App EcoSystems in Enterprise Software

How PaaS is accelerating the creation of new cloud SaaS companies and why this is Salesforce's biggest moat and growth driver.

This is the third article in the series on The Salesforce FlyWheel. You can read Part 1 and Part 2 here.

In Part 2, we covered why PaaS is a big deal for both vendors and clients. In this article, I will traverse the arc of application ecosystems over time and discuss how PaaS is creating a new generation of SaaS companies.

Let us first take a stroll down memory lane to understand the history (or lack thereof) of software vendors’ platform strategies and ISV ecosystems.

History of App Eco-Systems

While enterprise software has been around since the 1970s, few application vendors prior to late 2000s even entertained the concept of an eco-system for developers. This was for either or both of two reasons: a) Not wanting to share the market with other application software companies, and b) Not having a platform that developers could build on.

A couple of examples may be instructive in understanding this.

SAP

By the early 2000s, SAP —founded in 1972— had built one of the largest ecosystems ever for a software vendor. Large enterprises were spending 5-7x SAP license spend on its partners—systems integrators, OS, database, and hardware vendors. But there were few application vendors in the SAP ecosystem. SAP’s default mindset was to own the application layer in its entirety; the purpose of its ecosystem was to implement SAP products for its customers, not create complementary products; its platform was a workbench for customers and integrators to customize the product, not a full-stack platform for developers to build new applications.

This strategy did not change until NetWeaver (the brain child of Shai Agassi) in the mid-2000s. NetWeaver subsequently morphed and merged into a carousel of descendants with fancy monikers, but legacy products, hybrid delivery models, and large M&As with disparate technologies have hurt SAP’s ability to pursue a coherent strategy for PaaS and a robust app ecosystem. Circa 2020, SAP has a cloud platform and an app store, but it is unclear how actively these apps are used by customers or if any of its own products are even built on the platform. A closer look suggests they are more connectors, extensions, and add-ons than full-blown applications built on an end-to-end SAP cloud development stack. [1]

Siebel

Siebel Systems — the OG of CRM— had the ISV ecosystem opportunity staring in its face all along. In my own experience of working there from 1999-2005, I saw countless examples of systems integrators and customers building custom applications atop the underlying platform.

The platform was truly best-in-class and even now considered the progenitor of Salesforce. But at that time, Siebel did not see itself as a platform company. It wanted to be the sole developer of apps on its platform. At its peak, Siebel expanded into a number of new markets beyond its core —Integration, Employee Relationship Management, CPQ, etc.— in rapid succession. Look closer and you can draw a direct through-line from that to more dissatisfied customers, a distracted management, and the eventual disruption of its core market.

As late as 2005— notwithstanding claims of adhering to SOA (Service Oriented Architecture), point-to-point connectors, etc. —no large application vendor had built a developer platform or a real ISV eco-system.

The Salesforce ISV Ecosystem

When Salesforce started gaining traction in the early and mid 2000s and eventually launched a PaaS for developers in 2006, it seemed a laughable proposition to many. Few predicted it would catch on.

But the concept was sound, and addressed an underlying set of developer needs to build, deploy, and host that had become urgent in the new cloud era. Also, the launch of the iPhone and its App store in 2007 started priming users on the idea of downloading and using apps.

As it turned out the enterprise market was hungry for a platform, in terms of developers wanting to build, and customers willing to buy and extend.

What started as a trickle soon turned into a torrent —From just a handful of apps in early 2006, the Salesforce AppExchange now features more than 5000 apps spanning a wide range of industries and domains.

Why Was the AppExchange a Game-Changer?

Salesforce AppExchange sure got the timing right. But its success was also driven by a number of guiding principles that made the whole greater than the sum of the parts for each stakeholder.

Ecosystems are Stronger than Single Companies

The incentives for all parties are aligned to solve for the customer first; the products from varied suppliers work together well as they are designed using the same framework. It also results in a lock-in effect for the platform vendor, while offering the customer the ability to switch among vendors within the ecosystem.

It Creates a Win-Win-Win for Customer, ISV, and Salesforce

Customers receive functionality that might have taken years for Salesforce to deliver; Salesforce has happier customers, 15-25% share of the ISV’s revenues, and stronger moats; the ISV builds a new business with shorter time to market and dramatically lower costs.

The Customer POV: Customer Gets a More Complete Solution with the Salesforce Brand Promise.

Customers tired of the costs of integration between supposedly SOA compliant apps loved the idea of buying native apps built on the same platform using the same objects, accessing the same data services, and offering a consistent UX.

Apps on the ecosystem preserve all elements of the Salesforce brand promise including availability, security, upgradeability through metadata, extensibility through the platform, SaaS subscriptions, etc.

The ISV POV: An Application PaaS like Salesforce Dramatically Reduces Time to Market and Costs

If you are an ISV looking to build and deliver a cloud app, there are 3 basic choices.

1) IaaS + Custom Platform + Custom App: Build on top of AWS, GCP, or Azure IaaS Services. Do the hard-work of creating a platform and then build the applications.

The truth is cloud platforms cost hundreds of millions of $ to build and it is inconceivable today for any ISV to build their own platform. That makes this option NOT viable in most cases.

2) Generic PaaS+ Custom App: Use a PaaS like Google App Engine, Pivotal Cloud Foundry, etc. for creation and deployment.

This might make sense only if there is no need to be closely tied into a specific ecosystem, and its customers and vendors. Generic PaaS may need a non-trivial amount of work to support a domain like say, Marketing Automation or Commerce, that requires specific capabilities supporting custom experiences.

