No we’re not crazy!


I agree with a lot (most!) of what you said, but there are a couple of items that I think you don’t get quite right, having to do with the underlying nature of software development.

Software development has been around for a while now. There indeed has been quite a lot of change not only in how that software is built, but also its inherent complexity, and (perhaps most importantly!) in how it is marketed and sold. However, as it is often the case, things with a shiny new label are often strikingly similar underneath to the product of yesteryear.

Let’s look at the notion of selling software packages (old model) vs. selling software subscription (new model) a little more closely.

In the old model, you’d sell your software package upfront, usually at a fairly significant price, since that initial outlay was the biggest chunk of money you were likely to ever get from your client. And then you’d charge them an annual maintenance fee, usually about 18% of that original contract cost, for which you provided support and maintenance releases. Note that while a retail consumer buying a $20 piece of personal software wouldn’t normally pay any kind of maintenance, any serious software used by an actual business would always carry maintenance charges. First, many software companies simply wouldn’t sell you their software without an accompanying maintenance contract; but more importantly, no serious business would ever WANT to forego maintenance - it’s just too damn risky, because having no maintenance leaves you wide open to cyber attacks, or ability to deal with other production problems. No support is a corporate IT manager’s worst nightmare. So any software more complex than Notepad (including enterprise licenses of Microsoft Office!) ALWAYS came with a maintenance revenue stream. So the math on software sales of yesteryear looked something like this:

Initial license: $1000
Annual maintenance: $180 (18%)
This kind of license usually included a few major upgrades for a free, and then, in 4-5 years, you’d have to pony up again for the major new version.

And this model worked fine for a long time, it had its challenges (initial sales were hard!), but it still made billions for people like Oracle and IBM and the like. But at some point, corporate people figured out that they just loooove the financial predictability of recurring revenue (and more importantly, the stock market does too!). So they created the subscription model. And now it looks like this:

Initial license: $0!
Subscription fee: $25 a month!
Annual maintenance: Included!

It certainly sells a lot easier, doesn’t it? But when you look closer, you realize that the subscription fee is little more than the annual maintenance turned into a monthly maintenance, with a little extra to account for the lack of that big initial payment. But is it really that different financially? Maybe not quite as different as it first seems. It’s more about psychology, sales, marketing, and accounting. And btw, this kind of simple calculation is exactly how first subscription-based software companies figured out what their subscription fees should be in the first place! Case in point: Office 2000 Premium used to cost $800 as packaged software. Now its equivalent costs about $10 a month.

The second point I want to make is about costs of software development. People outside the industry struggle to understand what software companies actually spend money on (in addition to salaries). Everybody understands factories and raw materials. Software is trickier. But software companies can also have significant operating costs. While these costs do scale a LOT better than costs of companies that make physical goods, they are not infinitesimal. It’s just a different model, particularly with the world of cloud factored in. Here are two important categories that software companies spend money on:

Tooling: developers don’t just work in Notepad. They need advanced development environment tools, debuggers, testing tools, code repository tools, data management tools, deployment automation tools, data profiling tools, security packages, databases, application servers, messaging middleware, the list goes on and on and on. Yes, open source changed the world, and you can get a LOT of stuff for free nowadays. But again, remember support. No one who is serious about their business wants to use tools that are not backed by someone’s deep expertise. Or tools that don’t come with security patching services. Or hotfixes for those pesky production issues. So - you pay for support - at least for all the important stuff. That’s how the RedHats and the Elastics of the world make their money - on support contracts for free software. The bottom line is that to build and maintain software at any kind of scale you also need to buy some software. And the bigger you become, the bigger those subscription or licensing costs to your suppliers become too.

Infrastructure: you gotta run your software somewhere, right? Desktops, test environments, quality assurance environments, production environments, contingency environments. Don’t forget the networking equipment, either! So, either you are buying all that stuff and putting it in a data center (and maintaining it pretty much non-stop), or you’ve gone to the cloud, in which case you’ve just outsourced all that dirty hardware work to Amazon, and they just charge you computing fees. Which - yes, you got it! - go up and up the more data you store and the more compute cycles you consume. They do a great job for you - but it does cost you money, and that cost grows the more subscribers YOUR software has. So every dollar Mongo Atlas makes translates into cents that their cloud service provider makes.

