software as a service/ cloud computing

Once, when I was younger and more foolish, I owned shares in the Japanese company Olympus for a short time (this was in the late 1980s – early 1990s, long before the financial scandal that ultimately brought the firm to ruin).

What interested me was Olympus’s endoscope business. An endoscope is an apparatus that consists of a monitor, a computer and a long fiber optic cable encased in a hose.  Doctors feed the cable into the body of a patient to check out the state of his insides.

This business is supposed to work on the razor/razor blade model.  That is, the big money is in replacing the cable-in-a-hose, which Olympus recommended doctors do every three years or so.

Olympus had a problem, though.  Its salesmen could never persuade doctors to replace their cable/hoses.  They’d have marketing campaigns where they’d warn the docs that the cable might snap off inside the patient’s body if it got too old.  But even that cut no ice.  I guess doctors figured the patient is sedated and that they could extract the broken pieces, if need be, without anyone being the wiser.

So far, there’s no obvious investment angle–just a recipe for trouble.

But…

…in the US Olympus had switched from selling endoscopes to doctors to leasing them.  The sales pitch was that monthly payments matched the doctor’s cash inflow better.  The buyer also took on no debt and was no longer responsible for maintenance/upgrades.

US sales skyrocketed.  So, too, did profits–because factored into the “more convenient” lease payments was cable replacement every three years.

The lightbulb’s gone on, I figured.  Next step is rolling out the leasing model worldwide.  So I bought the stock and sat back waiting for the earnings surprises–and stock price appreciation–to roll in.

They never did.  In a dot-connecting failure I’ve come to think of as characteristic of most Japanese manufacturers, Olympus thought leasing was ok for Americans but for no one else.  Once I realized this, I sold–without making or losing much money, as I recall (meaning it probably was worse than that).

Nevertheless, this experience taught me a valuable thing about market dynamics:

–when people, particularly medium- or small-sized businesses, own expensive equipment, they’ll ride it until it dies.  Then they’ll revive it, with duct tape and string if necessary, and continue to use it until it falls apart. Even then, they may keep it around for spare parts.

This is a particular problem with software, since it doesn’t often cease to function.  All the power resides with the buyer.

–on the other hand, when people lease stuff, and the large initial capital outlay is turned into a much smaller recurring expense, the obsessive desire to squeeze the final dollar of value out of the equipment disappears.  Market power swings decisively to the seller.

In the case of software, the benefits of this move are especially big, since many of the costs of distribution of the product go away. Everything is done automatically over the internet.

That’s the power of software as a service.

Another thing:  during the transition period between ownership and leasing, surprisingly large numbers of customers–who have previously been using what are, in relative terms, Stone Age tools–sign up.  ADBE is a case in point.