Does Salesforce.com Have The Chops To Become A Billion-Dollar Company?

SAP has been talking up Web versions of its CRM software while continuing to make its real money on conventional apps--no harm there, but counter to Benioff's wager that most business software eventually will be used and managed as a Web-based service. "Vell! At SAP, let me tell you, softVARE as service is just one way to deliver softVARE!" Benioff blusters. "It's just a del-i-ver-y met-o-do-lo-gy! Customers vant hosted--and zen zay moove!"

It's an unusual performance for a CEO, but then, Benioff isn't your typical chief executive. He starts an interview by sandbagging a venture capitalist who wouldn't invest in his company and then asked him for a favor--then rewinds my tape recorder over his comments, declaring them post facto "off the record." (They're not.) He's prone to grand pronouncements: Online software isn't just about Salesforce. "This is a movement," he says. "No one will be untouched."

Benioff's right there--software vendors in nearly every vertical and horizontal market segment are exploring the model. They've watched organizations flock to 6-year-old Salesforce in droves--444,000 end-user licenses, by last count--sold on the service's ability to help on-the-road salespeople manage their frantic schedules with a minimum of technical fuss. Once dismissed as only a small-company solution, Salesforce apps are used at Amazon.com, DuPont, Morgan Stanley, Nokia, Sprint, Staples, and Target. The CIO of Merrill Lynch--another customer--is five floors below us as we speak, Benioff says.

"Salesforce attacked complexity," says Jason Maynard, an analyst who follows the company for Credit Suisse. "You didn't have to be beholden to the gods of IT to get your stuff up and running."

Salesforce last week reported that first-quarter revenue grew 63% to $104.7 million, the company's first quarter with more than $100 million in sales. But the company posted a $229,000 net loss as a hiring blitz increased costs. Salesforce added 45,000 new subscribers, down from 48,000 the previous quarter. This year, the company is on pace for $483 million in revenue, which would be 56% higher than in 2005. Revenue growth the previous three years: 76%, 84%, and 88%.

The question is, how far will the software-as-a-service movement reach, not just for Salesforce but for the IT community at large? The practice of running software remotely for customers has been around for more than a decade. But a confluence of widespread wireless connections, low-cost servers, and the ability to host many customers' data on a single set of computers has propelled the concept into big business. A wave of startups tried selling hosted software to companies in the late '90s, but many of those apps weren't tuned for the Web, and outsourcing to unknowns carried a stigma. But the dot-com collapse and wider economic downturn put pressure on CIOs to cut IT costs, which made it difficult for vendors to sell software packages with big up-front costs. Finally, PC users are more accustomed these days to working with Web software--after managing everything from their music collections to retirement funds online, it's not a big leap to continue working that way at the office.

Google, Yahoo, and others are building fast-growing consumer businesses around online-only software, but their money's in selling ads. So far, giants such as Microsoft, Oracle, and SAP haven't had much success selling conventional apps as Web services. And yet Salesforce's growth ambitions depend on companies wanting to access much more than CRM as a service. So one way to answer the question about software as a service's potential is to look at the growth prospects of its champion. Put another way, can Salesforce be a $1 billion-a-year company?

For Benioff, it's all about getting more subscribers. If Salesforce keeps up the pace, Benioff figures the company can reach 1 million subscribers sometime in 2008--enough to double annual revenue to $1 billion. "It really is all about seats," he says. "We have the million-subscriber dream."

Trojan Horse
Central to the strategy is an online marketplace for complementary software called AppExchange, which debuted in January. It includes more than 200 applications, from partners including Adobe Systems, Business Objects, Google, and Skype. AppExchange offers HR, marketing, finance, and other software--mostly from small vendors--that Salesforce doesn't make, and which runs inside Salesforce's user interface.

Every time a customer wants to run one of those apps, it has to buy another end-user license. Salesforce subscriptions start at $65 a month per user, and the company recently introduced an "unlimited edition" license for $195 a month that gives users access to the smorgasbord of AppExchange software. So without much engineering investment--Salesforce spends just 8% of revenue on research and development, compared with nearly 50% on sales and marketing--the company hopes to move more higher-priced software seats into places that may be maxed out on its CRM.

