SuccessFactors goes Public

Last week was a big week in the world of corporate talent management systems.  SuccessFactors, one of the fastest-growing providers of performance management software, went public.  The initial IPO valued the company at about $500 Million, or close to 9 times sales.  This valuation is very high relative to the other companies in this market (Taleo trades at 5-6X sales, Kenexa is trading at 2-3X sales, Salary.com is trading at 7.5X sales, and Saba and SumTotal trade at 1-1.5X sales).

What does this high valuation mean?  It illustrates three big things going on in this market:

1.  Growth rate matters.  First, SuccessFactors’ high growth and aggressive “become #1” strategy is highly valued by Wall Street.  Internet companies have found that the #1 player in a market tends to take 50% or more market share, and #2 is often 20-30%, and the remaining fall far behind.  

Does this strategy make sense in the talent management software market?  Not nearly to the degree it may matter in generic internet companies. The reason is that the market for HR software is very broad and segmented:  small businesses have very different needs from mid-market companies, which have very different needs from global enterprises.  Today SuccessFactors has done extremely well in the small to mid-sized market segment (where other focused competitors like Halogen <www.halogensoftware.com>  play) – but still has very small market share among global enterprises.  I believe that we are at least 3-5 years away from consolidation in this market – today most of the players are likely to grow.

In addition, today the different vendors in the market have very different strengths.  SuccessFactors’ strength is in its performance management modules.  Other vendors focus more heavily on recruiting (Taleo, Kenexa, Authoria), learning (Cornerstone, Saba, SumTotal), compensation (Workstream, Workscape, Salary.com), and HRMS (Ultimate, Oracle, SAP).  Buyers come to the talent management problem from different problem spaces, so they tend to select vendors based on their primary problem to solve.

2.  SaaS matters.  Second, SuccessFactors is a very well run Software as a Service (SaaS) company.  While other talent management systems vendors are also providing SaaS (notable CornerstoneOnDemand, Learn.com, Salary.com, and GeoLearning are three others which exclusively deliver in this manner), SuccessFactors has positioned itself very well in this segment.  Wall Street is very enamored with this business model (Salesforce.com has a similar valuation ratio to SuccessFactors), hence its high valuation. 

I know that many other software vendors are working hard to reposition themselves into this category.  The SaaS business model works very well when companies get large enough to amortize their infrastructure costs over many hundreds of customers.  In the early days (even SuccessFactors does not expect to be cash-flow positive for at least two more years), this business model demands a lot of up-front expenses for infrastructure, sales, and services.  

Remember, when you buy software from a SaaS vendor, you are essentially transferring the IT costs and software service expenses to them.  Presumably they are going to be much more efficient at it than you are – since they are supporting hundreds of customers with the same code.   The total cost of software development and maintenance may be the same for both SaaS and licensed companies, but in the SaaS case, all the implementation expenses are managed by the vendor.  You pay a higher monthly cost, but over the longrun our research shows that if you select the right platform, and the vendor provides open, easy-to-use interfaces, you will save money in the SaaS model.  (We have an in-depth research paper on this topic for research members).

3.  Business model matters.  Third, today Wall Street sees future profitability as more important than current profitability.  Today, as we wrote about a few months ago, SuccessFactors is a highly unprofitable company.  Even taking into account the deferred revenue, the company is spending almost $3 for every $1 of revenue.  According to the strategy, within 2-3 years the recurring revenue (“deferred revenue”) will start to catch up with the very high sales and development expenses to make the company profitable.   Investors believe this, hence the high multiple.

One can see evidence of this taking place with large, well-run companies like Salesforce.com, which is now profitable.  Traditional software companies (Saba and SumTotal for example) are not seeing this business model benefit.  Both these traditional software companies are still unprofitable but seem to be unable to convince Wall Street (at least so far) that they have a road to high profits in the future.  I think we will see an increasingly intense push by all the traditional software vendors in this market to lean toward SaaS models, in an attempt to capture the SaaS long-term profitability model.

That said, let me remind everyone that many traditional software vendors are very very profitable.  Oracle, SAP, Microsoft, Symantec, and many other companies that “ship software” have reached the “knee in the curve” where their sales revenues are high enough to dwarf their R&D expenses and they see tremendously high margins on software.  I believe this is still very possible in the HR/talent management software market — but only for companies that focus very intensely on market segments where they can get very high growth rates and avoid building products which do “everything for everyone.” 

One of the biggest challenges which traditional HR software vendors face is their tendency to try to build software for all types of buyers – from small businesses to global enterprises.  This spreads them very thin and makes it hard for them to gain enough traction in a single market to generate a profitable business model.  If there is one piece of advice I try to give to any technology provider in the HR and training markets, it is to focus, focus, focus.  When a vendor finds a segment they can dominate (geotraphic market, industry, problem area), their profitability goes way up.

Bottom line:  SuccessFactors is a very well run company (customers are very happy) which has really helped create the market for performance management (and now integrated talent management) software solutions.  Their highly successful IPO bodes well for everyone – the financial markets now see success here and this means more money and more investment for all the players.  More investment means better products, healthier companies, and faster-maturing solutions.  We should all wish SuccessFactors well and we will hope that others in this market see similar successes.

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