Salesforce's Mergers & Acquisitions Strategy

The reason I chose to write about Salesforce.com is because I always like a good underdog story. Salesforce has always been the scrappy new kid on the enterprise software block. Of course, one way that Salesforce feels like it can increase market share is by buying up young startups that they feel can can add value to users. The problem is that as Salesforce buys up smaller companies, the more it begins to look like Oracle and Microsoft.

What users want from enterprise software is a seamless experience. They want all of their enterprise applications to play nice in the same sandbox. Therefore, the best way for an enterprise software company to scale quickly to provide that seamless experience is to buy up strategically related targets that provide the bidder with additional economies of scope.

In addition to purchasing targets that provide economies of scope, firms like Salesforce can attempt to acquire targets that provide them with a new and different customer base. In its recent purchases of Radian6 and Buddy Media, Salesforce was able to add new customers that would have been difficult to convert otherwise. Switching costs for enterprise software customers is extremely high, as such, once implemented, most customers are hesitant to switch enterprise software services.

So there are two questions that Salesforce has to ask itself when courting a target:

1. Does the target provide a value added experience to Salesforce's current customers?
2. Does the target provide Salesforce with an increased customer base?

In the cases of both the Radian6 and Buddy Media acquisitions, the answer to both of those questions was "Yes".

Salesforce's Strategic Alliances

Below is a list of strategic alliances that Salesforce has engaged in over the past several years.

Twitter - June 13, 2012 - Salesforce and Twitter announced a strategic global alliance to provide Twitter’s Firehose of public Tweets to Salesforce Radian6 customers. This powerful combination allows businesses to analyze the more than 400 million Tweets generated daily to listen, fuel engagement and gain customer insight. This latest effort builds on an existing three-year relationship between the two social pioneers.

Intuit - April 1, 2011 – Intuit Inc. and Salesforce announced a strategic alliance that will make it easier for millions of small businesses to manage customer information alongside their financial data. This collaboration will merge leading CRM and financial management to allow small businesses using QuickBooks to more efficiently manage customer relationships so they can save time and close more deals. As a part of the strategic alliance, Intuit will resell Salesforce CRM with QuickBooks integration that synchronizes customer data with QuickBooks and QuickBooks Online. This application will provide streamlined information to those in sales and management to eliminate data entry in two different systems, showing aggregated customer information alongside probability for closing a deal.

 

VMware - April 27, 2010 - Salesforce and VMware, Inc., the global leader in cloud infrastructure, announced a partnership to jointly deliver, sell and support a new enterprise Java cloud called VMforce™. To be announced at an event today in San Francisco hosted by the Chief Executive Officers of the two companies, VMforce will bring together the technologies, expertise and communities of the two leading cloud computing companies driving the tectonic shifts in the information technology industry. With VMforce, the more than 6 million enterprise Java developers, including the over 2 million developers using the Spring framework backed by the SpringSource division of VMware, will have an open path to cloud computing. Now, CIOs and IT departments will be able to leverage their existing programming skills and investments in Java applications, and take full advantage of the industry-leading Force.com platform to build Cloud 2 enterprise applications that are social and work on any mobile device in real-time. VMforce will dramatically simplify how enterprises and enterprise Java developers can harness the economics of cloud computing without compromising the flexibility, control and choice they require.

BMC Software - November 19, 2009 - BMC Software and Salesforce, announced a strategic alliance to deliver BMC’s industry-leading IT management solutions on the Force.com platform. The initial joint offering addresses the overwhelming customer demand for critical service desk function and processes delivered via the cloud.

Google - June 5, 2007 - Salesforce and Google announced that they have formed a strategic global alliance to help millions of businesses leverage the Internet to achieve success. The newest product resulting from this alliance, Salesforce Group Edition featuring Google AdWords, is a robust offering that combines the power of Salesforce on-demand CRM applications with the Google AdWords™ platform to achieve integrated sales and marketing success. This joint solution provides businesses of all sizes with the same tools used by larger enterprises to successfully attract and retain customers.

Risks of Salesforce's Radian6, Buddy Media Acquisitions

In recent years, Twitter has improved its ad-buying and monitoring interface, providing customers with an improved user experience. The risk for Buddy Media is that Facebook will improve its ad monitoring service and dashboard capabilities, making the need for Buddy Media irrelevant. As mentioned above, one way to mitigate this risk is for Saleforce to integrate Buddy Media into its CRM, providing customers with a method for not only tracking clicks, but providing them with a way to measure ad spending and ROI.

