Ensemble Capital - ServiceNow: Creating Amazing Customer Growth Stories

The following segment was excerpted from this fund letter.

AI has been all over the news lately and we’ve seen some amazing results in terms of a step up in intelligence, productivity, and creativity come out of it. Nvidia (NVDA), the semiconductor leader in GPUs (Graphical Processor Units), has gotten the spotlight as the hardware enabler of the technology while Microsoft (MSFT), Open AI, and Google (GOOG,GOOGL) have been highlighted as the companies that brought the technology to the market.

However, the ramp in the use and application of the technology is just starting. As we’ve seen with previous innovations, the majority of the value often accrues more broadly to companies and societies who incorporate the technology into their offerings – creating new applications and enhancing existing ones – and see higher productivity and better living standards. Of course, there are also companies that get disrupted and have to figure out new business models or become obsolete.

We can think of ServiceNow’s (NYSE:NOW) core offering, the NOW Platform, as a “Platform of Platforms” within the enterprise, and as we’ll explain, it allows companies to stitch together their disparate, siloed software and data systems so that they can be accessible, modernized, and integrated to create more efficient workflows to unlock better customer services and increase productivity.

Adding Generative AI capabilities on top of ServiceNow’s core platform and applications only serves to further enhance its value proposition because it serves as one of the key complimentary tools large enterprises will need to take full advantage of Generative AI’s capabilities and benefits.

If we think about the nature of the IT systems in a large company, it’s likely to look like a spaghetti mess of systems that have an alphabet soup of acronyms like ERP, SCM, CRM, HCM, etc., and these systems have been implemented and incorporated into the way enterprises run their businesses in a piecemeal way over 40 years or more. Oftentimes each system is managed by teams of people operating separately from one another with siloed pools of data.

We’ve all experienced this jumble of software at work and even at home. You have a separate login into each one and you switch screens to get the data and functionality of each one. You download spreadsheets of data from one system to upload into another system or even manually entering data from one system to another to keep them synched.

Enterprises often tried to manually link systems so that they could have workflows built across different systems that needed to interact with each other, but these manually built links are often fragile and unscalable and expensive to fix and maintain. The whole hodgepodge of systems and custom connections was not upgradeable to the current instant access, instant gratification world that the mobile internet has brought to us all as customers and employees.

The dream was to have a system that sat on top of the underlying transaction systems and seamlessly integrated the software applications and the data they had within them. That more elegant and scalable solution was called an “Enterprise Service Bus” that would be able to connect these disparate systems and access and translate data between systems that had different terminologies and fields and function calls. Various companies attempted to do this, in the early 2000s but it was relatively kludgy, expensive, and unscalable. They sold the dream but didn’t really execute it because their technological architecture was not quite up to the job.

Enter ServiceNow… which leveraged the cloud-based software architecture to build a scalable integration platform, called the NOW Platform, at a time when cloud-based software systems were starting to take off and enterprise had standardized and implemented a few key systems like an SAP, Oracle, Salesforce, Adobe, Workday and Microsoft to name a few.

ServiceNow was able to create an integrated software model in the cloud that connected to these systems, which still didn’t talk to each other, yet had core data models that were known and standardized. By building an integration platform in the cloud, ServiceNow was able to become the enterprise service bus akin to a central nervous system for the enterprise, connecting to the key functional systems that enabled the enterprise to operate its daily business. This central platform could communicate between systems and access the siloed data in these systems in a scalable, standardized way that was both elegant and cost efficient.

That’s a really nice thing to be able to do technically, but in order to drive value from this capability, ServiceNow built applications on top of the core NOW platform. By creating a single data integration model with underlying commonly used functionality built in, the NOW platform allows ServiceNow’s R&D team to quickly create these applications that leverage the underlying technology. These applications are quick to build for its internal R&D team resulting in high ROI (return on investment) for the company and quick to deploy and fast time to value for the customer which also delivers to them high ROI.

These applications are tools that dramatically improve IT management of enterprise systems and devices, bring greater employee efficiency through lower cross system friction, and improve customer service through integrated systems visibility and automation. If you think about what applications are, they are basically collections of scripted workflows that enable a certain end functionality that the user is looking for to fulfill tasks or goals.

Think of a new employee joining a firm… HR has to add the employee to the payroll system, IT has to allocate laptops, software licenses, and other equipment, facilities has to allocate a space for the employee to work, legal and compliance has to vet and train the employee, etc. These are all different systems and teams of people that touch the new hire workflow, than at least one HR person has to coordinate and access. With an integrated workflow platform like ServiceNow, you no longer need a person to coordinate the steps and people, these can all be automated and reduce hours of time across the enterprise to get the job of onboarding done. You can think of a similar workflow for a customer service issue where the internet service is down, or logistical deployment and tracking of COVID 19 vaccines from the Federal level to the local level, which was a real problem ServiceNow helped solve in weeks not months by leveraging its core system.

This makes ServiceNow uniquely able to serve as the cross-systems workflow platform via its integration hooks into major systems used at companies. And the importance of these workflows in the daily operations and interactions of employees and customers in companies makes it very sticky and its value very visible to key decision makers. And the underlying capabilities of the NOW platform, once implemented in the enterprise, create opportunities to build new applications that couldn’t have been possible without it.

We can see how successfully ServiceNow has been able to leverage that core platform with its high margins and fast revenue growth coupled with increasing annual contract values (ACV) at existing customers nicely demonstrates the value of the platform and success of the growth strategy.

This leads to one of the most amazing customer growth stories we’ve come across. Even the oldest, most mature ServiceNow customers who were onboarded during the 2010-12 era have seen a revenue growth rate of about 28% per year with the youngest cohorts added in the past 4 years averaging 50% growth. To be able to grow customer annual contracts at a nearly 30% CAGR over a decade and maintain the sustained levels of high growth during challenging economic times, indicates a very compelling value proposition for customers backed by strong company execution.

There are always certain marketing buzz words that pervade the technology industry and the most common one during the COVID period was “Digital Transformation”, i.e., creating an agile organization that can support remote employees with consumer app level technology expectations (not green screens!), fast changing customer demands in a mobile first world, and intelligence from data within the organization to create new value. ServiceNow’s value proposition aligned really well with this theme.

The most recent buzzword of course is Generative AI. As we’ve highlighted, the NOW platform creates the capability for enterprises to really extract value and productivity from their own data. The NOW platform’s single data model and ability to access data from various siloed applications, means that ServiceNow becomes a key lynchpin in the enterprise’s ability to utilize and extract value from their own customer and transactional data in their systems. Therefore, Generative AI becomes a new complimentary value creator that improves ServiceNow’s already strong value proposition as a critical enabler.

Furthermore, the workflows that can be built atop the NOW platform leveraging AI can become even more effective at raising the level of productivity for employees via deeper, more intelligent automation that can both generate customer insights and deploy routine procedures with employee oversight needed only for exceptions. In an era of labor shortages, growing wage pressures, and the Fed’s singular focus on battling price increases, this sort of technology creates the ability to offset higher labor costs with higher productivity without the need to raise prices commensurately to protect margins. For other business models, more productive employees mean higher margins that can be achieved.

In both cases, we believe it makes ServiceNow’s value proposition even more compelling and opens further opportunities for continued growth for years to come.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.