This article is part of our Rising Star Portfolios series.
Few fields move as rapidly as technology. Businesses creating outsized profits and returns for shareholders quickly get a bull's-eye painted on their back as they become targets of other companies looking to disrupt their products by selling cheaper alternatives that still prove "good enough." Not only that, but even if a company continues to dominate its particular field, other changes in technology can shift spending away from their products. Think about how Microsoft (NAS: MSFT) still dominates PCs but feels pressure from the sales shift toward mobile devices such as smartphones and tablets.
With that in mind, today we're looking at how salesforce.com (NYS: CRM) innovates.
Technology companies can innovate either through acquisitions or by spending more money on research and development. We'll compare salesforce.com's spending in these areas with that of its closest peers and assess whether the company is investing enough in its future.
Research and development
Over the past five years, salesforce.com has spent an average of 10% of revenues on R&D. The following table below summarizes how salesforce.com's R&D expenditure relative to revenues compares with some of the company's closest peers.
Oracle (NAS: ORCL)
IBM (NYS: IBM)
Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates above are calendar years; yearly total is for company fiscal years closing in that period.
Over the past five years, salesforce.com's R&D expense has increased to be inline -- as a percentage of sales -- with key rivals Oracle and Microsoft. That's partially due to the company's expansion of its focus into new areas, and it's also the result of a deferred revenue model that leaves reported GAAP revenue lower than the real level of sales growth at the company.
However, while salesforce.com was innovative in its initial push of creating cloud-based customer-relationship software, the key to analyzing the company's continued growth against rival Oracle isn't in the R&D line. Instead, investors should be looking at sales and marketing expenses. The ability to successfully market its services to new cloud-computing adopters is where the vast amount of salesforce.com's resources are centralized.
Sales & Marketing
Source: Capital IQ, a division of Standard & Poor's. LTM = last 12 months. Dates above are calendar years; yearly total is for company fiscal years closing in that period. All figures in millions.
Nearly 50% of all revenue at salesforce.com goes directly to marketing its services and finding new clients. Compare that with Oracle, which spends a significantly lower 18% on sales and marketing.
That's not to say salesforce.com is doing anything wrong by spending such a large amount on sales and marketing. Qlik Technologies (NAS: QLIK) and NetSuite (NYS: N) , other cloud-centric companies looking to disrupt traditional IP powers, spend 54% and 48% of revenues on sales and marketing, respectively.
However, this does illustrate that while innovation is important in driving salesforce.com into new revenue opportunities aside from its core customer relationship offerings, having a sales team that's adept at evangelizing the company's solution to a world leery of giving up its IT infrastructure and embracing a cloud-computing future is salesforce.com's most important point of execution.
In technology, some of the best companies have turned growth through acquisitions into an art. IBM has adeptly spun off capital-heavy businesses such as the hard-drive and PC segments, while it focused on acquiring additional services and software expertise that have transformed its business model.
On the opposite end of the spectrum, Hewlett-Packard is often criticized for underinvesting in R&D, to the point that it has to overpay on acquisitions to catch up with its competitors.
Investors should remember, most of all, that companies are valued by the cash flow they can bring in for their shareholders over time. If companies need to continue making purchases in perpetuity to keep growing, that amounts to a reduction in cash flows, and investors should treat acquisition spending as a continuing outflow against cash flow.
Let's take a look at salesforce.com's free cash flow over the past five years against cash spent on acquisitions.
In its earlier years, salesforce.com wasn't particularly acquisitive, as the company organically created new products and services through internal R&D. However, recently the company has joined other tech titans in the hunt for smaller buyouts. In late March, the company announced a $326 million acquisition of social-media monitoring company Radian6. That buy followed closely on the heels of a $212 million purchase of Heroku, a company that created a cloud-based application platform that hosts more than 105,000 social and mobile applications.
The size of these buys shows the commitment salesforce.com is putting behind being the leader in the
"social enterprise area." The company's progress in this up-and-coming field was highlighted when it signed an agreement to create a private social network for Toyota based on its Chatter platform.
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At the time thisarticle was published Eric Bleeker owns shares of no companies listed above. You can follow him on Twitter to see all of his technology and market commentary. The Motley Fool owns shares of Intel, Oracle, IBM, Microsoft, and Qlik Technologies and has bought calls on Intel.Motley Fool newsletter serviceshave recommended buying shares of Intel, salesforce.com, Qlik Technologies, and Microsoft, creating a covered collar position in Microsoft, creating a diagonal call position in Intel, and shorting salesforce.com. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.
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