SaaS: Why Warren Buffet Won’t Invest in High Tech
Posted by Bob Warfield on May 27, 2009
Buffet is one of my heroes. He is the pre-eminent and most successful investor of all time. It’s unclear his record will ever be equalled, let alone exceeded. How does he do it?
There are whole books available on his strategies, and I have read several. It all boils down to one thing, in my opinion:
Buffet’s strategy is to buy stocks producing great earnings that he will never have to sell.
That’s a very interesting strategy, and it has deep implications. Asked why he doesn’t invest in high tech like his bridge player buddy Bill Gates, Buffet’s reply is very, “Aw shucks.” He’ll say it’s because he doesn’t understand those businesses. But the real reason is more subtle. Buffet wants companies that are as immune to change as possible and that have unnaturally high margin businesses. They will preserve their unnaturally high profit margins essentially forever. If they grow, so much the better, but he doesn’t even insist on that.
He wants no part of the Innovator’s Dilemma or Paradigm Shifts. The likelihood that a company can successfully beat the S&P 500 year after year is higher over a long period if they don’t have to deal with change. Change is often destructive to those unnaturally high margins, if only because you have to invest to keep up with it. Hypergrowth plus high margins can’t last. The math simply doesn’t hold up. If you work it out year after year, you wind up with every man, woman, and child on Earth having to spend a lot of money on something they never will.
In 1957 Buffet had his first investment partnerships, and he was a millionaire in 1962. He’s still at it today in 2009, over 50 years later. It takes a long time perspective to be successful on his scale. The magic of compound interest works slowly, but there is no more powerful force given time.
What does this have to do with SaaS?
Just that big companies are more like Warren Buffet. They don’t embrace change. It works well for them over time as they steadily grow and gain power, particularly if they are monopolies as so many are. But change is destructive to them. It is anathema. It means they’ve reached the plateau, they see higher peaks, but they must descend and start to climb over again to reach them.
SaaS is forcing that change inexorably on the big software firms. Some, like Oracle, have turned to acquisitions over innovations to insulate themselves somewhat from change. Eventually, there will be no more companies of a scale that matters to Oracle to buy that still sell on-premises software. Certainly they have narrowed the field considerably.
That leaves only two outcomes: either SaaS really only applies to an uninteresting subset of the market (largely SMB and only certain kinds of software are the usual claims) and the Oracle’s and SAP’s are safe, or big companies will eventually have to embrace the change or die as SaaS continues to take hold higher and higher up the food chain to ever larger companies. The first is a heck of a bet, and one that I think is wrong, even though there will likely always be some categories that can’t use SaaS. The latter is a heck of a challenge that most companies will fail at.
Michael Krigsman got me thinking along these lines (not that I haven’t thought of the subject before) with his excellent post today wherein he asks VC Mike Fitzgerald whether Enterprise software companies can do SaaS.
The post got me thinking about all the reasons it is so hard for big companies to embrace SaaS. They range from Mike Fitzgerald’s point that these companies have a culture that is hooked on Big Deals. That culture can’t deal with selling $1000 a month subscriptions. We could riff on that theme alone in so many ways:
– It takes a completely different kind of sales person to do Big Deals versus small deals. Not only can you not afford to pay a Big Deal Salesperson to close Small Deals, the tools they use will be ineffective as well. Fail on two levels.
– The marketing works completely differently. As Geoff Moore put it in a recent strategy session with my company, Helpstream, if you have a $200K deal, you can afford to create buzz inside an organization that may be a customer through feet on the street. If you have deals of $50K or less, you have to create the buzz through PR and marketing. Deals in the middle can’t win either way.
– It isn’t just the deal size. It’s the margin on the deals. SaaS companies have to be very numbers conscious because their margins are razor thin. When you close a big license deal for $1 million, probably $900K of that is pure profit. You do whatever it takes. On a $10K deal where maybe $6K is margin, you have to do very little lest you invest more than you can ever make back on the deal.
I am reminded of a scene that played out while I was in school. We were all shocked the day DEC’s Ken Olsen went on record as saying PC’s made no sense:
“there is no reason for any individual to have a computer in his home”
I remember realizing some time later that this statement probably had as much to do with the fact that Olsen’s minicomputer salesforce couldn’t tolerate selling in the computer stores of the day as much as any technical grounding Olsen may have felt the idea had.
The most destructive change is change that affects how products are sold. Add to that change that affects how revenue is collected and even how profit accrues and you have the Mother of all Nightmares for Warren Buffet or any Big Company.
SaaS is all that and more.