to software services, Microsoft has been killing it.

Microsoft’s potential entry onto Shopify’s turf was a major sore for Shopify stock on Tuesday, as its shares declined over 3% intraday before bouncing back slightly to end the day down 2%.

While facing intense competition has been nothing new for Shopify, I think Microsoft has the potential to become a formidable opponent that could end up stealing a considerable slice of Shopify’s market share a lot quicker than most investors seem to realize.

Why?

Not only is Microsoft a deep-pocketed company with seemingly infinite resources at its disposal, but the nature of the SMB space makes it easy for a new entrant to take a share of the incumbents without a moment’s notice.

You see, the potential for high churn was a major concern that I highlighted just over a year ago, well before short-seller theses regarding churn rates were disseminated to the public. I’d noted that monthly plans allowed merchants the ability to cancel their subscriptions at a whim, leaving a high degree of uncertainty attached to Shopify’s subscriber stream, especially in times of recession where businesses fold from left, right, and centre.

To take it a step further, the lack of long-term contracts allows subscribers to be promiscuous with regards to their platform of choice.

As a midsized merchant, there’s always the incentive to test out other products to see if the grass is greener on the other side. And seeing as it’s becoming faster and easier to start up a shop by the day, Shopify’s moat could erode a lot quicker than most are expecting. With increased ease of starting up come lower switching costs, so Microsoft’s entry into the space could have an insidious impact on Shopify’s attrition rates, assuming Microsoft can pull off what Amazon failed to do.

In short, I believe investors are overestimating the width of Shopify’s moat. Although Shopify had its way with Amazon in the past, another tech behemoth like Microsoft could easily make life a lot more difficult for Shopify as it looks to keep its numbers in the green.

Of course, Shopify could shoo Microsoft out of the space if it can continue innovating at a high level, but given Microsoft’s remarkable track record of success in software services, I’d be pretty worried to be a Shopify shareholder especially with shares trading at over 20 times sales.

Stay hungry. Stay Foolish.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Fool contributor Joey Frenette has no position in any of the stocks mentioned. The Motley Fool owns shares of Amazon, Microsoft, Shopify, and Shopify. Shopify is a recommendation of Stock Advisor Canada.

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