Salesforce: May The Force Be With You

Cloud computing original Salesforce.com has been on a tear since inception:

However Investors have been divided on the stock.

Joel Greenblatt has shorted CRM using traditional value metrics, While Soros disciple Stan Druckenmiller has gone long on promises of growth...

So what’s the story?

If You Understand It, It’s Not Innovation

What the Hell is Cloud Computing? - Larry Ellison

For our purposes, “Cloud Computing” just means accessing software over the internet; your data exists on someone else’s computer. That’s it.

Why is this important?

Because it is a phenomenal business model: no physical product to ship, one set of code to maintain, no hardware compatibility issues, and because of Moore’s law, the software actually gets cheaper to administer over time - witness the 75% gross margin.

If Steve Jobs & Larry Ellison Had a Baby…

It doesn't make sense to hire smart people and then tell them what to do; we hire smart people so they can tell us what to do - Steve Jobs

Salesforce CEO Marc Benioff is a Silicon Valley purebred, growing up in San Mateo and founding his first software company at 15.

He even spent time writing code for the SV godfather himself, Steve Jobs.

Benioff credits Jobs with supplying much of the Salesforce vision, culture, business strategy, and even the idea for an App Exchange.

But there is no one Marc learned more from than Larry Ellison.

Original G

“Most software comes in two flavours: it either doesn’t work or it’s not useful" - Alex Karp, Palantir CEO

For all the talk of innovation in the tech sector, most enterprise software is terrible.

Larry Ellison is not worth $60 billion because his version of the RDBMS is the best - Oracle caught the database wave, developed a product that was good enough, then put the pedal to the metal with aggressive sales and marketing practices.

One of the original Oracle Ads

So aggressive in fact, that Oracle almost went belly up in 1990. (Believe it or not, Oracle had a campaign where reps were literally paid in gold)

In the quest for growth, Larry’s troops mortgaged the future by pressuring customers to sign contracts for software years in advance.

Oracle booked the revenue up front, the sales reps made out like bandits, and when the money never showed up, shareholders sued and Ellison cut 10% of his workforce.

The Pen is Mightier

"The first thing we do, let's kill all the lawyers" - Dick the Butcher

Mr. Ellison atoned for his sins and began to engage in what could be called “legal engineering.”

I’m not sure if anyone here has done business with the big enterprise software companies, but they are every bit as ruthless as the banks. The org chart looks something like this:

They effectively combine complex computer science and verbose legalese to obfuscate customer contracts.

There are very few people with both the IQ & education to truly understand these papers, and most of them are working for the big software providers.

Big tech will discount the up-front payments on their software, knowing that long-term the contract gotchas will more than make up for any short term concessions.

So when it looks like Oracle is going to miss a quarter, a “data audit” is performed and customers are treated to a nasty surprise.

The message looks something like this:

“Hi Mr. Customer,

I hope you’re having an AMAZING day!

We conducted a data audit and found that you are over your transaction limit. Oh no! :(

Based on my math, you owe us 100 million dollars. You've got 3 options:

1. Pay.

2. Don’t pay, we sue, and you’ll spend 200 million over the next 10 years in court.

3. Purchase this new software module for $10 million, effectively locking you into our platform for the next 10 years!

Net 30.

Thanks! :)

CC

A Challenger Appears

The sequel is better than the original

After spending nearly 2 decades as one of Ellison's most trusted lieutenants, Marc broke out on his own and went to work building the next generation silicon valley icon:

• Salesforce now consistently closes 9 figure deals (revenue that recurs annually!)

• The annual Dreamforce shindig is the industries most exciting event

• The company is regularly recognized for innovation

• Employees are fervent true believers, catapulting the company to the top of the best to work for lists

• Benioff is seen as one of the most effective (and likable!) leaders in tech

To get here, Benioff applied the principles of Steve & Larry.

The Student Becomes the Master

Marc is related to Game of Thrones showrunner David Benioff - it shows.

Marc worked with accounting standards boards from the beginning to allow for the deferred recognition of sales commissions, proactively addressing one of the issues that almost destroyed his mentor.

And Jobs’ fingerprints can be seen on both the Salesforce marketing videos and keynote speeches, and (in my opinion anyways) SFDC does it better with a more personal, interactive feel:

Once more: Mr. Benioff combined the cult-like marketing of Jobs with the hardline business tactics of Ellison, and then added a clever twist of his own...

What Dreams are Made of

"There are three ways to make money. You can inherit it. You can marry it. You can steal it." - conventional wisdom in Italy

In the good ol’ days of on-premise software - when the application was actually run on site - your provider could employ data audit pressure tactics, hit you with a lawsuit, and then wait for the case to work its way through court…

But there wasn’t a whole lot they could do to actually stop you from using the application.

