Salesforce: Customer-First Approach To Digital Transformation
Businesses, small and large, have been impacted by the COVID-19 pandemic. Industries that took the biggest hit include retail, transportation, and travel & leisure given lockdowns, work from home, and a decrease in group gatherings such as sporting events or conferences. Though some companies in the technology and healthcare industries benefitted, not every business in those industries was equipped with the resources to adapt to this rapid change in conducting business. Despite the distinct impact each industry faced, the common denominator was technology, specifically, the need for software and cloud computing capabilities to enable businesses to develop online stores, manage data, communicate with one another and with customers, secure information, streamline operations and better understand their customers during this transformational shift towards digital.
What is Cloud Computing?
Cloud computing is the ability to access IT resources - servers, storage, databases, networking, software, analytics, and intelligence - via the internet. This allows organizations to store, manage and analyze information in a secure and fast way, enabling lower operating costs and economies of scale. The major benefits of the cloud are that it allows companies to run their infrastructure more efficiently and scale globally given that these vendors have the infrastructure in place to support this level of expansion. Moreover, enterprises do not need on-site datacenters, can cut down on electricity expenses, and eliminate the need for IT experts to manage the infrastructure - this is all handled by the cloud vendor and software updates happen automatically. Lastly, the cloud is highly reliable because it supports data backup and disaster recoveries.
Cloud services are broken into three major categories:
Infrastructure as a service (IaaS) is when a company rents IT infrastructure - servers, storage, networks, and operating systems - from a cloud provider (Amazon Web Services, Microsoft Azure) which helps to reduce ongoing expenses, allows companies to innovate quickly and scale at ease
Platform as a service (PaaS) incorporates the IT infrastructure that one gets from IaaS but adds on development tools, analytics/business intelligence (BI) services, and management systems. PaaS helps developers to create web applications with the ability to build, test, deploy, manage and update as they go
Software as a service (SaaS) encompasses both PaaS and IaaS and adds on business applications such as email, calendaring, office tools, and messaging allowing for an organization to conduct business seamlessly over the internet. One of the major benefits of SaaS is that you can scale up or scale down based on what your organization wants to use. SaaS enables companies to “mobilize” themselves quickly which has been instrumental during the pandemic as people want to communicate across multiple devices
The public cloud market has grown substantially in just a few years. In February 2019, the market capitalization was around $690B, increasing to $1T a year later. In February 2021, the public cloud market capitalization has reached an excess of $2.2T driven by the demand for collaboration, customer engagement, and digitization of sales and organizations themselves.
The industry has since faced some macroeconomic headwinds due to potentially rising interest rates and attractive bond yields that have pushed investors towards more “value-oriented” stocks and alternative assets. Nonetheless, the industry is going to benefit from secular trends beyond the work-from-home environment and post-COVID time. One of the largest verticals for cloud vendors is customer relationship management (CRM), which is technology for managing a company’s relationships and interactions with customers and potential customers.
What is Salesforce.com (NYSE: CRM)?
Salesforce is a leading cloud-based software company that provides customer relationship management (CRM) services and a complementary suite of enterprise applications centered around customers including marketing automation, data analytics and visualization, and application development.
Salesforce has created a broad portfolio of products via organic growth and inorganic through a series of acquisitions, which has enabled itself to be a leader in the industry.
