In Part 1, I looked at the customer value proposition of Salesforce. And why its proposition in CRM is stronger than your average enterprise SaaS company. This was #2 of my 4-question assessment.
- Is growth and value creation benefiting from a secular trend? Is there a tailwind? How is it changing?
- How strong is the customer value proposition? What is the state of the core engine? How is it changing?
- What are the competitive strengths of the business model?
- Are there external CGT factors that will impact 1-3?
In this Part, I want to focus on question 3. What are the competitive strengths of the business model? My area of research.
First, take a look at how Salesforce management describes itself in its filings.
Note the highlighted parts. You can see a lot of the language I mentioned in Part 1 (personalized, scalable, transform).
I actually think their description of their value proposition is a bit confused. I think my DOB2 and DOB3 explanation in Part 1 is a lot simpler.
But the competitive description is much worse. They describe their competitive situation as:
- Evolving (ok. true)
- With lots of technology changes (also true)
- With constant new products (not that frequently)
- With changing customer needs (again, not that frequently)
- Fragmented (nope, not really)
- With low barriers to entry (nope)
The key competitors to keep in mind are:
- Similar enterprise software package vendors. These are the direct rivals, which can be cloud or on premise. Think Microsoft, Oracle, and SAP.
- You can also consider tailored specific software. This is not a full suite or package of services. So, they are less direct rivals of Salesforce. Think Zendesk and NetSuite CRM.
- Platform and cloud companies. Which are increasingly offering off the shelf services and helping customers build their own tools. This is AWS, Azure, and others.
- Internally developed enterprise apps at their customers. This is their primary substitute.
These are the three I think most about. According to 6sense, Salesforce leads with 27% market share. But Microsoft is close at 20% and Oracle is a 10%. But you can also consider:
- Software with a freemium model. This could be a single free product or a suite. It can include software sold with direct salesforce
- Productivity tools and email providers. This can be consumer apps that enter the business software market.
- Other new entrants and horizontal moves.
I like to focus mostly on current rivals (1-3). It’s a profitable oligopoly which is a pretty good indication of strong competitive advantages.
Salesforce Has 4 Old School Software Competitive Strengths
Salesforce has a lot of the stuff I like about old school software businesses. It reminds me of both Microsoft and Adobe in 1995-2010. I see four big competitive strengths:
Strength #1: An Integrated Bundle with Recurring Revenue
I list bundling as a soft advantage and a barrier to entry in digital.
It just turns out you can do bundling far easier in digital goods than in services or physical goods. Microsoft Office and the Adobe creator tool suite are digital bundles. And Netflix is basically a huge bundle of digital goods.
That’s good. But I really like when the digital services integrate. Meaning, they each work better when you have the other services. That doesn’t happen when you bundle shampoo and conditioner. The shampoo isn’t better because you also bought conditioner. But Adobe and Salesforce solutions work better when the data and functionality are all integrated. I really like global, integrated software bundles with recurring revenue.
This is one of the things that eliminates most of the new entrants. And keeps the smaller rivals pretty much non-competitive. A new entrant or a smaller rival don’t need to just replicate one service. They have to replicate the entire bundle, which is much harder.
Strength #2: Switching Costs
This is my favorite competitive advantage. Because unlike economies of scale or network effects, every business can have this. And it turns out that software is really good at creating softer forms of stickiness.
I think about switching costs as a multiple round game. You have to win the first round to get a customer to start using your software. Freemium is a common approach to winning the first round. Customers will try lots of stuff if the basic level of service is free or very low fee.
However, in ERP and CRM enterprise software, you have to get the customer to install your software and integrate it into their workflows. It’s a big decision. There can be a very long sales cycle. You often need a big direct sales force to win this first round. The pricing and competitive ferocity of the first round can be significant.
But then you think about subsequent rounds, where the pricing and staffing requirements can be different. Moving into a storage facility is a pain. You have to hire trucks and lug boxes. Storage facilities will often give big discounts in the first 3-6 months. But then they re-price after six months when they aren’t really competing against anyone. It’s mostly about your willingness to move out.
It’s even more powerful for ERP and CRM systems. Once you’re in a company, it is effectively a monopoly against rival products. The difficulty of removing and switching is very high. The biggest factor is not a rival, it’s open source and internally developed solutions at the customer.
