Costs driven by software

[handycap5]

I'm looking for businesses where software/IT spending is a key component of costs and providing a quality service, while revenues are not driven software per se, but by another activity or pricing dynamic.  Can you help me brainstorm businesses which would fit this description?

 

Below are some examples and why I believe they fit or don't fit:

 

Amazon (YES): As is obvious, software development represents a significant portion of costs but revenues are driven by volume and price on the shipped items.  Competitive pricing dynamics in retail versus Target, Wal-Mart, Barnes & Noble, etc. are not driven by software.

 

Microsoft, Salesforce.com, IBM (NO): Costs are software development, but they basically sell software too.  Even though software-as-a-service businesses are not selling software per se, I think revenues will basically be driven by the same dynamics. IBM represents a hybrid of selling software wrapped in a service, in my view.

 

Schwab, Ameritrade (YES): Costs of servicing client activity increasingly driven by software, but revenues are driven by interest rates, trading activity, investor choices.

 

Bank of New York, State Street, Northern Trust (NO APPARENTLY): I would have thought that this would have been a business where costs were driven more by software development but revenues were driven by interest rates and balance sheet management. My quick look at history prior to the financial crisis shows that they did not seem to enjoy any fundamental operating leverage.

 

Title insurance, such as First American (NO APPARENTLY): I would have thought costs would have been driven by maintaining database and revenues driven by home sale and refinancing activity. But they do not seem to generate operating leverage by my analysis, perhaps because the archaic sales channel prevents it being meaningful.

 

Can you help me brainstorm other businesses which might enjoy cost deflation due to software, but revenues driven by other factors?

 

 

[SmallCap]

Paychex, ADP - Payroll companies

Ebay - did you mention them already

 

[ericd1]

Not sure if I am following your theme but perhaps these might fit...

 

EBIX - Intuit - Both create their own software

 

DG FastChannel (DGIT) - Centralized delivery system for shows, advertisements, etc to over 30,000 media outlets from 5,000 advertisers. They delivered 80% of this year's Super Bowl ads.  40% growth rate - ad revenues increasing - pretty good moat and excellent market share.

[turar]

I'd say Amazon is a NO or a YES/NO. Revenues are indeed driven by software, since everything is automated and a tiny software glitch can cause revenue for the day to drop sharply (i.e. site down for a few minutes results in thousands if not millions in lost revenue). It is even more so with the emergence of AWS, Kindle, Digital, etc.

[Ballinvarosig Investors]

I think Betfair Group is something that would interest you - http://www.google.com/finance?q=LON%3ABET

 

Gambling is mostly illegal in the States, but in Europe, it's a huge business. Historically, the industry has been dominated by a small number of large companies that ran the business out of bricks and mortar establishments. Betfair came along a few years ago and completely changed that dynamic. This company has not only taken gambling online, but has also taken the middleman (i.e. the bookie) out of gambling, allowing people to put wagers on sports events between themselves. Because Betfair operate solely online, this means that their revenues and profits are driven by by innovation of their website, and stability of their system. This is not trivial, as the volume of bets that they take on a typical days is in the million (if not tens, or hundreds of millions). If gambling is ever legalised in the States, Betfair are basically the only company in existance who have the scale and dominant position in the industry that they would just completely clean up.

 

The price has come down a bit since it IPO'ed. A little expensive for my tastes, but the business itself is basically a monopoly and has some incredible growth prospects.

[alwaysinvert]

There are quite a bit of legislative action going on throughout Europe in regards to online gambling, too, so I would not view it only as upside potential in terms of that.

 

The Betfair model is great of course, only providing a betting market and taking a small cut from the winner in two-sided bets and not acting as the house in any market, thus allowing for odds to be higher almost invariably for the players. OTOH, a vast majority of the players just don't care that much about the odds, and different bonus schemes may be more effective in generating customers. Care to elaborate on the monopoly comment and growth prospects?

 

In terms of player streams, online gambling as a business is verrrry hard to forecast. The leaders from some years ago are pretty much wiped out. If someone is undercutting you or in some other way outbesting you, you could se your customer base vanish extremely quickly. There are hoards of online poker/gambling companies out there just waiting to enter the slaughterhouse after enjoying a few fat years some 5 or 6 years ago.

[EdWatchesBoxing]

Overstock?

[Ballinvarosig Investors]

Care to elaborate on the monopoly comment and growth prospects?

