Zoho throws down the gauntlet at Salesforce feet

Den Howlett Profile picture for user gonzodaddy January 24, 2017
Zoho has ambitions to crush Salesforce. They have plenty of application firepower available, along with a business model that is antithetical to the VC model that dominates technology startups. Is it enough? We assess.

sridar vembu zoho
Sridhar Vembu - CEO Zoho

Zoho's 2017 analyst day was a fun packed event with plenty to pick over, not least the challenge it set for itself which is to be the company that disrupts Salesforce. Haven't we heard this before? Sure. Check out the conversation Phil Wainewright had with CEO and co-founder Sridhar Vembu in April 2015:

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...

...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.

At the time, Phil said in the context of a VC fueled bubble:

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.

The battlescape

What has changed in 2017? Remarkably little. Salesforce is on a path to becoming a $10 billion business with an ever expanding portfolio of cloud offerings. Zoho continues to expand its portfolio of solutions but Vembu is adding a fresh twist to the tale.

Zoho still insists that it can beat the big dog and is counting on a market implosion, coupled with Zoho's cash based business model to see it emerge as the victor in the SMB cloud based applications space.

We can argue the merits of Vembu's argument and in quiet conversations, some analysts argue that Salesforce is or has run out of application road, depending instead on relentless marketing to keep its sales engine ticking over. I have a different take.

It strikes me that Salesforce has largely abandoned its SMB base in favor of winning in the large enterprise. You get that impression from the way in which Salesforce has upped its pricing model, shrunk capability at the entry level, charges for storage and imposing significant revenue based charges on its ISVs. You also get that from field stories of which more later. Taken together, I can model a position that has Salesforce organic growth at zero. As one wag told me: 'Salesforce is more like Oracle than Oracle.'

I'm not quite as harsh but whether by design or default, Salesforce has left itself vulnerable to others in the SMB space. Whether that gets filled by Zoho is another matter altogether. Let's consider Zoho's value business model.

Zoho's business model

Throughout the day, different Zoho executives provided detail on customer counts, churn, the degree to which customers add modules and so on. All of those figures are comforting but the one number they absolutely refuse to divulge? Revenue.

Analysts get obsessed by revenue numbers because you can talk all the growth you want but if it is coming off a small monetary base then volume counts for nothing. Zoho left the room full of analysts scrambling to work out exactly what that number is. Wikipedia estimated that in 2012, Zoho was about a quarter the size of Salesforce. If true then at that time, Wikipedia effectively pegged Zoho revenue at some $500 million. Assuming that wikipedia sources are correct - and that is always open to conjecture - then that would imply current revenue at about $1.9-2 billion.

zoho growth

We have no real way to know whether that estimate is correct. If anything, I would argue that it is likely on the high side given that Salesforce has been increasing prices the last few years while Zoho pricing has remained static or has effectively declined via bundling. A more conservative figure would be in the $1.3-1.5 billion range but even here, I am not entirely comfortable.

Zoho threw out plenty of numbers covering CAC, MRR, employee splits, individual product growth and so on. But even taken together, without a clear line of sight into the base line starting figure, any number will be wildly inaccurate.

What we can say is that churn in their CRM product, which has been the most successful by volume, had a relatively high churn rate in the period 2014-15 but has moderated in 2016. We also note that Zoho's CAC is much lower than its competitors, standing at 29% and while it only counts 10% of employees in sales and marketing. Zoho claims that it is among Google's largest AdWords spenders.

The picture is made all the more complicated because Zoho is constantly adding products which now count 35 and span many major front and back office requirements with the exception of payroll, for which it (wisely) partners. You can argue that many of Zoho's offerings are small footprint features rather than fully formed applications but when bundled they do represent a powerful set of capabilities and offer the opportunity for Zoho to earn higher revenue per customer.

On go to market, Zoho has done well in multiple geographies but its on the ground footprint outside the US and India is miniscule. Its reliance on AdWords is interesting. Despite what popular media says about the rise of Facebook for advertising, Google Search remains THE way that technology is 'found' and so it is natural that companies which rely on inbound sales will continue to spend heavily with Google.

Outside of the US, Zoho has a very small channel although the channel share of revenue has grown from 16% to 24% in the period 2013-16.

Zoho insists that it is cash flow positive, that it invests 70% of revenue in engineering and makes a virtue out of its low touch freemium model that is predicated almost entirely on inbound sales. I fully understand this model because it is exactly the same one that diginomica has followed. What does it mean?

