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:

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

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

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Comments (27)

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Jul 10, 2018

Solid writeup

Jul 11, 2018

Thank you, I really appreciate it.

    • 1
Jul 10, 2018

Fantastic Read +1

Jul 11, 2018

Thank you very much.

    • 1
Jul 11, 2018

Good stuff, thanks for this.

"We listen, if it feels good we shake."
"This town is nuts, my kind of place."
-WSMFP

Jul 11, 2018

Thank you!

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Most Helpful
Jul 11, 2018

good write up.

what's your background? are you ER? AM? student?

the only comment I'll make is that I'm no expert at shorting but it seems foolhardy to me to short something like this, you have to be right twice: you have to be right that it's going down, and you have to be right soon so that you don't get bled dry waiting for your thesis to come true. while the shorts may be right eventually (all stocks eventually lose 20%+), doesn't mean it will be a good trade. perhaps he's under the assumption (a correct one, I'd point out) that trees can't grow to the sky and the lofty valuations can't persist in perpetuity (you can't grow at 30% per year forever, but since they're a $100bn company and not AMZN, they still could have lots of room to run.

if you're a student and have some time to do more of these, I'd be curious about some turnaround stories: GE, PG, WMT, as well as some other ones of interest: V/MA (how long can these guys go on a tear? I think for a while as the world moves electronic, but I'm biased because I own them), QCOM, AAPL (how valuable should the #1 smartphone company be? can it be $1tn?), and finally: FB (for obvious reasons).

thanks again brah

    • 4
Jul 11, 2018

Re: Qualcomm - I'm not smart enough to evaluate semiconductor manufacturers.

The business is cyclical, ungodly expensive, and if a fabrication cycle is missed shareholders pay through the nose.

Beyond that, there has been something of a renaissance in chip design: CPUs, GPUs, TPUs, FPGAs, ASICs, Quantum... an entire alphabet soup of "new paradigms." How do you predict what producer of which architecture will succeed?

I could spot the Nvidia spike, but only because I was close enough to the gaming, crypto and machine learning communities to see the rapid growth in hype; I have no idea how sustainable their advantage is.

I really think you need to be a device physicist with industry experience to understand where the value will accrue in the hardware chain.

    • 2
Jul 11, 2018

fair enough, that's probably the one I'm least curious about.

good look on dodging my question about your background ;)

if you don't want to answer for anonymity that's fine, I was just curious

keep 'em coming

Jul 15, 2018

IMO, whereas Nvidia has a solid, and I mean SOLID hold on the gaming GPUs market, their grip on the crypto mining market seems to be slipping, especially as ASIC chips are becoming more and more widespread on the mining scene. If you look at some of the newer mining rigs, many of them will utilize ASIC chips in the place of traditional GPUs because, as their name suggests, they are application specific and therefore better optimized for such, making them faster and more power efficient (which is arguably the biggest cost to consider when mining). With that all being said, Nvidia has been solidly expanding their lineup of GPUs and graphical accelerators targetted towards machine and deep learning type uses. If you look at a list of the fastest computers in the world, you'll note that many of them utilize hundreds, if not thousands of Nvidia GPUs, and they are becoming popular even for smaller scaled deep learning tasks. Also, to refer back to my point regarding a solid grasp on the gaming GPU market, the market for gaming GPUs seems to be closely correlated with the release of good/popular PC games, which would obviously drive up the market for GPUs. With the increase in popularity of Twitch streaming and ESports, I think there will be growth here. If you peep their financial reports, you'll see that the primary portion of their revenue is still dominated by the gaming GPU market, so I think that its still fair to keep NVDA in the books for now.

Made ya look

    • 1
Jul 15, 2018

oh wow that was a lot longer than intended, sorry about that.

Regarding above: tl;dr: Due to the growth in popularity of PC gaming, it's more or less safe to say that NVDA will benefit from such, and gaming GPU revenues can be expected to rise. Also, their expansive lineup of data science cards also shows strength in this fast expanding sector. Thus, NVDA can be kept (at least for now).

Made ya look

Jul 11, 2018

Pretty sure based on the last sentence he was positioning this as a Buy.

