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.

Salesforce's Differentiation Strategy

Differentiation relies on a firm achieving competitive advantage by increasing a consumer’s willingness to pay a premium for products and services through the firm’s manipulation of the product's objective properties. What sets Salesforce apart from its competitors are:
Cloud-based Platform - Salesforce works in the cloud as opposed to on-premises software.

• Force.com - A repository of third-party developer apps and modules built for the Salesforce platform 
• Chatter - An enterprise-wide social network for collaboration, which is incredibly popular and even used as a separate product outside of Salesforce's CRM software. 
• Mobile - Because it is cloud-based, it is accessible from any mobile device. 
• Plays well with others - Works well with Microsoft Office, Lotus Notes, and Google Apps. 

Salesforce markets itself as a friendlier, more user-friendly, and scalable alternative to SAP and Microsoft.

Cost Leadership & Economies of Scale

A cost leadership strategy focuses on reducing economic cost to provide a firm with a competitive advantage over its competitors. One of the main forces that provides a firm with a cost advantage is economy of scale. Unfortunately, Salesforce.com, a company that boasts its ability to help its customers achieve economy of scale, has not been able to capitalize on any kind of economy of scale itself. According to an article on YCharts, Salesforce's sales and marketing spending as a percentage of revenue continues to rise year after year. Research and development costs as well as general and administrative costs have all gone up as a percentage of revenue over the past two years, and it should be noted that revenues for Salesforce increased by 74% during the same two-year period.

Below is a comparison of some key statistics taken from Yahoo Finance:

As mentioned in previous posts, once Salesforce can vertically integrate by migrating its software from Oracle's servers to its own servers, it will be able to capitalize on an economy of scale that, until then will be difficult to achieve.

Salesforce: Applying the VRIO Framework

According to the VRIO framework, a firm's competitive potential can be determined by how it answers four questions:

• Value - Do a firm's resources and capabilities enable the firm to respond to environmental threats or opportunities?
• Rarity - How many competing firms already possess particular valuable resources or capabilities?
• Imitability - Do firms without a resource or capability face a cost disadvantage in obtaining it compared to firms that already possess it?
• Organization - Is a firm organized to exploit the full competitive potential of its resources and capabilities?

Let's attempt to answer those questions in regards to Salesforce's capabilities as a cloud-based CRM, since the firm uses that capability to differentiate itself from its competitors.

• Value - Yes. Because Salesforce's software is cloud-based as opposed to software installed on-premises, the software can be updated more frequently to fix bugs and install new features, making it more nimble than competitors like SAP.
• Rarity - No. Although SAP is installed on-premises, there is an increasing number of new entrants that are cloud-based, such as SageCRM and Microsoft Dynamics CRM, which has some web-based services.
• Imitability - No. Salesforce touts that, because it is cloud-based, it scales easily. The reason it scales easily, is because the software is less complicated to engineer than on-premises software.
• Organization - Yes. As mentioned in a previous post, what gives Salesforce a potentially sustainable competitive advantage is its decision to open up the platform for third-party developers to build apps providing additional functionality and customization to the software. 

Because Salesforce's cloud-based CRM is valuable but not rare, one might say that only provides the firm with competitive parity. 

Although the VRIO framework is a decent analytical tool, it is fairly limited since it doesn't take into account environmental changes or managerial influences. It also has a very narrow focus on resources and capabilities and ignores advantages and disadvantages on the firm level.

Salesforce.com vs. Oracle: When a Supplier is a Rival

How crappy would it be, if your biggest supplier was also your biggest rival?  It turns out, the backbone of Salesforce runs on Oracle databases.

Salesforce.com is understandably pretty secretive when it comes to the extent of their dependence on Oracle, but in October of 2012, Wired ran a story about how Salesforce posted several job listings for engineers with experience in PostgresSQL, an open source database platform.  Obviously, Salesforce is feeling the pressure to ween itself from relying upon Oracle as a supplier and is now looking for ways to become more self-sufficient.  

What sets the tech industry apart from most other industries, is its ability to tap open source technology. Because there is so much open source technology available for just about any developer to use, it removes a lot of entry barriers that would otherwise exist. New entrants no longer have to purchase existing technology or engineer their own from scratch. They can simply take open source technology and adapt it to fit their needs.

The rise of the tech industry has no historical precedent, in that the industry is so protective of its democratic roots.  As soon a first-mover emerges and plants its flag firmly in the ground to stake its claim as the leader in a certain area (e.g. Microsoft, IBM, etc.), someone is close behind, ready to push them off the mountain (e.g. Google, Apple, etc.).  In the tech industry, underdog is king, and you have an entire community of hackers and open-source developers supporting his efforts.

Right now, Salesforce is the underdog - the Apple to Oracle's Microsoft (or possibly even Microsoft's Microsoft).  Developers are rallying around Salesforce, and it will be interesting to see if they can neutralize the threat of its biggest supplier/rival and kock him off the mountain.

Threat of Entry

What sets salesforce.com apart from its competitors and other companies is its unique strategy for combatting the threat of new entrants while adding value to its product. In 2006 Salesforce acquired Sendai Corporation, which later became Force.com.

Force.com is a platform that allows developers to build apps for Salesforce. Developers can then sell the apps they they developed on the Force.com platform on Salesforce's AppExchange.

By allowing developers to build and sell apps that provide a more customizable and scalable product, Salesforce is basically crowdsourcing a large portion of its R&D without absorbing much risk. As more developers create and sell more apps, and the platform gains in popularity, the greater the network effect will be. 

Since developers have a revenue stream available through SalesForce's AppExchange, they are less likely to become new entrants. The AppExchange also allows SalesForce the opportunity to acquire top developers. 

I have a feeling that this model for fighting off new entrants will be oft repeated.

Competitive Advantage

In assessing the competitive advantage of salesforce.com (NYSE:CRM), I've decided to compare it to both SAP (NYSE:SAP) and Oracle (NASDAQ:ORCL). SAP and Oracle both provide enterprise software solutions in the software as a service (SaaS) industry. Microsoft's Microsoft Dynamics also competes directly with salesforce.com, SAP, and Oracle, but because Microsoft Dynamics is only a small portion of Microsoft's revenue stream, I decided not to include it in this comparison.

Salesforce.com is the underdog in the enterprise software fight with a market cap of $24.69B, while SAP's market cap is $98.63B and Oracle's is $167.5B. Salesforce.com has been able to grow revenues steadily over the last ten year. And despite the fact that SAP and Oracle outperform salesforce.com in just about every key financial ratio, investors have been extremely bullish on CRM over the 5-year period and 10-year periods.

Below are some of CRM's key financial measures:

Sales	2.85 Bil
Income	-253.68 Mil
Net Profit Margin	-8.91%
Return on Equity	-14.16%
Debt/Equity Ratio	0.25
Revenue/Share	20.47
Earnings/Share	-1.79

You'll also notice that I've added quotes and a comparison chart for CRM, SAP, and ORCL on the right hand side of this page along with top stories about salesforce.com.