In an announcement late Thursday, Xactly Corp., a leading provider of on-demand sales performance management (SPM) solutions, provided something else entirely: a surprise announcement that it had acquired Centive, its closest rival in the industry. Terms of the all-stock deal were not disclosed, but in an interview earlier today with CRM magazine, Xactly executives predicted that the acquisition will be fully accretive in 2009.

The paths of the two companies had grown increasingly intertwined in recent years. In addition to battling head-to-head in the SPM space for some time, both are partners of software-as-a-service (SaaS) leader Salesforce.com, and are available on Salesforce.com's AppExchange platform. Along with Callidus Software, Centive and Xactly account for the bulk of the SPM market, and Callidus has only relatively recently ventured into the SaaS end of the pool.

"It's been the three of us," says Christopher Cabrera, Xactly's cofounder, president, and chief executive officer. "But really the only deals we've lost have been to Centive, and the only deals Centive lost were to us."

As part of the acquisition, Xactly has guaranteed to extend support for Centive products for at least the next 18 months, according to Karen Steele, Xactly's vice president of marketing. By the end of that period, she adds, "the brand that will exist in the market will be Xactly." Cabrera says that customers of both companies should see no change in the short term, but Xactly will welcome their input and feedback for what they want to see in the unified company in the future. The merging companies expect to have an integration roadmap ready within six weeks, Steele says -- and, as Cabrera notes, the effort will comprise technological elements from both sides of the fence. "Each of these products is not equal," he says. "They do some things we don’t do, and we do some of the things they don’t do."

Cabrera and Steele say the deal has been in progress for the past six months, and that the two companies had first broached the idea nearly 18 months ago, but both contend that the companies are uniting at a time of strength, and not because of a drop in business. "Even in a down economy, this is an area where companies will invest, because they need to get more performance out of their sales teams," Cabrera says.

Industry analysts have been expecting some sort of move in SPM for some time, but many admit to having been caught off guard by the specifics of this deal. "The announcement is definitely a surprise," says China Martens, a senior analyst with The 451 Group. "We've been predicting some consolidation in SPM, but I didn't expect it to be these two rivals. This will be a strike against Callidus."

Denis Pombriant, founder and managing principal of CRM consultancy Beagle Research Group, says that he sensed some kind of deal was in the offing. "I wasn't sure what, but I thought Centive was going to get acquired either way. Personally, I thought ADP would be the acquirer." (ADP, the business process outsourcing and payroll management company, has a major partnership with Centive.) Nevertheless, he continues, "It's a combo that needed to happen -- [SPM] is not that big of a market. The acquisition could have gone either way, but I think Centive's investors were getting impatient and looking for an exit strategy."

While it's true that the market may not yet be that big — Cabrera, in his interview with CRM, essentially echoed Pombriant's sentiment word for word — an April 2008 report by industry-analysis firm Ventana Research estimated the sector's annual growth rate had reached 45 percent, and that the sector's overall revenue may reach $8.2 billion by 2011.

Centive, which was founded in 1997 under the corporate name Incentive, had raised at least $75 million in venture capital over the years, but much of the equity, Cabrera says, was bound up in the on-premises edition that Centive sold off in 2006 as it focused instead on its SaaS offering. And focus it did -- in fact, even amid the months-long negotiations and discussions between itself and Xactly, it was only a few weeks ago that Centive announced the eighth and latest revision of its flagship product, Centive Compel.

Xactly, for its part, has raised $57 million across four rounds of venture-capital funding, the most recent of which was also the largest by far: a mammoth $30 million round that also included a $10 million line of credit, according to Cabrera. "We don’t need more money," he says. "This is plenty of money to get us to where we want to go."

Like most SaaS companies, Xactly has yet to turn a profit, but Cabrera says the Centive deal effectively lowers the company's cost of generating a dollar of revenue. Before the acquisition, he says, the cost to generate each dollar of revenue "was in the $2 range" -- but he expects the economies of scale made possible by the addition of Centive will lower that figure to approximately $1.30. For the time being, he adds, the deal is an extension of Xactly's existing growth strategy, which favors market share over profitability.

"We could be profitable tomorrow," Cabrera says. "But our investors aren’t interested in being profitable at the revenue level we have now.... We’d be silly to prioritize profitability over growth." Of the myriad measurements that have been used to gauge advancements in the SaaS field, he says, "in every way this deal helps us with every one of those metrics...[and] we have the opportunity to gain market share over others."

"This is part of what will be a pattern of consolidations and mergers in the CRM industry, and in SaaS in general," says Jeffrey Kaplan, managing director of ThinkStrategies, a consultancy specializing in SaaS. "It's a good move by both parties, though there needs to be some time spent reconciling the product lines, streamlining the businesses, and making sure the customers stay on board. [Customers] don't care how the sausage is made -- they care how it tastes."

Many analysts predict that any next move will come from Callidus, the leader in the space, and the winner of CRM magazine's 2008 Market Award for Incentive Management, the first year the award was given. (Xactly and Centive were both named Leaders in the category.) Martens says the main concern for Xactly is whether it can retain Centive's customer base. At the same time, Kaplan says, Callidus will continue to face the ongoing challenge need to prove that its SaaS alternative -- the company's main offering is licensed software -- will be sufficiently scalable and economical to compete.

Pombriant calls Callidus the "800-pound gorilla" of SPM, with considerable resources to throw around as a result of its initial public offering in  being a public company. Having added a hosted option relatively recently, analysts say that Callidus' development of SaaS capabilities lags behind those of Xactly and Centive (which became a SaaS-only provider after selling its on-premises offering in 2006). As a result, Pombriant says, Callidus may look to acquire additional technology in that field. One viable target for acquisition is Makana, the makers of the Motivator line of on-demand SPM applications. "Makana is a relatively new entrant," Pombriant says. "The question is whether it does [Makana] any good to be the Number 3 vendor."

Cabrera, though, scoffs at the notion, predictably characterizing the Xactly-Centive combination as the only true game-changer. "This is a big [deal] in this space. I’ve been in this space for 12 years, and it’s the biggest thing I've ever seen." At the suggestion that Callidus might buy Makana, Cabrera's reaction was notably brusque: "Who cares? That’s a small little deal -- this is a big deal with two big companies with two great technologies and the [potential] to be one great company."

Additional reporting by Joshua Weinberger.

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