Salesforce Services Seven Different Use Cases
Sales Cloud enables sales representatives to manage leads more effectively, monitor pipeline, and automate administrative tasks
Service Cloud allows customer service agents to streamline workflows, juggle multiple cases at once, respond to customers through social platforms and automate route cases to specific agents or virtual chatbots which are automatically turned in transcripts for any dialogue that occurs
Commerce Cloud is powered by Demandware which empowers businesses to create seamless e-commerce experiences by catering to the needs of customers through all channels of communications, delivery, and payment options
Marketing Cloud allows enterprise marketers to create and manage marketing relationships and campaigns with customers. Salesforce provides the capabilities to build personalized email campaigns, aggregate customers’ data, communicate with customers through personalize mobile interactions (SMS, push notifications and chat messaging) and engage with customers across social media platforms
Platform through Salesforce’s Lightning Platform enables companies to build enterprise applications on top of Salesforce’s existing infrastructure through APIs and other software tools. The platform is low-code which allows for users with little technical knowledge to build applications at ease and can leverage AI to create insight-driven apps that are connected to Salesforce data
Integration is powered through Mulesoft, a leading application programming interface (API) or the messenger that takes a request and tells a system what a user wants it to do, then returns the response back to that user. For example, if you wanted to book a flight on Bookings.com and you inputted all your filters, Bookings.com would need to interact with the different airlines’ API systems to display all the possible flights that match your filters, allowing you to have a seamless experience. Mulesoft’s API-led approach allows businesses to integrate and analyze data across different systems, applications, databases and devices
Analytics through Tableau allows users to visualize data and make data-driven decisions to improve business processes and drive more customer engagement
Salesforce is Building Competitive Advantage and TAM Through Acquisitions
The cloud CRM segment is becoming extremely competitive with niche vendors like Segment, Mparticle, Tealium who specialize in customer data management, and legacy vendors like Microsoft, Oracle, SAP who compete across multiple services. Salesforce has acquired multiple companies over these past few years to bolster its portfolio of products and services which has helped to increase its competitive moat.
Acquisition of Slack Technologies for $27.7B (December 2020) allows Salesforce to focus on the digital transformation, adapting to the way customers want to interact with businesses through online and digital channels. This also allows the company to compete closely with Microsoft Teams and through its gradual integration onto the Salesforce ecosystem, may allow Slack to surpass its rival
Acquisition of Vlocity for ~$1.3B (June 2020) provides Salesforce with six industry-specific channels to cross-sell into including communications, media and entertainment, insurance and financial services, health, energy and utilities while leveraging Vlocity’s portfolio of vertical solutions
Acquisition of ClickSoftware for ~$1.4B (October 2019) helps to increase Service Cloud capabilities specifically in automated mobile workforce management and service optimizations solutions for enterprises and small businesses
Acquisition of Tableau for ~$15.7B (August 2019) allows businesses to better understand their customers through data analytics and visualization
Acquisition of MuleSoft for $6.5B (May 2018) enables businesses to easily integrate data across different cloud products and applications
In the last five years, the company has been able to grow its total addressable market (TAM) by nearly 2.5x (as shown below) from $72B in 2016 to $175B by 2025, driven by secular trends like data integration, cloud storage and the digitization of sales and commerce. Major acquisitions including Slack and Mulesoft provide another layer of strength to Salesforce’s ecosystem which enables existing customers to leverage the platform for other business purposes like communications and integration of data across other cloud applications they may use outside of Salesforce.
Salesforce’s Value Proposition
Salesforce is more than a provider of CRM services with an ecosystem of consumers, partners, businesses, consultants, and independent developers who build applications on top of the Salesforce platform. Salesforce’s customer-first approach towards building new products and making acquisitions enables it to be a best-in-class CRM cloud vendor given its ability to adapt quickly to digital transformation.
The Lighting Platform optimizes for developer productivity. Its low-code nature allowing developers to make new applications tailored to their organizations with the ability to integrate easily with other technologies
One-stop-shop for all CRM services (software, hardware, data management, analytics, security, communication, applications) deemed “Customer 360” - the idea that a company can build a complete and accurate picture of every customer by aggregating all each customer’s structured and unstructured data
Salesforce’s AppExchange, an applications marketplace, allows developers and registered partners to utilized those applications (some are free, some are on a subscription-based) tailored to a type, product, or industry which saves them time that they would need to build those applications from scratch. Also, they do not need to invest in development and maintenance costs, as they are often improved and enhanced by their providers
It’s important to note that once an enterprise customer becomes deeply integrated into Salesforce’s ecosystem - multiple departments are utilizing its services, developers are using the platform to create applications, sales representatives have stored all customer data, agents are using chatbots to communicate with customers - it becomes complex and quite costly to switch to another cloud vendor. As a result, Salesforce can provide other value-added services and cross-sell that to existing customers.
