We continue to grow, and the previous piece was well received. A good part of our growth has come from a kind mention on Twitter by my good friend, Rahul Mathur. Given how well maintained his newsletter is, it’s definitely an indication that we’re headed in the right direction. And it’s actually surreal for us to see how many new users visited us despite being inactive over the past couple of months.
A quick personal update
Since the last post, I’ve been involved with a couple of active angels in India. We look at and evaluate startup investment opportunities together. The engagement keeps me on my toes and is something you can attribute my AWOL to. As I successfully begin to reign in the moving pieces at my end, I look forward to sharing my evolved perspectives with y’all.
With all that out of the way, let’s get to today’s post.
Tech and the💰
Last fortnight, Salesforce (a cloud-based software company) just got Slack (an enterprise communication platform) for itself for a good $27.7B making it one of the largest acquisitions in software companies' history.
To put numbers in perspective, that’s more than what Microsoft paid for LinkedIn in 2016. It’s also more than what Facebook paid for Instagram and WhatsApp combined. It’s also ~87% bigger than Salesforce’s previous largest acquisition, the $14.8B purchase of Tableau in the summer of 2019.
Naturally, it all raises a bunch of new questions about who brings what to the table. There is no dearth of racehorse commentary about the tactical and competitive reasons for the deal either.
“Was it a bailout for Slack after having missed the growth bus Zoom rode in the pandemic? Is this offense or defense for Salesforce in a market where Microsoft remains the numero uno player by far?”
While I cannot promise any easy answers on this one, I’ll surely leave you with a toolkit synthesized from a scratchpad of observations to arrive at your own conclusion.
📝 The acquisition thesis for Slack
Before delving into the thesis, it’s important to look at some data and anchor ourselves around that. As I write this, Slack trades at $42.61 at an Enterprise Value (EV) of $24.56B. At ~87%, its gross margins are the highest of any of the 54 companies tracked in the BVP Nasdaq Emerging Cloud Index. It’s also the 8th fastest growing company in the index that has outperformed the Nasdaq by nearly 3x YTD.
Slack is loved by startups and enterprises alike. 65 of the 100 private companies by valuation according to CB Insights use Slack, including 8 of the top 10. And some of the largest enterprises love it too, including, but not limited to, the likes of Walmart, Apple, Amazon, Twitter, and Goldman Sachs. And it is little wonder that it was the fastest company in the index to get to $100M Annual Recurring Revenue (ARR), reaching there in a little over 3 years.
I was also looking to take a look at Slack’s first-year performance as a public company. Packy McCormick had simplified it for us here, and I quote -
In its first year public, Slack:
Grew revenue 49% from $145 million to $215.9 million
Decreased the cost of revenue from $31.1 million to $28.4 million as gross margins improved by 8.3% from 78.5% to 86.8%
Reduced SG&A, which includes S&M, by 39.1% (up 10% compared to the first non-IPO quarter)
Reduced spend on R&D by 56.7% (down 1% compared to the first non-IPO quarter)
Shrunk Operating Losses from $363.7 million to $68.6 million (or $26 million compared to first non-IPO quarter)
Improved Free Cash Flow by $18.7 million from -$7.9 million to $10.8 million.
These are phenomenal numbers for any publicly trading company, let alone Slack. And if you’ve been geeking out on the BVP Nasdaq Emerging Cloud Index like me, you’d also know it’s trading at top quartile multiples, which should be around $45.10 and a $24.7B EV. And if you value Slack with the top quartile players’ YTD performance, its EV would come around $28.4B, slightly more than the price Salesforce is buying it at.
Let’s also look at the product and pricing bit, though it’s fairly straightforward.
Slack’s pricing is as easy as it gets. It is a Software-as-a-Service (SaaS) business that charges companies a monthly rate for every employee that uses it. Put another way, for Slack to grow, it needs to acquire companies as users, keep them happy, and grow with them as they grow. The more people a company hires, the more people use Slack, the more money Slack makes. The product is pretty much consumerized and self-serve, which leads to shorter sales cycles and a bottoms-up adoption.
Customer retention is also one of the key metrics the product tracks. Slack daily scans your workspace to see how many people in a particular company use the product daily and selflessly refunds to the companies for users who have been inactive for a certain time span. Moreover, the evolution of Slack’s adoption has been 3 fold -
Initially, Slack’s users were predominantly small, agile teams within an organization that needed collaboration to effectively function, much like Salesforce started selling to the sales teams.
As the comfort level with the product grew, Slack was used for cross-team collaboration within the same organization (think Business Development with Tech & Engineering).
Now Slack channels are also used as a platform for cross-enterprise collaboration. Think of yourself as a PE firm that has hired strategy consultants to turn around the fortunes of a BPO in your portfolio.
