A homegrown Shopify rival is emerging as a market leader in Japanese long-tail e-commerce by focusing on the needs of individuals opening their first online shop. How big is the opportunity for BASE in Japan, and can they successfully export their unique model abroad?
By now, we should all be familiar with the idea that two countries can have completely different online ecosystems. Even if you have never been to China, you probably know that the market is dominated by local players, in part due to the Chinese government kicking the North American internet giants and others out in the early years of the ecosystem’s development. However, government regulation is not the primary barrier to entry for this industry; network effects driven by superior scale are far more important. Not much would change in China if the Great Firewall came down today. Who needs Facebook when all your friends are on WeChat? Who needs Amazon when you have more selection, better price, and more convenience on Taobao or JD.com?
Like China, the Japanese online ecosystem has evolved in its own unique way; it’s a parallel universe with many of the same consumer demands, which are met with very localized services by Japanese companies. Unlike China, the Japanese government does not block foreign firms from operating there. Japan is an attractive large developed consumer market with an e-commerce penetration rate still trailing the U.S., but it’s a market that is notoriously difficult to crack due to distinct language and cultural differences. The country is also full of top IT talent, which moves fast to build competing services to meet local demand while up and coming companies on the other side of the Pacific are still focused on winning in their home market. When foreign companies do get around to expanding to Japan, they usually face an uphill battle against companies with substantial moats, thanks to first-mover advantages and network effects.
While it’s tempting to draw parallels across these markets and dub businesses “the so-and-so of Japan” to analyze the ecosystem, it’s a lot more complicated in reality because the North American players are also present. For example, Rakuten (4755.T) could be called the “Amazon of Japan,” but Amazon has also operated in Japan since 2000. Amazon’s determination to survive in the Japanese market has helped them carve out a 20% share of Japan e-commerce, roughly equivalent to Rakuten’s share but far less than Amazon’s 49% share of U.S. e-commerce. In general, the presence of determined foreign players in Japan has led to a more fragmented and competitive market in software and e-commerce.
The “Shopify of Japan” is… well, Shopify. However, Shopify did not enter the Japanese market with a (partially) translated and localized offering until 2015, giving local players an eleven-year headstart to carve out their slice of the storefront e-commerce software market. BASE (4477.T) emerged from a crowded field with a differentiated free model that catapulted the Company to the top of the heap in terms of new shop openings, where it has held a significant lead for the past three years. The service has the best reputation in the industry for its mobile-first design and ease of use for beginners. According to a recent Macromill survey, a majority of online retail shop creators used BASE last year, with no other service accounting for more than 10%:
They are elephants or capybaras, but we are mere ants, in contrast. For ants, even if you join forces with capybaras, there’s no way you can defeat elephants. Therefore, you must dig up the ground so that you might trip up the elephants. Understand? – CEO Yuta Tsuruoka
BASE has several key advantages over the plethora of competing services, which vary by pricing model, features, and user experience. First, unlike Shopify or MakeShop, the current Japanese market leader by revenue, BASE does not charge a subscription fee, which lowers the barrier for physical store owners or entrepreneurs to try out new ideas. Compared to other free services, BASE provides a high level of customization (html edit), unique features (made-to-order, lottery and reservation sales), and value-added services (data analysis, sales promotions, inventory financing) to help its customers succeed with less required capital outlay. Once a shop begins to generate sales, the Company collects settlement and service fees on each transaction. The company mediates transactions by holding payment in escrow until a package is confirmed to be delivered, similar to former shareholder Mercari(4385.T). This enables BASE to allow new shops to receive credit card payments immediately, without the typical 2 to 3-week credit examination period required when using other free services, such as STORES (#2 free competitor). BASE also has a much faster deposit cycle than other free services, meaning shop owners can receive their money more than a month quicker than they could at STORES without paying an additional fee. BASE charges higher transaction fees than STORES (6.6% + 40 yen vs. 5%), but STORES is less customizable and does not include made-to-order sales or free access to data analysis tools.