A Checklist for Switching Costs
My standard breakdown of switching costs is here. Hamilton Helmer has a pretty good list of switching costs in his book 7 Powers. His list is below and combined with my own:
Financial Switching Costs
These are direct monetary costs for switching. Such as buying a new ERP system vs. paying the renewal fee. These financial costs can apply to both the core product and purchased complements. They can include:
- Contractual Commitments. Are there compensatory damages? For example, breaking a lease for an apartment rental.
- Durable Purchases. Switching can mean buying another piece of durable equipment, such as a big copier. However, the cost of replacing IT equipment tends to decline as the durable equipment ages.
- Specialized Suppliers. The cost of a new supplier may rise over time if capabilities are hard to find or maintain.
Procedural Switching Costs
This is an indirect cost. Such as being unfamiliar with a new product or service. Such as retraining costs. A new service may require changes in routines across the organization. There is also the difficulty of existing operational integration. The high connectivity of digital tools can make this especially difficult.
- Brand Specific Training. The costs of learning a new system can include direct costs and lost productivity. These tend to rise over time.
- Information and Databases. The cost of converting data to a new format tends to rise over time as the collection grows.
- Operational and Digital Integration. This includes customization.
- Loyalty Programs and Accumulated Value. This is any lost accumulated benefits from current suppliers. Plus, the need to rebuild cumulative use.
Relational Switching Costs
B2B businesses can be a lot about personal relationships. You work with the same suppliers over time. You are all in the same industry. Your career paths keep intersecting. These types of professional relationships can be long-standing. And in some cases, can be important in your career. There is a reason McKinsey & Co gets repeat business from the same clients year after year. This is part of the reason people stay with their physicians for decades. Whether B2B or B2C, people are only rational cost-benefit calculators to a point. Breaking relationships can be difficult. There is a familiarity, ease of communication, and mutual positive feelings.
Customers can also have affection for products and services. People really like their iPhones. People love their Teslas. A product can become part of one’s identity. It can create a community of users. Think the communities around certain video games. Switching a product can mean losing an identity and a community.
Real and Perceived Risk and Uncertainty
As mentioned, switching to another unproven product can sometimes create larger risks for a company or individual. There can be larger problems. The risks of buying cheaper brakes for a truck is far larger than the cost of the brakes. It’s just not worth it to switch, even if the risk and uncertainty are just perceived
Arguably, the greatest digital switching costs are in ERP systems. Once a company has built itself on a software and database platform, it almost never changes. It’s why Oracle and Microsoft are so dominant. Adobe doesn’t really have this. People can switch from Adobe to an alternative much easier. There is retraining but it’s not that hard. Open source and internal development is typically the biggest rival to proprietary ERP systems and databases. Cloud services are emerging as another major one.
For Salesforce, the picture is just really attractive. It’s not an entire ERP system but it is in one of the most important functions (i.e., customer relationships). And, as mentioned in Part 1, trust and criticality are a big part of this. Enterprises will switch their accounting software or HR systems far more readily than their CRM system.
So, it’s pretty great. Switching costs are Salesforce’s biggest gun. They fight like crazy to get installed (they have a huge sales force). And then, once locked in, they do lots of upselling and cross-selling. One of the big numbers to track for Salesforce is their renewal and attrition rates.
A final point on this.
Salesforce is also a SaaS business. And one of the reasons SaaS took off so quickly was because it makes it much easier and cheap to adopt software. You didn’t need a big upfront cost and installation of servers. That is part of how Salesforce broke in against incumbent Siebel.
However, this lowering of the adoption hurdle also means there are lower switching costs. You don’t lose the upfront spending. You don’t have to replicate that upfront spending and installation to switching vendors. As I have said many times, digital tools are really good at wrecking barriers to entry. And this can also impact switching costs.
Strength #3: A Global Direct Sales Force
If the bundling at Salesforce is somewhat like Adobe, their massive global sales force is much more like Microsoft. As of 2023, Salesforce had over 79,390 employees globally. And the sales department is estimated to be 30-40% of the total workforce. This would mean about 30,000 sales employees. When I hear the name “salesforce”, I always think of this sales force of 30,000 people.
And this is about economies of scale. It’s not exactly a fixed cost but sales and marketing is their biggest expense. It is the biggest expense (43% of revenue). This is how they fight to get into companies and win the all-important first round against smaller rivals. And this is the team that then pushes deeper into companies with upselling and cross-selling.
