On June 14, Etsy announced a seller transaction fee increase from 3.5% to 5.0%. This was long thought to be one of the major revenue levers that management had to pull, and they will be doing so from a position of strength as gross merchandise sales (GMS) growth has now accelerated over the last three consecutive quarters. The stock is now up over 25% since the announcement, and many investors remain bullish on the company's future. The key topics that investors talking about are:

- The other major areas of opportunity for Etsy, including more marketing, better discoverability, improved conversion rates, and more seller tools

- Possible seller backlash and competitive threats

Transaction Fee Raised; Numerous Levers Remain for Growth

Before jumping into the opportunities for Etsy, it's worth spending some time discussing why Etsy's areas of improvement are worth discussing. As an investor focused on fundamental analysis, it's important to understand the drivers of revenue growth and to understand as much detail around those drivers as possible. With more information, we can more accurately assess the likelihood that the growth that investors expect will occur. And this may seem counter-intuitive, but companies with significant areas for improvement can sometimes have an even brighter outlook, as addressing those issues could lead to a drastic improvement in financial results.

The rationale highlighted above is essentially what has happened to Etsy over the last year. Etsy's GMS growth peaked at 23% in 2Q16, but then decelerated at a greater-than-expected rate in the following four quarters. In mid 2017, the board put in a new executive team (led by CEO Josh Silverman) that offered a fresh perspective and a laser focus on growing GMS. The company has now shown accelerating GMS growth trends since that time, with the latest 1Q18 results showing almost 20% GMS growth.

Investors believe there are numerous more levers that can be pulled to continue to drive GMS and revenue growth going forward.

Seller Fees: As detailed previously, Etsy recently increased its seller transaction fee from 3.5% to 5.0%. This fee also now covers shipping fees as well. While the increase might seem steep, this was the first increase in the company's history, and overall fees remain below competitors' fees (detailed later). The company may also have some room to increase its listing fees. 

More Marketing: Etsy will be using its revenue gains to invest in marketing efforts, which is a significant area of opportunity for the company. Management noted that customers currently visit the site about once a year, and about 60% of customers only make one purchase a year (around Christmas, usually). The company plans to increase marketing around other holidays such as Valentine's Day and Mother's/Father's Day - holidays that are a natural fit for the platform's products. 

Management noted that they would increase direct marketing spend by at least 40% for the year, which should drive increased customer traffic to the site and strengthen the platform's value to sellers. The company has already seen encouraging returns, as traffic grew 13% y/y in 1Q18. Additionally, paid marketing represented 16% of GMS in 1Q18 vs. 12% in 1Q17. The company has also said they will trial TV ads in 3Q with ads aimed at driving higher frequency.

Better Discoverability: With millions of items on the platform, discoverability is becoming more important for buyers to find what they're looking for and for sellers to distinguish themselves from the masses. Search is the biggest area of low-hanging fruit here, as the search engine doesn't always show the most relevant items to customers. Etsy has already begun to implement Context-Specific Ranking (CSR) to show more relevant results. CSR uses additional data beyond search terms such as location, device type, colors, language, age, and recent activity to improve search results. On their 1Q18 conference call, management highlighted search results for the term, "wedding dress," and the results before and after CSR demonstrate the progress that they've made in this area.

This is especially important as 90% of buyers make their purchase decision within the first few pages of results. Going forward, analysts expect search to continue to improve and drive better discoverability on the platform.

Improved Conversion Rates: Etsy has a number of initiatives underway to improve conversion rate. Etsy has rolled out "nudges" - signals that urge a buyer to act more quickly. These signals have been used effectively by other marketplaces (such as Booking.com and Expedia) to improve conversion. Etsy has seen success with its scarcity signals (i.e. "Only 1 item left!"), and will look to implement more. The company will also roll out a structured return policy and a more frictionless checkout process to continue to hone the conversion rate. 

More Seller Tools: Etsy announced Etsy Plus and Etsy Premium, a set of tools for buyers to generate more traffic and improve conversion rates. The tools should drive increased recurring revenue while also increasing value add to both buyers and sellers on the platform.

Overall, management raised 2018 guidance along with its transaction fee increase, and investors believe updated guidance of 16-19% GMS growth and 32-34% revenue growth could prove conservative. Already, consensus estimates show that analysts are forecasting growth at the high end of the guidance range for both metrics.

Put together, Etsy looks to be a fast-growing leader within the large handmade space in e-commerce. And while they lack the polish of other tech marketplaces, they have a strong set of initiatives in place that will catch them up to other marketplaces and drive revenue and GMS growth for the next year.

Seller Push-back and Amazon are Risks

With such a steep increase in transaction fee, investors worry that sellers may push back and move to competitor platforms like eBay or Amazon Handmade. 

There are a few reasons investors remain bullish despite this risk around the increase. First, Etsy remains competitive compared to eBay and Amazon Handmade on price. Etsy's transaction fee is still just 5% compared to 10% for eBay and 15% for Amazon. All-in, including listing fees and payment processing fees, Etsy is at an estimated ~10% vs. ~15% for eBay and >15% for Amazon Handmade (as they charge a $1 referral fee). 

Second, Etsy increased fees by 43% but lifted revenue guidance by just 10%. Guidance appears to factor in some seller push-back and still leaves room for upside.

Another investor concern is one that all retail companies face: the threat of Amazon. As mentioned previously, Amazon Handmade launched in 2015 but has yet to make a significant impact on Etsy's results. However, the mere threat of Amazon making changes to the site and potentially pushing further into the space has historically sent Etsy stock downward. This will likely remain a risk for Etsy investors and should be monitored moving forward.