A Few Clouds Appear on Salesforce.coms Horizon

Opinion: The on-demand CRM company's revenue and subscriber base continue to grow robustly, but its first-quarter earnings report raises questions about whether it can sustain the pace.

There are some unsettling signs in Salesforce.coms latest earnings report that could indicate that the company may not be able to sustain its record of rapid revenue and customer growth quarter after quarter.

While the company remains a huge cash generator for its size, it reported a small net loss of $229,000 on revenue of $104 million compared with ayear-earlier profit of $4.4 million after option expenses and special items were deducted. The first-quarter revenue tally was up 63 percent over the previous years tally.

Without these items the company reported that its profit increased 3.2 percent to $5 million, compared to $4.8 million in the year-earlier quarter.

The higher revenue was offset by a 67 percent increase in operating expenses from $47.9 million to $80.2 million. The company said the increase was the result of higher spending on R&D and marketing.

/zimages/1/28571.gifClick here to read about Salesforce.coms recent acquisition of Sendia.

The most troubling issue, though, is a slight slowdown in the rate of subscriber sign-ups. Customer and subscriber growth are decisive factors in the question of whether Salesforce.com is to remain at the top of the on-demand CRM (customer relationship management) sector. The company reported that it signed on about 45,000 new subscribers, compared to 48,000 in the previous quarter. Still, the company noted that this was a 66 percent year-over-year increase as well as an 11 percent quarter-to-quarter increase. Its total subscriber tally of 444,000 remains the envy of the on-demand CRM sector.

Salesforce.com also reported that it added 2,200 new corporate customers and now has a total of 22,700, an increase of 46 percent year over year. As further evidence of customer satisfaction, it noted that Cisco Systems buys subscriptions for 7,500 employees, making it Salesforce.coms largest single customer.

Analysts will be watching closely to see whether Salesforce.coms customer and subscriber growth rates have peaked and whether it will find that it is harder to sign on new customers in future quarters. This could be an indication that the company is running into stronger competition from other on-demand CRM software companies such as RightNow Technologies, Oracle/Siebel, NetSuite and others who have been running to catch up with Salesforce.com.

However, Mark Murphy, a stock analyst for First Albany Capital, pointed out that this is a faster customer growth rate than Salesforce.com reported in 2003 when the company overall was much smaller. He also noted that customer churn had decreased to seven-tenths of 1 percent, which suggests increased customer satisfaction.

But the question remains whether Salesforce.com can continue its torrid growth rate. The slight quarter-to-quarter slowdown could also be the first sign that the outages and downtime that the company experienced earlier in 2006 prompted some potential customers to hang back and see whether the company could fix the problems or whether they were a sign that the company was hitting a systemic performance ceiling.

/zimages/1/28571.gifRead more here about the service outages Salesforce.com experienced late in 2005 and early 2006.

Salesforce.com said the problems were caused by the startup of a new sophisticated data center and a previously unknown database bug. It claims that the worst of these problems are behind it and it has set up a dashboard on its site to let customers check its uptime performance.

Sustainable customer growth is the biggest challenge that all on-demand software providers face. These companies have to keep on signing up more and more customers to keep their revenue and profits growing. Its the exact opposite from selling on-premises enterprise application software and collecting a steady flow of maintenance and upgrade revenue quarter after quarter. On-premises software vendors get to collect their revenue up front, even before they install the software.

On-demand vendors earn their revenue as they deliver services. While their continuing revenue is highly predictable, it totally depends on the quality and reliability of the service. If quality suffers, on-demand vendors can lose their credibility with customers a lot faster than on-premises service providers. There is intense pressure to keep on-demand customers happy and loyal because the barriers against switching to another vendor are lower.

Despite the challenges, Salesforce.com found plenty to crow about in its fiscal first-quarter results. Its claiming that it is the first pure on-demand software service provider to generate $100 million in a single quarter.

The company has also raised its revenue projection for 2006 to $478-$483 million from the $470-$475 million that it had estimated in the previous quarter.

In general, the company still looks robust and the latest report didnt exactly set alarm bells clanging. But Salesforce.com is riding the tiger of rapid growth and it has to remain high in the saddle if it wants to avoid a steep and nasty fall.

John Pallatto is a veteran journalist in the field of enterprise software and Internet technology. He can be reached at john_pallatto@ziffdavis.com.

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John Pallatto

John Pallatto

John Pallatto has been editor in chief of QuinStreet Inc.'s eWEEK.com since October 2012. He has more than 40 years of experience as a professional journalist working at a daily newspaper and...