Buddy Media has historically been a money-losing company, losing $3.5M in the first two quarters of 2011 and $20.6M in the first two quarters of 2012, despite increasing revenues by almost 80% period-over-period. From an equity holder perspective, this Salesforce’s investment in Buddy Media is incredibly risky, since the investment represents negative-present-value. 

Assuming that there are agency costs in the form of managerial perquisites tying Salesforce’s corporate performance to managerial compensation, the acquisition is a surprising investment given Buddy Media’s inability to generate profit. In fact, according to Salesforce’s press release announcing its agreement to acquire Buddy Media, the acquisition is expected to lower Salesforce’s non-GAAP EPS by $0.14 or $0.15 in the 2013 fiscal year despite raising revenues by $20M to $25M. According to the same press release, Salesforce “now expects FY13 revenue in the range of approximately $2.990 billion to $3.025 billion, and FY13 non-GAAP EPS in the range of approximately $1.45 to $1.49.“ Therefore, the drop in non-GAAP EPS is estimated to be close to 10%.

Since the announcement on June 4,2012 that Salesforce would be acquiring Buddy Media, Salesforce’s stock price (CRM: NYSE) increase from $131.22 to $169.52 at the close of trade on April 12, 2013; an increase of 29.19%. Since Salesforce was willing to pay $689M for a money-losing firm, it must believe that the economy of scope that the acquisition provides is greater than the purchase price.

From an equity holder’s point of view Salesforce’s acquisition of Buddy Media seems like a risky investment; one that, if presented as a stand-alone investment, most investors would likely pass on. This type of investment presents a possible agency problem for Salesforce’s shareholders, especially since the acquisition is expected to lower the firm’s EPS. Monitoring mechanisms and bonding mechanisms can provide Salesforce’s outside equity holders with assurances that the firm’s management is making decisions in line with its shareholders. Unfortunately, the cost of monitoring and bonding come at a cost to its outside equity holders in the form of residual agency costs. Therefore, any time Salesforce makes an investment in any external acquisitions or major internal investments, there will be subsequent residual agency costs that will increase the cost of capital.

Diversification at Saleforce.com

Salesforce has not been an historically diverse firm. As a dominant-business firm, between 70 percent and 95 percent of its total sales comes directly from its cloud-based CRM platform. However, with its acquisition of Radian6, a social media monitoring platform, in March of 2011 and its subsequent purchase of Buddy Media, a social media marketing platform, in June of 2012, Salesforce has increased its diversification into the advertising industry. The two services were combined under the name of Saleforce Marketing Cloud to provide customers with the world's biggest social media analytics and ad-buying platform.

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Together, these acquisitions signal a strategic shift for Salesforce. In the press release announcing its deal to purchase Buddy Media, Marc Benioff, chairman and CEO, Salesforce.com was quoted as saying that “With CMOs surpassing CIOs in spend on technology within the next five years, our Marketing Cloud leadership will allow us to capitalize on this massive opportunity.”

The "massive opportunity" the Benioff is banking on continued increases in social media advertising spending as estimated in a 2013 BIA/Kelsey study and outlined in the chart below. 

In my next several posts, I will outline the benefits and risks of Salesforce's diversification strategy by examining these acquisitions more closely. 

A More Vertically Integrated Salesforce.com

As mentioned in a previous post, one of the issues that is preventing Salesforce from being more profitable is the fact that Salesforce still runs on Oracle software (presumably some version of MySQL).

If Salesforce can acquire its own database supplier for its cloud software (similar to Oracle's acquisition of MySQL in 2008) or use a free, open source platform, it can end its reliance on one of its biggest competitors. As an October 2012 Wired article pointed out, Salesforce was actively searching for engineers and devs with PostgreSQL experience.

Although PostgreSQL is known for its scalability, it is unknown wether the database can scale to meet the huge data demands of Salesforce.

Besides labor, data storage and data processing are probably the largest costs that Salesforce has.  If Salesforce could build its own data farms to store its data using PostgreSQL's free, open source database, it would achieve a greater level of backward vertical integration.

Because Salesforce distributes its own software, there really isn't much room to vertically integrate in the forward direction. There may be opportunities to purchase some companies that sell custom implementation services, but the company would be better served by focussing on backward vertical integration than forward vertical integration, since there is a greater opportunity for cutting costs.