3) Domain-Specific Application PaaS + Custom App

Building cloud apps on an Application PaaS —like Salesforce Lightning— is a superior alternative for any ISV seeking to build apps in CRM or adjacent domains.

Why? Here are insights from Code Science on the top benefits for ISVs to build on Salesforce. #1 and #2 are time to market and access to the install base for customer acquisition.

“With Salesforce’s large footprint in the enterprise, partners are hungry for access to these accounts. We expect business-focused concerns (faster time to market, access to install base, and gateway to the enterprise) will continue to dominate.”

David Schmaier, CEO of Vlocity summarizes it best here:

“The AppExchange Partner Program accelerated our trajectory by five years from both a business and a technology perspective. We didn’t have to build a platform that would cost hundreds of millions of dollars. We got to use the Salesforce Platform. We didn’t have to build relationships with various companies by ourselves. We got to do that in concert with Salesforce.”

The Salesforce POV: The ISV Eco-System Offers a Risk-Mitigated, Smarter, and Sustained Growth Strategy With Optionality

Salesforce has been wise to not repeat the mistakes of software companies that expanded into too many markets too soon, all on their own, and without mindful of the concomitant risks.

In contrast, Salesforce has stayed away from the areas they do not understand well or consider as higher risk, letting companies in its ecosystem address industries and domains with specialized needs. This is uncommon in the software industry where vendors with strong brands have hesitated to share opportunities with other players.

Consider Veeva CRM in Pharma that has grown to be valued at $30+B, Vlocity in multiple industry verticals that was bought by Salesforce for $1.3 B, or nCino in Banking that is now valued at $7+B after the recent IPO. All three were built on the Salesforce Platform. Being the underlying platform for Veeva and nCino alone might contribute an additional ~$6B to Salesforce valuation. (~ 15% of $37+B).

The ability to a) be judicious about what to build on its own vs. what to let the ecosystem build, and b) know when/where to elevate the stakes by acquiring select ecosystem partners have allowed Salesforce to have the cake and eat it too: i.e. retain focus on the core without losing access to new market opportunities.

Mastering these competencies and getting it right more times than not is no small thing in this business. And Salesforce Ventures has played a pivotal role in executing this strategy.

Corporate Venture Investments

Salesforce’s corporate venture arm is the single largest VC in the Salesforce App Ecosystem. For example, it made 43 investments from 2017 to Q3 2019. The next highest was 14 by Insight Partners.

From Salesforce Annual Report, 2019,

“As of January 31, 2020, our portfolio consisted of investments in over 260 companies, with capital investments ranging from less than $0.3 million to approximately $300 million, and 27 investments with carrying values individually equal to or in excess of approximately $10 million.”

The total capital deployed into active investments (excluding exits) as of Feb 2020 is $1.5 B with a carrying value of $1.9 B (unrealized gains of $400M). Note that this does not include exited investments (more than 91 to date) [2]

Salesforce Ventures has taken significant equity positions in several ecosystem companies, and in select cases (Vlocity, Steel Brick, etc.), Salesforce has purchased them at reasonable valuations a) once they attained product market fit, b) after the technical and market risks had been mitigated, and c) the products were ready to be distributed through Salesforce’s formidable direct sales channel.

Venture investments provide Salesforce the ability to influence the direction of these companies, and keep a close eye on their progress by serving on their boards. It also builds a high quality M&A pipeline for select areas where Salesforce may decide to exercise the option to play. [3] [4]

PaaS Offerings and Their ISV Ecosystems Are Driving the Next Generation of SaaS Companies

From the Code Science Report on the state of the AppExchange,

“AppExchange ISVs represent roughly 7% of global SaaS companies. However, in looking at the global funding for SaaS companies ($13.2 billion), AppExchange companies received roughly 19% ($2.5 billion). AppExchange ISVs represent a greater share of investment dollars proportionately.”

Remember that we are in the early stages of PaaS. Outside of Salesforce and smaller ecosystems like Atlassian and Shopify, Application PaaS offerings are relatively immature.

ServiceNow, Workday, Intuit, and several others are aggressively building their PaaS offerings, so it is not crazy to suggest that the vast majority of new Application SaaS companies in the next decade are likely to emerge from PaaS ecosystems. Their growth and success will likely provide fresh tail-winds for the platform vendors, driving a virtuous cycle of growth between PaaS offerings and their SaaS offsprings.

In the next piece in the series, I will discuss the role of M&A in the growth of Salesforce, the playbook it has used to expand both technology capabilities and TAM, and how PaaS mitigates a number of M&A risks.

---

Foot Notes:

[1] Do you know of a successful SAP Cloud ISV operating at scale that has either been acquired (or) gone public? I don’t either. Note that SAP uses Cloud Foundry beneath the hood.

[2] https://www.crunchbase.com/organization/salesforce-ventures/recent_investments

[3] ROFR (Right of First Refusal) rights are typically part of Corporate Venture investments and provide special M&A privileges to the corporation making the investment

[4] It will be interesting to analyze returns of corporate venture capital funds for different companies (SAP, Salesforce, Oracle, etc.). Prima facie, it appears as if Salesforce Ventures acts more as a well-deployed tool of corporate strategy, solving for long-term success of Salesforce products and its ecosystem, and less as an autonomous VC fund. SF Ventures has raised 12 funds, each ranging from $50-$125M, and has paved the path to several successful Salesforce acquisitions at attractive valuations.