Here’s The Reason Behind Salesforce’s Unabated Growth
Leading customer relationship management (CRM) software vendor Salesforce.com (NYSE:CRM) continued its relentless streak of strong revenue growth in the third quarter of fiscal 2016. (Fiscal years end with January.) [1] We have reflected on the recently reported quarter at length and offer the following analysis. Salesforce’s farsightedness in expanding its portfolio beyond CRM has paid off in a big way. The unabated growth can be attributed to the success of its products even outside the CRM category, which has long been dominated by Salesforce. Until last year, the Sales Cloud accounted for over half of the company’s total revenues. This status quo is now changing rapidly with the Service Cloud outperforming the other divisions by a wide margin. It is set to catch up to the Sales Cloud gradually.
The strong adoption of not just the Service Cloud, but also the Marketing Cloud and new Analytics Cloud, is clear from the consistent double-digit growth rate achieved each of these offerings. Thus, we believe that the primary reason behind the company’s continued success is the it anticipated key growth drivers well ahead of time and expanded its product portfolio to leverage them.
Here is a snapshot of Salesforce’s fiscal 2016 third quarter performance:
- Revenues grew by 24% year on year (27% in constant currency terms) to reach $1.7 billion
- Non-GAAP operating margin improved by 221 basis points year on year to 13.3%
- Non-GAAP diluted EPS was $0.21 compared to $0.14 in the prior year period
- Fiscal 2016 revenue guidance was raised by $25 million, to $6.64 billion to $6.65 billion
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See our complete analysis for Salesforce.com here
A Well-Rounded Product Portfolio
Salesforce has come a long way from being a pure-play CRM company. Its erstwhile exclusive reliance on the Sales Cloud has given way to a well-rounded product portfolio, including the Service Cloud, Marketing Cloud, Apps Cloud and others. A major new growth driver, the Analytics Cloud is already making waves and is set to join the ranks of the above categories once it achieves sufficient scale. The notable point here is that each of these Clouds are pulling their weight and consistently achieving double-digit year on year growth every quarter. This is in contrast to other software majors like Oracle (NYSE:ORCL) and SAP SE (NYSE:SAP), which have one underperforming division or the other pulling down their revenue growth.
Source: Salesforce Annual Investor Day 2015 Presentation
As the above chart depicts, Salesforce expects the Sales Cloud to be a small part of the markets it intends to address. The company is currently banking upon the Wave Analytics Cloud to usher in the next phase of growth. We believe that it is moving in the right direction by integrating the Analytics Cloud across its entire portfolio, which could lead to better discovery and adoption. (Read: The One Theme Underpinning Salesforce’s Dreamforce 2015 and Its Entire Future) Separately, the Service Cloud and the Marketing Cloud have shown no signs of slowing down. Consequently, the trio of Service, Marketing, and Analytics Cloud could well help Salesforce maintain revenue growth of over 20% in the medium term.
The only downside in Salesforce’s current revenue trend is its concentration in North America. Salesforce derives almost three-quarters of its revenue from North America alone. This exposes it to saturation and heavy competition in the market, while missing out on the opportunity in international markets. To be fair, the company is gradually expanding its presence in international markets like Europe. Still, its focus undoubtedly remains in North America. For maintaining its historical pace of growth, Salesforce could do well by stepping up its expansion in Europe and Asia Pacific.
Margin Expansion a Good Sign
In the third quarter, Salesforce’s non-GAAP operating margin improved by a commendable 221 basis points year on year to reach 13.3%. Given that the company’s revenue is no longer growing at the historical rates of over 30%, it is encouraging to note that margin improvement has come into focus. Salesforce is targeting a non-GAAP operating margin of over 30% in the long term. [2] While this appears to be a tall task at the present, the inclusion of margin improvement among the company’s top priorities bodes well for long term performance.
Most of the margin improvement so far can be attributed to the decline in Sales and Marketing expenditure as a percentage of sales. The figure has been on the decline since 2012 and fell to 47.8% in the third quarter. The reduction is because the expansion in sales has outpaced the increase in Sales and Marketing expenditure. Combined with tapering off of the aggressive promotional activity undertaken by Salesforce, the ratio is likely to decline further over the medium term. Additionally, Salesforce’s operational efficiencies program has proved to be quite effective in yielding cost savings, which could help the company further improve its non-GAAP operating margin over the medium term.
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Notes:- Salesforce SEC Filings [↩]
- Salesforce.com Fiscal 2016 Third Quarter Earnings Call Transcript, Seeking Alpha, August 20, 2015 [↩]