Jul 11, 2018

I see how that's confusing, I was more addressing his comment on joel greenblatt's short position

Jul 11, 2018

Great post. I've always loved Ellison simply because of the push on the sales and marketing side. Oracle was one of the first companies that came out as having one of the best comp plans for sales people. Mind you, competitive as hell, very cut throat, but it wasn't (possibly still isn't) unheard of to make over $500K-$700K a year as a top performer. The CRM market is weird though. I view it very similarly to Social Media as a general market. We're seeing stuff come through which is pretty amazing with the new sales enablement and integrations between various platforms. I know a lot of organizations that practically utilize a series of sales enablement tools, integrated into existing systems (Microsoft Outlook, etc) and they're just a reliable as using a CRM -- but much more agile.

"It is better to have a friendship based on business, than a business based on friendship." - Rockefeller.

"Live fast, die hard. Leave a good looking body." - Navy SEAL

    • 2
Jul 11, 2018
UTDFinanceGuy:

Great post. I've always loved Ellison simply because of the push on the sales and marketing side. Oracle was one of the first companies that came out as having one of the best comp plans for sales people. Mind you, competitive as hell, very cut throat, but it wasn't (possibly still isn't) unheard of to make over $500K-$700K a year as a top performer. The CRM market is weird though. I view it very similarly to Social Media as a general market. We're seeing stuff come through which is pretty amazing with the new sales enablement and integrations between various platforms. I know a lot of organizations that practically utilize a series of sales enablement tools, integrated into existing systems (Microsoft Outlook, etc) and they're just a reliable as using a CRM -- but much more agile.

Oracle is known for rewarding top sales reps handsomely, however the company is every bit as litigious with troops as it is with the enemy...

Jul 11, 2018

This is a good read. Salesforce is a true tech company, where capitalism resists extinction. Do you just buy the dip whenever you see something like this?

"Loser terrorists" & "bad hombres"

"Typical candidates are those who attended a top-tier academic institution"
-Most job applications

Jul 11, 2018

For whatever reason, whenever another cloud provider misses guidance, the market predicts End of Days and Salesforce stock tanks. That's when I buy.

Workday follows a similar pattern, and they are absolutely crushing the legacy vendors in their space (SAP and Oracle). Long term, WDAY is a strategic acquisition for Salesforce so there's your catastrophe risk protection.

    • 1
Jul 14, 2018

Deleted

Jul 14, 2018

Re: Hubspot - Hubspot is primarily an inbound marketing tool, which integrates with Salesforce; the CRM piece is basically a free add-on.

As far as rip & replace Salesforce... at the bottom end of the market, maybe. But at SFDC's scale, they are beginning to leave the bottom 10% of the market behind anyways.

Software companies do not have to constantly innovate and be better than competitors, if they did Oracle, SAP, and Microsoft would have been out of business 15 years ago.

Salesforce has a ridiculous amount of leverage over customers.

Jul 14, 2018

Salesforce is a piece of shit company with a piece of shit product. The only reason they sell anything is because procurement of that shit in corporate America are by and large morons, and they still can't make money .

    • 3
Jul 15, 2018

Great insight, thanks for sharing.

Jul 14, 2018

I know most of us on here on WSO are in finance or trying to break in, but what do you guys think about the potential for entry level sales at an enterprise b2b company like sales force? (IBM,oracle)?

I've heard the base is around $60k out of undergrad with no ceilings for sales commissions.

Thoughts on this career path as compared to iBanking then PE?

Jul 15, 2018

Very excellent article about Salesforce, and a great overview of the Enterprise Software market as a whole. I was reading about SAP just earlier today, and SAP's CEO, Bill McDermott, predicts that SAP's cloud ERP's revenue growth rate would be in the range of 30%! every year. Do you see this as realistically possible? 30% seems like a lot to me, especially considering how, as far as I can tell, larger companies still favor on-site ERP services as opposed to on the cloud (partially for some of the reasons you have mentioned above, and that they have already expended plenty of capital getting such a system set up, so why leave it when it works just fine). Of course, however, SAP and Salesforce have two pretty different approaches to the market. Whereas Salesforce has roughly stayed within the market of CRM, SAP has flourished in ERP and HCM as well. Clearly, however, remaining within the confines of CRM has worked out just fine for Salesforce as of yet. What is your take on this situation? How do you see SAP' matching up against Salesforce? Thanks in advance.

Made ya look

    • 1
Jul 15, 2018

SAP's cloud specific ERP revenue growth might touch 30% per year, but they are starting from a very small base... SAP was a decade late to the cloud party.

I'm not a big fan of Bill McDermott, and I think Benioff did an amazing job of goading SAP into a war they can't win - https://diginomica.com/2018/04/25/sap-mcdermott-go...

Jul 15, 2018

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Jul 15, 2018