Cowen

  • December 20, 2011
  • The McKinsey Quarterly is pumping out some very useful and interesting and I might even say fascinating material on a variety of subjects.  I am trying to make them a habit and you should too.  My interest here is to share some ideas on growth, corporate growth, economic growth, the stuff that makes economies work.  But first I also have to caution that past is not prologue and I have lately read some influential books such as “The End of Growth” by Richard Heinberg that take the opposite tact.

    Nonetheless, McKinsey is useful in helping us understand the recent past and in helping potentially settle a simmering disagreement that I have with Cowen Research over Salesforce.com’s recent acquisition tactics.  That’s a lot for one post and I am not sure I am up to it but WTF?  No body reads this anyhow.

    Way back in April 2011, McKinsey published “The Granularity of Growth” a report on how companies pursue growth.  They found growth centered in three areas: “portfolio momentum, or the market growth of the segments in a company’s portfolio; M&A; and market share gains. The exercise showed us that companies outperforming their peers on two or three of these drivers grow faster and achieve better returns than those that outperform on just one.”

    The research started in 2007 just before the meltdown and the April report update provides perspective on how companies have fared in the intervening turbulent times.  The most interesting findings involve companies of a certain size, with revenues in the low single digit billions.  Again quoting McKinsey, “companies from emerging markets are outgrowing competitors from developed ones at a startling pace. The third [finding] is that the smallest companies in our database, with revenues of less than $1 billion, are growing by increasing their market share to a much greater extent than larger companies are. For the latter, the role of share gain is marginal or even negative.”

    What interests me in all this is that the company type discussed in the quotes is exactly the kind of company that Salesforce is.  And the tactics that Salesforce has pursued are those described by McKinsey, plus or minus.

    When you compare this with Cowen’s recent critique of Salesforce’s strategy (er, ah, tactics) especially over the last few months—its entire lifetime really—you see that the company has pursued what in retrospect looks like an optimal approach.  True, the approach may not resonate with what the financial analysts believe is optimal but last time I looked very few of those guys were headed for Cooperstown, if you know what I mean.  Moreover, this shows how much the financial community still needs to learn about the subscription before it can make more meaningful contributions to the economic discussion.

    Published: 6 years ago


    I am not a financial analyst and I don’t even play one on TV.  Of course, judging by the last five years’ performance of those in the financial sector I’d say there is a serious dearth of such talent.  Of course, that doesn’t stop the sector from issuing reports and guidance about individual companies.  Heck, it’s their job.

    I ran across a report today from Cowen Research about Salesforce that leaves me with lots of questions.  The report downgrades the stock based on potential future performance, which is fine as far as I am concerned.  No company and no company’s stock stays at the top all the time, that’s a given.  But I don’t understand the logic of the analysis.

    The reasons for the downgrade are several but all stem from what the report sees as “…billings growth slowing faster than expectations.  In 3Q, CRM (Salesforce’s ticker symbol) missed billings expectations.  Mgmt repositioned other bookings related metrics as better metrics, yet is unwilling to provide regular details around these other metrics.”

    I was at Cloudforce New York earlier this month when a financial analyst pointed this out during a press conference in a question for Marc Benioff, CEO of Salesforce.  If you are an industry analyst as opposed to the financial variety, what ensued was about 20 minutes of the most boring back and forth between the analyst and Benioff.  It reminded me of the Monty Python skit about the dead parrot. http://www.youtube.com/watch?v=e6Lq771TVm4

    I am not sure anything material was accomplished other than for Benioff to reiterate his company’s guidance that it would have a run rate north of $3 billion in its next fiscal year.  I am working on memory here but I believe the issue was that the company issues revenue numbers as its primary guidance.  They could, but don’t, focus on gross sales because they are a SaaS company.  If for example, a customer signs a $20 million deal over five years that works out to a million dollars per quarter and that’s what they report on because that’s what’s current revenue.

    So, no matter what the size of the deals Salesforce is signing, they only recognize a fraction of them each month or quarter.  This is effectively leaving money in the bank and the analysts have a problem with that.  This is a part of educating the financial markets about the subscription economy.  Subscriptions are so different from conventional product sales, and their revenues, that some analysts effectively try to put a square peg into a round hole when they are assessing a company.

    Salesforce also recently announced that it will offer enterprise licenses to enable whole enterprises to take advantage of its sprawling product lines and the analysts have problems with that too.  Here in three parts is, in my opinion the most serious and erroneous part of, their analysis.  Let me take them sequentially.

