I’ve done a bit of digging as a relative newbie to PME. My main question is what could possibly be driving those 90%+ gross margins — a level very few software companies ever reach. I’m mainly thinking about this in terms of what to look for in future opportunities.

In an environment where “your margin is my opportunity,” I wonder how much of PME’s moat comes from the decades spent integrating its system with different hospital technologies, combined with the unusually high impact of failure. That risk seems to be reflected in the long contracts, which hospitals themselves push for, and the fact that PME’s fees are only a small slice of the revenue hospitals earn from imaging probably reduces any pushback on price.

The closest parallel I can think of is WiseTech. It also has decades of integrations, high switching risk, and its fees represent a tiny share of value, which could be why its margins are in the 80s. The difference, perhaps, is that WiseTech’s risk is financial/operational, while PME’s is clinical/legal — and that might explain why PME still edges higher.

I think they also have a strong moat @PhilO because hospitals in particular and radiology specifically in PME's case are slow to embrace change - they will generally stick with what they've got already unless (a) the new alternative is streets ahead and offers real tangible benefits which might include significant time savings, or (b) everyone else in the industry is changing and they don't want to be left behind.

So ProMedicus was started and developed by radiologists who know their stuff and they are clearly the best at what they do in terms of radiology software - storing, sending, receiving and analysing images electronically, and it took a while to break through but once they started making sales into major hospitals there was a snowball effect. The moat is the industry being loath to change, and therefore a potential competitor has to have an offering that is not just a little bit better than what ProMedicus do, it has to be HEAPS better before it would even get considered.

And you've hit the nail on the head in terms of PME's annual fees being such a small fraction of their clients' overall annual opex, so PME can push through price increases without much risk of causing churn. In simple terms, they can charge what they like because once their software is in use, it is very unlikely to ever get replaced.

So, yeah, you're honing in on the competitive advantages that PME have, and it's all about the quality of what they offer, the massive advantages their software has over what was in use in that industry previously, and their clients being price-insensitive (not particularly worried about the cost) as well as loath to change to an alternative provider.

The reasons why they are loath to change is really about risk management - nobody wants to be the first to change and risk having their systems fail or not work as designed and that possible system failure potentially cause legal liability issues if patients' outcomes are adversely affected - so there has to either be a massive incentive (which is usally better outcomes and time saving) or else they will change because they see the market leaders changing and they don't want to be left behind in terms of using state-of-the-art tech. It's always way less scary to follow after others when they have proven it's safe to go there.

Anyway, that's my high-level view of why they can charge so much in terms of massive gross margins, even compared to other SAAS providers, and SAAS itself tends to have high margins anyway because of the basically-fixed cost base where the vast majority of extra sales go straight to the bottom line with providers who are already profitable and have their business structure sorted already. ProMedicus have the advantages of being a SAAS provider, AND servicing an industry where churn is really not going to be an issue as long as they maintain their market leadership. I think all the stars have aligned in PME's case.

Disclosure: I haven't held PME IRL for years having sold out at well under $100 because they looked too expensive (overbought) to me at the time (and ever since), but that was clearly a mistake on my part, eh!! I do hold a small position here in my SM portfolio, but I've trimmed that position all the way up and now only hold 7 PME shares here. I don't tend to dwell on "What if..." scenarios in relation to my past investment (/divestment) decisions, however, in the case of PME... ...let's just say it's difficult not to occasionally do a back of the envelope calc of what those shares would be worth now if I'd kept them all.

Thanks for sharing @Bear77 — all great points about the unique circumstances PME operates in. I completely agree with your take on how entrenched they are once they’re in a hospital and how little incentive there is for clients to change unless the alternative is radically better. The low price sensitivity and risk management angle you raised really do help explain their exceptional margins.

In trying to identify a broad lesson to apply across industries, one I keep landing on with PME and other hugely successful software companies I’ve reflected on is the value of integrations. Companies that quietly plug away at building and cultivating integrations with other systems and software — in industries where those integrations really matter — seem to develop a more durable moat than those relying on simply world changing product innovation. With the right dynamics, the ROI on integrations seems more reliable and defensible than chasing the next flashy product feature.

I remember attending a Xero accounting conference years ago (in their relatively early days of taking accounting to the cloud) and being struck by their obsession with this. The highlight of the four-day event was an award ceremony for the best Xero-based app. The buzz among hundreds of partners made it clear: nobody could realistically touch Xero’s position. Competitors might catch up on product development, but they couldn’t replicate that vast network of collaborations.

I get a similar sense with Wisetech — though, again, it feels like the horse may have bolted there too. And from my own experience, I’ve seen how entrenched systems like Salesforce and HubSpot become. When so much is tied into them — from Facebook and Google campaigns, to phone and sms software to internal reporting — companies stick with them even when a better option exists.

Inversely I also wonder how much a lack of focus on collaborations may explain the poor performance of companies that seem to be otherwise well positioned from an industry and capability standpoint - haven’t looked at them for a while but Alcidion comes to mind in heath tech space.

Anyway, it’s not something I see talked about often, but it’s a lens I’ll be giving more weight to when looking for future compounders. A useful exercise for me will be assessing how integration-focused the younger tech companies on my watchlist are — for example, Audinate or Catapult — where the horse may not have bolted (as much) just yet.

Totally agree @PhilO - I'm a big gardener and tend to think in gardening analogies.

To me, PME, WTC, XRO, etc are like couch grass - not all that impressive growth on top, scrappy looking and not showy, but the tendrils reach everywhere, and they are bloody difficult to rip out.

In contrast, other companies are more like dock or nettle - abundant growth on top, but they have a single albeit deeper-reaching tap root. Despite the depth of root, they are relatively easy to pull out.

If I want weeds that are easy to rip out and discard, I know which I'd rather. But for long term growth, the "metastasizing" weeds always win.

Moral of this weed-based story: For long-term growth, it's the spreading roots that count.

Great analogy @Clio. The more I think about it the better it gets.

@Clio In trying to pay my rates lately on my council website I came across this page and noticed the Technology One mark below the “about” button. Maybe the worst payment page I’ve seen. And I remember them touting that they’ve never lost a customer. I’m thinking it’s their deep roots.

TNE have lost at least one customer @PhilO - Brisbane City Council who had a protracted dispute with TechnologyOne over a cancelled $122 million contract to replace 13 legacy systems with a single platform, which led to mutual lawsuits for $50 million in damages. The dispute ended in a confidential settlement in December 2017, where both parties resolved their differences on a "without fault" basis. The disagreement stemmed from significant project delays and cost overruns, with the council blaming TechnologyOne for breaches and TechnologyOne blaming the council for scope creep and poor governance. Because the council cancelled the contract, that counts as a lost customer.

Interesting! Kind of shows these companies that compound over the decades are not always the way we imagine them from the outside.

@Clio Reflecting on this conversation as I watch the WTC share price tank. Wondering if this is finally my chance to finally get me some of those metastasizing weeds.

Macquarie University also uses TNE for their student management system. It's not that intuitive to use with lots of digging through menus but gets the job done. I've not tried the mobile version.