Salesforce.com has created a product portfolio that spans the key pillars of customer relationship management delivered in a multitenant, public cloud environment that allows for rapid deployments, instant updates, and lower total cost of ownership for the company’s customers.
We believe enterprises will increasingly turn to cloud computing to eliminate costly IT infrastructure and maintenance costs, creating a long runway for growth in each of Salesforce’s product verticals.
Though the company is best known for its salesforce automation services, Salesforce.com has diversified its revenue stream into three $1 billion-plus clouds (sales, service, and applications) along with a fourth (marketing) that should eclipse that mark in short order. Salesforce.com has solidified its status as a software platform, with more than 75% of the company’s top 200 customers deploying at least four of these clouds. Despite Salesforce.com’s movement into adjacent markets over the past several years (highlighted by acquisitions such as ExactTarget and Demandware), customer and dollar attrition rates have fallen into the single digits, indicating the robustness of the company’s applications. Further, we believe switching costs have room for upside as the company pushes more aggressively into new markets such as analytics and the Internet of Things, though we acknowledge these products are in their relative infancies.
Despite a boatload of success to date and $10 billion in annual sales on the horizon in fiscal 2018, Salesforce.com will continue to feel the heat from the likes of Microsoft (MSFT), Oracle (ORCL), and SAP (SAP) as each races to establish its cloud business. Still, we think Salesforce.com’s SaaS prowess and broadening application portfolio will power the company’s rise in the global software market.
One of the Widest Moats in Software
We assign Salesforce.com a wide economic moat rating. The company’s software lineup has grown from a singular salesforce automation product to a suite of offerings spanning customer relationship management, digital marketing, campaign management, customer service, analytics, and application development, making it the largest pure-play software-as-a-service company in the world by many multiples. We think the combination of the mission-critical applications Salesforce offers, the ubiquity of its products in the enterprise, and increasingly valuable data generated by these applications yields substantial customer switching costs and a network effect that support one of the widest economic moats in software.
Between its sales and service cloud offerings, Salesforce has quickly become the dominant vendor in the customer relationship management vertical. These products include features around lead management, performance tracking, and engagement insights for the salesforce, as well as general customer engagement management in the service cloud. Salesforce.com’s salesforce automation products boast upward of 40% market share, more than tripling that of competitors Microsoft, IBM (IBM), Oracle, and SAP, and the company controls roughly 20% of the broader customer relationship management market overall, which incorporates most of Salesforce.com’s flagship products around sales, marketing, and customer engagement. Given the tenure and strong reputation that Salesforce holds over its larger software contemporaries as a cloud software vendor, we think the company will continue to take share in these verticals.
From the customer’s perspective, the advantages of using Salesforce’s applications are increasingly apparent. By gaining insights into which practices are most effective, enterprise sales teams can close potential customers more efficiently. Further, by layering in customer feedback via Salesforce’s customer service offerings, sales teams can be more proactive when there are issues, diminishing customer attrition. These applications are closely tied to revenue-generating activities within the enterprise, and, when coupled with the necessary integration process, training required to get users up to speed, and customization that occurs around proprietary customer application development leveraging Salesforce’s applications and data, we think each Salesforce product holds substantial switching costs once deployed.
Salesforce has successfully expanded into adjacent markets including marketing and, more recently, analytics, though it has some ground to cover before it can claim a leading position in the latter. The company is an established contender in the digital marketing and campaign management vertical, though it faces some heavy hitters from the likes of Adobe (ADBE), IBM, Oracle, and SAP, and we believe Adobe will hang on to the top spot in this market. Still, we think Salesforce is carving out an advantageous position in this market, and its marketing revenue is growing much faster than for the number-two player, IBM.
As users across the enterprise continue to flock to the Salesforce platform for a bevy of use cases, we think the company has a unique opportunity to position its analytics offerings. The Salesforce applications house valuable data about employee efficiency and customer satisfaction, creating clear use cases for Salesforce Wave. Revenue contributions from this product are negligible relative to the sales, service, and marketing clouds, but we think the company will continue to make inroads into this space.
Salesforce has built a powerful application development platform between Force.com, Heroku, Lightning, and other products, as well as an application store, AppExchange. Enterprise developers can use internal data generated by employees and customers across Salesforce applications and tools from Salesforce to build powerful applications to improve business processes, while independent software vendors can build and sell their own applications on the AppExchange, which boasts nearly 3,000 applications. For example, large-scale applications from the likes of DocuSign, S&P, Sage, and Veeva Systems have been built and run on the Salesforce platform.
Competition and Security Breaches Are Concerns
We still see a fair amount of risk to Salesforce.com’s long-term success, though the company continues to progress into a well-rounded application software vendor. The company’s marketing cloud offering is vying for the number-two spot, as we believe Adobe will maintain its lead in this space, leaving Salesforce.com, IBM, Oracle and SAP in a battle for market share. Further, we could be overestimating the size of Salesforce.com’s addressable market across all of its operating verticals, which could jeopardize management’s long-term goals of reaching $20 billion of revenue and our key valuation assumptions. Larger vendors such as Microsoft, Oracle, and SAP are not going anywhere in terms of pursuing SaaS, platform-as-a-service, and infrastructure-as-a-service revenue, which will keep the heat on Salesforce.com to continue to deliver high-quality applications with virtually flawless reliability.
Security concerns remain central for enterprises when considering cloud vendors, so any disruption or security breach could be catastrophic to Salesforce.com’s operating reputation, which could cost the company customers and revenue.
Acquisitions have been a key strategic initiative to round out existing applications and move into new verticals, and the company does face overpayment risk if it continues to pursue this strategy, if it enters adjacent markets. However, we believe Salesforce.com has been quite prudent in its capital allocation, investing heavily in sales and marketing to support revenue growth that we believe enhances returns on capital. Furthermore, management has often chosen to forgo near-term accounting profitability in favor of higher spending that we believe generates excess shareholder returns.
We retain our positive view of Salesforce.com’s historical capital allocation with respect to its ongoing business, and we are less cautious than we have been previously about the company’s acquisitions. Over the past several years, the company has spent more than $6 billion on acquisitions, using a combination of cash and stock. While some of its initiatives may be delaying profits, we believe the integrated product strategy is likely to make Salesforce.com the most significant provider of cloud products in customer relationship management for the foreseeable future.