Salesforce (CRM 0.42%) announced a round of price hikes this week, its first in seven years, following a slew of product updates focused on artificial intelligence.
Management has justified the move by pointing to its 22 new releases, thousands of new features, and the more than $20 billion invested in research and development since the last round of price increases.
The new pricing is 9% higher on average, and it goes into effect in August. The immediate impact should be a boost to Salesforce's top and bottom lines, but it may also suggest a long-term slowdown in revenue-growth for the company.
Improving profitability
Salesforce management surprised investors at the start of the year by sharing its expectation that the company would exceed its 2026 profitability goal by this year.
It previously said investors should see 25% operating margins by 2026, but it now expects to reach a 27% operating margin this year (fiscal 2024). Keep in mind that's non-GAAP operating margin, which removes certain expense items like stock-based compensation. Still, the profitability guidance was surprising.
Increasing prices is a simple step to improve profitability. There's limited additional expense related to the price hike beyond the product improvements Salesforce was already pursuing.
Moreover, Salesforce benefits from high switching costs, which means most of its customers will simply pay the higher price instead of switching to a competing platform. Businesses invest a lot of time and money in building out their organizations on Salesforce's platform and training their staff on how to use it. For what they might save on a contract with a new platform, it won't be worth the cost of rebuilding and retraining on a new system. That's a big competitive advantage for Salesforce.
As such, investors can expect the price hike to be immediately accretive to Salesforce's bottom line, showing up in its gross and operating margins.
Is this just a short-term fix?
Salesforce is experiencing a significant slowdown in revenue growth, and some analysts suggest the price hike may be seen as a way to pad the numbers for the next couple of years.
Management's fiscal 2024 guidance for 10% year-over-year revenue growth may seem disappointing for a company that's consistently grown much faster. Last year, it produced revenue growth of 18% on top of 25% growth in fiscal 2022.
That level of growth may never return.
First, a significant portion of the elevated growth in recent years stems from acquisitions, but management is moving away from big acquisitions. That will improve Salesforce's GAAP profitability thanks to lower stock-based compensation, but it'll also result in slower revenue growth.
Second, Salesforce has taken considerable market share over the last 20 years. It'll be hard for it to outperform the overall growth of its addressable markets. To that end, management said its total addressable market will grow 13% per year from 2021 through 2025, so investors should expect revenue growth after fiscal 2024 to fall in line with that level of expansion. Expectations of a $50 billion top line by 2026, however, may be too optimistic.
To be sure, the price increases should provide some padding to help ensure Salesforce hits its 2024 outlook. But the long-term growth opportunity remains intact as more enterprises move to cloud solutions.
With shares trading at an enterprise value-to-sales ratio of less than 7, there's still strong upside potential for the stock, especially considering the likelihood that revenue growth accelerates in 2025.
