This is a computer software company, y'hear. Maybe this is sufficiently obvious that it doesn't need restating, but as the company grows there is a tendency for every department to look upon what it does as central to the mission of the company. Departments then tend to see if they can make a direct contribution to the till by adding products to the company's line. For example, training could offer courses to users around the country for a fee. Technical could offer consulting services to driver developers for an hourly charge. QA could perform screening of third party software products for vendors. Marketing could prepare promotional materials for OEMs and third party vendors. And Production could manufacture third party products. Within the next year, we may be doing any or all of these functions, and these activities may be contributing dollars to the company's revenue totals. But they are incidental to the business the company is in, which is designing, developing, manufacturing, selling, and supporting computer software! Our company's value largely derives from the fact that what we do is so extraordinarily profitable. It is so profitable because we are selling intellectual property; virtually pure value added; pure reason without the critique. As I said three and a half years ago in the original Working Paper, there are few legal businesses as attractive. If we wish to go into another business, we must review that proposal as we would review the purchase of an operating company: looking at capital requirements, sales projections, pro forma income statements and balance sheets, and risk factors. This is one of the most profound decisions a company can make, and is not to be taken lightly or backed into inadvertently.
If you aren't used to thinking in the terms expounded above, the impact of stumbling into a new business can be less than obvious. Suppose we were to start doing direct contract support to major user accounts. Suppose that this was so extraordinarily successful that by the end of the year we had generated 5 million dollars in support fees, and had managed to do this with expenses of 4 million for personnel and travel. We would then add 1 million dollars to the pretax profit number and $500,000 to after tax profit. Sounds great, right? Wrong. That component of the business would be operating at a 20% pretax margin and a 10% after tax margin. When these numbers were consolidated with software operations, they would reduce our operating margins, and Autodesk would be perceived as having eroding margins. The analysts would then look at the numbers to find out what was happening and discover that we had gone into the education business. Education is not a stunningly profitable business (as thousands of colleges know, and Westinghouse and CDC learned to their dismay), and Autodesk would lose some of the attractiveness of being a ``pure high-tech CAD play''. This would reduce our P/E, and the stock could be clobbered.
I don't want to dwell on this too much, but it is a problem that growing companies typically have. We'll have to keep focused on the ultimate goal of selling a lot of software if we're to avoid it.
Editor: John Walker