October 23, 2015
Salesforce.com has been experiencing diminishing gross margins during the past few years. The gross margin of Salesforce’s cloud business has deteriorated every year since the year 2011, dipping from 87% in the year 2011 to 84% in the year 2014. However, conspicuously, the company’s adjusted EBITDA margin fortunately has demonstrated improvement from 15.5% to 16% during the same period.
It is believed that the deterioration in the company’s gross margin could be as a result of its massive investments in brand new data centers that are causing progressively higher depreciation assigned to the cost of its goods sold. However, this opinion does not stand good because Salesforce’s depreciation has been increasing consistently, as a percentage of income has increased consistently from 3 per cent in 2008 to 8 per cent in 2014.
What Comprises Cost of Goods of Salesforce?
Obviously the deterioration in the company’s gross margin is chiefly because of an upsurge in the actual COGS (cost of goods sold). The company offers a service. It does not offer a product, and also, the service is usually in the form of a subscription for SaaS (Salesforce’s software-as-as-service) offerings. As such it is understood that its COGS actually is nothing, but the cost of offering these services. Such costs chiefly include customer support as well as account management expenses, hosting as well as monitoring costs, and royalties/licenses meant for embedded products.
Hosting and monitoring expenses actually include the charges incurred for hosting the company’s computing capacity which is offered to clients through the cloud. Such hosting charges could be actually rent paid for data centers or devaluation on data centers that are owned. Salesforce is known to utilize its extensive resources for building data centers instead of renting them.
Account management and customer support costs may include cost of offering services such as onboarding, customer support, troubleshooting and also, gratifying customer-specific requests. Royalties and licenses meant for embedded products also, include the amount payable to the third-party software vendors as license fee.
The Defining Factors for This Depreciation
It is not exactly possible to accurately pinpoint regions or services which are causing the margin decline for Salesforce, as the firm does not make a cost of goods sold breakout publicly available. Evident spikes in depreciation in the gross margin seem to be arising from investments into data centers.
It seems that in an effort to expand its customer base, Salesforce has made attempts to increase its bandwidth and computing capacity by investing in more servers, or data centers. They have been opening centers all over, from UK and France to Germany and as far as Japan. Just a while back, Salesforce announced that they have big plans in Germany, and intend to invest a formidable figure of $1 billion over the coming five years. These large investments have been a major source of depreciation, and will continue to do so if the company stays in its present large-scale expansive mindset.
Depreciation percentages from revenue for Salesforce rose astonishingly from 3% in 2008 to 9% in 2013. 2014 saw the figure drop to 8%, but that isn’t any consolation. The estimated plant age has suffered too, having fallen to 1.0 in 2013 from 2009’s high of 1.6. It has since risen to 1.4. This goes to show that the rapid pace of investment is augmented by a very brief interval, over which the depreciation in computing capacity has occurred. Experts have predicted the gross margin of cloud products for the company to keep falling, eventually to 80% around 2019.
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