In the enterprise technology industry, the most noteworthy IPO of the year so far is one that didn’t happen — Globoforce. As a category leader in rewards and recognition, its IPO was anticipated to be a landmark moment — the first major publicly traded company in the category. However, when the company abruptly postponed its IPO on March 20 citing unfavorable market conditions, many people in enterprise technology circles were confused. We believe it’s important to explain what’s going on at all levels, and we hope that this analysis will bring some clarity and sanity to the discourse. Want to learn more? Download the full Industry Bulletin from The Starr Conspiracy Intelligence Unit.
We’ve been dissecting what happened with the Globoforce IPO and whether or not the recent news is an indication of a cloud bubble about to burst. To understand what’s going on with Globoforce, we first need to talk about the two growth models in enterprise software.
The business reality of enterprise software in the cloud is that fast-growth tech companies funded by VC, PE, or IPO money will operate at a loss while they grab market share — even Workday and Cornerstone OnDemand.
In any enterprise software category, there are two types of companies: profit companies and market share companies. Profit companies focus on a business model that is familiar to most — they are in business to make money and must see black ink on the books every month. Typically, a profit-driven company will spend about 5 to 10 percent of gross revenue on sales and marketing, but can go higher if the company wants faster growth. Typical year-over-year growth for these companies is 10 to 33 percent.
Market share companies operate in a fundamentally different way. They spend disproportionately on sales and marketing in an attempt to capture market share to increase valuations ahead of an IPO or an acquisition. It’s not uncommon to spend 25 to 35 percent or much more on sales and marketing for market share companies because they aim for 40 to 100 percent year-over-year growth. There are three steps to this model:
- Step 1: Secure private funding. Overspend on sales and marketing.
- Step 2: Go public. Expand market share and platform capability with multiple acquisitions. Overspend on sales and marketing.
- Step 3: Get acquired. Shift to profit strategy. Pull back on sales and marketing.
A good example of the market share strategy in enterprise technology played out in the integrated talent management category:
- SuccessFactors won the category when SAP acquired it in 2011 for $3.5 billion (11.9x LTM).
- Taleo finished second when Oracle acquired it in early 2012 for $1.9 billion (6.2x LTM).
- Kenexa finished third in the category when IBM acquired it in mid-2012 for $1.3 billion (4.1x LTM).
Even though SuccessFactors and Taleo were similar in size in terms of revenue, SuccessFactors came in first and commanded the premium in part because of its willingness to invest in sales and marketing — 47 percent of gross revenue in 2011. This investment eclipsed the level of investment of Taleo (36 percent in 2011) and Kenexa (23 percent in 2011).
You can look at SEC filings for companies across enterprise technology and HCM software in particular. We have. These trends hold up over time. It’s something we believe in like we believe in electricity. It just is.
Want to learn more? Download the full Industry Bulletin from The Starr Conspiracy Intelligence Unit.