Software's Risky Business
There is a well-worn recipe for technology companies that tailor their wares for companies rather than consumers: Develop products. Spend oodles of money on sales representatives to persuade companies to use those products. Fetch buckets to collect the profits. Repeat.
That's the recipe Oracle, Cisco, EMC and others used to build their empires. A younger generation of business-technology sellers including Salesforce.com, Workday and Box are following along, with twists that amp up both the potential windfall if they succeed and the risk to investors if the strategy doesn't pan out.
Of 80 large U.S. technology companies that disclosed such costs in the most recent fiscal year, one in four was devoting 35 percent or more of its revenue to sales and marketing costs including paying sales commissions and participating in trade shows, according to Bloomberg data. Many of the big spenders are young software firms that went public in the last few years -- a time when business-software firms were among the hottest tickets on the IPO market.
One reason for the high percentage is the unbalanced approach of the younger companies, which tend to sell software by subscription rather than by outright purchase like their software predecessors did. That means the young software firms have to absorb all the costs up front to persuade companies to buy their technology, but they spread out the resulting revenue over months or years.
The result is red ink into the foreseeable future but fast-growing revenue as the upstart software firms spend lavishly to persuade corporations to break out their wallets.
Workday, the human-resources software firm, is emblematic of the growth-at-a-cost model. The company said late Monday that its revenue rose 43 percent in the three months ended Jan. 31, and its loss amounted to $81 million under generally accepted accounting principles.
Workday's sales and marketing costs gobbled up 37 percent of revenue, the company's second-biggest operating expense behind product development. In part because of those sales expenses, Workday hasn't produced profit on a conventional basis 1 since it went public in 2012. The company does generate a nice chunk of cash, though.
Salesforce, which spends nearly 50 cents out of every dollar of revenue on sales and marketing, has been unprofitable in each of its last five fiscal years. Box, the file-sharing company, and security software provider FireEye each spend an even larger percentage of their revenue on sales and marketing to land new customers. They're unprofitable, too.
The business-software sellers say they'll eventually reach a point where they can ease up a bit on the sales pitches. That's what happened to their elders. Workday said it expected by next January to have a backlog of nearly $1.9 billion in billed but unpaid contracts.
But there's an existential question for these still-young sellers of business software: What happens if the buckets of money dry up? If investors are no longer willing to trade profits for growth and force the companies to ease back on sales efforts, revenue growth is sure to slow. Valuations predicated on fast growth would crumble.
The companies say they can rein in efforts to sign new customers and simply harvest profits from existing ones. That's easier said than done. Some of the biggest sales spenders haven't been tested yet by a global recession. What if global companies enter cutting mode and stop buying what the young software firms are selling? Of course, companies don't rip out the plumbing when times are tough; they still need water and electricity. All technology companies say the products they sell to companies are as essential as water and electricity. In many cases they're not.
For now, the software big spenders including Salesforce and Workday are holding up just fine. It's worthwhile harboring some doubts, however, about what happens to companies that were designed for the full-court sales press when customers stop taking their calls.
Workday, like the majority of tech companies in a recently Gadfly analysis, prefer to report earnings excluding the cost of stock compensation for employees. Excluding more than $70 million of employee stock compensation and other items, Workday said its non-GAAP loss narrowed to $2 million. As Warren Buffett said in his annual shareholder letter released Saturday," If compensation isn’t an expense, what is it?"
To contact the author of this story:
Shira Ovide in New York at firstname.lastname@example.org
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Daniel Niemi at email@example.com