To summarize, Slack has a two-step blueprint for success
Acquire Young, Fast-Growing Users. Companies like Stripe, Razorpay, Unacademy, Airbnb use Slack.
Retain Those Users and Grow With Them. This is all about stickiness that ultimately translates into a Net Dollar Retention*.
*Net Dollar Retention means how many of your current users pay more in the next year.
Slack’s churn rate in the first year is only 10% (the median “monthly” churn rate for a SaaS business is 5-10%, meaning proportionally, an average SaaS business loses as many customers per month as Slack loses in a year). It retains a whopping 80% of its paying users over 5 years.
Interestingly, as revenue has grown, SG&A and R&D have stayed largely flat. That’s called operating leverage. Over the past year, Slack went from an Operating Loss of $363.7M and FCF of -$7.9M in Q2 2020 to an Operating Loss of $68.6M and a positive FCF of $10.8M in Q2 2021, the most recent quarter.
Put in other words, for every 100 companies that are using Slack today, 80 will still be using Slack in year five, and those 80 will spend 2.4x as much as the original 100 did in year one. And unless it makes a conscious decision to spend more on Sales & Marketing or R&D in the future, the gains from compounding revenue growth are going to drop straight to the bottom line.
Moreover, another area Slack wins over its younger, nimbler users is the number of integrations it keeps on adding. In September ‘19, Slack had a shade over 1800 integrations on its platform. Right now, the number of integrations is over 2200, and in case you are wondering, Microsoft Teams has over 700 integrations today.
If you’re an enterprise company and want to drive adoption of an enterprise tool, (Atlassian shipped 11 product integrations which now see about a million active users every month), or wish to raise a Series A for your venture (the asynchronous video-messaging tool, Loom counted Slack as one of its investors), the signature Slack “ta-ta-ta” seems to be the best way to be a part of the discourse right now.
Image Credits: Atlassian
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☁️ Salesforce and the Cloud
If you spend a lot of time listening to CIO interviews like me, you’d understand that a real-pain point for them is to find out the best platform to standardize their operations. They have limited time and resources, and hence, need to pick a commercial ecosystem that will provide concrete dividends: new applications, new talent, new revenue streams. They have to decide whether they will be an Oracle shop, an SAP shop, a Microsoft shop, or a Salesforce shop. Slack’s purchase by Salesforce is an announcement to the world that it’s taking the gloves off in the platform wars against Microsoft.
I’ll help you understand what I mean by a shop but before that, let’s take a step back and understand how Salesforce has evolved as a company over the last couple of decades. As I’d written here -
SF (Salesforce) has been a category-defining company since it's inception & has stayed ahead of the evolution curve, even steering it at times.
At the start of the millennium, it was a CRM tool for the sales team delivered as an application software as a service over the browser.
Over time it evolved to serve more needs of enterprise customers, quickly realizing a lot of them host data on their on-prem servers.
SF then acquired MuleSoft & Quip to offer a hybrid cloud capability as a natural extension to their existing offerings.
Today, the definition of cloud extends well beyond public/hybrid & is about the different capabilities a vendor can provide to the customers.
And the recent acquisitions Tableau Software (analytics) & Slack (professional communication, assuming the deal goes through), strengthen SF's offerings across the board.
It fits perfectly into their vertical cloud strategy, adding workflows & one-stop integrations & offering them as a service.
At the turn of the millennium, Salesforce, one of the world's largest companies today, started as a cloud-based CRM or customer relationship management tool, which was an operating system mainly for salespeople. Salesforce has now added automated marketing, business analytics, customer success, and back-office work to its repertoire. Unsurprisingly, this fiscal year, Salesforce’s revenue was $17.1B, growing 29% YoY, and it has left behind industry pioneers like Oracle and IBM.
Interestingly, however, if you discount Tableau’s contribution to the top-line, the growth would have been 23% only, representing a slow down from the previous year. And like most tech companies on NASDAQ, the rising growth rate was the major tailwind that drove the growth of Salesforce.
Like Slack, the Salesforce playbook is pretty standard, too - acquire and merge several companies that fit into the complete digital business environment Salesforce wants to build. Slack is a cherry on top as it’s the coolest, most-effective, transparent way for companies to communicate internally and across departments.
Let’s get back to understanding what a shop means.
💻 The Stack of Enterprise IT
Within the enterprise, the buyer has moved from a central IT team to an office knowledge worker with a LinkedIn account, to someone with an iPhone, to any developer with a GitHub account.
As Josh Elman illustrates in the aforementioned diagram, an Enterprise IT stack comprises of 3 fundamental layers -
Systems of Record (SOR): Systems of record (SOR) are software that essentially serve as the backbone of any particular business process. Their superpower is that they’re the ultimate source/record of critical business data. There are four fundamental systems of record, one for your customers (CRM, Salesforce), one for your employees (HCM, Workday), and two for your assets (ERP financials, Oracle Financials/ITSM, ServiceNow). These are the databases on which your applications are built. The leading players in this SaaS strategy are well-established with strong field-sales teams.
