Shares of Salesforce (CRM 0.42%) have notched an incredible rally in 2023, up over 70% year to date as of this writing. Despite the company's slowing growth due to worries about the direction of the global economy, the leading provider of customer relationship management (CRM) software has sharpened its focus on increasing profit margins -- bringing renewed investor optimism. Let's see if that enthusiasm is justified.
Following the introduction of a slew of new AI features across its product portfolio, management's drive for profit has led it to decide it's time to increase prices. The stock market was apparently happy with that choice, but I think it will result in more than a one-time bump for this top AI software stock.
Paying for new AI services on the Salesforce platform
According to Salesforce management, starting in August, the list prices for many products across its Sales, Service, and Marketing Clouds, as well as Industries and Tableau (the data visualization and analytics platform it acquired in 2019), will increase by an average of 9%.
As the company noted, this is its first price hike in seven years. Since the last increase, Salesforce says it "has delivered 22 new [product] releases, thousands of new features -- including recent generative AI innovations -- and invested more than $20 billion in research and development."
About that AI software: This year, Salesforce released a number of product updates, including its AI Cloud service, and Sales GPT and Service GPT. These AI-enhanced features were quickly added by integrating ChatGPT, the generative AI chatbot that can answer queries and solve problems from simple text prompts.
Adding these AI features is one thing, but once customers start using them, they'll need to be paid for in some way. And currently, the computing costs for generative AI are high. Salesforce probably needed to hike prices in part to cover the costs associated with clients' use of these new tools. However, if generative AI provides the massive worker productivity increases it promises, many customers could be more than happy to pay up.
Two more reasons price hikes make sense
There are a couple of other factors that make Salesforce's move look even more savvy.
First, as the cloud software pioneer and its peers have been reporting, many customers are moving more slowly when it comes to signing new or expanded deals right now as they try to manage their expenses more carefully. Widespread fears that the U.S. economy was headed for a recession have been driving the belt-tightening trend, but the economy has thus far proven resilient.
Initiating some list price hikes might give Salesforce's own sales teams added leverage in getting deals across the finish line. After all, list prices are simply that: list prices. Big companies signing large contracts can negotiate better prices on a per-user basis, but Salesforce could indicate to those clients that they may wind up paying more later if they wait too long to commit.
And second, Salesforce itself is also in expense-management mode this year. In the wake of the severe punishment inflicted on the stock during 2022's bear market, a number of activist investors began putting pressure on the company to cut costs and boost profit margins. The effects of those measures are now in force and yielding results, but CEO Marc Benioff has embraced the "do more with less" mindset (apparently in no small part from rubbing elbows with execs over at Oracle). After seven years of keeping prices stable, it was time for Salesforce products to get a bit more costlier to reflect all those new features.
Time to buy?
This price hike will contribute to Salesforce's profitable growth not just this year, but into next year as well. The shares are trading for about 32 times trailing-12-month free cash flow, and just under 23 times next year's expected free cash flow. So this isn't the cheapest stock out there.
However, Salesforce has been exceeding expectations this year with more gradual but nonetheless resilient growth in spite of the complex economic situation. It's also turning the corner toward more robust profitability faster than many expected. If you believe Salesforce can keep up the pace, I believe this stock is still a timely buy for the long term.