    1) Competition is catching up.  Oracle is defending the enterprise, Microsoft is gaining traction in the mid market, and SugarCRM is gaining ground at the low end.

    This is true.  Everyone has a flavor of cloud computing today.  After more than a decade of having their brains bashed in by Benioff touting the benefits of SaaS and cloud, other vendors have put browser front ends on their products and shipped operations elsewhere (a.k.a. but not really, “The Cloud”).

    But we all know that this minimal move does not accomplish the intent and that real cloud computing is also more sustainable because it makes far better use of storage and compute facilities, sharing gear where it makes sense.  Moving a data center to another location with dedicated servers and spindles is like moving your dirty coal fired powered power plant to another state and calling yourself an environmentalist.

    Other vendors are catching up in CRM but most of them also have ERP customer bases that they are spending considerable effort defending as the industry enters a new replacement round.  Several competitors have also announced social media products and their versions of cloud computing.  Alas, announcement is not delivery but it does raise an important question:  if the market is so crowded why are so many vendors rushing into it?

    2) Massive investments in Sales have over stimulated the market beyond its natural growth rate. Next year normalized sales productivity will decline, making growth even harder absent extremely aggressive investments in sales and marketing at the expense of margin.

    I am not sure what the natural growth rate for CRM is but I believe you can say the same for ERP, except in the once in a decade period when everyone wants to buy the new technology.  The market for enterprise software’s existing solutions is fairly saturated.  Heck, if you’ve looked at the GDP nationally or globally lately, you understand that growth is not exactly on the march anywhere.  That’s why innovation is key.

    3) The company has lost focus. Management’s obsession with the new new thing has distracted it from crisp execution in its core market, SFA. The push behind Collaboration, PaaS and Social Media Monitoring have taken sales into different and unproven categories with different buyers.

    A natural characteristic of markets is that growth slows over time as demand is satisfied.  That is why companies come out with new products and services.  It’s also why market lifecycles graph out as sigmoid curves instead of straight lines.  Given this truth, number 3 above is puzzling.

    Salesforce has done an admirable job of refreshing and extending its product line into uncovered areas of the front office.  The company could have easily built an ERP system and jumped into an already crowded market for back office technology.  But it chose instead to build net new products in markets that are quickly evolving and where there is little organized competition.  This is sometimes referred to as a “blue ocean strategy” after a book by the same name.  The essence of the idea is that a successful company finds unoccupied niches and satisfies the needs of those niches.

    By my analysis, in the software world that means identifying new approaches to business that will help organizations reduce the friction found in all business processes.  Business today is being buffeted by credit and other financial challenges as well as soaring resource costs lead by oil but also including many raw materials especially the so-called rare earth elements that are needed to make modern technology.  You don’t need to be a chemist to understand that rare earth easily translates into expensive.

    So in all that should a company like Salesforce elect to penetrate ERP or decide to penetrate new markets in a blue ocean strategy?  Time’s up.

    The financial analysts see it differently.  According to them Salesforce has lost its lead on the competition and then lost focus by going after new niches.  “Management’s obsession with the new new thing has distracted it from crisp execution in its core market, SFA. The push behind Collaboration, PaaS and Social Media Monitoring have taken sales into different and unproven categories with different buyers.

    If you take this at face value, the only thing for a company to do is the stand still and let the competition devour it.  Many companies have taken just this advice and obligingly gone to hell in a handcart.

    How can you first say, that massive investments in Sales have over stimulated the market beyond its natural growth rate and follow it up with management’s obsession with the new new thing has distracted it from crisp execution in its core market, SFA?

    Finally, there’s this weird nonsequitur: “…we remind investors that the company’s platform was built over a decade ago and is likely in need of a rewrite at some point to take advantage of the latest technologies.”

    Well, not exactly.  The application set was begun more than a decade ago and through its life Benioff has stated that they’ve rewritten the platform.  Salesforce has been rebuilding the platform to expose it to the outside world incorporating other languages (Java, all of Heroku, etc.) and ways of delivering content including websites and to add functionality, especially in the social media realm.  Who else is trying to do this?

    Salesforce is far from a perfect company and it’s right for analysts to be watchful of any company so that they can advise clients on investment decisions.  But I’ve been watching this company for a long time and I don’t understand how some of it’s core strengths can be seen as weaknesses.

    Published: 6 years ago