Installed Base

An Installed Base is the total number of a company's products or systems that are currently in use by customers. Think of it as a company's “footprint” in the real world. For example, the installed base for the Apple iPhone isn't just the number sold this year, but every iPhone that is currently active. This concept is incredibly important for businesses whose products require ongoing purchases, such as services, spare parts, software upgrades, or consumables. A large and loyal installed base is a goldmine, representing a captive audience and a predictable stream of future revenue. For a value investor, it's a powerful indicator of a company's market dominance, customer loyalty, and long-term health.

A company's installed base is far more than a simple sales statistic; it's a strategic asset that can reveal a lot about its business quality and future profitability. Astute investors look beyond a single quarter's sales and dig into the size and health of the installed base.

The most beautiful aspect of a large installed base is its ability to generate high-quality, predictable, and often high-margin recurring revenue. This is the magic behind the famous Razor and Blades Model, where a company sells a durable product (the “razor”) at a low price, sometimes even at a loss, to lock in a customer who will then repeatedly buy high-margin consumables (the “blades”).

• Classic Examples: Think of printer manufacturers selling cheap printers to create a market for expensive ink cartridges, or Keurig selling coffee machines to fuel the demand for K-Cup pods.
• Modern Examples: The principle extends to technology and industrial goods. A video game console's installed base drives sales of games and online subscriptions. For a company like Rolls-Royce Holdings plc, its installed base of aircraft engines generates decades of revenue from maintenance contracts and spare parts.

This steady stream of cash flow is less susceptible to economic downturns, making the company more resilient and easier to value—music to a value investor's ears.

A large installed base often creates a formidable Economic Moat, protecting the company from competitors. The two most common forms are:

• High Switching Costs: Customers are often “locked in” to a product or ecosystem. Once a business has trained its entire staff on a specific software (like Adobe Photoshop or Microsoft Windows), or a factory has been built around a particular type of machinery, the cost, time, and hassle of switching to a competitor are immense. This gives the incumbent company significant pricing power.
• Network Effect: In many industries, the value of a service increases as its installed base grows. Facebook isn't valuable because of its technology, but because everyone else is on it. The same is true for Microsoft's Windows operating system—its value comes from the vast library of compatible software and the number of other users. A massive installed base creates a virtuous cycle that is incredibly difficult for new entrants to break.

A company's existing customers are its best future customers. A large installed base serves as a low-cost platform for launching new products and services. The company has a direct marketing channel to a group of people who are already familiar with and trust its brand. For instance, Apple Inc. masterfully leverages its enormous installed base of iPhones, iPads, and Macs to cross-sell high-margin services like the App Store, Apple Music, and iCloud storage. The cost of acquiring these service customers is minimal compared to acquiring a brand-new customer, making this an incredibly profitable growth engine.

While a large installed base is often a positive sign, investors must look closer to understand its true quality.

When reading a company's annual report or listening to an earnings call, pay attention to management's discussion of these figures:

• Growth Rate: Is the installed base growing, stagnant, or shrinking? A growing base is a sign of a healthy, competitive business. A shrinking base can be a major red flag.
• Churn Rate: What percentage of customers are leaving or discontinuing their use of the product each year? High churn is like trying to fill a leaky bucket; it erodes the value of the installed base.
• Average Revenue Per User (ARPU): How much revenue, on average, is the company generating from each unit in its installed base? More importantly, is this number trending up? An increasing ARPU shows the company is successfully up-selling and cross-selling to its captive audience.

A large installed base is not always an asset. It can sometimes be a liability, representing an anchor to outdated, legacy technology that is expensive to maintain and prevents the company from innovating. For example, many old-school tech companies struggled because their large installed bases of mainframe computers hindered their ability to pivot to the new world of personal computers and cloud computing. The key question an investor must ask is: Is this installed base a platform for the future, or a relic of the past?

For the savvy investor, the installed base is a critical piece of the puzzle. It's a powerful lens through which to view a company's competitive standing, revenue stability, and future growth prospects. By understanding the size, quality, and trajectory of a company's customer footprint, you can gain a much deeper insight into its potential for creating long-term value.