 

In terms of player streams, online gambling as a business is verrrry hard to forecast. The leaders from some years ago are pretty much wiped out.

It's important to distinguish between the traditional bookie operating online, and the likes of Betfair. The traditional bookie competes with other bookies on over-round. The lower the over-round, the less profit the bookie makes and the more risk he is exposed to (it's basically the insurance game without the ability to invest float). Betfair is different - it doesn't care about over-round. In fact, it would actually want the over-round to be non-existent, or at least negligible. Remember, they take their cut from each transaction - therefore the greater the volume of bets being place, the more they make. This also explains why they have a near monopoly position. If you place a bet and you're looking for the best odds, you have to go to Betfair, because they are the only company that has the liquidity to get your bet matched. It's a vicious circle for competitors trying to compete. If they want people to use their exchange - they have to offer liquidity; however, because they're a new competitor, they cannot offer the liquidity, because they don't have it, more customers are even more driven to Betfair.

 

A lot of competitors have tried to compete with Betfair (Betsson, WBX, etc.) but they have all failed and had to close down. Even when these guys reduced their commissions, they still couldn't compete with Betfair, the inertia and liquidity that Betfair had was too great. Like you've stated, the big challenge for Betfair is more likely to be legislation rather than competition. It's a great business, a little expensive right now.

[alwaysinvert]

Care to elaborate on the monopoly comment and growth prospects?

 

In terms of player streams, online gambling as a business is verrrry hard to forecast. The leaders from some years ago are pretty much wiped out.

It's important to distinguish between the traditional bookie operating online, and the likes of Betfair. The traditional bookie competes with other bookies on over-round. The lower the over-round, the less profit the bookie makes and the more risk he is exposed to (it's basically the insurance game without the ability to invest float). Betfair is different - it doesn't care about over-round. In fact, it would actually want the over-round to be non-existent, or at least negligible. Remember, they take their cut from each transaction - therefore the greater the volume of bets being place, the more they make. This also explains why they have a near monopoly position. If you place a bet and you're looking for the best odds, you have to go to Betfair, because they are the only company that has the liquidity to get your bet matched. It's a vicious circle for competitors trying to compete. If they want people to use their exchange - they have to offer liquidity; however, because they're a new competitor, they cannot offer the liquidity, because they don't have it, more customers are even more driven to Betfair.

 

A lot of competitors have tried to compete with Betfair (Betsson, WBX, etc.) but they have all failed and had to close down. Even when these guys reduced their commissions, they still couldn't compete with Betfair, the inertia and liquidity that Betfair had was too great. Like you've stated, the big challenge for Betfair is more likely to be legislation rather than competition. It's a great business, a little expensive right now.

So I guess Betfair is starting to look really interesting now? :)

[Ballinvarosig Investors]

Care to elaborate on the monopoly comment and growth prospects?

 

In terms of player streams, online gambling as a business is verrrry hard to forecast. The leaders from some years ago are pretty much wiped out.

It's important to distinguish between the traditional bookie operating online, and the likes of Betfair. The traditional bookie competes with other bookies on over-round. The lower the over-round, the less profit the bookie makes and the more risk he is exposed to (it's basically the insurance game without the ability to invest float). Betfair is different - it doesn't care about over-round. In fact, it would actually want the over-round to be non-existent, or at least negligible. Remember, they take their cut from each transaction - therefore the greater the volume of bets being place, the more they make. This also explains why they have a near monopoly position. If you place a bet and you're looking for the best odds, you have to go to Betfair, because they are the only company that has the liquidity to get your bet matched. It's a vicious circle for competitors trying to compete. If they want people to use their exchange - they have to offer liquidity; however, because they're a new competitor, they cannot offer the liquidity, because they don't have it, more customers are even more driven to Betfair.

 

A lot of competitors have tried to compete with Betfair (Betsson, WBX, etc.) but they have all failed and had to close down. Even when these guys reduced their commissions, they still couldn't compete with Betfair, the inertia and liquidity that Betfair had was too great. Like you've stated, the big challenge for Betfair is more likely to be legislation rather than competition. It's a great business, a little expensive right now.

So I guess Betfair is starting to look really interesting now? :)

I wish, the frosty regulatory environment adds a worryingly high speculative factor here. Shares have slumped because of a German proposal to impose a 16% turnover tax on betting over there. That would effectively drive Betfair out of the Germany market, having said that Germany only accounts for a small part of Betfair's revenues. If governments turned their attention away from gambling firms, I would certainly be much more interested in this one.