Has the long-anticipated AI reckoning for enterprise software finally come home to roost?
• Salesforce's valuation hit all time low on cash flow basis last week
• Investors are anxious about impact of AI on enterprise software
• But it's far too early to assess impact of new AI services
Shares of Salesforce ($CRM(CRM)), Workday ($WDAY(WDAY)) and UiPath ($PATH(PATH)), among others, have dropped by more than 20% since those companies warned customers were wary about committing to long-term software deals.
While most of the companies didn't blame artificial intelligence for the slowdown, it's hard to believe AI isn't connected. Who could blame companies for holding off on big software commitments given the possibility that AI will make that software less necessary in the next couple of years?
But the market's panicked reaction may be overdone. It's far too early to judge how much companies will shift their spending from existing enterprise software firms to new AI services, and when. Given questions about large language models' accuracy and cost, which have caused many businesses to hold off spending on AI-powered services so far, the near-term impact on software spending may be minimal.
And, of course, software companies such as Salesforce are adding AI tech to their existing products in an effort to cash in on the AI boom. That complicates the issue, as some software believers think AI can help drive growth for older companies, while others think it will kill them. Whatever happens, the shift is likely to take years.
For that reason, some investors think this is a buying opportunity. Scott Berg, an equity analyst at Needham & Co., for instance, noted that Salesforce's valuation, measured as a multiple of free cash flow, was an all-time low of 16 times, whereas historically investors have paid easily between 20 and 25 times.
Berg takes that upbeat view even though he thinks Salesforce and Workday won't make as much from weaving AI into their platforms as the markets think.
What does Salesforce.com do?
Salesforce.com, commonly known as Salesforce, is a cloud-based software company that primarily provides customer relationship management (CRM) service. Here's a breakdown of what they do:
1. Customer Relationship Management (CRM): Salesforce's main offering is its CRM software, which helps businesses manage their relationships and interactions with customers and potential customers. The CRM platform is designed to streamline processes, improve customer service, enhance sales, and increase profitability by organizing customer information in a way that makes it accessible and actionable.
2. Sales Cloud: This is a module within Salesforce that automates the sales process, making it easier for sales teams to track leads, manage contacts, and close deals. It includes features like lead management, sales opportunities, and integrations with email and calendar systems.
3. Service Cloud: Another key component, Service National provides tools for customer service and support. This includes features for managing customer requests, automating service processes, and creating self-service customer portals.
4. Marketing Cloud: Salesforce also offers digital marketing automation and analytics software under its Marketing Cloud. This platform helps businesses create and manage marketing campaigns and customer journeys across multiple channels, including email, social media, and digital advertising.
5. Commerce Cloud: This platform enables companies to create seamless customer experiences across web, mobile, social, and physical locations, managing everything from product content to customer interactions and transactions.
6. Salesforce Platform: This is a platform-as-a-service (PaaS) offering that allows developers to create and deploy custom applications powered by Salesforce. It includes tools to build, run, and optimize apps that are integrated with Salesforce's main CRM functionality.
7. Integration and Analytics: Salesforce provides extensive integration tools, such as MuleSoft for connecting various applications and data sources. They also offer Einstein Analytics, an AI-powered data analytics tool to help businesses make data-driven decisions.
8. Industries Solutions: Salesforce tailors its solutions for various industries including healthcare, financial services, government, and manufacturing, providing specialized software that addresses the unique needs of these sectors.
Overall, Salesforce aims to provide comprehensive tools that help organizations connect with their customers in various ways, leveraging cloud technology to enhance efficiency, productivity, and growth. Their services have expanded far beyond CRM to include all aspects of customer interaction and management, making them a central hub for digital business operations.
Implications
If you carefully think through each of these core offerings, you can see how much of the value proposition stands to be invaded and colonized by AI functionality over coming years.
The primary implication is an inevitable reduction in pricing power.
However, it's possible that a corollary implication is a reduction in the company's cost structure as it incorporates AI internally, which may stabilize the long-term trajectory of the company's margins.
The upshot is layoffs, which will certainly be a running theme as AI systems emerge and assume an increasing role across many industries.
Changing Guidance
One reason to think investors may be overreacting right now is that while several companies have changed their growth projections for this year, they did so very slightly. Salesforce, for instance, lowered its projection for growth in subscription and support revenue for the full year fractionally, from approximately 10% to slightly below 10%.
It didn't change its projection for overall revenue growth, although admittedly, at 8% to 9%, Salesforce was already expecting an anemic year.
Workday, too, cut the guidance it had set out earlier for top-line expansion from subscriptions next year by roughly 1 percentage point to 17%. Executives attributed the decision in part to slowing headcount growth at the companies that buy its software.
UiPath, which sells software that automates repetitive tasks, said Wednesday it was cutting its overall revenue outlook for the year. The fact that its CEO quit, to be succeeded by the company founder returning to the top job, helps explain why its stock plunged more than 30%, far more than Salesforce or Workday shares did after their reports.
On calls with analysts, company executives gave varying responses as to whether AI services were displacing their business. UiPath's incoming CEO, Daniel Dines, was the most candid, acknowledging that AI was creating a little bit of confusion with its customers as they decide which tasks are suited to using UiPath versus automating with AI.
Executives at Workday said it was hard to say. Salesforce's always-ebullient CEO, Marc Benioff, said the challenges stemmed from broader macroeconomic forces after a pandemic-era boom in software purchases by companies, not from AI.
Even if AI may be more of a benefit than a death sentence to these companies' businesses, it's certainly not helping them yet.
Software analyst Brad Zelnick of Deutsche Bank, for instance, sees the latest rout as a sign that investors are lowering their expectations around how quickly, and to what extent, software companies will benefit from integrating AI into their products.
It's certainly going to take more time than people thought, and I think the reasons for that are manifold. Some of it comes down to just risk aversion, and large enterprise customers wanting to see the early adopters' [user] experiences before they're going to dive in, Zelnick said.
That's perhaps the most optimistic view.
Others on Wall Street are much more bearish. Typical of the downside case was this comment on X, posted by Tobias Francis, founder of wealth management firm Atlas: AI tools have enabled an entire generation of startups to build clone products of massive companies with skeleton teams and offer them for 10% of the cost.
Benioff, not surprisingly, takes the AI bull argument. He proclaimed that AI models, which Salesforce licenses from OpenAI and others, would unlock so much more commercial potential for the firm by bringing together disparate functions such as sales, marketing and customer service.
Benioff argued that the data Salesforce sits on—-over 250 petabytes, as he mentioned several times on Wednesday's earnings call—-would be more important than building the best models or user interface in terms of unlocking value from AI. For reference, one petabyte of data is the equivalent to the amount of storage space a person would need if they took 4,000 digital photos every day for the rest of their life, according to software firm Cobalt Iron.
To some extent, he's right.
Customers might find it more convenient to use AI that's built into software they've already used for years rather than going directly to OpenAI, which would require them to move their data, which can be onerous. That dynamic should give Salesforce some confidence that its existing customers will stay loyal.
But even Benioff isn't home free just yet.
One of Salesforce's customers, consulting firm PwC, announced this week that it was buying subscriptions to OpenAI's ChatGPT for a large chunk of its workforce. Given that Salesforce's own AI tools are built on OpenAI's models, it's possible more and more customers may go direct and eventually ditch Salesforce.
The big question facing Benioff and other software bosses is whether launching new AI products will actually deliver incremental revenue – and profit – or simply convince existing customers to stick with them.