In comparison to Shopify, BASE works out to be cheaper than Shopify Basic until monthly GMV crosses ~US$900:
It stands to reason that store owners would be switching to Shopify or MakeShop as they comfortably surpass $1000 in monthly sales to save costs, but in FY20Q1 and FY20Q2, average monthly GMV per shop was JPY136k ($1,276) and JPY208k ($1,950) respectively. The mean is likely skewed higher than the median, as management noted in their recent results presentation commentary that some shops generate monthly GMV of over JPY8m($80k). While the majority of revenue-generating shops (~50k) likely save money using BASE over Shopify, it’s worth noting that there are outlier shops that could save up to US$25k/yr by switching to Shopify but have continued to use BASE instead. Furthermore, BASE was able to increase commission rates by an additional 2% of GMV in September 2017 with minimal impact on GMV, as most shops chose to stay on the platform. I believe there are several factors that increase switching costs over time and lock in customers for the long run.
First, there are some notable features that BASE has that Shopify is missing, namely make-to-order and lottery sales. Make-to-order sales is an API extension powered by Canvath that allows the seller to manufacture and sell T-shirts, mugs, key chains, tote bags, and other items designed on the Internet, without any working capital requirements. Lottery sales are used to sell rare items (like my favorite Japanese whiskey) by lottery instead of a first-come-first-served basis. These two features are important for long-tail e-commerce, which is basically sellers using social networks to market a customized product or service to a small but highly engaged and passionate target market (like how you found this blog about Japanese internet small caps on Twitter).
Second, as a store grows, the store manager may use more extensions, or APIs, to manage that growth. BASE Apps provides a wide range of free and freemium APIs for store administration, sales support, social media management, and so on. As users integrate more APIs into their BASE store, the switching cost increases as more additional labor is required to ensure a seamless transition to a new platform. While Shopify offers more APIs than BASE, many are still not localized for the Japanese market. This is the biggest source of Shopify’s moat in North America, so it can cut both ways, but we can see how important it is to acquire users at the inception of a store.
Third, BASE stores increasingly benefit from network effects in payments as the platform attracts more stores and customers. BASE stores are required to use PAY.JP, which has several advantages over competing services. One, it covers all major credit cards and five other payment methods (Shopify does not yet support JCB, which has 40% retail and 20% EC market share in Japan). Two, whereas customer credit card data has to be managed by stores independently with other services, PAY.JP manages customer data centrally and monitors transaction data in real-time, enhancing data security and consumer convenience. Three, PAY.JP is also made available to third-party merchants, and consumers are able to transact with any merchant in the network without re-entering their credit card data with PAY ID.
Lastly, BASE stores benefit from the Company’s sales promotion activities and financing efforts. While stores manage much of their traffic to their own sites independently through social networks, BASE offers a number of services to assist in generating traffic for new stores. For instance, BASE lists customer products on a shopping app with 5 million users. The Company plans to distribute JPY60m worth of coupons in the second half of 2020, although that amount could be increased due to record profitability, and it regularly runs television commercial campaigns to raise awareness of the platform for both store owners and shoppers. Stores can win a lottery to have their products featured in physical BASE shops. The Company also introduced a new financial service, Yell Bank, in 2018 that uses past customer sales data to offer risk-free growth financing to stores. Therefore, leaving the BASE ecosystem could mean a reduction in traffic, sales, and financial support.
Given its strengths in new user acquisition and a purely transaction-based model, BASE has been one of the biggest beneficiaries of the COVID-19 pandemic. GMV increased 196% yoy in FY20Q2, driven both by sales increases at existing shops and a surge in new shop openings:
The number of revenue-generating stores increased by 90% yoy, while the average GMV per shop increased 55% yoy:
Net sales and gross profit increased about 210% yoy due to slightly higher take rates:
As the employee count only rose by one person, and promotional costs were in line with past campaigns, the Company displayed impressive operating leverage for the quarter:
Following an IPO in late 2019, BASE is now flush with cash and cash flow to invest in product R&D and user acquisition. The CEO has stated that they do not intend to target large enterprise accounts on competing platforms that require relatively high acquisition costs, as these accounts could be easily lost to competitors in the same fashion. The Company will continue to focus on acquiring first-time users and building out more services to accommodate growing customers. Historically, the payback period for new user acquisition has been around 12-13 months, but in these exceptional times, it has fallen to an astounding 3 months.