"CRM is our Trojan horse," Benioff says. "That's our whole strategy: more seats at essentially the highest price we can deliver value for." Last month, Salesforce spent $15 million to acquire Sendia, whose technology lets Salesforce work on the BlackBerrys and Palm Treos that road warriors check every three minutes. Putting Salesforce on PDAs could add $10 to $20 to the price of a user license.

Salesforce sees itself as a technology platform upon which companies can build. Benioff knows he needs more business from big customers to reach his goal, and software as a service has been limited in those companies. Letting customers tailor their Salesforce installations with additional features may open the door. "I want to know how to get more seats in General Electric and DuPont," Benioff says. "They want to manage information, and the world has changed in how you manage information."

Where Services Don't Cut It
DuPont, the $26.6 billion-a-year chemical manufacturer, shows the potential and limits of software as a service. More than 500 DuPont salespeople use Salesforce. Still, while CIO Bob Ridout expresses frustration at slow and costly CRM implementations of rivals SAP and Siebel Systems, now owned by Oracle, SAP remains the "backbone" of DuPont IT.

Salesforce has a problem integrating with other apps. That's why Ridout has 10,000 DuPont salespeople, marketers, and engineers using SAP's conventional CRM app, integrated with the vendor's inventory and manufacturing software, to check customer orders against inventory and production schedules. Salesforce's service can't do that today.

Conventional software also is better than online apps for regimented, standardized work, like processing financial transactions and monitoring production quality, since DuPont can customize a package to its process. "Just imagine you were trying to do Sarbanes-Oxley compliance with software as a service," Ridout says.

Still, he says more software will be offered as a service. When DuPont modernizes its 60,000-seat Lotus Notes E-mail system, it will consider Yahoo and Google services, which now host millions of E-mail accounts for consumers, if their scale lets them offer a lower cost. "As we look to the future," Ridout says, "why wouldn't we ride the curve?"

Four Vulnerabilities
For all its strengths, Salesforce looks vulnerable on four counts.

First, sales management software is becoming a commodity--a must-have, but something CIOs aren't willing to pay premiums for, unless it's connected to systems like production and marketing. Startups including NetSuite, RightNow Technologies, and SugarCRM have moved onto Salesforce's turf. Salesforce "is great for managing a sales staff, but not so great for managing a business," says Zach Nelson, CEO of NetSuite, an online accounting software startup funded by Oracle CEO Larry Ellison, Benioff's onetime mentor. "Whoever owns the business data is going to win the battle." NetSuite's customers can populate its sales software with data on orders, invoices, and shipments pulled from Oracle or SAP, providing more information pertaining to a sale, Nelson says.

Second, hosted business applications are becoming more common across software segments, bringing the likes of Microsoft, Oracle, and SAP into more direct competition with Salesforce. SAP this month added marketing capabilities to its hosted CRM offering and says it's developing hosted versions of all its apps. Unlike Salesforce, SAP has lots of experience selling to CIOs and can offer sales systems that tie in data from manufacturing, the supply chain, and other parts of its customers' operations. And it can promise an alternative if a company wants out of hosted software. "Over time, paying the subscription gets more expensive than owning the thing," says SAP VP Graf, who refrains from mocking Benioff. "The current startups are trying to create this big discussion to challenge the big guys by saying everything is going to be on-demand. But this creates price dependency." (See story, Software-As-A-Service Isn't A Big Seller For The Biggest Software Vendors.)

Third, Salesforce has had several recent system outages, including one in December that cut some customers off from their data for about six hours, another in January, and one in April lasting most of a day. Those raise doubts about whether its platform can be trusted for apps more time-sensitive than CRM. As the scale and uptime demands grow, a huge new cost awaits Salesforce's hosting operations.