The Achilles heel of software is complexity. And that is the other super important difference in how software scales vs. how hardware scales. Tesla’s Gigafactory 2 looks pretty much like Tesla’s Gigafactory 3, and so on. Once they’ve figured one out, they can keep cloning them. Very clear, linear cost and growth model. Software isn’t like that. Software grows on itself. What’s wonderful about software (as you noted!) is that you can just keep selling the same thing over and over again! But the little understood dark underside of that equation is software complexity. With every new release, with every new customer, every new feature (does the wish list ever stop?!), the software grows more complicated. You need more developers, more testers, better tools and more infrastructure to keep managing it. Just like SaaS software sales, SaaS software complexity also grows exponentially, not linearly. That’s how the “dinosaurs” - Oracle, IBM, Microsoft - eventually become what they become. The first relational database was beautifully simple. So was the first word processing program. The first operating system. DOS used to fit on one 1.44MB floppy disk!! The first version was essentially written by one dude! (He is pretty famous now). Then 30 years of new releases happened. And now we have Oracle, MS Office and Windows 10. They take veritable ARMIES of people to manage now. What happened? Did those companies just start to suck somehow? Nope. It’s software complexity. And it is coming for them all. And - rarely talked about fact - SaaS software is actually a LOT harder to write than non-SaaS software to begin with - because it is inherently massively multi-tenant - and that is a HARD engineering problem.

Now you are still right in many, many of the things you said. Internet did change the world. There is a big difference between thick client software that needs to be installed and zero-footprint browser software that does not. Open source changed the world too. And so did virtualization, and cloud - yet again. Software became beautifully easy to use for end consumers. But the complexities underneath did not really go away. Each of these breakthrough innovations stands on the shoulders of the leaps before it, and so when you dig under the covers, you start to see that. SaaS companies with 90% gross margins feed tons of other SaaS companies with 90% gross margins. Which is why their net margins aren’t that great. Splunk uses Mongo. Zscaler uses Splunk. Mongo uses Atlassian. Atlassian uses DataDog. DataDog uses Elastic. Etc. etc. etc. - I am making some of these up, but you get the point.

All in all, I am still with you - I LOVE investing in SaaS companies, and we DO live in a special time where we can watch the world change before our eyes. But having been in software development all my life, I’d just advise a little caution, because it’s all far more incestuous than it first seems underneath, and for every SaaS company that has a truly groundbreaking product, there are 10 SaaS companies that do not, and are merely riding on the coattails of the overall SaaS excitement for the time being. So we have to be watchful. Not every SaaS company is created equal - not at all. And so I think our greatest success here remains not the fact that we recognize that SaaS is great, but in continuing to find true standouts and visionaries in the space, and investing in them for the long haul. And that also is a very old idea.


Hi Shikotus,

Thanks for taking the time to write such a thought provoking post.

One question- you mention finding the true standouts and visionaries in the space and investing in them for the long haul.

You seem to have a lot of insight into the software industry. Who do you think are the present day standouts and visionaries that are going to be all stars over the next decade?


It all comes down to valuation. A p/s of 35 isn’t as egregious in the subscription model as it is in the license model. If you are licensing, then you need to triple your user count every year to maintain your growth rate because the is year’s customers will not be the same people that purchased licenses last year. If you are a SaaS company, you only need to double your users. This doesn’t take into consideration renewals, etc, but you get the idea. This is why DataDog growing at 85% today and trading at 34p/s is not as overvalued as Netscape trading at the same valuation in 1996.


I didn’t say that there weren’t any companies that called themselves “SaaS” companies,
or who leased part of their software.

They called themselves “SaaS” companies because they were “SaaS” companies. All those were pure
play. Saul, SaaS businesses have been around since the turn of the century.

