SaaS Companies Going From "Asset Light" to "Asset Heavy"

Signs of management's own expectations of the durability of their growth and existing customer base

A concept I’ve been thinking a lot about recently is when asset light companies (think software, marketplaces, fintech, distributors, etc) move into an asset heavy area. In general, companies usually chase higher margin and lower capex opportunities. Clay Christensen’s classic, The Innovator Dilemma, goes into this in depth.

In the book, Christensen talks about the steel industry. The integrated steel mills kept moving up-market and serving bigger and higher paying customers while the mini mills served the smaller, low margin customers eventually pricing them out and improving the quality to beat out the steel mills.

If you haven’t read the book, this article has a good description of it.

So what does it mean when we see a company that is asset light moving into and investing heavily in an asset heavy area (which many times has corresponding lower margins as well)? The best way to analyze this is probably by looking at historical and current examples.

A good example historically has been Amazon moving from the marketplace model to AWS which required heavy capital expenditures to build out the infrastructure. Another good example is any distributor moving into owning the assets that they previously were facilitating the transfer of. I know a wedding planner that has now bought decorations, chairs, tables, napkins, and cutlery and pays for a warehouse to store them in. Why did this planner take on the additional cost when the previous business model required no such inventory or maintenance expenditures?

The reason is a focus on long term free cash flow rather than free cash flow margins ($ vs %). Jeff Bezos has a great quote: “Your margin is my opportunity”. And yet this doesn’t just mean high margin businesses, Amazon has been investing billions of dollars annually into expanding their logistics capabilities (warehouses, planes, vans…even robots!). The reason is even if these affect the asset light nature of the business, they help generate more free cash flow in the long term as long as customers spend more or use the service for longer because of these investments.

So whenever I see a public company doing that now. I pay close attention. The confidence that management needs to have to take a risky bet of spending tons of capital on a business that may not pay off usually means they assess the probability of success to be a lot higher than anyone thinks. It also usually means they are thinking about long term free cash flow dollars and believe their current customer base is durable and sticky enough to spend the company’s resources building out this new area.

Where is this happening now? Shopify is spending significant dollars on building out logistics to serve their customers. Salesforce is acquiring system integrators and consulting firms bringing more professional services (a low margin, more “asset heavy” business than traditional software) in house. Salesforce is doing this even as they have a massive partner ecosystem that they rely on for revenue…so how confident are they in their own ability to be a channel partner for themselves and for other software companies if they’re willing to invest heavily at the potential expense of those partners? Disney is also doing this with Disney Plus. They could keep making the movies and licensing them to many different companies at a higher margin but instead are keeping them in house for the Disney+ streaming services that requires significant customer acquisition costs and even more ongoing content spend to work.

These moves don’t happen often but when they do, I believe they’re worth spending time on to study why management is doing it and what that likely signals about the prospects of the business.

The first time I talked about this idea was my podcast with Andrew Walker below. Andrew writes Yet Another Value Blog and has a brilliant podcast. I recommend you subscribe to both if interested in public markets!