The cloud changed everything. Customers were sold a dream...:

• Automatic upgrades
• Subscription model, no more lock-in!
• Less expensive!

...and delivered a nightmare:

• Upgrades can break custom modifications
• Lock-in is actually worse
• Software costs less upfront, but way more over time

But the worst part? Customers have no real control - If you get into a dispute with Salesforce, they simply turn off your software.

Try collecting on accounts receivable when you don’t know the phone number or e-mail address of any clients.

Benioff has even taken things one step further, using Salesforce as his soapbox to - ostensibly (more on this soon) - address larger social issues.

Mr. #MeToo

https://www.youtube.com/watch?v=TdJjqApa3e0
All warfare is based on deception - Sun Tzu

No matter what you think of the ongoing gender battle, one thing is clear: the public can’t get enough.

The CEO as politician narrative is in full effect, and Benioff has been a master of exploiting popular culture. Marc has addressed:

• Women in tech
• Transgender bathrooms legislation
• K-12 Schools
• Philanthropy

There is tremendous value in playing to the crowd, and the cuddly public image, the cozying up to left wing leaders, the 1/1/1 model, the hospital donations... all provide cloud cover (see what I did there?) for the most ruthless monopoly this side of Facebook.

The New New Thing

“Almost all successful companies in Silicon Valley had some model of starting with small markets and expanding.” - Peter Thiel

Please excuse the following acronyms and tech lingo:

Salesforce began as a Software-as-a-Service (SaaS) company, with a sole focus on Customer Relationship Management (CRM).

Over time, Salesforce evolved from this “paradigm” into a Platform-as-a-Service company (PaaS) - essentially acting as an Apple iOS/Microsoft Windows for business applications.

This was a brilliant business decision.

Salesforce is now the operating system for an organization’s every customer interaction, and startups entering adjacent industries are encouraged to build on (and forced to integrate with) Salesforce - witness Veeva Systems, a $10 billion (!) life sciences specific CRM built on the SFDC platform

This widens the Salesforce moat - potential competitors are discouraged from building up small monopolies in related busineses, and then leveraging them to attack Salesforce itself.

Better still, as strategically important applications from different vendors duke it out on the platform, SFDC gets to watch from the sidelines (while getting paid!), and then simply subsumes the best of breed.

Again, a brilliant business decision.

King of the Castle

But all the time, if you’ve got a wonderful castle, there are people out there who are going to try and attack it, and take it away from you. And I want a castle that I can understand, but I want a castle with a moat around it - Warren Buffett

Extending beyond the Salesforce ecosystem, Benioff acquired Mulesoft which was, in my opinion, the most important acquisition made by any enterprise software company in the past decade.

As software continues to “eat the world,” the number of software providers increases in lockstep - the typical enterprise uses applications from over 1000 different software vendors; it’s simply no longer possible to be the single, vertically integrated software solution provider for every business need.

With the Mulesoft acquisition, Salesforce now dictates how software providers "talk" to one another - the strategic advantage this provides cannot be overstated.

Salesforce now controls the flow of information within a company, the equivalent of controlling oxygen within a human being.

Above the Cloud

I think moats are lame… they’re like nice in a sort of quaint, vestigial way. But if your only defense against invading armies is a moat, you will not last long. What matters is the pace of innovation. - Elon Musk

One of the most important competitive advantages Salesforce has is clean, structured data that customers enter themselves.

Benioff has built a dynamite machine learning/artificial intelligence team to take advantage of this phenomenon: whenever a user performs an action on the Salesforce system, Salesforce as a whole gets smarter - customers literally pay to make Salesforce more valuable.

To me, Salesforce looks like a classic Phil Fisher growth stock; it meets all of the criteria laid out in Common Stocks and Uncommon Profits.

Given the price of the stock, I think the most important questions are: can Salesforce continue to grow at a rapid clip for the next 5-10 years, and can management cut costs when growth slows?

CRM as a market is expected to grow to $82 billion by 2025.

Salesforce currently owns 20% of this market - increasing this number steadily year over year - and has been aggressively expanding into other lucrative sectors (customer service, marketing, ecommerce, etc.). Continued growth seems likely.

At ~50% of revenue, the company’s single largest expense is sales and marketing. As I mentioned before, vendor lock-in is tremendous, so sales efforts are really only required for net new business, not maintenance.

Observing Oracles growth trajectory vs. sales and marketing spend, you’ll see the same 50% of revenue cost during rapid growth followed by a rapid decline to a steady 20% when things slowed down. It's highly likely that SFDC will follow a similar trajectory.

If you have a longish time horizon, and can stomach the volatility, I think CRM is a great buy.

Cheers,

CC