SaaV, SaaA, and Portfolio Consolidation
Software-as-a-Virus, Software-as-an-Annuity, and changes to the portfolio.
It’s been a rough year for software stocks, but they remain an important part of the overall portfolio. The unique characteristics of the business model, and their growth profile, make them an essential part of a global equities portfolio.
Software as a Virus
It may be that the world has heard too much about viruses in the last three years. But the analogy, comparing software to a virus, makes considerable sense.
Good software takes a task, automates it, and makes the user more productive. It should spread rapidly, as a result. In other words, the process automation replicates itself (just as a virus spreads) across teams, firms, and then industries, as the productivity gains are made evident to additional potential users.
Similarly, the best SaaS companies are able to find ways to apply a technological solution to new and diverse processes. This mutation is crucial to a software firm’s survival and growth. For instance, both Slack and Zoom are examples of software that replicated rapidly, but failed to mutate. Slack has been bought by salesforce.com, and Zoom’s growth has stagnated. By contrast, the best software companies are able to drive mutations through their platform, to solve an increasing array of problems. Or, as is broadly the case with Microsoft, particularly Teams, broaden through replication of competitor solutions.
Software-as-an-Annuity
ServiceNow is a company that has been highlighted as a core holding in Lessep. The company operates a platform that supports the digitisation of workflows within large enterprises. But that’s a jargon-laden explanation.
Instead, it’s useful to look at the impact it makes on the businesses it serves. Below is a slide from a recent company conference. It outlines the savings made for various clients.
The best example here is from Lloyd’s Bank; a 99% decline in time taken to make direct debit refunds. It highlights three strengths of the SaaS business model:
The accrued improvement is too substantial for a business to ignore. No one wishes to return to three day refunds with attendant costs and customer dissatisfaction.
A competitor is not able to improve upon the existing service. There is no functional difference between three minutes and three seconds, in this case. The only competition is in price, and that’s likely insufficient.
Other than care and maintenance, ServiceNow doesn’t need to make improvements to the software. The process works.
At the same conference, ServiceNow highlighted the effectiveness of its planning software in scheduling maintenance workers for a medical device firm in Germany. The software uses Artificial Intelligence to more precisely schedule employees based on data about the time it takes to solve a problem, the availability of parts, and even the travel time between clients. The scheduler increases the work done by employees, and the time available for the team’s manager to work on higher value tasks.
ServiceNow is creating annuity streams of income. It has embedded itself as an essential part of these companies’ business operations by improving productivity. This is Software-as-an-Annuity.
Portfolio Positioning
For much of the last five years, the correct position for software in a portfolio has been a diversified one. This is a mix of dominant platforms, such as Microsoft, and new, and emerging, technologies such as Slack.
But the post pandemic market place has changed this dynamic. Corporations are increasingly looking to consolidate their software spend into the platform businesses. In addition, the platform businesses have been successful in “replicating” the product offering of their competitors (Microsoft Teams). Finally, it’s become clear that mutation occurs best within a platform business.
As a result, it seems worthwhile, given the indiscriminate selling by the market, to consolidate the software position into the businesses with more developed platforms. These businesses are:
Microsoft
ServiceNow
Autodesk: a platform for the technical design industry
salesforce.com: a platform for sales, with the potential to broaden and mutate through its acquisitions that are reflected in its cheap valuation.
The Trade Desk: a platform for programmatic advertising
Intuit and Xero: a platform for small business accounting, particularly digitally native businesses
DataDog: monitoring and security platform for cloud applications
The acquisition by Adobe of Figma highlights this company’s challenges in driving platform benefits and competing with Canva. Despite the cost of the acquisition being reflected in the share price, the names above have a clearer growth path. Similarly, there’s less confidence that Atlassian has been able to mutate within industries. It remains very much a software, devops, and IT Service Management business. This contrasts to ServiceNow that has broadened from this base.