Build it, they will come vs complex integration

[GauchoRico]

I’ve been thinking more about these fast growing tech companies with lots of recurring revenue. There are many ways to compare and contrast them. Another way to look at these companies is to divide them into 2 groups.

The first group we can call “build it and they will come”. These are companies such as AMZN, NFLX, SHOP, HUBS, SQ, WIX, etc. The commonality is that these companies build something once and the customers are easy to get onboard because what you can built adds tremendous value. The company continues to invest to improve the offering which attracts more customers and makes switching away less and less likely. An important feature is that customers basically do most of the work to customize the system to their specific needs. For example, with NFLX the customers simply consume what’s available a-la-carte. With WIX, the customer is given to tools to design, build, and manage their own website. With AMZN, they have build a vast offering to attract and retain their users (think Prime and AWS).

In contrast, the second group requires the customer and the company (the provider) to work together to engineer a customer solution through a complex integration. Companies in this category include MULE, NEWR, and BL. These companies go for very large enterprises and can spend a significant amount of time and effort in acquiring the customers and getting the customers implemented. Yes, once a customer is acquired they will not leave.

Now, I’ve decided that I like the first group much better as an investment. Clearly, the business model is much more scalable than the second model. The one thing to watch out for with the first group, though, is that the product offering must continue to be improved such that competitive offerings are kept at bay. If competition is allow to enter with a competitive offering then market share and margins can take a hit.

Chris

[XMFfuma102]

Chris,

In a similar vein, I like to think of it like this:

Consumers are not likely to jump onto a radical new idea, rather, they need to be coaxed:

Netflix going straight to streaming, would not have worked well. They built a brand on DVD’s (also, their prompt delivery in the early days helped- or so I recall), as well as simplistic design- just a DVD in a sleeve to your door. They gradually introduced streaming. Now its entirely streaming. Then they started their own series, then their own comedy specials.

I think that the early 2000s electric vehicles partially failed because they looked so radically different from what we were accustomed to. Tesla made a car that looked like a high end sports car, priced it as such, and gave it awesome features. Mix this with the era of the “apple fanboy”, and the time is ripe for Tesla to thrive.

massive success involves:

1. society being led by the nose and it not being a far mental leap
2. consolidating fragmented markets
3. some form of perceived cost savings to the consumer (time savings, monetary savings, etc)

I’m sure I’m missing a few, but just one soul’s take.

[XMFBreakerTinker]

<<<The first group we can call “build it and they will come”. These are companies such as AMZN, NFLX, SHOP, HUBS, SQ, WIX, etc. The commonality is that these companies build something once and the customers are easy to get onboard because what you can built adds tremendous value. The company continues to invest to improve the offering which attracts more customers and makes switching away less and less likely. An important feature is that customers basically do most of the work to customize the system to their specific needs. For example, with NFLX the customers simply consume what’s available a-la-carte. With WIX, the customer is given to tools to design, build, and manage their own website. With AMZN, they have build a vast offering to attract and retain their users (think Prime and AWS).>>>

Gaucho, exactly! A company like Twilio fits here as well, so does Microsoft and Intel and other companies that may produce more complex products but that in the simplify technology, enable it to be customized by the user, and enable its distribution to be on a mass scale.

A company like ZEN fits the bill as well. I don’t know enough about Workday, but I would suspect they are. My law firm software is of this type.

This differs from a company like MULE that requires expensive sales process and technical integration.

When I said I took MULE off my list to consider after hearing talk about how well MULE is doing retaining and hiring new engineers, it was exactly for this reason. Where is the scale!

Very few companies requiring this sort of high maintenance sales and installation have been successful as stocks. SAP comes to mind. But that was a long time ago.

There are many investing opportunities and the use of “rule of thumb” to weed through opportunities is a rational strategy.