Let's turn to Salesforce as Zoho's chosen competitor.

How about Salesforce?

We can keep this discussion short because there is plenty of data in the public domain for readers to explore. In summary.

Salesforce has won because it takes a marketing first approach. Regardless of anything else you might wish to say, Marc Benioff, CEO Salesforce IS the Pied Piper and PT Barnum of Silicon Valley all rolled into one. No one else comes close in terms of vision and charisma. That matters a great deal, even if, as Vembu says, Salesforce makes very little profit.

Salesforce does, however, throw off plenty of cash, much of which has been used to fuel acquisitions in the last few years. That in turn is what matters to investors who have rewarded Salesforce with a market cap that at time of writing stands at $53.8 billion, a 7x multiple on current revenue. Zoho can't come close to that although it prides itself on $31.6 million in data center investments.

Zoho's value proposition - only price?

In direct comparison to Salesforce, Zoho insists that price matters and sure, during our discussions, other analysts reflected that the SMB market is extremely price sensitive. I believe that's true in the micro business but in the larger SMB market (10-100 users), value matters much more than pure price.

We heard from one customer for example who has 160 users and who is happily paying modest amounts to Zoho which I estimate at no more than 0.5% of revenue. It runs its business on Zoho. That is great but it is an exception. The benchmark for IT investments is in the range 2-3% of revenue.

You can (and should) argue that cloud based systems change the economics radically but so far, much of what we've seen both in quantitative studies and anecdotal evidence on the ground, suggests that IT budgets get shuffled rather than reduced. From that perspective, Zoho could argue that it is actively freeing up resource for SMBs to invest in higher value IT spend. That's not an argument I hear them make but one which should be central to their pitch.

Instead I hear one thing - price - which you can wrap up as equivalent to a bargain basement pitch. In my view that reduces the perceived value when it is clear that across the portfolio, there is much value to be had.

For example, a combination of Zoho Campaigns, SalesIQ and Unbounce allowed one customer to eliminate its investment in Hubspot. That's a significant win, given that Hibspot is actively trying to up its ARR from customers with a starting price in the $10K range.

More important, that same customer, which planned to grow from 65 Salesforce users to 100, found it could not only make huge savings by switching to Zoho's suite, but could also eliminate a full time Salesforce developer at a cost of $80,000 pa.

So while Zoho makes a virtue of its incredibly low priced applications, that is not the only determinant in a deal. Zoho has understood that customers respond to bundles and is currently in the throes of figuring a pricing model for an 'all you can eat' package to suit the very small customer. I am not permitted to disclose the number but I can say that after some furious debate on the analyst day, Zoho stunned us with its 'firm and final' offer.

My expectation is that for those very small customers, Zoho will ensure that it ramps its success teams to ensure that it can keep customers on board. In that sense, the weaknesses are not just those of value perception from a low price. It is that Zoho is sticking to a purer form of SaaS model where the customer can walk away any time they wish without penalty but not necessarily supporting customers as well as it could in the on boarding experience.

Zoho - the future and my take

I said at the top of this story that there was a lot packed into the day and towards the end, I heard them start to talk about using predictive techniques and variants of ML and DL that are in development. right now, Zoho isn't saying too much about what will be included but the emphasis is on sales intelligence, an obvious win.

In something of a detour, Zoho said that it is ensuring that mobile is a first class citizen for all its products. That's fine but I would lie to see them start rethinking what a CRM delivered via mobile looks like. I don't see it as a prettier SFA system but one that is much more likely to be bot driven, providing the sales teams with help to close rather than acting as a reporting engine for managers.

Earlier, I referred to the packaging efforts. What I can say is that Zoho is working to ensure that the bundles truly integrate with one another. This is a big engineering task and I would be surprised if they manage to cover all the bases before needing to get into market. My sense is that they should ensure the most important integrations (e.g. Books to CRM) are covered off but also ensure clean integrations at the top of the business process as well, i.e. ensure there is a bi-lateral synch between marketing, CRM (sales) and accounting.

I also want to see Zoho much more aggressive and 'out there' in the public domain on why, beyond price, Zoho should be the brand of choice. They have the products and they have the engineering resource to keep customers happy. They need to provide the kinds of customer we saw on the analyst day as solid examples of switching and/or growth with Zoho.

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