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

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.