Financial Summary
In Fiscal Year 2020, Salesforce generated ~21.3B in Revenue
94% of Salesforce’s revenue came from subscriptions across its four major business segments - Sales Cloud (24%), Service Cloud (25%), Marketing and Commerce Cloud (15%), and Salesforce Platform and Other (30%)
The remaining 6% came from Professional Services such as technical support, infrastructure design, security updates to help customers to receive the full value of the Salesforce platform
Geographic revenue breakdown: Americas (69%), Europe (21%), Asia Pacific (9%)
Gross profit margins remained at historical levels of around ~75%
Two indicators of future revenue visibility are:
Contractual Remaining Performance Obligations (cRPO) represent all future revenue the company has under contract. cRPO increased to ~$36.1B (+17% YoY) which shows the strength in Salesforce’s ability to drive new customers/upgrades by gaining longer-term contracts with them
Total Billings represents any unearned revenue (deferred revenue) that has been invoiced in advance of revenue recognition and will be recognized when services have been provided (in the case of Salesforce, either at the end of each month or year depending on the service level). Total Billings increased to ~$23.2B (+20.8% YoY)
Competitive Landscape
As mentioned earlier, the industry is very competitive. Its core competitors provide packaged business software, integration software, e-commerce solutions, platform development, and other cloud computing capabilities.
Public and Private Competitors Broken By Product/Service:
Sales Cloud (Microsoft Dynamics 365, HubSpot, SAP, Oracle, Zendesk)
Service Cloud (ServiceNow, Zendesk, SAP, Oracle, Workday)
Data Management (Segment, Mparticle, Tealium, Splunk)
Communications Software (Microsoft Teams, Skype, Monday.com, Zoom)
Commerce Cloud (Shopify, BigCommerce, Oracle)
Marketing Cloud (Adobe, Oracle, IBM, HP, Nielsen)
Analytics (Microsoft BI, IBM, Oracle, ThoughtSpot, Sisense, Snowflake)
APIs (AWS, IBM Connect, Microsoft Azure, Oracle)
Valuation Analysis
Below are comparable companies (pulled from S&P’s Capital IQ) to Salesforce broken into two different tiers. The first tier is legacy cloud vendors who have a keen focus on CRM applications and compete across several products and services. The second tier consists of other fast-growing cloud vendors across one or two products who have benefited from the secular changes.
Salesforce is trading at a slight discount on a NTM EV/Sales multiple basis of 7.3x compared to its Tier I peers with an average of 8.7x, but trading at a premium with a NTM EV/FCF multiple of 40.8x versus 28.9x. This can be justified by the company’s competitive gross margins, LTM sales growth of 24%+ (well-above legacy vendors’ average), and track record of growing contractual revenue. Salesforce has >$20B in recurring revenue and is addressing very large markets with a sticky ecosystem that enables enterprise users to better understand their customers as they adapt to the secular shift towards digital transformation. When we look at the Tier II peer set, we can see that Salesforce performed relatively in line in terms of LTM Sales Growth, with the exception of Zoom who experienced unprecedented growth due to the pandemic, which many analysts expect to taper back as people move back to the office. That being said, Salesforce is growing at similar rates to its Tier II peers, while having a market capitalization of 2-3x greater, which is quite impressive.
Downside Analysis
Several investment banks have conducted surveys with existing customers and a comment that was presented a few times was the pricing, which is quite expensive for small and medium enterprises, so more niche vendors may be more attractive. However, for large enterprises that have an international presence, larger operations, and want to scale quickly, Salesforce has a sustainable competitive advantage through its broad portfolio of products and services and ability to streamline all business processes
There will be an increase in competition from traditional infrastructure vendors like Amazon and Google who are slowly moving towards application software to compete across the whole cloud stack and niche vendors who are looking to expand their product offerings
The integration of Slack will initially have a negative impact on margins but should reflect positively in the long-term
Continual headwinds across cloud-enabled and growth companies given ongoing macroeconomic factors and market uncertainties
Upshot and Outlook
Enterprises want a way to better track leads, market their products, understand customer data, use and build business applications tailored to their industry to drive top-line growth and retention. One can argue that the current growth and valuation multiples are “inflated” due to an unprecedented demand for digital services. However, given the stickiness of the cloud and the value proposition of Salesforce and its peers, many enterprises are likely to stick with their vendors post-COVID. We are living in a new world where consumers want to get things done at ease whether it be ordering food, booking a flight, sending/receiving payments and businesses have to adapt to this secular trend. Cloud computing enables these businesses to operate more efficiently and allows them to focus on their core initiatives - serving and understanding their customers.
Salesforce’s customer-first approach to digital transformation will allow it to sustain market leadership in CRM cloud services and continue to grow its ecosystem of empowered enterprises.