The emergence of the novel coronavirus has significantly altered the landscape of work, forcing billions of people in China and beyond to stay home and practice social distancingAs businesses faced delays in resuming operations, remote work became the go-to solution for many companiesThis shift not only affected the way people work but also reshaped various industries globally.

Given the pandemic's rapid spread, business travel experienced a dramatic decline, impacting companies worldwideConsequently, investors flocked to Zoom Video Communications, effectively reversing the company's declining stock trendZoom's shares skyrocketed, reflecting the newfound relevance of their platform during an unprecedented time.

Zoom was listed on the Nasdaq stock exchange in April 2019, with its stock price initially surging past $100. However, after disappointing earnings reports and concerns regarding high valuation levels, the stock price fell back to around $60. Yet, as the pandemic took hold, Zoom reentered a period of explosive growth, riding the wave of heightened demand for virtual communication.

Upon examining Zoom's business model, one might find it surprising that the company has focused solely on the niche market of remote meetings

The simplicity of their model, primarily driven by subscription fees, raises questions about how the stock market can assign such a high valuation, with price-to-sales (P/S) ratios reaching 54, a staggering price-to-earnings (P/E) of nearly 4000, and 50 times enterprise value to salesThese figures suggest a pronounced premium for what is often labeled as a “small but beautiful” companyHowever, the challenges faced by such companies in recent years cast shadow over this category; the critical question remains: What did Zoom get right?

Key Takeaways: The remote video conferencing market has traditionally been outdated and hardware-intensive, creating a significant barrier to entry due to exorbitant costsBy adopting a consumer-oriented strategy to the business-to-business market, Zoom successfully aligned itself with trends where employee preferences influence IT spending decisions

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This approach disrupted the top-down procurement practices that many companies had relied on in the pastFurthermore, unlike many high-growth SaaS companies characterized by massive losses and cash burn, Zoom has not only achieved profitability but has also generated positive cash flow—an anomaly in the SaaS industry.

Prior to Zoom’s arrival, the remote meetings sector was dominated by complex hardware solutions, necessitating heavyweight installations in conference roomsIn reviewing the existing landscape, it became clear that these high costs deterred many potential customers; even setting up a modest conference room system could require significant investments running into tens of thousands of dollarsAccording to a survey by J.PMorgan, less than 4% of the world’s 19 million conference rooms had video capabilitiesThis lack of accessibility limited video conferencing primarily to larger corporations with deep pockets.

Eric Yuan, founder of Zoom, began his career at WebEX, a conventional video conferencing provider, where he played pivotal roles, eventually becoming Cisco’s vice president after Cisco acquired WebEX for $3.2 billion in 2007. Yuan soon recognized the stagnation in Cisco's innovation and the dissatisfaction among customers due to lackluster offerings

He was inspired to address the evolving needs of customers, pursuing a fresh vision for video conferencing that catered to modern demands, which WebEX was not designed to meet.

Determined to start anew, Yuan gathered around 40 engineers to create Zoom, focusing on the development of an online communication toolBy utilizing multimedia routing, Zoom eliminated the need for centralized bandwidth-heavy MCUs, which was crucial for offering services that operate seamlessly across varied bandwidth scenariosThis adaptability became one of Zoom's core strengths, making it viable for both high and low-bandwidth contexts.

In the realm of SaaS, many disruptive opportunities exist within various niche markets, particularly when addressing specific customer needsZoom emphasized a design philosophy centered around “frictionless” user experience, sparing unnecessary bells and whistles and ensuring that users can conduct video conferences with minimal hassle

This cornerstone principle is what positions Zoom as a model “small but beautiful” company.

One of the keys to Zoom's rapid growth was treating their B2B services as if they were B2C in natureDespite being a SaaS solution aimed at businesses, Zoom took a consumer-centric approach, making the platform accessible for individual users to experience its benefitsThis model encouraged enterprise clients to adopt Zoom rapidly, driven by favorable pricing and enticing free trials.

The cost-effectiveness of Zoom's offerings stands in stark contrast to traditional hardware-based solutions, which had consistently been a roadblock for many enterprisesInstead of needing to invest significantly in complex setups, businesses could start using Zoom with minimal upfront costs through straightforward setups with devices like iPads or smart TVs.

Additionally, Zoom's free offering—providing users with up to 40 minutes of free video conferencing—tapped into a fundamental understanding of time management, as studies suggest the ideal meeting duration is around 45 minutes

The strategy not only aimed to build goodwill among users but also encouraged widespread adoption, effectively allowing Zoom to gain traction with its services.

