Best in breed:

Software is a wealth creator for companies that take advantage of life’s challenges

The Covid-19 pandemic, according to Tobi Lutke, chief executive of the $80 billion juggernaut Shopify, caused the online shopping platform to put its 2030 plans into place 10 years earlier, such was the change in the commercial and technology landscape.

Kogan, the online retailer and marketplace, saw its sales double in April and May, compared with a year earlier.

People previously unfamiliar with online shopping or video-conferencing flocked to them in droves. And contactless payments, though already popular, came into their own as retailers asked customers to avoid using cash where possible.

Change, as is often said, is the only constant in life. And that change, driven by circumstance, has taken 2020 by the scruff of its neck. It’s not just technology that’s changing, of course, but it has, by its very nature, become ubiquitous. It can move quickly and is at the heart of most innovation – it’s been prominent in shaping how we respond to the challenges of living with and hopefully eradicating Covid-19.

And technology (in particular, software) has some characteristics that should warm an investor’s heart. While barriers to entry might be low (coding isn’t exactly a dark art, and there’s no lack of qualified programmers), toppling incumbents remains a tall order. The company that can – through skill, luck or both – make headway, brings with it an economic engine that should be the envy of almost every other business.

That’s because software, once written, costs very, very little to produce and distribute. If you’re making cars, you have a full manufacturing process to serve each new customer. If you’re selling software, the customer simply downloads a costless copy of something you’ve already done.

Or – and this is where it gets better – the customer doesn’t download anything at all, but rather gains time-bound access to an online service that requires a regular, recurring (monthly or yearly) payment to maintain. Stop paying, and they can’t use the software any more. That makes for some high customer retention.

Take Microsoft Office. Once a onetime-sale product, we now access it as a subscription. And once the software is written, there’s almost no cost difference whether the company has 10, 10,000 or 10 million customers. Sure, there are sales and marketing costs, and ongoing development costs – and no one has yet unseated Office after 35-odd years of domination, so it’s not as easy as it seems – but if it can get there, and if an investor can jump on the bandwagon early enough in the journey, such a company can prove to be a lucrative wealth creator.

Foolish takeaway

It’s not an excitement machine like some others in this area – and the next few months could be volatile – but given its dominance, pricing power, and undeniable business quality, for long-term investorsREA Group is our best in breed.

Of course, it’s not all plain sailing. In a pure coincidence, the ASX All Technology Index – billed hyperbolically as Australia’s NASDAQ – launched on February 21, the day after the ASX hit a record high.

When it comes to choosing the best, it’s hard to look past the “classifieds” trio of REA Group (owner of realestate.com.au), Carsales and Seek. While the economy mightn’t be in tip-top shape right now, these companies have a lock on their categories and seemingly endless pricing power.

And while it’s not traditional “recurring revenue” – because homeowners only sell every five or 10 years – the true economic goldmine is the lock REA has on real estate agents, who have little choice but to recommend sellers place their listings on the company’s market-leading site.

It’s those agents who are REA’s true recurring customers.

Scott Phillips is The Motley Fool’s chief investment officer. You can reach him on Twitter @TMFScottP and via email ScottTheFool@ gmail.com. This article contains general investment advice only (under AFSL 400691).