With Salesforce.com due to announce its Q1 results tomorrow, attention is likely to turn once again to the 16-year-old, $50bn company’s continued growth without achieving profitability. It has been an eventful quarter for Salesforce, with rumours of its acquisition (my money is still on Microsoft) and a switch in focus from its core CRM business to analytics in order to drive future growth being the hot topics of conversation. It is the potential of that future growth that some analysts are beginning to call in to question as Salesforce’s own revenue guidance for 2016 indicates that its growth will decline to 20-21% from previous rates of more than 30% per annum. While at the same time big players like Oracle, SAP, and Microsoft are seemingly catching up in the market where Salesforce was originally so disruptive. Nevertheless, these are still admirable growth rates for a company of its size but at what point does it make sense for Salesforce to start turning a profit?
Profitability vs. Growth
Salesforce has followed a path similar to Amazon in consistently sacrificing profits for growth. The company reinvests the profits earned from its rapidly growing business units to encourage growth in other areas and to, at all costs, continue to increase its market share. This is highlighted by the fact that Salesforce spends 50% of its revenue on sales and marketing in comparison to the 20% spent by rivals such as CEO Marc Benioff’s former employer, Oracle. In fundamental accounting terms, the key reason for the existence of a PLC is to create value for its shareholders – a concept which Salesforce clearly understands but has chosen the route of continued growth in the short to medium term in order to deliver long term value (LTV) to its shareholders. So, if you’re an investor looking for short to medium term dividends, Salesforce is probably not your best bet. In fact, it may be precisely the wrong time for Salesforce to start earning a profit.
It may seem counter-intuitive to suggest that a company should avoid earning a profit but there are trade-offs and opportunity costs to every decision and if Salesforce were to decide to cut back its sales and marketing efforts and begin to ride out the LTV of its existing customer base, it might just give its competitors the opportunity they need. Salesforce has been named the world’s most innovative company for good reason – its products are indeed innovative, but by forgoing profits it can also afford to offer competitive pricing and to keep its customers sticky on both sides of the value spectrum. It is also worthy of note that, despite years of exceptional growth, Salesforce’s market share in CRM still stands at roughly 20%, with regions like Asia-Pacific still relatively untapped and Europe still dominated by legacy players like SAP. So why stop growing now?
Striking a balance
In my opinion, this is exactly the wrong time for Salesforce to settle for profitability in favour of growth. The cloud native company is in a unique position to take advantage of the potential in the data analytics market which, according to Gartner, is a top strategic technology trend in the coming years and one in which Salesforce competitors like SAP and Oracle are heavily investing. Salesforce is off to a good start with its Wave Analytics Cloud offering and its advantage in this market may well be that of the vast amounts of structured and unstructured data to be analysed, it is often CRM data that takes precedence – and this kind of data is most definitely in Salesforce’s wheelhouse.
Nevertheless, there must be a plan in place for the company to turn a profit one day and, perhaps more importantly, it must give its shareholders an indication that it will get there at some point in the not too distant future. In fact, its latest results showed a decline in sales and marketing expenditure as percentage of revenue from 53% to 51%, indicating a slight move in the direction of long term profitability. We will watch with interest tomorrow then to see if Salesforce throws another bone or two to its more profit-hungry investors by way of cost-saving initiatives while re-assuring the more long term focused of its plans to expand in to new geographical and product markets. No doubt Satya Nadella and his colleagues in Redmond will be paying close attention too.
by Michael Cullen @michaelcullen87