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Lessons from the death of a tech Goliath

January 23, 2014: 11:47 AM ET

Salesforce's ascent and Siebel's demise has long been characterized as a classic Silicon Valley tale of the little guy triumphing over the giant. The facts are quite different.

By Bruce Cleveland

David and Goliath

FORTUNE -- Not too long ago, I was asked to speak to a class of MBA students at INSEAD. Before I began my presentation, I asked the students how many were familiar with Siebel Systems, where I had spent 10 years as one of the members of the founding senior executive team.

Only about a third of the class raised their hands. Seven years had passed since Oracle acquired Siebel, which created the customer relationship management (CRM) business, now dominated by Salesforce (CRM). I was the head of Siebel's products division when it was acquired by Oracle (ORCL) in 2006.

Six months after Siebel was acquired by Oracle, I joined InterWest Partners as an investor. And, since that time, dozens of entrepreneurs have passed through our offices to present their new software business ideas. The theme of the presentation typically goes something like this: "We are going to do unto [fill in your favorite large incumbent tech company] as Salesforce did unto Siebel Systems."

The basic premise is that Salesforce summarily dismantled Siebel through its revolutionary software as a service (SaaS) business model and took so much market share away that by 2005 Siebel was forced to sell to Oracle. The proverbial story of "David defeats Goliath" played out in the high tech industry.

It sounds like a nice tale, but it's little more than that. The facts are quite different.

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Siebel Systems was founded in 1993 by Tom Siebel and Pat House. Within five years, the company went from little-known startup to a nearly $2 billion a year powerhouse, with 8,000 employees and a market cap of $30 billion. It was the leader of the CRM market. In 1999, Siebel Systems was recognized by Deloitte as the "Fastest Growing Company" in U.S. history, with 782,978% growth over five years.

By 2002, the company's top line had stalled, the stock had fallen to a fraction of its former stratospheric level, and on Sept. 12, 2005, Oracle signed a definitive agreement to acquire the company. The transaction was valued at a little more than $6 billion. On March 1, 2006, Siebel Systems no longer existed as an independent entity, a rather inglorious end to a once unassailable company.

Siebel started out developing enterprise sales software. And, these applications were responsible for Siebel's initial growth. However, Siebel also had developed call center technology. In 1998, Siebel made a key decision to acquire Scopus Technology -- a company in the call center market that was nearly as large as Siebel. That decision dramatically changed Siebel's revenue mix and propelled the company into hyper growth.

Over the next three years, a significant amount of Siebel's revenue growth was due to the rapid conversion of the world's custom-built call centers to Siebel's call center applications. In fact, the Siebel call center product line was responsible for 70% of Siebel's revenues during the company's peak sales years.

However, in 2001, a global recession hit. Businesses began to cut back on expenses in all areas, but especially in IT. And, one of the industries most heavily affected by the recession was the telecommunications sector, Siebel's largest source of revenue.

During the recession, enterprise customer relationship management projects across all industries were put on indefinite hold. The people who had been assigned to those projects were let go or reassigned to other projects.

SAP (SAP), Oracle, and IBM (IBM) suffered through the recession as well. But Siebel Systems' reliance on telecom wreaked havoc on its revenues overnight, and it stayed that way for three years with no end in sight.

Why didn't the recession hurt Salesforce? From 1999 to 2004, Salesforce primarily sold its software to small companies and divisions of larger companies across the U.S. that couldn't afford, or didn't want, a "complex" enterprise CRM system. The average seat count for Salesforce was around 24 per company. By contrast, Siebel sold into large enterprises with a complex product line and had 5,000 customers with 5,000,000 active seats, an average of 1,000 seats per customer.

With the recession in full swing, there were few IT workers in place to install Siebel applications. Salesforce needed no IT -- well, very little IT -- and it was able to fill a gap in the small and medium size business market segment that Siebel could not easily move into.

Siebel was optimized to sell to large companies and had on its roster a large, expensive direct sales team. Salesforce was built to go after the small and medium-size business market, with nimble internal telemarketing, and telesales teams.

In 2005, Salesforce reported $176 million in revenue when Siebel recorded around $1.4 billion. Siebel was nearly eight times the size of Salesforce and could not easily change its business model.

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Through 2005, the growth of Salesforce was primarily fueled by its uptake in the small and medium-size business market, while Siebel was dragged down by a drop in demand from large companies. Salesforce came out on the other side of the recession in 2006, filling the void Siebel left behind.

In the summer of 2005, Siebel's turnaround plans were interrupted by Larry Ellison's surprise offer to acquire Siebel Systems. Siebel's board approved the offer.

The process of integrating the two companies left Salesforce virtually unopposed in the CRM market for the past eight years. As a result, Salesforce now has significant market share and recently entered the call center market with an offering called "service cloud."

While Marc Benioff didn't create this market, he did reimagine how CRM and other business applications could be delivered via a new type of business model -- software as a service (SaaS). For that, he deserves to be recognized and rewarded.

So, what can companies competing in the market today learn from this history lesson?

  1. Business models are stubborn creatures. Once the "DNA" of a company -- the business model -- is set, it is very difficult to modify. Today, software companies that rely upon a perpetual license "do it yourself" model struggle to compete against the software as a service business model.
  2. Always be adapting. No matter how successful your company currently is, you should always be willing to adapt to the market and competitors, despite how small or seemingly inconsequential they may appear. The moment you hear a senior executive stand up on stage or in a meeting and say something like, "We will win this market because we are smarter and bigger than everyone else," it is time to get nervous. Very nervous.
  3. Diversity is your best shot at survival. It is critical that your company not rely on any one product or any one market for too long. The very thing that drives your success today may be your undoing in the future.
  4. Architecture is critical. Today, your product architecture may enable you to compete and win in the market but it will surely be a drag on your business in the future. Your ability to recognize when that is happening and to actually do something about it in time will determine whether your company survives.
  5. Beware of the status quo. Large organizations thrive on status quo and attempt to kill anything that appears as though it may upset it. New products, new business models, new employees, new processes are all anathema to the status quo. Large organizations and Wall Street reward predictability and reliability; they abhor uncertainty and instability, the very things that innovation foments. This is why true "innovation" is seldom found nor survives inside the four walls of a large and successful incumbent. Today, it is becoming popular to create a chief innovation officer to foster internal innovation -- this reads well in annual reports to shareholders. But unless companies move innovation outside the legal, technical, and business constraints of the existing company and allow people to build businesses that may cannibalize and destroy the existing business of the parent company, these well-meaning efforts are doomed to failure.

The mythical story of "the David" Salesforce slaying "the Goliath" Siebel that has been propagated over the years may play well inside the halls of Salesforce or in various industry reports, but the truth is far more pedestrian.

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Both companies were headed toward an eventual collision. But Siebel succumbed well before such an epic battle occurred, to a much bigger problem -- a global recession. And once Siebel was acquired, few of the people who made the company successful stayed at Oracle.

In another 10 years, I wonder which companies MBA students will be studying and discussing in their classes. Will Salesforce survive an impending transformation or will a new startup emerge with a new technology -- and perhaps a new business model -- that upends the unassailable CRM leader?

Bruce Cleveland has been part of InterWest's IT team since 2006, focusing on investments in the software and services sector with an emphasis on mobile, cloud computing, and analytic applications.

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