Business software leader Salesforce.com (NYSE:CRM) reported rather disappointing earnings last week, and after looking over the report, I'm beginning to wonder whether investors are falling for CEO Marc Benioff's marketing tactics hook, line, and sinker.
While the company has a compelling business model providing subscription-based software on demand over the Internet, I wonder if it really generates a sustainable competitive advantage. After all, customer relationship management (CRM) software, which allows companies to better track and manage customer relationships and their associated data, is a pretty competitive marketplace nowadays. Saleforce's first-quarter revenues were $104.7 million, up 63% over last year. However, the company had a net loss of $229,000, versus a profit of $4.2 million last year, due in part to "investing heavily" for market share gains.
Given the rich stock price -- seven times 2007 sales, with a P/E ratio of 118 -- investors are clearly expecting great things from the company for some time to come. I think those investors need a bit of a reality check. While subscription-based software is a revolutionary market niche, if Salesforce.com is to reward investors at this level, it will have to overcome difficult hurdles. And I don't just mean the database giant Oracle, who recently acquired one of the leading CRM providers, Siebel.
The keywords for Salesforce.com's success are "inertia" and "integration."
True, Oracle (NASDAQ:ORCL), Microsoft (NASDAQ:MSFT), and SAP (NYSE:SAP) have been late or MIA to the on-demand software game, but that isn't quite the colossal advantage you might think. While Saleforce's Benioff is a brilliant marketer who seems to regard conference calls as an opportunity to trash the competition, investors should dig deeper than the rhetoric.
For example, SAP has been integrating its very popular back-office business process software with "SAP CRM." For current SAP customers, SAP CRM is only a migration path away, with no need to retrain employees on a new system, re-enter data, or modify current business practices -- all of which can cost hundreds if not thousands of man-hours. By forcing Salesforce.com to integrate its subscription offering with SAP software, the advantage shifts from the disrupter (Salesforce.com) to the incumbent (SAP), since the innovation is no longer disruptive and becomes sustainable. This is why the incumbent Baby Bell phone providers were able to extend their landline dominance to wireless; the wireless providers made the strategic error of integrating their network with the local phone network. By connecting the two networks, the Baby Bells then saw wireless networks as an extension of their own networks, rather than a separate competitive space.
SAP, by virtue of being the back-office operator, has a built-in advantage in its huge customer base, which has made multimillion-dollar commitments in time and resources to install and utilize its software. Salesforce.com will be boxed in as it seeks to grow larger, since one-stop shops like Microsoft and SAP can leverage their existing platforms and inert customers to embrace applications such as on-demand CRM.
Will Salesforce.com succeed in overcoming these trends? Perhaps -- but you wouldn't know it from the stock price. Investors, tread carefully.
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Fool contributor Stephen Ellis does not own shares in any companies mentioned in this article.
