How Rackspace is Getting Bigger by Getting Better
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I’ve been digging around a bit into some well-known large cap stocks to take a look into the secret to their success. I was inspired after hearing a story about Chick-fil-A founder Truett Cathy where back in the 1980s when a rival recently went public and now had the cash to really start growing, which of course was a concern the management team, so they spent time discussing how they too could get bigger in order to fend off the competition. After hearing more than he could take about how best to get bigger, Cathy pounded the table and said, “I am sick and tired of listening to you talk about how we can get bigger. If we get better, our customers will demand we get bigger.” Today I want to look at a company that is so focused on getting better, I’d be shocked if they don’t get a whole lot bigger over the next few years.
I think I’ve heard more about Rackspace Hosting’s (NYSE: RAX) Fanatical Support than about what the company actually does, so let’s start there. I’m sure you’ve heard phrases such as, “the customer is always right,” or “under promise and over deliver,” but Rackspace takes things not just a step further -- they are on a whole other playing field. They call their employees Rackers and they have built a culture of empowerment that gives their employees the freedom to find solutions for their customers. For these Rackers, it’s a no excuse, no exceptions, can-do way of thinking where the complete satisfaction of the customer is their sole ambition. Rackers are responsive, take ownership, are resourceful, have expertise and are transparent with their customers. They take their customer service very seriously; in fact if a customer isn’t satisfied they can leave before their commitment us up. I’m sure it’s not surprising to learn that their customers hardly ever leave as their monthly churn rate is just 0.8%.
Now to what they do. Rackspace is the world leader in managed hosting and an emerging leader in cloud hosting. However, hosting as a business is nothing more than a commodity and their competition is found in the likes of IBM (NYSE: IBM) and Amazon (NASDAQ: AMZN). Despite who they are up against they now host over 180,000 businesses on over 82,000 servers. Their subscription-based revenue model is 99% recurring and is now up to a billion dollars of annual revenue, up from just a quarter billion in 2006.
So the real question is if Fanatical Support will be enough to keep growing their business. While it might not sound like a lot, they are growing their customer base by about a net 1% per month. While they have those 180,000 customers as of March of 2012, the year prior they had 142,000 customers. The big push going forward will be in cloud computing and their Rackers are working hard to make sure they become a top player in this industry. Rackspace will need to play a key role in this industry to ensure they can continue growing. With their fanatical support as a key differentiator, they need to maintain their competitive edge. While I mentioned before that both IBM and Amazon are industry competitors, neither are as focused on hosting as Rackspace. Both, however, are known for their customer service. Take these quotes for example:
Jeff Bezos, CEO of Amazon:
“If you do build a great experience, customers will teach each other about that. Word of mouth is very powerful.”
“We see our customers as invited guests to a party, and we are the hosts. It’s our job every day to make every important aspect of the customer experience a little bit better.”
“If you make customers unhappy in the physical world, they might each tell six friends. If you make customers unhappy on the Internet, they can each tell 6,000 friends.”
Thomas Watson, former CEO of IBM:
“If you don’t genuinely like your customers, chances are they won’t buy.”
If either decides to make a major push into hosting, Rackspace will simply have to continue to be better than these and others in order to fend them off in the future. I like their chances. What I don’t like is the current price. At over 70 times earnings Rackspace is priced for a whole lot of growth. This is exactly what they are projected to do as analysts estimate they will grow earnings by over 40% the next two years.
While the price might be high, for a company that simply is better than anyone else when it comes to customer support I think they have the potential to grow a whole lot bigger over time.
latimerburned has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com and International Business Machines. Motley Fool newsletter services recommend Amazon.com and Rackspace Hosting. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.