In a year of many changes and shakeups in the technology world, the recent news that Salesforce would acquire Slack for $27.7 billion (!) definitely raised eyebrows. What, exactly, did the veteran customer relationship management (CRM) company want from the breakout chat application? Why did Slack, which had seen record growth this year, sell? And just how much value could be created from combining a sales tool with an email substitute? The news left a lot of folks scratching their heads — and Salesforce’s stock dropped more than 8% after news of the deal surfaced.
On the face of it, the two companies don’t have much in common. Salesforce pioneered the category of software as a service (SaaS) for enterprise customers. It built upon its flagship CRM offering to eventually include a portfolio of related marketing and analytics applications, and a cloud infrastructure services business. Slack, on the other hand, achieved great popularity as a communication tool, primarily used within organizations (although it’s recently aimed to be used across organizations as well).
What the companies share, however, is the threat of Microsoft. While Salesforce’s CRM sustains a strong position against Microsoft’s competing offering (Dynamics 365), it faces steep competition from Microsoft in business analytics (Tableau vs. PowerBI), and it relies on Microsoft (along with Amazon and Google) to host its services in the cloud. The direct threat to Slack is more existential: Microsoft’s 2016 announcement of Teams, an enterprise chat and videoconferencing application. While Slack really is better at chat than Teams in many ways, Teams is effectively free to most customers — either through a standalone free version or as a bundled add-on to Office (formally, Microsoft 365), the world’s most popular SaaS offering. The bundling explains why, by late 2019, Teams had nearly twice as many daily active users as Slack.
The motivations for this acquisition — and the reasons it could turn out to be a mistake — reveal a lot about the nature of competition in the technology industry today. Until this deal, Slack epitomized what we refer to as the best-of-breed strategy: focusing all efforts on maximizing the quality of a single standalone application. But Slack’s combined effort with Salesforce is a pivot to what we refer to as the integrated bundle strategy: an ecosystem of applications that are sold together, where those applications do not necessarily have to be the best in their categories (and are often not). The acquisition puts Salesforce CEO Mark Benioff one step closer to his vision of offering an integrated bundle of applications that comprehensively connect enterprises with their customers — and offers Slack a modicum of security as part of larger ecosystem.
Technology leaders today face the same strategic decision as Slack: When should you go it alone and strive to be best-of-breed? And when it is better to just be a part of the integrated bundle? Victory (and survival) depend on picking the right strategy.
Competition between best-of-breed and integrated bundles has been a central focus of our recent research. In the early months of the pandemic, we began researching Zoom — an exemplary best-of-breed success story — to develop a case study to teach our students about how having the right early strategy and culture can position firms to leverage unexpected customer opportunities. We spent hours (on Zoom) meeting with executives to understand their strategy and their path forward — the foundation for several quarters of explosive user and revenue growth.
We are also deeply familiar with Microsoft’s technology, and one of us (Wu) has spent many hours speaking to its executives about the company’s broader cloud strategy, which includes Office.
This background helps contextualize Slack’s predicament — and decision to sell. Despite their divergent outcomes this year, Slack and Zoom share some key similarities (and differences). First, both serve as excellent illustrations of the best-of-breed strategy. Second, both face a well-heeled competitor fighting with the integrated bundle strategy — Microsoft’s Teams, part of the Office suite, offers chat and video capabilities, directly challenging both companies. By assessing Slack and Zoom in their competition with Microsoft, we can identify takeaways for entrepreneurs hoping to succeed as best-of-breed and executives pushing integrated bundles.
Put simply, the core strengths of the best-of-breed strategy derive from focus. Because the goal is to ensure that the application is the best of all available options, best-of-breed companies never have to move resources to other projects or accept trade-offs that undercut product quality. The strategy also opens up novel partnership options. But Slack may have found that these strengths didn’t translate into a long-term advantage against a competitor like Microsoft.
Organizational prioritization. Under a best-of-breed strategy, managers exclusively commit engineering, sales talent, and cash to the single application without other offerings competing for their attention. Dedicating excess resources (which academics fittingly refer to as “slack” resources) allows mangers to be more agile in how they innovate, as they continually adapt their application to keep it the best. Before founding Zoom, CEO Eric Yuan worked for Cisco on its WebEx videoconferencing application, eventually leaving in frustration in 2011 because in his 10 years there, he “did not see a single happy [WebEx] customer.” WebEx was never Cisco’s priority — instead the company poured cash into networking hardware and eventually security software.
