ZoomInfo: A Growing Threat To Its Business (NASDAQ:ZI)

ZoomInfo’s (NASDAQ:ZI) core service offers tailored and automated lists of leads for B2B sales and marketing reps. Its main competitive differentiator is its ability to accompany leads-lists with actionable intent signals, allowing sales professionals to better target key decision-makers at enterprises at the right times by recognizing corporate clients’ needs early. While ZoomInfo’s solutions are relatively more expensive than alternative offerings, their premium prices reflect the advanced nature of their solutions over commoditized leads-lists that tend to lack the actionable context that ZoomInfo offers. The company is well-positioned to capitalize on corporations’ needs for superior data-driven insights to outmaneuver their rivals at winning new sales contracts. This competitive edge is underpinned by potentially troublesome third-party data sources, which raise both legal and reputational risks.

ZoomInfo has been delivering impeccable growth rates. Between 2018 and 2021, revenue grew by 418%. More importantly, this revenue growth has been accompanied by an expanding gross margin (73.8% in 2018 to 81.71% in 2021). The expanding gross margin reflects strong pricing power, enabled through effective R&D to constantly advance its solutions to maintain its superiority over competing solutions.

Evolving regulatory developments relating to data privacy concerns

While investors are excited around ZoomInfo’s remarkable growth rates thanks to its actionable B2B marketing solutions, the firm’s business model relies heavily on third-party data collection, without which the company would not be able to offer its distinctive intent signals.

Over the last several years, data privacy laws around the world have been becoming increasingly restrictive around third-party data collection, storage, and usage, including the European Union’s General Data Protection Regulation (GDPR), China’s Personal Information Protection Law (PIPL), and similar initiatives in the U.S. like the 2021 Data Privacy Act. In fact, in its annual shareholders report, ZoomInfo cites data privacy regulations as one of the most prominent risks facing the company. Periodical evolvement of such laws could pose serious challenges to ZoomInfo’s data collection and usage practices. The inability to maintain access to current lucrative data sources due to advancements in restrictive legislature could undermine the firm’s ability to maintain or enhance the accuracy of its intent signals, which could in turn reduce demand for its solutions. The subsequent weakening pricing power would ultimately stifle revenue and gross margin growth.

In the interest of mitigating such risks, ZoomInfo will need to develop future-proof (or more specifically, regulation-proof) solutions for data collection, usage, and transfer practices, though these might not offer the same targeting accuracy as its original solutions. Furthermore, finding work-arounds to new regulatory advancements will require intensive R&D expenditure, exacerbated by the fact that data protection laws can vary from country to country, only adding to the complexities of maintaining a valuable service for its corporate clients. R&D expenditure is usually targeted towards innovations that augment the value proposition of a company’s products/services, conducive to strengthening pricing power to drive future revenue growth and gross margin expansion. However, ZoomInfo’s need to allocate resources towards developing regulatory work-arounds (tailored to comply with each country’s specific data laws) will divert resources away from innovations that enhance the accuracy of its data-driven solutions, and instead focus on trying to maintain the accuracy of its solutions amid compliance with new regulations. Therefore, not only will expanding R&D budgets compress operating margins, but R&D expenditure itself is less likely to lead to innovations that bolster pricing power and revenue growth going forward.

Over-reliance on third-party data is a competitive disadvantage

As part of its data collection efforts, ZoomInfo relies on various third-party data brokers for insightful information that feed its leads-lists and intent signals, and the company discloses in its annual report that it is “unable to verify with complete certainty…that such information was collected and is being shared with us in compliance with all applicable data privacy laws”. A public perception of a company misusing third-party data or negligence towards protecting personal data rights can incur detrimental reputational damage (think back to the Facebook-Cambridge Analytica scandal unfolding in 2018).

In its annual report, ZoomInfo addresses the reputational risks associated with the perceived misuse of third-party data:

Even the perception that the privacy of personal data is not satisfactorily protected or does not meet regulatory requirements could discourage prospective customers from subscribing to our products or services or discourage current customers from renewing their subscriptions.

While third-party data can offer lucrative insights that drive higher sales conversion rates, they come at the expense of legal and reputational risks. Unfavorable legal developments or incidents of data misuse by ZoomInfo or its network of third-parties could result in serious loss of business, particularly to competitors that possess lucrative first-party databases. While ZoomInfo likes to proclaim that “there are currently no competitors who offer a sales, marketing, operations, and recruiting intelligence platform as comprehensive” as theirs, investors must acknowledge that competitors with first-party data, particularly those with robust financial positions, can always extend the functionalities of their solutions to better compete with ZoomInfo.

A key rival is Microsoft’s (MSFT) LinkedIn, a professional online service where users voluntarily disclose personal and corporate data. As a result, LinkedIn benefits from a treasure of first-party data to generate leads-lists. While ZoomInfo offers superior actionable insights and intent signals through the use of third-party data, Microsoft could indeed decide to allocate its financial resources towards advancing LinkedIn functionalities that invite users to share more insightful business data on the platform, based on which Microsoft could strive to build intent signals, to complement its current offerings and improve sales conversion rates for customers. Microsoft’s access to a growing first-party database is conducive to less reliance on third-party data sources, hence is relatively less exposed to regulatory developments related to data privacy and reputational risks. This may augment the appeal of its marketing solutions over those of ZoomInfo, as the prominence of LinkedIn’s first-party database incurs lower legal and reputational risks for corporate clients, as well as a more sustainable source of actionable data that is unlikely to entail as much alteration requirements for regulatory compliance.

Summary

Corporate enterprises selling B2B-oriented products and services face intensifying competition and are constantly seeking ways to exceed their rivals in securing sales contracts. ZoomInfo’s solutions are strongly positioned to capitalize on this business need, by arming corporations’ sales reps with valuable leads-list augmented by actionable intent signals, conducive to higher sales conversions.

Third-party data has served as a pillar to ZoomInfo’s impressive growth rates, but over-reliance raises significant legal and reputational risks. Essentially, long-term legislative trends are counteractive to ZoomInfo’s core business model. Data privacy regulations are only likely to become increasingly restrictive, as governments seek to iteratively address new forms of data privacy issues. This will require ZoomInfo to constantly invest extensively behind new data collection and utilization methods to maintain compliance with evolving laws around the world, leading to operating margin compression and undermining pricing power and revenue growth potential overtime. The company also faces increasing risks of losing customers to larger competitors with first-party databases, such as LinkedIn, as corporations seek to avoid third-party associated risks.

Recommendation

Over the near-term, ZoomInfo stock is likely to continue facing downward pressure as worsening macroeconomic conditions will inevitably induce contractions in corporations’ sales & marketing budgets, hence inducing a ‘hold’ rating. The stock will certainly be able to recover from the current slump as economic conditions improve again, as the company still offers valuable solutions to augment corporations’ B2B sales efforts. That being said, such growth stocks that heavily rely on third-party data are always susceptible to significant downturns amid unfavorable legal (or other) developments restricting the company’s fundamental business practices and threatening its core business model. Pivotal developments in data privacy regulations can induce sudden and sharp stock declines.