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Why is Salesforce.com’s S&M Expense so High?

Posted on Tuesday, Apr 15th 2008

And it is finally official that Salesforce.com is integrating Google Apps into its CRM applications to provide the first cloud computing suite for enterprises. Called Salesforce for Google Apps, it leverages the Force.com Platform and Google’s open APIs. Sridhar Vembu, CEO of Adventnet, whose company also competes with both Salesforce.com and Google with productivity suite Zoho, yesterday wrote a scathing review of this move where he challenged Salesforce.com’s financials, particularly its heavy sales and marketing expenditure. Let’s take a look.

Salesforce.com (NYSE: CRM) released its earnings for Q4 and fiscal year 2008 on February 27. Earlier coverage is available here and here. I also did an interview with the then General Manager and Senior Vice President of AppExchange, explaining their platform strategy.

Q4 revenue was $216.9 million, up 50% y-o-y and 13% sequentially. For the full year, revenue was $748.7 million, up 51%. Net income was $18.36 million or $0.16 per share for the full year and $7.4 million or $0.06 per share in Q4.

In the year, it spent a whopping $376 million on sales and marketing, about 50% of its revenue. And it gained 2900 and 11,000 new customers in Q4 and fiscal 2008, respectively. It ended the fiscal year with 41,000 customers. It recently crossed the 1 million subscriber milestone and ended the year with nearly 1.1 million subscribers, up nearly 450,000 y-o-y. And its churn rate was less than 1% of net paying subscribers per month in Q4. Deferred revenue at year-end was $481 million, up 69% y-o-y and 41% q-o-q.

Q4 GAAP gross margin was about 78%, up nearly 1.5 points from Q3 and up 2 points from last year. The mix of revenue between small, medium and large businesses continues to remain at roughly 1/3rd, 1/3rd, 1/3rd.

CRM did well internationally also. In Q4, revenue from Europe grew 70% y-o-y to $38.4 million and Asia grew 85% y-o-y to $20 million. Q4 revenue in the Americas grew 43% y-o-y to $158.5 million.

Based on its performance, Salesforce.com has raised its full year revenue outlook. It now expects fiscal 2009 revenue in the range of $1.030 billion to $1.035 billion. It expects to achieve GAAP EPS of $0.32 to $0.33. For the first quarter, it expects revenue between $233 and $235 million and diluted GAAP EPS between $0.06 and $0.07.

Its stock is trading around $60 after hitting a 52-week high of $66.48 on April 7. Its market cap is around $7.2 billion.

One of the reasons Salesforce.com has an extraordinarily high sales and marketing cost is that it is doing a platform strategy, which costs money to establish. Personally, I have huge respect for Marc Benioff’s pioneering thinking in pushing the envelope on where the SaaS industry goes. I also believe, that this platform strategy creates a great “outsourced” / off-P&L R&D opportunity, such that Salesforce.com would be able to acquire from a rather vast pool of SaaS applications that are built upon its platform and are exceedingly easy to integrate. At the same time, all the risks of market testing are outside of the P&L. They can pick and choose which ones to acquire as and when the applications show traction.

While I have tremendous respect for Sridhar Vembu, I think, in this case, his analysis is missing a major dimension for which Marc Benioff deserves some serious credit.

Chart for Salesforce.com (CRM)

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Sramana,
The customer has to pay for their business model. I believe that the software market (particularly enterprise software market) is ultimately rational, much like the hardware market. Business model taxes cannot be indefinitely extracted.

We spend our money on R&D, and our market reach is starting to rival that of Salesforce. When the downturn arrives, their model is going to be heavily exposed.

Sridhar Vembu

Sridhar Vembu Tuesday, April 15, 2008 at 2:11 PM PT

Sridhar,

You know I am a huge fan of yours. But your market reach is not rivaling Salesforce.com quite yet. I am rooting for you, but as I told you in person, don’t discount sales and marketing entirely 🙂 You will need some of it to go from $40 M to $400 M.

Salesforce.com is going to hit 1 Billion in revenue next year. Very few companies achieve that milestone.

I hope you do.

But they certainly deserve credit for their achievement.

Sramana

Sramana Mitra Tuesday, April 15, 2008 at 3:08 PM PT

Completely agree with Sramana. AppExchange was remarkable breakway in SF’s strategy and they should be appreciated for that.

Sridhar, I would have rooted though for Salesforce tying up with Zoho rather than google for web apps. Pity the former did not work out

Balaji Ganesan Wednesday, April 16, 2008 at 4:06 PM PT

Sramana is full of it. Benioff rails against Microsoft, SAP and Oracle saying they are “dinosaurs” and that their business model based on software licenses is obsolete and inefficient. He has blatantly admitted that his taunting of the big guys is a marketing gimmick to attract attention. Why can’t Vembu blast Salesforce.com in the same way? What kind of hypocrisy allows people to praise Benioff for his behavior but criticize Vembu for doing the same?

Jeff Devault Friday, April 18, 2008 at 7:04 PM PT

Jeff, If you do your homework, you would find out, that the maximum publicity and recognition Vembu has got is because of Sramana. So, as I say in certain other occasions, “Cut this crap!”

Sramana Mitra Friday, April 18, 2008 at 10:17 PM PT

Well get Vembu to send you some flowers or something. Benioff sent this reporter some flowers:
http://blog.penelopetrunk.com/2007/07/02/my-run-in-with-marc-benioff-and-tips-to-be-a-star-performer/

I mean the man oughta throw a party every once in a while and invite you and other tech journalists to it for some free food and booze. I know he is a cheapstake but bribing journalists to write fluff pieces is par for the course if you aspire to be a huckster like Benioff.

Jeff Devault Saturday, April 19, 2008 at 12:32 AM PT

Well Jeff, Read what you wrote above and ask yourself what value you have added in this comment?

Sramana Mitra Saturday, April 19, 2008 at 9:15 AM PT

Sridhar,

What can I say? … you are the man ! You absolutely got this nailed on the head!

Don’t ever do an exit – ever – take the whole project to the pinnacle … don’t let anyone ever buy you out for any amount of money or enticement!

Please build that into your incorporation, charter, constitution, … have it cast in concrete if you have to – that this one company will stay the course of time and have a life longer than Microsoft’s! Even if you decide to give up the helm at some point!

I would love to have my project tied to some synergies that you have … but hey, if its not to be then its not to be!

Jay Swaminarayan and may His Force be with you!

Kirti.

Kirti Patel Saturday, April 19, 2008 at 4:49 PM PT

I think both Mr. Vembu and Salesforce are right on their own. It’s about the vision that Mr. Vembu has for Adventnet. I think both companies have different philosophies.

I agree with Mr. Vembu that in the long run Adventnet will win over it’s competitors.BTW, You don’t always have to spend a lot of money for publicity/sales/marketing. There has to be some innovative ways to get known across the world. Companies have to discover those and I hope Adventnet does that.

Again, there are no straightforward ways to spending money on Sales/Marketing vs. R & D. It has to be a conscious decision based on company startegy and long term goals.

In principle Adventnet is doing the right thing.

Only time will tell ! 🙂

Saswat Praharaj Monday, April 21, 2008 at 3:38 PM PT

[…] que con un alto gasto operativo y con mas del 50% de sus ingresos gastados en publicidad, por mucho ingreso que se tenga debe causar nerviosismo en las filas de Marc Benioff una empresa […]

MDO Tecnología » Blog Archive » Acerca de Sridhar Vembu Sunday, June 22, 2008 at 12:17 AM PT