It doesn't help Slack's case that Office 365 Commercial has over 180 million active monthly users (across Word, Powerpoint, Excel, OneNote, Outlook) which means Microsoft has an upper-hand in freely distributing Teams to all their existing business customers. Those business customers also happen to be some of the largest companies in the world. In 2019, Microsoft claimed that 91% of Fortune 100 companies already use Microsoft Teams.
A free add-on is also a much easier sell than a product that costs money. While Slack needs to make money exclusively through Slack subscription fees, charging between $6.67 and $12.50/user/month for access, Microsoft can bundle Teams as a free add-on for their 180 million existing Commercial customers.
On the surface these seem like significant advantages for Microsoft Teams, but they don't seem to be impacting Slack's recent push into enterprise customers.
Slack's Enterprise Shift
Slack’s early success came from small and medium-sized businesses. As late as Q4 of 2016, Slack only had 135 customers paying more than $100k per year for Slack. In comparison, Slack had tens of thousands of smaller customers contributing the vast majority of the company’s revenue.
The following quarter (Q1 of 2017), Microsoft Teams launched - a product that the world’s largest enterprises were expected to adopt. From Q2 of 2017 onwards we should have seen the first indicators of Microsoft’s potential to steal enterprise customers away from Slack, but that didn’t happen.
In fact, Slack’s gain of 29 new enterprise customers from Q4 2016 to Q1 2017 was the smallest gain that the company has seen since. Slack has consistently earned more enterprise customers than ever before in almost every quarter since Microsoft Teams was released.
By Q1 of 2018, Slack had 351 customers paying over $100k/year and those enterprise customers represented 36% of Slack’s overall revenue. This was the first time Slack began reporting the % of revenue derived from enterprise customers (companies paying over $100k/year), and it has never been as low as 36% since.
In the most recent quarter, Slack saw by far their largest increase in enterprise customers in company history - as their competition with Microsoft Teams heated up. 101 new enterprise customers joined Slack (up to a total of 821), and they now represent 47% of Slack’s total revenues (up from 43% in the past two quarters). So not only is Slack rapidly adding new high-value customers, those customers are also making up an increasing percentage of Slack’s fast-growing revenue.
That’s because the monthly revenue derived from enterprise customers has shot up. The average Slack enterprise customer paid between $27K and $29K per month in 2018 and the first two quarters of 2019. But this past quarter, Slack’s average enterprise customer paid Slack $32,196 per month. A clear outlier from an otherwise steady trend.
Can Slack's Enterprise Business Compete With Microsoft Teams?
Slack's recent enterprise wins could either be a one-time event, or a turning point towards more valuable enterprise customers. At first I was skeptical, but after reading management’s commentary from the Q3 earnings report, I am confident that this trend will continue for two reasons.
First, management didn’t mention any significant one-time outliers that may have contributed to the rapid rise in enterprise customers, nor did they mention that investors should expect lower enterprise numbers in Q4. Instead, they signaled the recent success they’re having and their increased focus on larger enterprise clients. This is a quote from Slack CFO Allan Shim on the Q3 earnings call:
“We expect large customer growth to exceed total paid customer growth for the foreseeable future, as we invest more in enterprise sales and customer success.”
Allan continued by mentioning that Slack’s sales and marketing expenditures would be growing to over 50% of Slack’s revenue in Q4, up from just 46% in Q3.
Some may look at it as a negative that Slack is spending more money on marketing (when they’ve never made a profit), but such a conscious increase in sales and marketing spend is often a good indication that a companies prior efforts were successful.
Second, Slack noted in their Q3 conference call that nearly 70% of their largest enterprise customers are also Office 365 customers. These customers had access to a free "Slack competitor", but instead chose to pay money for a more feature-rich product. That says a lot about the quality of Slack's product, and how enterprise customers are valuing Slack's ability (vs. Microsoft's) to save their company time and money.
My take is that Slack knows that they’ve won the enterprise segment and they’re doubling down specifically on enterprise sales.
Why Is Slack Focusing On Enterprise Customers?
Because Slack’s largest customers can best take advantage of Slack's newest feature. Shared channels. It’s a feature that connects Slack customers with their external vendors, partners, agencies, and suppliers through dedicated channels on Slack that both companies have access to. It means internal and external back-and-forth emails are a thing of the past for Slack customers.
This is the first true network effect that Slack has built, and the network effect is most powerful when it starts with large enterprises.
Small startups may have one or two external partners, maybe a marketing agency and an external accounting or legal team. In all likelihood, the small startup doesn't have enough leverage to convince their (probably larger) partners to switch over to a new collaboration tool just for their convenience.
But when a Fortune 500 company is convinced that Slack improves the way their company works, they’ve got enormous leverage over their dozens, or more likely hundreds of (probably smaller) partners. They can convince partners to switch over to Slack, and once those partners open shared channels with other clients, the network effect starts to expand.
In fact, Slack has already seen cases of businesses paying out of pocket for the Slack memberships of their external partners - just for the convenience of keeping all internal and external communication on Slack. That's powerful.
And the most exciting part is that this is a feature that has only been in full production for a few months. The earliest beta testing began in 2017, with just over 4,175 customers using shared channels at the end of 2017. By the end of 2018, there were 15.093 customers testing shared channels.
But it was only in fall of 2019 that the feature was rolled out for general availability, and the usage has been impressive. As of Q3 2019, there are over 26,000 organizations on Slack using shared channels, and over 70,000 shared channels between them have been created.
Remember, Slack only has 105,000 paying customers, so 25% of them are already sharing channels with external partners. By focusing on enterprise customers, Slack is building a secondary (and free) sales force of influential corporations that try to convince all of their partners to collaborate through Slack. And best of all, it's a feature that Microsoft doesn't offer in their Teams application.
Slack CEO Stewart Butterfield has an intimate knowledge of network effects, having founded Flickr prior to launching Slack. His comments about the power of Slack’s shared channels network effects should not be taken lightly. In his blog post about why shared channels are so cool, he said:
I’ve been making network-based software for a living for the last 20 years. Over that time I’ve worked on a lot of great projects directly, and have seen many more from the inside, as an investor, board member or just as a friend. I have never been more excited about a product or its product market fit than I am about shared channels.
Shared channels is a feature unique to Slack, and at a certain point, Slack’s network effect of connected companies may grow too large for Microsoft to overcome.
This is Slack’s shot to build a world-class moat around their product and protect themselves from increasing competition from Microsoft.
Personally, I think Slack’s shared channels network effects are already too large for anyone to overcome, but we’ll get further clarity on the progress of the network during their upcoming Q4 ER.