The global video conferencing market has long been concentrated with enduring players like Cisco and Huawei dominating the industryWith estimates showing that Cisco, alongside other major players, held around 74% of the market in 2018, Zoom faced an uphill battle to disrupt established orderHowever, many enterprises found that the top-down purchasing approach led to complex systems that ended up being underutilized due to their design and operational hurdles.

Zoom managed to circumvent this commonplace challenge by seamlessly integrating into organizations at the grassroots level, starting in smaller teamsThe ease of use allowed departments to independently adopt Zoom without waiting for central IT decisions, multiplying its adoption within enterprises

Based on their own findings, by January 31, 2019, 55% of Zoom's 344 customers contributed over $100,000 in revenue, with many starting their journeys using free personal accounts that gradually transitioned into corporate paid subscriptions.

This shift away from centralized IT procurement is part of a broader trajectory seen in enterprises, with Zoom positioned as a prime beneficiary alongside other industry leaders like DropboxDespite the existing opportunities, ongoing potential remains; notably, in Fortune 500 companies such as Walmart and Oracle, only about 55% have adopted at least one paid Zoom account, indicating vast room for growth.

Notably, organizations like Walmart transitioned to Zoom from traditional solutions like WebEX, seeing a 50% increase in personnel utilizing video conferencingMeanwhile, Uber, aligned with Zoom’s collaborative culture, enabled the service across the organization, adding thousands of accounts to accommodate its rapid expansion

However, Eric Yuan has emphasized a balanced approach to deployment, suggesting that a unified solution across large firms remains elusive and may benefit more from an integrative approach among multiple providers instead.

Zoom’s consumer-driven strategy has broad implications for market sizeConventional estimates place the global video conferencing market at approximately $7.8 billion in 2018, with only modest growth projected for the coming yearsHowever, Zoom’s ability to attract a diverse range of individual users, many of whom are knowledge workers will lead to a larger addressable market, resulting in estimates suggesting a potential ceiling around $40 billion when accounting for broader adoption of remote communication technologies.

A defining factor of Zoom’s platform lies not only in its rapid growth but also in its unique financial metrics and valuations

Many SaaS companies structure their business around achieving 100% revenue growth, yet few can boast a $300 million revenue level while generating positive profits and cash flow, which is a rare phenomenon within the software space.

Zoom’s profitability can be effectively attributed to its low research and development costs, which remain under 10% of total revenue, augmented by the company’s focus on branding and marketing that benefits from spontaneous user-led expansionThough tasked with updating core functionalities continually, most developments take place at a far lower cost compared to industry normsNotably, approximately 80% of Zoom's technology is developed in China, where salaries are significantly lower, driving down overhead costs while maintaining quality through stringent internal controls.

Distinctively, Zoom’s growth has not been hampered by overspending on marketing; its user base expansion comes from a natural organic growth process

During the fiscal years of 2018 and 2019, enterprises with more than 11 employees reported significant expansions in their user base, further demonstrating Zoom’s replicable model across companiesWith average quarterly customer additions near 5,000, forecasts suggest sustained growth, projecting at least 23,900 new enterprise accounts on an annual basis for the upcoming three years.

While Zoom currently exhibits positive cash flow and operates within early growth stages, its financial stability still requires attentionThe application of a discounted cash flow model presents a more suitable valuation method than conventional multiples due to the unique position and lifecycle of the company, with J.PMorgan suggesting an estimated EV/Sales ratio of 48x by 2021.

A valuation of 48x EV/Sales signals substantial investor confidence in Zoom, not typically observed even among high-growth SaaS equities, which average 8x and can reach up to 16x multiples

This high expectation places immense pressure on the company, allowing little room for error, underscoring the volatility link between performance and valuation.

After failing to meet analyst projections in Q2 2019, Zoom’s stock price dropped significantly, but the onset of the pandemic propelled its stock to new heights as demand surgedWith currently strikingly high multiples—trading at around 54x P/S—Zoom finds its valuation primarily driven by current market dynamics and investor sentiment rather than historical performance metrics.

As with many nascent companies, profitability draws larger competitors' attentionZoom stands to face robust rivalry against Microsoft, a company already entrenched in the enterprise software sphere with its competitive offeringsMicrosoft’s platforms, such as Skype for Business and Microsoft Teams, illustrate the fragmented approach taken thus far; should Microsoft intensify focus and consolidate its strategies towards video collaboration, the competitive landscape could shift dramatically.

In the ecosystem of business, there are three pathways: "big markets with big players," "big markets with small players," and "small markets with big players." Most startups find it challenging to navigate the former; however, Zoom’s model highlights viable opportunities within the latter two categories, distinguished particularly by several notable aspects:

1. Zoom's unique approach of addressing business needs from a consumer perspective allows individual users to influence procurement decisions