What I said was that as little as 5 or 6 years ago you couldn’t imagine a company growing revenue 70% a year

Workday (WDAY) ipo in 2012 – grew revenue 103% 2012-2013, 71% 2013-2014, 68% 2014-2015 ($787 Rev).
ServiceNow (NOW) ipo in 2012 – grew revenue 61% 2013-2014, 47% 2014-2105 ($1B Rev, 74% GM)

And to say the current ones are growing like mad because of billions in seed money?

ServiceNow had 83M in funding.
Workday had 200M in funding.
Crowdstrike had 480M in funding.

More funding = faster growth, higher market cap at IPO.



Ears, this is probably the most insightful post I have read on here in a long time. OTOH DDOG has raised less than $150 million. But I doubt WDAY went public anywhere near 40x sales.

In other words the trade is getting very crowded.


I don’t think you get a +100% retention rate by simply having “funding.”


I’ve spent the last couple of days catching up on the board as I’ve been distracted by other subjects. I’d like to add my two cents to this thought provoking thread.

First, I’m just going to ignore the usual attacks that we frequently see here. The reversion to mean, the bubble, momo valuations are doomed, etc. Those of us who have been readers/contributors here for a while have seen these over and over again. But guess what, we’re still here making money from our investments even when we have to grit our teeth and weather a downturn. We are all aware that these investments tend to be volatile. Saul, with his several many years of experience can attest to the fact that volatility comes with the territory of growth investing. If your temperament can’t handle it (and I admit, it can be difficult to calmly watch considerable erosion in your portfolio), then this style of investing is not for you. I have no idea exactly what is to be gained by those who come here with dire warnings of imminent collapse of our investments which just never seems to materialize. Something must be motivating them, but I’m hard pressed to understand what it is. 'Nough said along those lines.

I would like to expound a little on a couple of comments as I think they warrant a bit more discussion. Addedupon brought up the examination of the management team. Are these guys running the company really up to the task? I whole-heartedly agree, but at the same time think the comment is irrelevant to this discussion. The reason I say that is because it is a true observation no matter what style of stock investing you adopt. Are you an income investor? How about a value investor? I don’t think it makes any difference. The competence of the management team is critical for success, it really has nothing to do with growth investing in particular. This is routine due diligence irrespective of style. It also can be difficult to do as most the time executive management takes pains to insure that you only get to see their best side, and they’ll paint the best picture possible. It’s only occasionally that you get to see inside the pretty veneer. Maybe some of you recall Mr. Garrabrantz at Bank of the Internet that was one of our darlings for a while. Once I got a better picture of this guy I bailed in short order. Never looked back.

The other thing I’d like to comment upon is Shikotus’s comments, born of a career in software development. I spent 30 years in IT. I had numerous different positions during my tenure in the business, but for the most part I was associated with software development or related activities during most of those 30 years. I’m not going to really dispute his comments, actually, I think they are pretty valid. But the one thing I want to point out is that there is a tendency to generalize about these investments in that they share many attributes. I needn’t go through the litany of similarities. In fact, Saul’s excellent post does a bang up job in this regard.

But the one thing that at times gets overlooked in light of the similarities is that we don’t just invest in companies that are high growth, cloud based, subscription sales, etc. There are far more companies that share these attributes that we don’t invest in than ones that we do. The products actually make a difference. Saul repeatedly reminds us that he’s not a techie, but he’s not ignorant of the importance of the technology. Alteryx is one of our darlings for all the fundamental reasons we look for, but they also provide a product suite of unmatched capabilities in an area of increasing importance to every mid-sized company to the largest enterprises in the world. Crowdstrike is not without competition, but the product offering is again unmatched with the truly unique fact that the capability of the product improves for every customer with each new customer they bring on board. Can you think of any other company that can honestly make that claim about their product? I could go through most every investment discussed on this board and make similar observations. Some maybe a lesser degree than others, I think we summarize our assessment by asserting our sense of the intangible confidence level we have about our investments. But, in a nutshell, we look for the category crushers as Saul puts it.

