How to Invest in a US$1 Trillion Tech Opportunity in the Making

Every decade brings along with it some megatrends...and the acronyms to mark them.

Think of BRICS, FANNG, and now anything that can be offered 'as a service' - 'aaS'.

The recent wave of tech IPOs latched on to one of these trends - Platform as a Service (PAAS). Nykaa, Zomato or Paytm, platform businesses, despite losses, saw huge interest from investors because of size of the opportunity.

What did not get its fair share of limelight in this tech wave was SaaS - Software as a Service.

SaaS i.e. Software as a Service, is a model where the users pay for software on a subscription basis as against buying it one time.

In a conventional software delivery model, the software is installed/downloaded on a machine or machines.

But in a SaaS model, the client does not need to install and run apps on a limited set of computers or local hardware.

One can access the software from any device with internet connection and a browser. The application itself are located on a remote cloud network. It can be accessed through the web or an API.

Think of using web based email services such as Outlook. It's a form of SaaS. It's just that it's a free service for individual use. The SaaS I'm talking about is for organisations helping their business grow.

While the seeds for SaaS were sown in the last decade, covid was the catalyst which accelerated this megatrend.

It's an industry that is witnessing strong tailwinds of digitisation. SaaS caters to multiple industries - health care, manufacturing, media, entertainment, financial services, travel, retail, food services, and education to name a few.

It's one of the fastest growing sectors in India. It's potentially US$1 trillion opportunity by the end of the decade as per SaaSBOOMi.

Why is SaaS finding high acceptance among users?

Under the SaaS model, the user doesn't have to pay huge upfront fees to buy the software. They can rent it and pay per use via a subscription.

The client also saves cost on hardware acquisition, installation, upgradation, and support. In short, capital expenditure is not required. One can manage with a fraction of the operating expense.

As such, the cost of ownership is low and also gets distributed overtime based on usage. This is affordable and easy on cash flows for the user.

This makes SaaS popular among small businesses.

How is SaaS is different from traditional software models.

The first is scalability.

Lower upfront costs for clients allows more customer acquisition in less time and with fewer resources.

The upfront revenue for software companies from a single customer is lower than the traditional model.

But the SaaS model allows companies to increase the lifetime value of users due to lower customer churn, better tracking of clients and the ability to up-sell/cross-sell overtime.

This incentivises software providers to update and develop the service as revenues come over a period of time as against a big initial payment.

Also, the software works through cloud delivery model. The cloud provider could be a third party. Thus, it's less susceptible to plagiarism or copyright violation.

Overtime, an efficient SaaS model results in lower marketing spend as a percentage of sales and a higher revenue per user due to higher customer lifetime values.

Hence SaaS companies have more predictable revenues.

In short, it's a win-win for customers and software firms.

Examples of SaaS are Shopify, Salesforce, Freshworks, Chargebee and so on. Adobe is a company that made a big, successful transition from a traditional to a SaaS model.

SaaS has become a disruptive force to conventional way of delivering software. And a lot of tech and software companies are integrating SaaS in their businesses.

Many Indian startups have laid the foundation to become unicorns in this space. These include Freshworks, Postman, Zenoti, Druva, Chargebee, Browserstack and more.

While investing in this megatrend, there are a few points to keep in mind...

Here is the golden rule to assess the performance of SaaS companies.

Revenue recognition under SaaS happens over a period of time i.e. recurring versus one time payment. But costs could be front ended and are booked when incurred.

As such, a conventional way of looking at revenue and profits over a period does not capture the potential of a SaaS company.

A better way is using the 'Rule of 40'.

A SaaS company is considered to be in a good place if its revenue growth plus its operating profit margin is 40% or above.

It allows for some tradeoff between sales growth and profits.

Remember, the SaaS model allows companies to upsell and increase lifetime values of customers. So it's okay to go easy on the operating margins if it allows scalability gains in market share.

When you think about it, this is what most new age businesses are doing.

I like SaaS because the tradeoff between growth and profits is not absolute. SaaS companies are scaling up while growing profits. This is unlike the case of most new age businesses that make losses, like Zomato and Paytm.

A few weeks ago, I applied the rule of 40 to companies in software, tech, and platform companies.

I further narrowed down this selection to companies that have...

1. Shown double digit growth rates in FY21 because growth remains our primary focus.
2. Positive margins.
3. A minimum revenue of Rs 1 bn.
4. A minimum marketcap of Rs 3 bn.
5. Qualified on 'Rule of 40' metric for at least three of last five years, i.e., from FY17-FY21.

With these filters, these companies make it to the list.

• Tanla Platform
• Affle India
• Infosys
• Tata Elxsi
• Intellect Design Arena
• Mastek

I suggest watching this video for more details on these companies.

This does not imply a buy view on any of these stocks. It's simply a rule of thumb and one of the key parameters to assess the relative performance of companies in this space.

Along with the rule of 40, metrics like lifetime value, customer acquisition cost, churn/retention rate, can give a good sense of the business.

To know more of these concepts, you can read this editorial.

Stay tuned for more from me on disruptive trends in the Indian economy.

Warm regards,


Richa Agarwal
Editor and Research Analyst, Hidden Treasure