If for some reason MULE stock was doing very well, then perhaps it would be the exception to the rule and worth looking into. But given that the stock is not doing well, and it is a company of this sort, moving on is my opinion. Obviously other opinions differ.

Excellent post on how a company like SHOP is growing their referral base from their network of vendors and how their ability to retain clients is not becoming more expensive but is actually accelerating and become more efficient the more clients they retain.

Tinker

[XMFBreakerTinker]

<<<How SQ and SHOP get new customers is a critical factor in how they get new customers. Organic traffic is SHOP’s largest source of getting new customers. Wow! That’s completely free. Paid marketing is second and is also very cheap. Third is their partner network. This is why merchants are flocking to SHOP in increasing numbers. They are coming in the door without SHOP having to find them. The same is happening with SQ.

Contrast this to MULE and BL. They spends months to a year trying to convince a customer to join. Then they take up to a year to implement a customized solution that requires highly trained engineers to achieve. This process is slow and has several scaling limitations due to limiting resources (e.g. having enough sales people and trained engineers onboard).>>>

Gaucho,

This is actually what I was referring to at the end of my last post. Right on point and very rare for a company like a MULE to be able to achieve the same sort of accelerating economic returns given the different business realities.

It is our decision as to which companies we want to invest in. I want to invest in companies like SHOP and SQ. In the past it was companies like Microsoft and Intel, that did the same thing for the PC.

Tinker

[Smorgasbord1]

I want to invest in companies like SHOP and SQ. In the past it was companies like Microsoft and Intel, that did the same thing for the PC.

Lots of good stuff in this thread, but this last comment has me perplexed.

Microsoft and Intel created the Duopology, which is essentially a monopoly owned by two partnering companies. Microsoft made thee software (Windows) that everyone wanted to run, and it only ran on Intel x86. Eventually AMD (and others) broke the hardware lock-out via clean-room reverse engineering, which put some pressure on Intel to keep up performance-wise while Microsoft expanded their dominance to MS Office and was probably very happy to have more than just Intel machines on which to run.

So, how do SHOP and SQ have any kind of monopoly between them?

I do own SHOP and have made money on PUTs on SQ in the past, if that matters.

[XMFBreakerTinker]

<<<So, how do SHOP and SQ have any kind of monopoly between them?>>>

It is not about the duopoly/monopoly.

It is about making a technology that scales. Microsoft made software that shipped on mass amounts of PCs that scaled. Intel made chips(and the specific software for the chips) that shipped on mass amounts of PCs.

One did not need to have an army of engineers and spend a year making sales to open up the market.

As it turned out, the PC platform was such that it needed an open standard for software to be built to. It so happens that Microsoft and Intel ended up being that standard, and thus winning over the world.

We do not have that same PC platform issue. We now have a more open Internet that theoretically precludes the need for the world to standardize on a single standard. As such, SHOP is never going to be a 90% marketshare company. Square will not be either.

However, what both companies have is that (1) they scale, with simple “on boarding”, and (2) their marketshare leads and momentum and relationships are making their client acquisition costs more and more efficient visa vie competitors.

History never directly repeats itself, but the lessons of history do not disappear. Companies like SHOP can create superior and enormous economic returns because their ability to scale, and how the product keeps improving and become stickier and easier to market the larger it becomes.

I am comparing this type of company to the sort of company like MULE.

If you want another potential Intel like company, that is NVDA. NVDA has both the hardware and the software that runs the chips, very similar to the x86 that Intel had, it is called CUDA. NVDA has utterly dominating marketshare in GPUs in multiple markets of 70% or higher. In the data center for AI GPUs I believe it is 90% (perhaps a little lower, perhaps I am correct) compared to Intel’s 99%.

Maybe history can repeat itself in this rare circumstance.

But in the end my only point was, I believe, given there are so many investment options out there, prefer companies that have easy “on boarding” that have accelerating marketing efficiency due to the network effect, that makes the product more and more desirable the larger the user base becomes.