Product trade-off mitigation. Focusing on a single application also sidesteps the need to make difficult decisions trading off the quality of one application against others for the sake of integration. Cisco had to make sure WebEx could perform best with its own VoIP phones and hardware, sacrificing the WebEx user experience on other hardware. Until recently, the forced integrations between Microsoft Word, OneDrive, and SharePoint caused crashes and lost files when saving. Best-of-breed Dropbox optimized solely for file hosting — ironically making it safer to save a Word document on Dropbox than on OneDrive.
Customer-side customization. Because a best-of-breed application doesn’t force or push customers to adopt and pay for a whole bundle, it allows customers to optimize their overall experience by picking and choosing what they want without paying for redundant services. Instead of purchasing the whole Microsoft 365 package, a customer might prefer to use the best videoconferencing (e.g., Zoom), the best file hosting (e.g., Dropbox), and the best presentation design (e.g., Prezi), and so forth, all from different vendors.
Partnership opportunity and platformization. By remaining narrow, the best-of-breed can present itself as a non-threatening partner to other best-of-breed applications in different categories. Sustaining this position leaves open a growth opportunity to transition from a lone application to a multi-sided platform that creates value by allowing for integration with other complementary best-of breed applications. When Zoom launched its Zoom Apps platform in October 2020, it counted Dropbox and Slack among its 25 launch partners. In the best-case scenario, this opportunity can generate a virtuous cycle of indirect network effects between end users and third-party complementors, leading to mass adoption, as recent research by Wu and co-authors shows.
By contrast, the integrated bundle strategy offers economies of scope and scale across applications that benefit customers or lower costs for the firm. To justify the Slack acquisition, the resulting Salesforce integrated bundle must be able to demonstrate some of these benefits.
Higher pricing. Through what economists refer to as price discrimination, the integrated bundle can generate more revenue than the applications sold separately. For example, imagine that there are two customers for Office applications — call them Scott and Andy. Scott would pay $10 for Word and $8 for PowerPoint, while Andy would pay $8 and $10 respectively. If Microsoft sold Word and PowerPoint separately, it could generate the most revenue by charging $8 for each application — the highest price under which both Scott and Andy would buy both — leading to $32 (= 2 × ($8 + $8)) in revenue. However, if Microsoft sells the two applications in one bundle, then the company can charge both Scott and Andy $18, earning $36.
For this to work, customers must differentially value the applications in the bundle but still have some desire for both. Are there customers that want both Slack and Salesforce CRM, with some valuing Slack more while others value Salesforce CRM more? It is certainly plausible, although this is probably not the main motivation for this particular acquisition.
Efficiency in go-to-market sales. By giving its account managers and third-party channel partners more to sell, the integrated bundle can get more bang-for-the-buck on customer relationships. Existing customers on one application can be cross-sold another application. Moreover, an integrated bundle can justify a higher cost of acquiring a new customer since the revenue potential is greater. As the quintessential example of this advantage, Cisco uses its customer relationships in networking hardware to sell both WebEx and security software, a now routine process that Wu has examined.
This was a major weakness of Slack: Its sales efforts could never be as efficient as the massive and experienced Microsoft enterprise sales force, amplified by Microsoft’s deep network of partners like Accenture and decades-long customer relationships. The Salesforce and Slack sales effort can be more efficient together than separately, even if it still pales in comparison to Microsoft.
Driving value through integration. In theory, complementary applications can create more value when they are integrated. Remember, there are two key stakeholder types for a given enterprise customer: the end user and the high-level executive (usually a CTO) that makes the actual purchase. As end users of Office, we may appreciate being able to directly edit Excel graphs in PowerPoint so we don’t have to switch between applications. But it was the Harvard CTO — not us — who made the decision to subscribe to Office. And for the modern CTO, who manages dozens of services, the value of integration comes from being able to just go to a single vendor, say Microsoft, when anything goes wrong.