Collusion & Strategic Alliances

According to Investopedia, collusion is defined as:

A non-competitive agreement between rivals that attempts to disrupt the market's equilibrium. By collaborating with each other, rival firms look to alter the price of a good to their advantage. The parties may collectively choose to restrict the supply of a good, and/or agree to increase its price in order to maximize profits. Groups may also collude by sharing private information, allowing them to benefit from insider knowledge.

There does not appear to be any evidence that Salesforce has been involved in any type of illegal or explicit collusive activity. However since there are so few competitors in the CRM world, it is within the realm of possibility that CRM developers indirectly keep prices artificially high.

Although Salesforce does not appear to have ever been involved in any collusive agreements, the firm has engaged in a number of strategic alliances.

Investopedia defines a strategic alliance as:

An arrangement between two companies that have decided to share resources to undertake a specific, mutually beneficial project. A strategic alliance is less involved and less permanent than a joint venture, in which two companies typically pool resources to create a separate business entity. In a strategic alliance, each company maintains its autonomy while gaining a new opportunity. A strategic alliance could help a company develop a more effective process, expand into a new market or develop an advantage over a competitor, among other possibilities.

Below is a list of just a few strategic alliances that Salesforce has had with other firms:

Twitter - June 13, 2012 - Salesforce.com and Twitter announced a global strategic alliance that provides full access to the Twitter Firehose of public Tweets to Salesforce Radian6 customers. This alliance allows social enterprises to turn the massive volume of social conversations about their products, brand and industry into dynamic engagements that strengthen customer relationships.

Toyota - May 23, 2011 - Salesforce.com and Toyota Motor Corporation announced that they formed a strategic alliance to build “Toyota Friend”, a private social network for Toyota customers and their cars. Toyota Friend will be powered by Salesforce Chatter, a private social network used by businesses, and will be offered, first in Japan, initially with Toyota’s electric vehicles (EV) and plug-in hybrid vehicles (PHV) due in 2012.
Intuit - April 1, 2011 - Intuit Inc. and salesforce.com announced a strategic alliance that will make it easier for millions of small businesses to manage customer information alongside their financial data. This collaboration will merge leading CRM and financial management to allow small businesses using QuickBooks to more efficiently manage customer relationships so they can save time and close more deals.

VMware - April 27, 2010 - VMforce will enable Java developers to instantly tap into Force.com platform services, including the Force.com database, Chatter collaboration, workflow, analytics and search. Part of the industry-leading Force.com cloud platform, VMforce will enable Java developers to quickly and easily build next-generation enterprise Cloud 2 apps that are instantly social, mobile, and collaborative.
Google - June 5, 2007 - Salesforce.com, the market and technology leader in on-demand business services, and Google today announced that they have formed a strategic global alliance to help millions of businesses leverage the Internet to achieve success. The newest product resulting from this alliance, Salesforce Group Edition featuring Google AdWords, is a robust offering that combines the power of Salesforce on-demand CRM applications with the Google AdWords™ platform to achieve integrated sales and marketing success. This joint solution provides businesses of all sizes with the same tools used by larger enterprises to successfully attract and retain customers.

Flexibility & Real Options Analysis

One way in which a firm can attempt to mitigate risk under conditions of uncertainty is to adopt a strategy of flexibility. A flexible strategy provides firms with the ability change course quickly and sharply, should the firm experience unanticipated changes in the competitive landscape. In his book "Gaining & Sustaining Competitive Advantage" Jay B. Barney outlines the following types of flexibility:

TYPE OF FLEXIBILITY	EXAMPLE
The option to defer	An oil company leases land for potential exploration instead of buying it.
The option to grow	A firm builds a plant with the ability to add capacity at low cost
The option to contract	A firm hires contract and temporary employees instead of full-time employees.
The option to shut down and restart	A firm outsources distribution to a firm that distributes the products of many firms instead of outsourcing distribution to a firm that distributes only its production.
The option to abandon	A firm builds a manufacturing plant that employs only general-purpose machinery.
The option to expand	A firm invests to create one product because that investment could lead to the development of other products in the future.

As a tech company with a high level of scalability, Salesforce already has a great deal of inherent flexibility just by the nature of the industry in which it operates. This economy of scale provides Salesforce the option to grow and expand quickly and at very low cost. Tech companies also have the ability to contract, shutdown and restart, and abandon certain aspects of its operations.

Unlike hardware manufacturers, Salesforce does not have to worry about investments in plant and equipment that makes flexibility options more costly to exercise. This position makes it easy for the company to expand and contract quickly when the competitive landscape faces unanticipated changes.