The special circumstance and need for one standard for the PC is from a by-gone era. I wish we could find a mirror to that circumstance today, we cannot. But that does not remove the lessons of history. I simply used Microsoft and Intel as two earlier (and most successful) examples of what I am talking about.

Tinker

[Smorgasbord1]

It is not about the duopoly/monopoly.

It is about making a technology that scales.

Fine, but that hardly reduces the potential number of companies for us to look over to anything manageable by itself. Silicon Valley is filled with the carcases of many failed startups who product would easily scale had it been compelling in some way. Others limp along. One-shot wonder Zynga with Farmville is more an example of the Walking Dead. Pandora scales as well, but their special sauce that works so well as a car radio replacement falls flat with many people who are more discriminating in what they want to hear. Microsoft eventually ran out of new people to buy Windows and Office, and didn’t make the shift to mobile, but looks to be doing well with Azure and Web Services for enterprises, despite that business being like MULE (matter of fact, the company at which I work chose Azure API Manager instead of MuleSoft).

I agree that NVDA has a bright future, but not an Intel-like monopolization potential. Google and Intel and others are working on alternative parallel processing chips, taking the tact that it doesn’t have to be a GPU, just lots of small cores in parallel. Not needing the Graphics side of things (the G in GPU) may enable them to be better at the non-graphic AI tasks that will be desirable.

Anyway, good discussion - sorry if I sidetracked it.

[XMFBreakerTinker]

<<<Fine, but that hardly reduces the potential number of companies for us to look over to anything manageable by itself. Silicon Valley is filled with the carcases of many failed startups who product would easily scale had it been compelling in some way.>>>

Yes it does, because you don’t invest in potential, you invest in actual success. And as markets mature, investment opportunities change. When the “Tornado” as it has been called dies down (which is the rapid adoption phase of the market) so will the price of the stock.

When (and this is the best term for it) discontinuous innovation takes over, that will disrupt the prior lead companies. That is what happened to Microsoft on two fronts (1) Internet, (2) mobile.

The easiest example, and the world is so full of these examples that they cannot be denied, is AOL. AOL became utterly dominant internet juggernaut, so powerful and dominant that they bought Time Warner.

What happened? Simple: broadband. AOL dominated on the dial up technology. When broadband began to proliferate AOL went down the tubes.

For every new DOMINANT (and the term is dominant, not theoretical or potential or nice if it happened trend) disruptive innovation a new company comes into its own, usually displacing powerhouse companies that came before them.

ARM to Intel, as an example as the world turns wireless and mobile no matter how many billions of dollars Intel spent on it.

Google disrupted EBAY. eBay was considered to be perhaps the most undisruptable company in the history of the world given the importance of scale to an auction marketplace. Nope, turns out eBay makes most its money from regular stores. And regular stores found out they could do without eBay with the Google search engine and pay per click.

Everyone is subject to disruption.

As things stand now, SHOP is disrupting and is the dominant company in the current technology paradigm. Will that change? When? Dunno. Not in the foreseeable future, but at some point the Tornado winds will slow down for market growth, and at some point some new disruptive technology or business paradigm may be spotted and start to proliferate.

For Nvidia you identified some potential disruptive technologies. Those products have no real market presence currently, so not something we need to consider at the moment. But they are things to watch to see if they really do become material disruptive solutions or not. If they do, then time to reevaluate Nvidia.

But I go on. These are fun and interesting things to follow. You can follow them in real time, and we can invest in them.

You don’t need to invest in the start-up (that you discussed), and you don’t need to keep holding Intel or Microsoft when they’ve been disrupted. You can wait and see the companies become real and true disruptive forces (not just potentially) and you can watch to see if they get disrupted.

So yes, it does limit the stocks you may want to consider investing in, if they are technology stocks. Rapid share price appreciation usually goes along with such companies as well. It is a sign that they may be on to something good. Just a sign, but one worth investigating.

Tinker