While some reversion to the mean was to be expected following the cancellation of Japan’s COVID-19 state of emergency at the end of May, I think it is likely that the current economic climate continues to drive new shop openings. BASE is providing physical shops a lifeline as many consumers are still working from home and foot traffic has fallen at physical stores. Results for the second half of the year will likely exceed management’s updated guidance, as strong growth in shop openings continues. Management had the following to say about the monthly GMV trend:
“For the BASE Business, GMV growth rate YoY accelerated in April and May. From May 235.2% is the number you see here, but at the end of May with the lifting of the state of emergency, we saw a slowdown in June. But in July and August, we have seen a higher than expected level. I think it’s fair to say that we are plateauing at a high level.”
If the Company is setting a new revenue base now at roughly JPY120B (~$1.2B) annual GMV, and the PAY business is generating an additional ~JPY35B annual GMV, the stock today with a JPY189B market cap is trading at about 1.2x annualized GMV. Shopify, in comparison, generated $30B GMV in Q2, so at a $125B market cap is now trading at about 1x GMV. However, BASE enjoys significantly higher take rates than Shopify in its core business, which means it is valued at roughly 19x annualized sales based on Q2 results, far lower than Shopify which trades at 44x annualized sales. BASE also enjoys higher overall gross margins (62.9% vs. 53.4%), higher yoy overall GMV growth (132% vs 119%), and higher 3-yr cumulative GMV growth (+600% vs. +417%). Clearly these are both incredible companies and valuations are much higher than the market averages, but they seem to be mispriced relative to one another. I think the primary reason for this is size and investor awareness, as many interested in the space are just now taking a look at BASE, a sub-$2 billion company, while most investors know about Shopify by now.
I would argue that BASE has a longer runway for growth than Shopify, given its small size and positioning as a champion of the long-tail economy, which has potential for endless growth. The theory here is that products and services with low demand or low sales volume can collectively make up market share that rivals or exceeds the mainstream economy if the distribution channel is large enough.
The Japanese EC market is about JPY20 trillion today (less than 10% penetration), management estimates the EC storefront creation market is growing faster at about JPY1 trillion, and BASE is growing significantly faster within that market at about 10% share of GMV. Based on current growth rates, the Japanese EC could double again in 5 years or so. Assuming storefront share grows to 10%, and BASE share grows to 25% of storefront GMV, BASE GMV could grow another ~10x in this timeframe. Taking this out further, let’s say Japan EC reaches JPY100 trillion in ~15 years, storefront EC grows to 25% as the long-tail thesis plays out, and BASE market share trends towards its current share of 50%+ of new store openings. In such a scenario, BASE GMV could grow a mind-boggling 100x in Japan alone!
The beauty of the long-tail is that a tool like BASE enables very niche supply and demand to find each other in a way that was never before possible. In the long-run, the acceleration of the long-tail economy may actually spur overall growth in the Japanese retail economy, contrary to many observers’ expectations. The BASE CEO does not see a ceiling on the domestic growth opportunity any time soon:
“There are 1.6 million retailers nationwide in Japan. If you consider the number of stores dealing with daily use items, I think we can target around 300,000 or 400,000 merchants on our platform. But if we consider independent creators as potential merchants, I think there’s no limit to our future growth.”
The other obvious avenue for growth is expansion abroad, both through cross-border e-commerce and by making the service available for international merchants. The Company is actively working on building out services and adding new partners to facilitate easier cross-border transactions. I wouldn’t be surprised if at some point we see Buyee, which I featured here, introduce an API to BASE Apps. As for making the service available internationally, management notes that there is probably no equivalent service available, as Shopify and BigCommerce focus on larger customers. Management thinks that BASE has “a lot of opportunities” on a global basis, and says they “are looking forward to providing services to non-Japanese people as well.” In terms of execution, BASE is already integrated with some foreign players for certain services and functions, but there is likely a lot more to be done to export an equivalent ecosystem to the world. If they are successful, the opportunity is huge; Shopify’s global GMV is already 100x larger than BASE’s today, but a large portion of the potential market is probably unserved due to Shopify’s relatively expensive monthly subscription fee for its basic service.
It’s amazing that this company with such a massive runway in front of them went public at around a $300 million valuation less than a year ago. The stock has risen sharply, but for good reason. I think the shares are quite reasonably valued in the context of their competitors and the opportunity ahead.
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