Salesforce.com (CRM) is certainly one of the most remarkable growth stories of the past decade, having grown its business from $50 M in revenue in 2002 to over $1.6 B last year. That’s a 32-fold increase over a span of only eight years, with revenue growth of at least 20% in every single year, achieved almost entirely organically, in a market that ten years ago most analysts would have characterized as fairly mature and consolidated, at least by standards of the software industry. Management’s execution in growing the business has been simply superb.
While I’ve never invested in the company, I did have the opportunity to meet with some members of their management team on a roadshow they were doing to promote the company roughly six years ago. With a seemingly lofty valuation of around 5 or 6x revenues and negligible profitability, my interest in the meeting was more to learn about the growing area of “on demand software”, as it was called at the time. On demand software referred to any hosted software application that customers paid recurring subscription fees to use, and Salesforce.com was roundly viewed as the poster child due to their early successes and loud proclamations of “the end of software.” Considering that the company has grown its share price from $20 at the time to over $148 today — a 7-bagger in six years –passing on making an investment in the company has obviously proven to be a huge mistake. Mea culpa.
The growth in the market for on demand software was very foreseeable at the time, but what wasn’t was who the beneficiary would be. Oracle (ORCL), the dominant market leader in CRM software owing to their acquisition of Siebel Systems just months earlier, was already preparing for the launch of “on demand” versions of their competing products. And so with the 800 pound gorilla of the industry about to enter the fray, a rich valuation didn’t seem particularly deserved for the young upstart.
What was missed by many, your fallible author included, was that Salesforce.com wasn’t on the path to gaining substantial share in the CRM market because of their on demand, subscription-based model. Rather, their successes have largely been due to, well, simply having a superior product. By all accounts Salesforce.com is an unusually strong and cost-effective CRM system that easily bests its competition.
With the current investment fervor for all things “cloud”-related, this is an important point to understand. Investors are now paying very high multiples for just about every software-as-a-service company that goes public, on the expectation that they will go on to disrupt their market in the same manner as Salesforce.com. And, of course, many companies are taking advantage of this mania by now marketing themselves to investors as “cloud” companies, if their product or service in any way makes use of the internet. It’s all rather silly. Every “cloud” company is most certainly not Salesforce.com. And few, if any, will even approach their success.
While the times they are a-changin’, enterprise software is a competitive business with large, entrenched incumbents — many of whom have already shifted large portions of their business into hosted products with subscription-based revenue models. Industry analysts would have you believe that there is an army of new “cloud” companies that are poised to generate double-digit growth for the next decade, just like their forefather, Salesforce.com. I believe that the fullness of time, however, will show that the changes we are witnessing in the software industry today are more evolutionary than revolutionary, and that investors in many — but certainly not all — of these new “cloud” companies will be sorely disappointed as they fail to live up to their much hyped potential.
