Why It’s So Hard for Salesforce.com to Make a Profit

Salesforce.com's marketing expenses currently account for half of its sales revenue, which is unusually high for its industry, and makes it very hard for the company to turn a profit. Its revenue growth,however, remains the highest in its industry, and its investors have been willing to overlook its lack of profits so long as the company continues to grow its topline admirably.

Mar 4, 2014 at 11:00PM

Salesforce.com (NYSE:CRM) CEO Marc Benioff and Amazon's (NASDAQ:AMZN) chief executive Jeff Bezos have one big thing in common: Both have perfected the art of unflinchingly telling investors that their No. 1 priority is growing their companies' top-lines, and that margins and profits don't matter much for them. For the last ten quarters or so, Salesforce.com has returned a net loss, and the last quarter was not any different. The social enterprise Software-as-a-Service, or SaaS, provider recorded a $116.6 million net loss, close to six times the previous year's comparable quarter loss.

Salesforce.com's CRM systems are considered higher-end, perhaps on an equal footing with Oracle's (NYSE:ORCL) or SAP's (NYSE:SAP), while Microsoft's (NASDAQ:MSFT) are considered mid-range. SAP is a better comparison for Salesforce.com since the two are pure-play enterprise software developers, while Oracle and Microsoft are both into software and hardware businesses.

Interestingly, Salesforce.com investors always seem to give it a get-out-of-jail free pass, and bid up its share price after the latest result.

Source: CRM Data by YCharts

Strong revenue growth
Salesforce.com and Amazon have a few other things in common. Both have very strong revenue growth, accompanied by either razor thin profit margins (Amazon) or negative margins (Salesforce.com). Salesforce.com grew its revenue at more than three times the industry average last year-- 36.5% vs. the industry average of 10.8%.

What excited Salesforce.com investors so much was not its big loss, but the fact that the company raised its revenue guidance for the current quarter by $100 million, the biggest quarterly revenue guidance raise for the company in its history. But the nagging question remains, why can't Salesforce.com sweeten the deal further by growing not just its top, but bottom line too? Its profit margin has remained in the negative territory for close to two years now.

Source:CRM Data by YCharts

The biggest reason why Salesforce.com finds turning a profit so tough is, ironically, the same reason why its top line has been growing so admirably—its sales crew. Salesforce.com spends roughly 50% of its sales and revenues on marketing expenses, with the percentage gradually inching up higher to around 52% last year.

Salesforce.com exhibits diseconomies of scale, with its last sale getting harder than the previous one. Any sales guy will tell you that that's 180 degrees from the way things are supposed to work in the real world.You would think that something that's over-hyped as cloud computing products would be flying off the shelves, but judging from the company's high marketing expenses, it seems that the customer is playing hard to get.
Salesforce.com's marketing and sales expenses also escalated 47% during the quarter compared to the year before, to hit $639.8 million. In contrast, its revenue rose "just" 37%. That's why the loss widened.

Piling up losses can give a company deferred tax assets, including loss carry-forwards, that can help shield its future profits from taxes. Salesforce.com established a $149.1 million reserve for deferred taxes in 2012. That's worrying, because it in effect signaled that the company does not think it's going to become profitable anytime soon.

Peers in comparison
SAP reported results that were in line with earlier guidance. Cloud revenue was up 32% during the quarter (excluding inorganic growth from the acquisition of Hybris), with total revenue for fiscal 2013 growing in triple digits -- 121% -- from $586 million to $1.3 billion.

Microsoft's outwardly flailing demeanor can be quite deceptive--the software giant performed quite well last quarter, powered by strong Xbox One and 360 sales, with the consoles selling 3.5 million and 3.9 million units respectively. The company generated $24.5 billion in revenues from its multiple segments, and $8 billion in profit. Its commercial operations continued to thrive, while its consumer section recorded mixed results. Cloud services shot up 107%, thanks mainly to Office 365.

Oracle has in the last few quarters been disappointing investors with results that fall short of its guidance, or issuing lower guidance than consensus estimates. During the company's second-quarter fiscal 2014 earnings call, Oracle reported that its software division grew 5% and generated $6.9 billion in revenue, with software updates bringing in $4.5 billion, almost half of its overall revenue. The firm's hardware division, including hardware support, grew 2% to $714 million. Overall company revenue came in at $9.3 billion, a 3% year-over-year growth. Non-GAAP net income moved up marginally by 1% to $4.2 billion.

The industry trend, therefore, seems to be strong performance for the cloud computing segment, while the hardware segment is getting mixed results.

Salesforce.com has been growing its top line at an average 35% annual clip over the last five years or so, far above the industry average. It's bottom-line, however, has remained in the red. The company issued revenue growth guidance above 30% during its latest earnings call. Salesforce.com enjoys the same equivocations as Amazon, and its investors don't seem to mind the lack of profits as long as it keeps growing its revenue briskly. Trying to short this stock would be akin to jumping in front of a speeding train.

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Joseph Gacinga has no position in any stocks mentioned. The Motley Fool recommends Amazon.com and Salesforce.com. The Motley Fool owns shares of Amazon.com, Microsoft, and Oracle.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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