Of course, we don’t all own the same companies. But I’m sure there’s a fair degree of overlap among many of our portfolios. Saul’s post is a terrific document that explains that no, indeed, we are not crazy. These companies are worth the lofty valuations they have for very good reasons that are based on quantifiable attributes. We can measure revenue growth, margins, expansion rates and the rest. We can measure and study and compare the cost structure of our investments and react to changes in the numerical assessment. In no way am I trying to diminish the fundamental analysis that resides at the base of a lot of our investment decisions. I’m indebted to Saul, Bear and many of the other “numbers” folks that contribute here as they generously share their analysis and thought process. More than once I’ve mentioned that I am pretty adept with math, but I am still not skilled at financial analysis. There’s a special skill required to gain the insights Saul and others routinely write about.

But the thing I wish to emphasize is that products really make a difference. Of the myriad cyber-security products on the market we have narrowed the field to a very few. There are numerous no-SQL database products available from public companies, we’ve narrowed the field to one. There are several companies that offer monitoring/visibility products, most of us who at one time invested in New Relic have long since abandoned it, only quite recently have many of us chosen to invest in their competitor, Data Dog (it seems to me they could have put a little more thought into the company name, but oh well).

So the next time we are regaled with admonitions of how risky it is investing in these high growth companies with valuations that are “unreasonably excessive” pause and reflect on the actual companies and their actual products. There is some validity to the criticism when applied to companies in general that share the business model, sales and delivery strategies, etc. But none of us (I assume) are invested in an ETF either as a publicly traded equity or constructed within our own portfolios.

Just one more comment. At times we hear from folks who post about the potential demise of one of our positions due to projections that demonstrate five years (or more) down the road the growth will slow and pricing power will collapse and who knows what horrible fate will befall the company. I don’t know about the rest of you, but I pretty much re-examine every position I hold no less often than every quarter. Like Saul, I invest without an exit strategy. I have no price target in mind. I plan to hold every investment I make so long as the “story” remains valid. That might be five years, it could be more, but so far in practice it has inevitably been less. I think Mongo has a good chance of truly being a LTBH investment. But I assure you, if the story changes, I’m gone, Even if the only change in the story is that other investment opportunities appear more promising sooner.


shikotus, I too started out as a programmer – when GOTO was still being used. I’ve been on both sides of the aisle, as a seller with IBM, NCR, and my own software, and as a buyer. While I don’t disagree with your take on software I think you are missing a very important issue. SaaS is “Software as a Service.” Your focus is on the Software, mine is on the Service. In the good old days you bought or licensed the software and ran it on your own hardware. That required a DataCenter Priesthood. With SaaS you no longer have the hardware and, more importantly, the DataCenter Priesthood. At comparable prices SaaS is giving clients a heck of a lot more than a software license. I’ve been running websites on hosted servers for some 20 years and not having to deal with the servers and the (LAMP) software plus all the supporting bit and pieces of software and supporting hardware (UPS, backup, connections, etc.) has been a godsend. Oddly enough, outsourcing the hardware makes it cheaper because a dedicated team of DataCenter Priests can service hundreds of customers.

As you mention, the SaaS providers might be outsourcing the servers (not all do), but that is not an extra expense, on the contrary, it probably is a saving. Moving from vertical integration to horizontal value chains (outsourcing) would not happen if it did not produce a net benefit.

Denny Schlesinger


Hi Shikotus,

Thanks for taking the time to write such a thought provoking post.

One question- you mention finding the true standouts and visionaries in the space and investing in >>>> them for the long haul.

You seem to have a lot of insight into the software industry. Who do you think are the present day >>>> standouts and visionaries that are going to be all stars over the next decade?

I feel pretty strongly that Mongo will be around for a long time. Alteryx is also very strong, but ultimately their moat is not quite as difficult to leap as Mongo’s, in my opinion. I’d put Twilio somewhere there as well, I think they’ve carved out a very successful and important niche that’s still quite a bit underappreciated on the whole.

Elastic might very well end up joining the above list as well, but I am a little less sure on that one for now.

The rest I am a bit less confident in. There is probably another “great” somewhere in the list of our security companies (maybe Okta), but security on the whole is a very specialized area, and I just don’t have the depth there that I have in the broader software space to make high confidence calls.