We ❤ Slack

Slack Technologies is another recent investment we made. I’ve been following the company for a few years, and this year I had the opportunity to attend Slack Frontiers, the company’s two-day user conference in San Francisco, held in late April. I’ve been spending most of my research efforts making these sorts of trips and participating in user and developer conferences. I usually know what to expect.


I thought Slack was special, but at Frontiers I met the management team, employees and most importantly, customers large and small, and witnessed firsthand the enormous utility of the product. Lazard, Lyft, Ford, Hearst, IBM, Oracle, Shopify, Wayfair and Electronic Arts (to name a few) have thousands of users on Slack (in IBM’s case, over 165,000 seats). They all have hundreds of app integrations and the productivity enhancements they demonstrated were incredible.


Ford has software developers in different continents coding on the same project, using a Slack channel for collaboration. Hearst created a Slackbot to easily check what type of content is working across its publications, allowing the right data to always reach the right person.


Another presenter showed the deep integrations between Slack and Atlassian’s general-purpose productivity tools like Jira and Confluence (Atlassian became a Slack shareholder in 2018 after shutting down its competing product). Even 3-star Michelin-rated restaurant Single Thread, which operates a 5-acre farm, a 180-acre vineyard, its namesake restaurant and an inn, runs its entire operation on Slack.


Out of the Fortune 100 list of largest companies, 65 already are Slack users. Eric Yuan, the CEO of Zoom (another Slack user), noted that some companies can’t even hire unless they are Slack users because candidates are demanding it.


The common thread across all these stories: after watching how these companies work on Slack, you’d be hard-pressed to understand how they could possibly operate without it.


By the end of the first day of the conference, I was so blown away by what I had seen that I was convinced Slack is the future of enterprise collaboration software. And I became even more impressed by co-founder Stewart Butterfield (named Dharma at birth and raised in a hippie commune in Canada). Butterfield has been very successful at serial pivots: his first creation was a video game that didn’t catch on, but whose photo management software became Flickr. He sold it to Yahoo! for $25 million. His second creation was a game called Glitch which also didn’t work out, but whose internal collaboration tool turned into Slack. I had listened to several Butterfield interviews before the event but meeting the team and seeing the culture he created sealed the deal in my mind.


I made some phone calls and found out Slack had been valued at $7 billion recently. I built a rudimentary model and realized that was very likely an enormous bargain, so I called Slack’s general counsel to find out if there was a way to buy stock before Slack’s direct listing. Alas, my timing was a bit off: Slack would publish its prospectus and kick off its listing process the very next day, at a substantially higher valuation. (After reviewing the numbers in the prospectus—one of its impressive cohort charts appears below—my assumptions were confirmed: $7 billion was an enormous bargain.)

Slack's ARR. Source: Slack's S-1


The simplest way to think of Slack is as a replacement for internal email. Slack solves several critical problems, particularly for larger companies. Instead of an inbox for every worker, Slack is organized around channels for each team or function. These channels can have different permissions and visibility across the organization, different data retention policies, workflows and documents associated with them.


Suppose a new employee joins a company without Slack. On day one, she is staring at an empty inbox. She has no message history to learn from; she doesn’t know the social interactions that are typical of her team; there is no searchable archive. If she is taking over someone else’s job or project, she’ll likely get forwarded several unwieldy email threads. Slack channels solve this problem. Not only do they provide employees this utility, they also enable visibility across functions and across teams. A CEO can drop into any channel and quickly get up to speed on how different departments are functioning, how deals are progressing and what challenges are being faced. This would have been impossible with email.


The other critical problem Slack solves is one of connecting siloed applications. Large organizations use thousands of apps and collaborating across these requires a lot of context switching, remembering passwords, copying and pasting and the use of import/export tools.


Slack connects these apps in a way that dramatically reduces these complexities, saving time and making workers more productive. If an enterprise spends $100 million per year in technology applications, Slack wants to be the 2 percent of that spend that leverages the other 98.


One underappreciated aspect of Slack is that it makes work more fun. The vast majority of Slack users report being more productive and believe teams work better with Slack. Chat interactions are more informal than email. Slack works great on any device and is suited for mobile as well as desktop. Users tend to use emojis much more frequently, and the ease of developing simple workflows, routines and bots eliminates repetitive work.


There are fun apps like Donut, which randomly pairs employees and automatically sets up a time to get coffee, a great way to encourage collegiality and cross-pollination. One senior director of sales managing eight teams across five cities and two countries said it’s really hard to get a sense for how people are feeling, so she uses a Slack integration that periodically pops up and asks people how they are feeling and what have been their week highlights or lowlights. Human capital management behemoth Workday was able to increase coworker feedback 5x just by placing the user interface inside of Slack rather than making folks switch context to the Workday app (there was huge pent-up demand for Workday’s Slack app: 97 companies signed up for their early adopter program).


When Slack finally listed its stock, it shot up by nearly 50 percent and entered “this makes no sense” territory. But today, with the stock down to an $11 billion valuation and two additional quarters of growth in the business, the numbers make sense.


Following Frontiers, I attended Slack’s Investor Day, and recently its developer conference, called Spec. These events allowed me to learn more about the company’s opportunity and burgeoning developer ecosystem. The latest count is that Slack now has 1,800 app integrations, 600,000 developers and 12 million daily active users.


The biggest overhang over Slack’s shares today is the threat of Microsoft Teams, which was launched as a Slack copycat in 2016. At the time, Slack was the fastest-growing enterprise software in history.


