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A Wide-Moat Firm That Thrives on Complexity--Page 2

Autodesk has been affected by the economy but should prosper long term.

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Autodesk benefits from the economies of scale inherent to the cost structure of the software industry, with large fixed expenses (mainly research and development) and marginal costs (such as producing an additional copy of software) declining virtually to zero. Moreover, management has honed its ability to successfully identify, acquire, and integrate small companies (usually in the range of $15 million-$50 million). These small firms can provide key technologies that are incorporated into Autodesk's solutions at a marginal cost, as they are spread over a large customer base. We think this acquisition strategy also enables Autodesk to reduce the threat of potential future competitors.

Last, the entry of a new competitor into this niche industry does not represent a significant threat to Autodesk in the near term, in our opinion. Matching Autodesk's technology, scale, and leveraged reseller network of more than 1,700 channel partners--which enables the company to extend its presence to more than 106 countries--would require not only the commitment of a significant financial investment and time, but would also require matching Autodesk's industry expertise and customer relationships that the firm has nurtured over many years. Still, large companies have tried to penetrate into this industry in the past. For instance,  Siemens (SI) acquired UGS (formerly known as Unigraphics), but the results of such acquisitions have so far been negligible within the CAD industry.

Low Threat of Substitution
Clients tend to select and stick to the same CAD solution for the entire development cycle of a given product or project, which lowers the threat of substitution. In addition, the ever-increasing complexity of products and projects, ranging from electronic consumer devices to large infrastructure projects, renders the use of alternative design, simulation, and visualization technologies virtually impractical. In sum, we believe there are no practical substitutes for CAD solutions.

Autodesk's wide range of solutions places the company at an advantage against other CAD providers because its solutions are more likely to cover the different design requirements of multielement projects or entire vertical industries.

Low Bargaining Power of Buyers
Autodesk serves a diverse customer base that ranges from almost 90% of the Fortune 500 companies to single-individual architectural firms. We believe that the highly fragmented nature of the company's customers minimizes their collective bargaining power against the firm. Moreover, Autodesk's prices give the company a competitive advantage over its rivals, in our opinion. Large customers, usually served by the firm's direct salesforce, have a propensity to have heterogeneous CAD environments (certain CAD solutions perform certain tasks better than others do), whereas smaller clients, targeted by the indirect sales channel, tend to standardize on a single platform, typically Autodesk's.

Although  Dassault Systemes (DASTY)--spun-off of Dassault Aviation in 1982 and Autodesk's closest rival--is an instance of backward integration, we believe that this type of threat is lower nowadays because the CAD industry is more mature and the barriers to entry previously discussed are significantly higher.

Additionally, while the indirect sales channel accounts for more than 85% of Autodesk's total revenues and represents a source of competitive advantage, Autodesk often dictates pricing policies and promotions to steer its client base toward the adoption of certain products (such as the current migration from 2-D to 3-D technology), thus leaving its distributors with little leeway to generate a decent profit. Even  Tech Data (TECD), a large IT distributor that accounts for about 12% of Autodesk's revenue, wields little bargaining power against the firm and presents a negligible backward-integration threat, in our view. In general, the software-distribution industry is a cutthroat business marred by poor economics, which in turn, limits its negotiating power. Like many other software companies, squashing casual piracy is an area of opportunity for Autodesk. According to the company's estimates, there are more than 20 million unlicensed users, compared with only 9 million license-paying users.

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Rafael Garcia does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.