Systems of Engagement (SOE): Systems of Engagement are the interfaces that sit atop the Systems of Record and allow/control how users can utilize and interface with the data. These have migrated up from mainframe terminals, through dashboard visualizers like Tableau, and today we have Slack, Alexa, Wechat, chatbots, email and every other variant on text and conversational UIs.
Systems of Intelligence (SOI): Systems of Intelligence leverage data from your IT and enterprise systems of record, applying machine learning and predictive analytics to generate a higher level of insight and understanding. SOI is a culmination of analytics, data, machine learning, domain expertise, and network effects where applicable.
Let’s build on these layers a little bit. In SORs, generations of companies have been built around owning a system of record and every wave has produced new winners that eat away the marketshare of the incumbents. Salesforce won the CRM category by knocking out Siebel while Workday replaced Oracle Peoplesoft for employee data. Both these companies benefitted from the trend of application software moving from an on-prem, licensing model to a “as-a-service” model delivered over the internet to your browser.
The SOE layer interfaces b/w the end users and the SOR. Thus, it naturally needs to be easy-to-use and self-serve. The layer has all the ingredients to be a powerful standalone business in itself as it controls end-user interactions. Initially, in the mainframe era, SORs & SOEs resided at the same place as the mainframe and terminal were one unified product. In the client-server era, companies tried to own the laptops/PCs but were disrupted by browsers and subsequently by mobile-first companies.
Unlike SOR though, successive generations of SOEs didn’t replace the previous layers as users keep adding new ways to interact with the applications.The number of channels through which communication can happen is ever-increasing, and in today’s connected culture, it can happen at any time.
For engineering a competitive advantage, SOEs need to be self-serve and simple to attract maximum users and all of the data from the interactions resides in SORs and is thus, shared across SOEs. A quick example could be how CRED sends me the payment notifcation on WhatsApp and on the app.
The SOI layer is the most transformative of the lot as it enhances the value of the SORs by adding data from multiple datasets and systems of record, sometimes external sources, or adding previously unseen insight through the addition of ML/AI. Using a company’s data, you can upsell customers, automatically respond to support tickets, prevent employee attrition, and identify security anomalies. Products that use industry-specific data (i.e. healthcare, financial services), or unique to a company (customer data, machine logs, etc.) to solve a strategic problem for a business begin with a pretty deep moat, especially if they can replace or automate an entire enterprise workflow or create a new value-added workflow that was made possible by this intelligence.
💡 It’s imperative that we talk about Microsoft here -
Its SOE is as full stack as it gets - Github for Devs, LinkedIn for B2B Sales & recruiters, Outlook and Teams for employees.
For the SOR layer, is has Dynamics 365, SQL server along with Azure’s support for a few other types of databases.
At the SOI layer, it’s now integrating Open AI with Azure’s AI/ML Product Suite
Armed with an understanding of Microsoft’s portfolio and about the enterprise IT stack, a look at Salesforce’s arsenal should help visualize why this acquisition makes sense -
Salesforce has much superior CRM Capabilities, even catering to industry verticals at the SOR layer
With Einstein, it already has its own System of Intelligence layer
Slack plugs the hole in the SOE layer. Not to forget that Salesforce lost to Microsoft’s in an arm-wrestling match for LinkedIn back in 2016.
This surely helps even the odds a little bit, helps Salesforce compete with Microsoft on an equal footing, and turns the entire Salesforce’s offering into a compelling one for their customers. I expect Slack to soon be the default interface/abstraction layer on top of Salesforce’s Enterprise Software products, targeted towards developers, fusion teams & knowledge workers inside an organization.
Regardless of who is victorious, customers are bound to win. And before we close the section on enterprise shops, let’s also take a moment to think about SAP & Oracle - both have very strong SORs but lack the SOE layer. Will they be forced to buy something next? Will it be Discord or Notion? It’s a topic I plan to explore at a future date.
🎯 Concluding thoughts
I’m long on $WORK and hence, argue that Salesforce got for itself one of the most valuable assets in the category in the future of work, and the deal will look like an absolute steal in a few years. Together, I believe, both the companies have what it takes to build the next-gen digital HQ solution for future distributed workplaces to all the departments in a company and to all kinds of companies.
The destination is a new operating system for work, accessible to everyone and from anywhere. The future of digital work is being forged as I write this and it won’t take long for us to see more transformations as digital operations become new normal for all businesses even after the pandemic.
But is this a marriage made in heaven? Make of that what you will and let us know in the comments.
Very well researched, especially around why Slack should be valued at the price Salesforce is buying it at.