Salesforce likely hopes to create value for both users and CTOs by integrating Slack into the Salesforce CRM. In particular, Salesforce CEO Marc Benioff has had a long-running vision to replace email. Integrating Slack’s ongoing foray into inter-business chat would give salespeople using the CRM a seamless way to communicate with customers, without having to leaving the CRM to email or make a phone call. Third-party developers often help with this innovation — Salesforce already has a sizable ecosystem of third-party applications, and Slack brings 2,400 Slack-supporting applications into the fold. And CTOs would now have one less vendor to deal with when salespeople have technical problems.
The make-or-break question for a best-of-breed application is whether the incremental customer value it offers can beat out the convenience and across-application value offered by an inferior application included in a bundle.
Think about it like this: If most enterprises already subscribe to Microsoft 365, then best-of-breed applications competing against Microsoft are likely asking customers to purchase their applications redundantly with something already (or soon to come) in the Office bundle. Customers will only pay for a redundant best-of-breed application when it really distinguishes itself from the “free” applications already included with Office. When Microsoft launched Teams in 2016, Slack took out a full-page advertisement in The New York Times arguing that to get customers to switch, Microsoft was “going to have to match our commitment to their success and take the same amount of delight in their happiness.” Unfortunately for Slack, that wasn’t quite true: “free” (or at least, “zero marginal cost”) can be a powerful motivator for customers.
There are several factors that allow a best-of-breed application to achieve the difficult benchmark of customers being willing to purchase redundantly — and many specific considerations that depend on the application category and the type of customer targeted. But there are two key questions that just about every best-of-breed company needs to consider:
Do incremental improvements create disproportionate customer value? Answering this question boils down to (1) how intensely customers use the application and (2) whether the application is mission-critical for the customer.
First, end users need to use the application intensely — frequently enough and for long enough time to care deeply about their experience. Customer value from the marginal superiority of a Zoom video feed is a function of the fact that office workers now spend a huge percentage of their time every week in videoconferences: at that level of usage, small visual distortions, like when a video feed drops off, get really tiring and impair engagement and productivity. On top of that, incremental quality has a multiplicative effect on the customer value. The more comfortable Zoom is to use, the more hours we will (or can) use it.
Unlike videoconferencing, most users never really fully immerse themselves in a chat conversation for long periods of time: They tend to glance at Slack, not spend hours at a stretch on it. A few small aberrations or inefficiencies in chat might go unnoticed and certainly won’t be draining.
Second, the application must be mission-critical to the decisionmakers who decide to sign the check. It does not need to be mission-critical all the time — just in key moments where even minor failures are unacceptable. For example, our dean considers teaching to be a top priority, and it would be absolutely unacceptable to him if our videoconferencing application failed during a class. Thus, Harvard Business School spares no expense to ensure we are using the best-of-breed applications, including Zoom, for everything pertaining to the classroom. On the other hand, a 30-minute outage in our chat system would be survivable.
Is the customer positioned to maximize potential value? To a large extent, this question comes down to how large the customer is: Global enterprises are better positioned to get the most value from best-of-breed applications as opposed to small- and medium-sized businesses (or consumers). When the customer has scale, the incremental advantage of a best-of-breed is easier to justify the cost of and pays more dividends.
First, large sophisticated enterprises have the scale and resources to effectively build their own bundles — they don’t need someone else to do it for them. A smaller customer would be better off just getting the integrated bundle, as it does not have as many end users that can benefit from the customized effort.
Second, many best-of-breed applications also rely on direct network effects to create value: Slack is only valuable if many other people in the organization use it. Often that means that a high-level decisionmaker needs to tell everyone in an organization to install and use the application to ensure the internal installed base is large enough that the investment pays off. Indeed, in order for Andy to chat with Scott using Slack, both have to have it installed and check it regularly. If people are used to another form of messaging, such as email, then there isn’t as much value from being on Slack, specifically — and that means the application doesn’t create enough value to justify buying it separately.
