Which Software Verticals Survive?
Better to be good than lucky
The better title to this note might be “which pieces of software deliver value in excess of their cost-to-develop, and in which circumstances might there be a substantive switching cost for an organization?” but that is quote wordy. A good way to answer this verbose question might be “who is the optimal customer to sell software to?”
Outside of the obvious financial health of the business (its better when the company has more money, obviously), we want to focus on what qualitative aspects of the customer works best for software sell-through. And using sophomoric things like “pricing power” and “demand elasticity” masks real-value added services that customers care about. Customers don’t push back on price when you’re delivering real value or solving problems for them— reasoning this in reverse is a recipe for pissing everyone off (not just your customers but also your sales staff that has to push the product).
Integrates with customer hardware. The classic example is Apple and their suite of software— it’s sort of a chicken/egg situation of what customers hate/love the most about the iOS ecosystem/iOS hardware. The app store stifles creativity, but also adds a layer of fraud/scam protection. The iCloud provides storage that’s a cost center for Apple, but also offers a chance to upsell subscriptions etc. This lowers search costs for customers as they can focus on whether they like the hardware or software best, and just accept they’ll pay more for a bundle. Ultimately this saves timein lieu of mixing-and-matching software and hardware. Axon (AXON) and Motorola Solutions (MSI) are the other great examples here, but none have been touched by the recent SaaSacre.
Solves a regulatory problem with customers. Classic examples here include Jack Henry (JKHY) in banking, or VEEV in health care, or Tyler Technologies (TYL) in legal services. TYL in particularly has been hit quite hard— Munger saw this vertical and did his own thing with the Daily Journal/Journal Technologies acquisition (DJCO). Of course, none of these are cheap, but the good stuff never gets cheap. It’s best to think of these as royalties on government growth and bureaucracy, but also offering value in the form of insurance against regulatory blowback.
Ugliness as a service. Certain businesses just don’t want to do some of the things they need to do to get paid by their customers. And they don’t want to employ For example: prestigious schools with friendly faces do not want to be in the door-knocking loan servicing business. Harvard does not want to hire a full-time henchman to collect delinquent tuition. Nor do these schools want to handle payments infrastructure either. So something like a Nelnet (NNI) offers the bundle: loan servicing, lending, payments, school portal login software. It’s a brilliant model to service bundle. Unfortunately, these companies border on the predatory. When you’re a tech company and you think you can bank better than the more specialized lending firms, you’re going to get adverse selection. So it’s best to partner with someone to share balance sheet in that circumstance. Some other ugliness as a service names: ICE that runs a clearinghouse and bought Black Knight’s mortgage servicing business. Maybe something like CareCloud (CCLD) which I wrote about has potential. I wasn’t that excited about CCLD when I wrote about it but if management can pull it off there’s a big TAM and opportunity.
Adaptability. Very few software suites have ever replicated what Microsoft did with Excel. It is the eminently customizable piece of equipment that integrates with everything across space, time, language, use case, user competency etc. People are happy to pay for this into perpetuity to use as a 10 line-item budgeting tool like my mom does, or for a 300-page modeling exercise that takes 5-minutes to calculate every cell when you hit F9.
I don’t know what products fit this bill. Maybe CRM. I don’t know if its super analogous since the price point is so much higher. No one will ever vibe code an Excel replacement— can the same be said about Salesforce? For small companies, maybe, but for enterprise I would say no way. Or maybe that’s precisely backward— enterprises with the resources to vibe code their own stuff will ditch CRM, while SMBs who don’t have the resources to do the same will rely on a centralized provider like CRM.
Regardless, there’s crazy narratives going around in software-land. If you can scoop up the quality stuff that hasn’t really cracked yet like JKHY or TYL, probably do so. Nelnet is intriguing as well. Unmentioned but worth exploring: Cellebrite (CLBT). Happy hunting.