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A construction tollbooth
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I love how Procore describes itself – “we build software for the people that build the world.” The company is a leading software provider for the construction industry.
Its simple dashboard allows developers, contractors, subcontractors, engineers, and architects to bid on and streamline projects. The company, unlike its biggest competitor, Autodesk, focuses solely on the construction management space.
In 2002, the founder, Craig “Tooey” Courtemanch, was working in Silicon Valley but his wife wanted to move to Santa Barbara. They ended up making the move and renovating a house. Fed up with how frustrating the whole process was, Tooey created a software prototype to enable his contractor to work more efficiently with subcontractors, while simultaneously allowing himself to monitor the progress.
Now, the company boasts 15,000 customers and nearly $800 million in revenue, still growing 30%+. Procore’s business model is a bit unique since they don’t charge based on the number of users but rather a combination of the number of modules used by customers and the overall revenue from the job. After talking to some users, my understanding is that this typically falls in the 0.1-1.0% range of revenue, not profit, from the contractor’s point of view. So when contractors bid on a proposal, there is typically a line item for Procore that they may have to include in their final price.
Before getting too deep, it might be worthwhile to understand the different parties that are involved in the process of a large scale construction process. Let’s start with residential, since it’s a little bit simpler. Someone buys a home and decides they want to tear it down to create something bigger and better. So they hire a general contractor (GC) who has his/her own people but it’s more likely he/she will subcontract specific jobs out to a plumber, a framer, an electrician, an HVAC specialist, etc. The GC acts as a middleman to make the homeowner’s life easier since they don’t have to spend a bunch of time vetting all of the different subspecialities. It’s much more efficient to just hire a GC to do the main task of coordination between all the parties. When it comes to a large commercial development, it’s not a homeowner but rather a developer who initiates the construction process. This developer might be an institution or an individual that purchased a raw piece of land but is looking to build a giant apartment complex, a skyscraper, a stadium, a hospital or whatever else you can imagine.
So the developer will create a budget and make ROI projections based on his purchase of the land. Usually, unless it’s a big institution that has an internal team, the developer will put out an ITB, or an invitation to bid. Contractors will submit bids based on what they think it will cost and how long it will take to build what the developer is looking for. Then, one contractor will win the bidding process and start hiring subcontractors to actually build the project; that is, of course, unless the GC has his own people. And sometimes the lines are blurry between all of the parties and there is substantial overlap. A sophisticated developer may actually be a GC as well and hire out the specialties. It’s all about division of labor. Usually, it’s not worth the developer’s time to actually manage the project, especially if they have a few projects running concurrently. Another name for a GC might be a builder. The developer buys the land, or an old building, and initiates the process. The GC/builder manages the building itself. And then the subcontractors specialize in certain areas of the building. Ok, I think I’ve belabored the differentiations by now!
Procore is usually purchased by the GC who uses it as a portal to submit proposals, manage subcontractors, communicate with the developer, send invoices, and many more modules that make his life easier. Getting back to the revenue model, it’s fairly similar to Snowflake where customers actually can pre-commit to a certain amount of spend based on their pipeline of projects. If a project falls through, however, they can dial down the contract. Procore charges based on the number of modules used and the total construction volume that is flowing through the GC’s business. What typically happens is that when a Procore customer signs up, the rep will ask them how much business the GC will do over the next several years. The more business, the bigger the discount. A GC can underestimate the volume but then they will get hit with a higher price if they end up doing a lot of volume. Conversely, a GC can overestimate the amount of expected volume but then hit a snag and be left with a huge Procore bill. Procore can choose to negotiate this sort of thing to keep the client as long-term thinking but usually the contract doesn’t include refunds in that case. So there is a tricky balance upfront for the GC when deciding how much to pre-commit between going for a large discount or being left with a sizable bill if projects don’t pan out. That’s why Procore wants to sign customers to a multi-year deal because projects get delayed all the time. If a deal gets pushed to another year, in a multi-year deal, it’s no problem and the contractual obligation can also get pushed.
Procore has no limits on users so there is a decent network effect here as well. Further, once GCs and subs (subcontractors) get the hang of the system, there is a reasonable switching cost to porting all of your projects and work into a new program. Because of this, gross retention has been around 95% for the past several years.
Management says their total TAM is global construction volume which is $3.5 trillion. However, management also says they have 14% of that global volume and 25% of all GCs are already using the company’s system. If we divide the company’s $800 million in revenue by 14% of $3.5 trillion in volume, that’s about 16 bps. So, on average, that’s what Procore charges. However, it’s quite a tiered system – a small GC without much pre-commitment can easily run in the 1% of revenue range. Other, billion dollar developers, pay considerably less than 10 bps. So it definitely runs the gamut. One reason why customers can be hesitant to sign-on is because of the revenue model. While there are so many more moving pieces of a hundred million dollar project compared to a million dollar development, Procore is likely not adding 100x more value. So that’s why the company has big discounts for big volumes but that conversation and settling on the right commitment levels is probably the biggest friction in the sales process.
This is one main reason why the company spends about 55% of revenue on sales and marketing. It certainly takes more than a few steak dinners to convince a huge construction company to sign-on and spend $10 million a year on Procore. About 10% of the company’s 15,000 customers spend over $100,000 per year which means that over 1,500 customers likely do more than $60 million in annual volume (100,000/0.0016).
With this business model, investors can reasonably worry about a slowdown in construction. In Q1 2023, the company even saw some conservative customers with smaller pre-commitments. Management also noted that if business does pick up for those customers, it will be a bit of a tailwind since the take-rate will be higher (since the discount will be smaller). The majority of customers are on multi-year plans but if there is an extended break in construction, Procore will definitely be affected. We saw this a little during COVID when revenue growth dropped year-over-year from 52% to 23% in Q1 2021 to Q1 2022.
Management also noted that office building construction, while it has clearly slowed down, only makes up 5% of commercial projects. This seems low but apartments, hospitals, stadiums, schools, government buildings, hotels and transportation certainly do account for a large swath of commercial. A lot of good businesses out there are toll booths on some form of economic activity, like Visa/Mastercard on global cashless consumption. Procore seems to have that same benefit, as a tax of sorts on global construction. The software makes projects run more efficiently, with a clear value proposition. And the revenue model definitely aligns the company to capture value as well. Those are the two important inputs to a strong business model and I’d say the company scores pretty well along these dimensions. Procore is about breakeven on a free cash flow basis but GAAP margins are pretty low because stock-based comp makes up over 20% of revenue and there is over $500 million goodwill that is amortizing as the company has done 6 decent-sized acquisitions over the past 5-ish years.
The fact that Procore is the clear mindshare leader in the construction space and considering how much of the industry still uses Excel and email, there is still quite a sizable runway ahead. As the company’s brand, network effects, and switching costs do its thing, I wouldn’t be surprised to see the company maintain 15-20%+ growth for a while. We’ve yet to really see operating leverage in the business but I wouldn’t be surprised if the company does have some latent profit potential since gross churn is so low and the value proposition is clear for GCs. Procore is an interesting business that I’ll be keeping a close eye on.
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