Zoho CEO: cloud's in a bubble, Salesforce is the new Siebel

I believe we are in a bubble, for sure. We are in a bubble and this bubble is in many ways even bigger than the dot-com bubble in 2000.

Sridhar Vembu's words echo the fears of leading VC investors such as Bill Gurley and Michael Moritz, at at time when late-stage private equity funding is fast outrunning IPO returns. But although Vembu lives in California, his perspective comes from far outside of the VC investment community.

Zoho, the company Vembu founded and which he leads as CEO, would be one of those much-watched, high-flying, billion-dollar value 'unicorns' if it were venture funded. But this purveyor of cloud applications to small business is a closely-held private company that has never raised any equity or debt funding on its path to 13 million users. It has several hundred thousand business customers and revenues said to be rising more than 50 percent year on year.

With more than 100,000 customers in common with Google Apps, Zoho claims to be the largest player in Google's business ecosystem. It is also winning Salesforce customers to its rival CRM solution at a rate of "tens every day," says Zembu.

Venture-fueled burn rates

From his stance outside the financial maelstrom of Silicon Valley, Vembu worries about the effect that venture capital is having on the cloud industry in which Zoho plays.

If you look at the cloud companies as a whole, very few of them actually make money.

This was the same logic applied in 2000 too — growth at any cost.

If you look at the way they're expanding, they're spending $5, $6, $8, perhaps $10 on sales and marketing for every dollar they are spending on R&D. If you look at a typical cloud company now, they may employ 50 engineers, maybe 100 engineers, but they'll employ 500 people in sales and marketing.

As a result, the product portfolios are very narrow, focused on one area, even though the company's size is quite substantial — five hundred people, or a thousand, fifteen hundred — the headcount has ballooned actually.

Even some leading venture capitalists are starting to sound the alarm on this trend where the burn rate is too high. Fifty million dollars a year is now a very common burn rate. That's the landscape that we live in.

Intensely competitive with Salesforce, he is specially caustic in his judgement of how his CRM rival goes to market.

For all the new model that they claim to have created, they really go back to a very old model of doing business. It's still the very old one — the sales guy chasing the big enterprise deal.

We are the truly new model. We are very disruptive, the way we do business. Our sales and marketing spend is much lower, correspondingly our cost we charge the customer is much lower.

The way I tell the customer is this: we are not charging you for the privilege of selling it to you.

Rules of business 'not abolished'

Vembu rejects the commonplace argument that cloud companies are sacrificing short-term profitability in favor of sales and marketing spend that builds market share.

One problem with that argument is, when you get used to spending money that way, your culture is deeply infected. Your culture intrinsically changes and you cannot get back to the mindset of actually making money or being prudent — all of the conventional things you need to stay in business.

You know, the rules of business have not been abolished. They remain the same. You've got to make more than what is spent. If you get used to spending lots of money, it goes haywire.

In contrast, Zoho prefers to spend as much or more on product development as it does on sales and marketing, says Vembu.

Our focus is, use our R&D resource as an advantage, to lower our cost of customer acquisition. It's a strategy of marketing through engineering. The product portfolio itself has the breadth and depth to attract customers.

This emphasis on functionality underpins more durable customer relationships than those built on sales and marketing, argues Vembu. Zoho's most lucrative customers are businesses with a few hundred employees up to a thousand. Increasing numbers are signing up for multiple applications, he said.

I believe in the long-term potential of the business model. But we also have a financial bubble that has blown things way out of proportion. People are over-expanding, particularly the sales and marketing.

The interesting part of it: people think sales and marketing gives them a durable advantage. I don't believe it. If it did, Oracle would still be ruling the roost. Cisco should still be ruling. Because they have vast numbers of sales staff.

The fact that they're not able to hold on in this spate of technology disruption shows that that cannot be the real force. You do need the technology advantage.

Salesforce shortcomings

He accuses Salesforce of following the same model of investing in sales development to make up for shortcomings in its product portfolio.

What has happened is Salesforce has become the Siebel or SAP in that market.

In my opinion, they invested more in the whole sales and marketing side than in the product. Most of their product expansion came through acquisition, which they have not really integrated well — if you look at, from Desk.com to the new Marketing Cloud, all of these. Heroku has never been integrated into the core Salesforce experience.

Which tells me that they're having trouble with keeping all these separate pieces meshing it together. Which is always a massive technology challenge. It's not easy.

To make up for it, they're expanding the sales and marketing. To me that strategy is only short-term, and the gains they make tend not to be durable. But we'll see. That's what I'm betting on, we'll see how the market evolves.

As a result, he suggests, Salesforce is losing out in the small business market to Zoho.

The more you resort to this high-end strategy, your salesforce itself discriminates against the smaller customer. Which salesman's going to be motivated by selling a 5-seat deal?

On a number of orgs count, we probably sign more every quarter than they do. Ours tend to be much smaller organizations than theirs. But just on that raw number of net additions to the customer base, we actually [sign up more].

Emphasizing product over sales spend

Zoho's approach is to emphasize product investment over sales and marketing spend, Vembu told me.

What we figure is, companies typically spend a thousand, two thousand, five thousand to acquire a customer. That's actually what the typical SaaS company metrics are. We figured, why don't we cut it in two.

Maybe, instead of spending a thousand dollars, spending two to three hundred dollars, but take some of that, put it back into the product, give it away free? The customer is grateful and happy. We lower our spend, and we've still got the customer. That's how we think.

Venture capitalists don't like that type of thinking, because for them a company that grows fast but also spends a lot of money is good. Because money is what they supply.

If you don't have the need for the fuel they supply, what's their role? That's why they don't like our model. But we like our model.

My take

Well he would say that, wouldn't he? But some of his points are well made.

Is there an over-emphasis in Silicon Valley on sales over product development? Probably, yes.

Does the venture capital model encourage spending over profitability? Time and again, this has proven to be the case.

Are we in a bubble? Yes, but bubbles can go on for a very long time, and while they persist they fund periods of extraordinary innovation.

When the music stops, will Zoho still be on its feet? Almost certainly, yes. If we are in a bubble, then Vembu has staked Zoho's chips in the right place to come through on the winning side. Even if we're not, the company is still on a good course.

There's more to come on Zoho's business model in part two of this interview.

Disclosure: Oracle, Salesforce and SAP are diginomica premier partners.

Image credits: Bubbles with cloud in blue sky © Uschi Hering - Fotolia.com; headshot by Zoho.