Teams has been growing even faster, as measured by daily active users (Slack has a free tier and then the least expensive tier is $7 per user per month; Teams is bundled for free for Office 365 users above a certain tier). There is significant debate, however, about how active Teams’s active users are. Most analyses show that the answer is not much: Microsoft has been moving Skype Business users to Teams and it seems Teams is used mostly for video calls, while everything else is happening in Slack. Indeed, Slack’s paid users are spending 9 hours per day connected to Slack, with an average of 90 minutes of active usage every working day, and there appears to be significant overlap between Teams and Slack users.


Slack’s paid customer count increased 37 percent year-over-year in its most recent quarter, but the largest customers grew 75 percent year-over-year. Having attended three Slack events and spoken to many of these large customers, this was obvious to me: Slack is ideal for large enterprises, and Teams has a fraction of the app integrations that Slack has. Countering the misguided narrative that Teams is making a dent on Slack, Butterfield came out swinging in Slack’s earnings call:

This quarter saw win after win in the largest companies in the world. […] A Fortune 100 financial services firm, which has been a Slack customer for years, with continual expansion throughout the company, added thousands more active users and is now going wall to wall for their more than 50 thousand employees across functional roles including, marketing, HR, legal, finance and sales.
Of course, like most of our large enterprise customers, they run on Office 365. They still chose Slack because only Slack was capable of meeting their needs.
Increasingly, in regulated industries, we are seeing significant traction because Slack blends security and compliance with scalability, an open platform and a great user experience. In addition to exciting wins in healthcare following our ability to support HIPAA compliance, a large Midwestern insurance company also expanded to thousands of users this quarter. Slack is a key plank in their transformation efforts and plays an essential role, as it does elsewhere, as a lightweight fabric for systems integration. They leverage more than 500 integrations, including PagerDuty, Dynatrace, JIRA and an extensive set of internally-developed integrations to drive more return from their overall investment in software.
This is another Office 365 customer, and they chose Slack because only Slack’s open platform integrates with the full range of internally and externally developed tools they use.

While competing with Microsoft sounds scary, we can flip this around, too: how many businesses with Slack’s exceptional characteristics exist out there, that have only one meaningful competitor? The answer is… none that I can think of.


Given the huge size of the market for enterprise collaboration software—especially one that, once adopted, becomes part of the infrastructure of a business—I believe there will be plenty of room for both Slack and Teams (there are products that are complementary to Slack, like Workplace, which is an incredible enterprise SaaS offering by Facebook, but that is a topic for another letter).


Financially, Slack is no slouch: the company sports gross margins of 87 percent, which should eventually translate into free cash flow margins north of 30 percent. In terms of go to market, the company has frictionless onboarding through its free tier, requiring no sales team, as well as a high touch enterprise sales team and customer success folks making sure key integrations and best practices are being adopted for its most valuable customers. Once a large customer adopts Slack, they rarely churn, resulting in a very attractive customer lifetime value. When we add the cost of acquiring customers to the equation, Slack ends up with attractive unit economics (think very high returns on incremental invested capital).


It therefore makes sense to pour fuel on the fire and grow, and that’s exactly what Slack is doing, projecting higher expenses for sales and marketing and revenue growth of 47 percent for the upcoming quarter.


Network effects are a big part of the benefit of using Slack: even among the largest customers, 95 percent begin using Slack in a self-serve way. Butterfield recently gave the example of one such customer who began using Slack in one of its teams, with the manager using his corporate credit card. He kept increasing the limit until he hit $35,000, finally looping in his CIO. The more employees use Slack, the more valuable it becomes.


If one company stops using Slack, the network effect is gone. Is there a way to strengthen this by having network effects across businesses? This would mean that Slack becomes more useful and valuable the more companies use Slack. From Slack’s last earnings call:

Shared Channels allows customers to securely collaborate with external partners, suppliers, and their own customers in channels while still maintaining their internal controls and compliance policies. More than 20,000 paid customers have already adopted Shared Channels during our beta program, a number that far exceeded our expectations at the program’s launch. What is incredibly exciting is that, as the size of the cohort has increased, the intensity of usage has also increased. That means that the average number of Shared Channels in use by Shared Channels-using customers has increased as more customers joined the beta. And the same thing is true with the size and density of the largest network cluster, resulting in a lower number of average “hops” from any two randomly selected participants.

This is an actual network graph of organizations using Slack. Initially, the entire circle looks like the outer rim of sparsely connected organizations. As more shared channels emerge, they blossom into the densely connected graph in the center. This represents over 26,000 shared channels-using organizations and their connections on October 31, 2019. Source: Slack

We are already seeing customers choose Slack because of Shared Channels. We had a big win in the quarter with a major American sports league beginning to use Shared Channels to communicate with the franchises, a network made up of the league, the teams and their partners.
We even saw a large media streaming service requiring its creative agency to adopt Slack so they could use Shared Channels to collaborate. In some cases, because Shared Channels were so important to them, larger customers postponed their upgrade to Enterprise Grid, until Shared Channels beta became available in Grid this June.
This is our first real network effect across customers. We orient the business to seek out increasing returns dynamics anywhere we can find them, and that’s definitely something we’ve seen in the platform ecosystem and the network inside of individual companies — Slack gets more valuable as more people are on it. But now we expect to be able to increase the value for all of our existing customers as new customers start using Slack.

Given Slack’s enormous opportunity, we expect the company to continue innovating and capturing more customer wins, while at the same time growing its developer ecosystem, strengthening its various network effects. Our modeling shows it’s reasonable to expect the company to be worth 5-6x more than the current market value within a decade.


[Note: this post is an excerpt from one of our letters to investors, originally published on December 2, 2019. To learn more, check out our investors section.]

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