Yet Zoom does not rely as heavily on this network dynamic. If Andy sets up a meeting with Scott and sends him a Zoom link, Scott does not need to have Zoom at the ready to take his call. Scott could still take the meeting with Andy even if Scott had Teams as his default videoconferencing application. (For the record: he does not!) It’s easier for best-of-breed applications to gain an advantage when they don’t rely on network effects — but of course, this isn’t always a choice.
If a best-of-breed product doesn’t already face an integrated bundle competitor, it is virtually inevitable that some bundle provider will try to move into the space. Once that happens, existing integrated bundles will stick around and compete — likely sinking a lot of money into protecting their overall product. Microsoft doubled down on Teams once it saw the opportunities (and potential threat to Office) demonstrated by Slack and Zoom. Google aimed similarly with recent upgrades to its Meets messaging and videoconferencing. An integrated bundle doesn’t have to innovate on its own, it just has to imitate the best-of-breed, which it can often do quickly thanks to superior resources.
Whether the best-of-breed stay ahead of a deep-pocketed integrated bundle depends on several factors:
Potential to maintain product distinction. For a best-of-breed application to sustain its lead against a bundle, it must be technically possible to continually build on that lead by incrementally improving the product as competitors copy the best-of-breed’s past innovations. For a chat application like Slack — whose innovations in topic-based channels and fun user interfaces are visible to competitors and easily replicable — that could prove a real long-term challenge.
Again, consider Zoom. Most people have forgotten this already (or maybe never noticed) but Zoom pioneered the concept of the virtual background in videoconferencing, which required significant investments in technology around computer vision. Once Zoom proved that this was a meaningful feature to have, the virtual background became a bull’s-eye for competitors — and others rapidly began replicating the feature. But products like videoconferencing improve through complex technology advancements protected by trade secrets or patents, which buy applications like Zoom crucial time to maintain their lead while working on its next big product innovation. Indeed, the virtual background took Microsoft months to copy, and Zoom rolled out a number of new features in that time. It’s not clear that Slack on its own would have been able to generate similarly defensible technical innovations in just chat messaging.
Extent of customer lock-in. For a product that relies on within-organization network effects like Slack, ease of adoption is particularly essential — but it also makes it vulnerable. Factors that lock in customers often directly conflict with design decisions made to make the product accessible or easy-to-use. A product category with a steep adoption curve raises the bar for best-of-breed customers considering switching to another application. Once customers have invested significant time and effort into figuring out features — the breakout rooms and polling features in Zoom, for instance — they do not want to have to start the whole process over again.
Importance of across-application synergies. A best-of-breed takes the bet that it can survive on the strength of doing one thing — and that novel combinations in bundles won’t render them suddenly obsolete. For example, Teams demonstrates some synergy from combining chat with document sharing, which it can probably do better than Slack given that Slack users often share Word and Excel files. If there turns out to be value in combining videoconferencing and document editing, Microsoft would be far better positioned than Zoom to take advantage of it, unless Zoom can get ahead of that opportunity now. But if there’s little value in such a feature, that will help Zoom maintain its advantage.
Potential for network effects between stakeholders. Finally, a best-of-breed application can push to turn itself into a multi-sided platform that integrates with third-party applications, creating an ecosystem that in essence is an integrated bundle of best-of-breed applications. Slack had a fairly solid ecosystem, and Zoom has recently started pursuing this strategy. But while this strategy allows for new across-application value that the best-of-breed can or will not build itself, Slack’s experience shows it might not be enough to overcome comparative weaknesses in the core application strategy.
The rise of best-of-breed applications has been of great value to all of us — especially this year, as the world has faced upheaval in how we communicate and work. Without Slack and Zoom, we would not know how valuable it would be to have strong chat and videoconferencing tools in our daily lives. The applications that previously dominated these categories, many of which existed in integrated bundles, never innovated enough to really demonstrate what was possible.
In that sense, we are rooting for future best-of-breed entrepreneurs to keep pushing the frontier in these and other categories. These entrepreneurs make us all better off. But as revealed by the Slack and Salesforce announcement, sometimes the best-of-breed needs to be absorbed into an integrated bundle. For its first significant acquisition ever in 1997, Microsoft acquired Forethought, a small company which made a best-of-breed presentation application called PowerPoint. And as was true then — and is still true today — the cycle continues.
This content was originally published here.