As mentioned, CRM enterprise sales typically have a long sales cycle. These are big commitments and long-term relationships. The CRM systems are always evolving. If it is the product bundle that eliminates the single solution companies, it is the size of the sales force that eliminates similar suites but with smaller scale. This is an economy of scale advantage against similar but smaller rivals.
Strength #4: Economies of Scale in R&D
This is not as important as the first three. But it’s important. Once you’re the market leader in digital or tech-centered business, you use your scale to outspend rivals in R&D.
You can start with operating expenditures. Salesforce spends 16% of revenue on R&D in terms of operating expenses.
Then you look at the maintenance and growth capex that are really about R&D. And you want to look at M&A in the same area.
If you add those, you can get a clear number on what percent of revenue is going into advancing the technology on a steady-state basis. You want an annualized number. And you compare that with rivals.
However, you do want to isolate just the R&D going into the core products. A lot of M&A can be speculative investments, which I don’t include.
That’s level one thinking on R&D economies of scale.
But you also want the R&D spending to be specialized and cumulative – and ideally for a niche market. That’s level 2.
If the money is being spent on servers or warehouses, it’s not that specialized. Lots of companies do that. If it is being spent on brake pad technology for large trucks, that is much better. AWS and Google Cloud have much bigger R&D spending, but they don’t spend as much on specialized CRM tools and services.
It’s even better if the spending is cumulative.
One of the reasons Microsoft and Coca-Cola are so powerful is because their main fixed cost spending (versus rivals) is cumulative. If you’re a small cola, you’re not just competing against Cola-Cola’s marketing spend this year. You are competing with all the spending they have been doing for decades. Every human being has seen Coke ads their entire life.
Similarly, Microsoft is spending tons on R&D this year for their operating system. But this is really for an upgrade of their existing system. Their IP has been accumulating for decades. Some of it does become obsolete but a lot of it does not.
That’s what you want. You want to look at cumulative R&D spending over a 5-10 year time period. Note: Salesforce has lots of existing software and patents.
And finally, you want it to be in a niche market. The weirder the better.
If you are spending lots of R&D developing digital tools for retail, that is ok. But a lot of businesses are doing that. It’s better if you are spending all your R&D on new digital tools for retail for young mothers buying formula and only speak French. This is about outspending rivals and it’s easier to dominate niche markets.
That’s what I look for – R&D spending that is larger, specialized and cumulative – and for a niche market.
Final Question: What About Marathons, Complements and Ecosystems?
Ok. That’s most of what I wanted to cover for Part 2. But there are other potential factors that matter for competitive dynamics.
For example, what digital marathon is Salesforce running?
Salesforce describes its market as:
- With lots of technology changes
- With constant new products
- And with changing customer needs (again, not that frequently)
And in the risk section, they talk about keeping pace with technological development. Which includes continuing to be integrated with existing services.
So, they are running a sustained innovation marathon. That’s the key competitive dimension over time. They need to stay on the frontier. And they need to stay integrated into other enterprise software systems.
But I don’t think it’s a powerful as with Arm Holdings in semiconductors. Or SpaceX in rockets. The core technology of CRM software is not advancing that fast. It’s important and required. But not a huge competitive strength.
What about their complements and ecosystem?
Is Salesforce a product plus an ecosystem? Like ARM and the iPhone? Do they have a robust ecosystem that creates lots of complements? Is it a platform business model? Do they have a network effect?
My answer is “sort of”.
Salesforce is definitely a product plus an ecosystem. But “ecosystem” is a fuzzy term. There are actually several types. I’ll go into this in Part 3.
Ok. That’s it for Part 2.
Cheers from Las Vegas, Jeff
Here’s some pictures from U2 at the Las Vegas Sphere. Which was awesome.
- A Digital Strategy Breakdown of Salesforce. Spoiler: It’s Awesome (1 of 3) (Tech Strategy – Daily Article)
- A Strategy Breakdown of Arm Holdings (1 of 3) (Tech Strategy – Daily Article)
- 3 Digital Concepts Powering ARM Holdings (2 of 4) (Tech Strategy – Daily Article)
From the Concept Library, concepts for this article are:
- Switching Costs: Financial, Procedural, Relational and Risk
- Economies of Scale: Fixed Costs: Specialized, Cumulative and Niche
- Enterprise Software: CRM
From the Company Library, companies for this article are:
- Salesforce Inc
I write, speak and consult about how to win (and not lose) in digital strategy and transformation.
I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.
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