Fourth, Salesforce must prove it can sustain its current growth pace and keep the customers it lands. The net number of new Salesforce subscribers is slowing. Goldman Sachs analyst Rick Sherlund says the slowdown explains an 18% drop in the price of Salesforce shares since early April. "They've had outages, and it makes you wonder if the churn's increasing," he says.

In Search Of Smart Partners
AppExchange has had a few modest successes. Morgan Stanley bought 400 new seats of Salesforce in February because it wanted to run recruiting software from AppExchange.

But Salesforce has larger ambitions for AppExchange, where it offers software layers for data storage, analysis, security, presentation on the Web, and PDA delivery, all exposed through APIs and development tools that partners say Salesforce has finally gotten right, after a few false starts. All that plumbing can be exploited by other companies' software. Over time, Salesforce wants AppExchange to become a platform for other Internet software to run on.

Getting big consultants on board is also part of Benioff's growth plan. Accenture is developing customized versions of Salesforce for oil and gas, insurance, and pharmaceuticals, specialized markets Salesforce doesn't have the resources to tackle. Benioff says Salesforce won deals at Aon, Chevron, and Kaiser Permanente because of its Accenture partnership. Now he's trying to get Indian outsourcers Tata Consultancy Services and Wipro Technologies to customize Salesforce's apps.

The next step may be for Salesforce to license generic versions of its code, so companies can use it to create Web services for resale. Salesforce is trying out the concept with a small company called Remend, which makes real estate software. Remend licenses Salesforce seats at a reduced rate, then resells them with its customization to real estate brokers. "Marc gives up a little of his brand but is still able to control ongoing development of the platform," says Gordon Ritter, a general partner at Emergence Capital Partners, a VC investor in Salesforce before it went public. "He's meandering through that carefully now." Ritter also holds a large personal stake in Salesforce.

Benioff is coy about quantifying how much money AppExchange is bringing in. Will Salesforce turn technology licensing into a new revenue stream? "That could be, but I'm not making a bet there," he says. How many Salesforce seats are being sold as a result of AppExchange? "It's too new." What percentage of customers have bought Salesforce's pricier unlimited edition? "Almost zero." Will AppExchange lead to acquisitions? "I don't know," he says.

That last question raises Benioff's hackles. And it speaks directly to the larger question of who's going to lead the software-as-service movement in the future. Investors have suggested Salesforce must acquire more companies to expand faster and head off competitors that offer online software beyond CRM. NetSuite is preparing for an initial public offering early next year, says CEO Nelson, and some investors and analysts suggest that Salesforce buy AppExchange partner Intacct, which makes accounting and HR apps, to counter the move.

Acquisitions Required?
Acquisitions could give Salesforce more influence. AppExchange puts new functions a couple of clicks away from Salesforce.com, but it's "still two separate apps with a sheen of integration," says VC Ritter. It's unproven whether that will be enough to help Salesforce crack departments such as accounting and HR without software it owns, develops, and supports.

AppExchange skeptics abound. "Benioff has just admitted there are 130 things this software can't do," says Joshua Greenbaum, principal at Enterprise Applications Consulting. "In the world of CRM, that's a liability, not an asset."

But Benioff nixes the notion that Salesforce must buy new capabilities. "People say to me, 'You're so stupid. You only make a CRM app. You should make Widgetforce, you moron.'" His rendition of the follow-up conversation: "How big is the market for Widgetforce? Well, I don't know, but I bet it's bigger than CRM!"

His strategy centers on more CRM seats. But to get them, Benioff is betting big on customers' desire to hot-rod his product to suit their needs or gain more features. Seen to its conclusion, the plan requires Salesforce to get into the business of development tools and middleware, areas dominated by Microsoft and IBM, two vendors Benioff has managed to avoid while duking it out with SAP and Oracle. Can Salesforce survive having the whole software industry on its tail?

Benioff dismisses Microsoft as "just more software"--full of interdependent products, hidden costs, and IT complications. Whether Salesforce can move into the $1 billion club while holding those demons at bay may be the ultimate test for how much of the market for business technology can move to the Web.