Business Breakdowns
· Matt Reustle, Sam Eden
[00:00:00] S0: In terms of getting those users, were they just in front of the community of open source developers? Or was there anything that got the attention to where they got that initial user base going? Was there anything that stands out? [00:00:00] S1: A lot of their early customers – they served a lot of non-profits because they had a lot of traffic but couldn't pay much. So that was really big. And they actually served a lot of the hacker community because a lot of hackers get hacked as well. So hackers would sign up to Cloudflare to protect themselves. Those are some of the big starting customers that really proved that this service could work. Because if they could protect hackers, then they could protect a more basic website as well. [00:00:00] S0: That's very interesting. It also introduces they had to then be better than the hackers because in theory, the hackers would see what they're doing. The hacking community is one that is fascinating to me.
· Sam Eden
[00:00:00] S1: One thing that's important to understand, and this is why their business is so hard to replicate if anyone tried, is trying to understand why competitors just didn't do what they did. Why not just intercept all the traffic? The reasons would be revenue and costs. So with revenue, Cloudflare, it's a classic case of the innovator's dilemma. So these large enterprises that I mentioned before, they didn't want to offer this simple interception because that's not what the large enterprises wanted. So the short-term revenue wasn't there. So Cloudflare could build for this long tail on their own. And then cost is the other reason that competitors didn't do this. It's really technically difficult to build a system that scales to intercept all the traffic. And they made a decision early on to just use commodity hardware. They didn't want dedicated hardware to process this. They created the software-defined network, which was inspired by Google running on commodity hardware. So they could just scale their network with cheaper hardware. And today, that's still the case. Today, Cloudflare is still that single global network of commodity hardware with layers of very sophisticated software on top of that. And another really important thing is the peering relationships with the ISPs. So your ISP is who you pay each month for your internet bill. If we go back to that New York-Australia example we mentioned earlier, let's say you visit a small website in Australia. This small website, they can't afford those legacy services that only cater towards the enterprises. In this case, the ISP has to pay those transfer fees to get the traffic to and from Australia. And the ISPs provide a slow traffic experience. So it's lose-lose. Those enterprises aren't serving those customers. Now, because Cloudflare makes it easy – they have that product-led growth and that really generous freemium model, they can start providing those services for these small websites. Now one website isn't enough, but if you aggregate that whole long tail that they serve, Cloudflare has negotiating power with the ISP. They can say, "I see you're transferring a lot of bandwidth to this region. And I know that because I see all the traffic from my customers. So why don't I just put my server next to yours? We'll have a peering relationship.
· Sam Eden, Matt Reustle
That means you don't have to pay those transfer fees. I'll serve the content directly." And that ISP situation has gone from a lose-lose, kind of cost and slow internet – to a win-win because they don't have to pay those transfer fees and the internet just sped up. So Cloudflare can negotiate this relationship and often doesn't have to pay bandwidth fees. [00:00:00] S0: Is the ISP the loser in that case?
· Sam Eden
[00:00:00] S1: I would say it's a win-win situation because without Cloudflare, they have to pay the cost of connecting to other networks. So it's a cost for the ISP. If you think about your own internet experience – if your internet's slow, you don't blame the fact that the server is on the other side of the world or anything like that. You blame your internet service provider. By partnering with Cloudflare, they cut out those costs – because they just serve it from Cloudflare. And they can speed up their internet so their customers are happier. They partner with all these ISPs across the world. And one way that I like to visualize Cloudflare is they have this single global network that spans across the world. It's a single web, and that connects to all these sub-networks, all the ISPs. And today their single global network connects to over 13,000 different networks directly. And these sub-networks could be ISPs, they could be cloud providers, they could be corporate networks, but they connect them all together in this one connectivity layer. Now we're ready to piece this all together. I think this is the most important part of the Cloudflare business. So if you put this history together, it creates a reinforcing loop. So I'll try and help you visualize it that at the top of the cycle, we talked about their low bandwidth and low hardware costs. And they're easy-to-use products that enables this product-led growth motion, so they can serve that long tail of customers. What that enables is more traffic goes through their servers. So they collect more signals, they collect more data, and then they get better and better at blocking malicious actors. They get better at optimizing the network for speed and just providing better website services. And better services – which is halfway around the cycle now – that leads to more paying customers and more enterprise customers, which again brings in more traffic. And then as they get more traffic, they can negotiate even more with these ISPs to reduce their bandwidth fees further, create more peering relationships that brings their costs down further. And then they can reinvest that revenue and cost saving back into their global network, create more products, continually building out. And the cycle continues – they attract more of that long tail, collect more data, build out their network.
· Sam Eden, Matt Reustle
This network gets better as it gets bigger. We often look for businesses that follow this characteristic. Because they've been doing this for over 15 years, it's an incredibly difficult system to replicate, and it's a really important part of their moat. So that's how they can continually offer these freemium services while processing over 20% of the world's traffic. And it's just a powerful reinforcing loop that gets stronger and stronger. [00:00:00] S0: In terms of controlling that volume that puts you in a better position from a negotiating perspective, you can bring down costs in a lot of ways. But for a business like this, which is trying to detect certain things and optimize certain things, you get better in terms of what you're offering, if done right. On the evolutions that occurred over that period, I'm really curious too, just in terms of when they hit a point of evolving into the commercial operations, what that looked like, how challenging that might have been. And then some of the products that have been layered on since then, because it definitely has evolved into a full suite of things that are very complimentary. But how did that pace out together?
· Sam Eden
[00:00:00] S1: The Cloudflare we just described looked very different to the Cloudflare of today in terms of their product suite. The main product evolutions have been going from that product-led growth to enterprise, and then using that single global network to add services. So they've added a lot of internal cybersecurity products, and then a whole developer platform on them. We can go through each of those. The first one is just that transition from serving this long tail only of freemium customers to serving the biggest websites in the world. And it follows that same loop. The more data they collected, the more they could build out the network. It reached a tipping point where now their capacity and their services were better than the legacy companies. Their capacity to absorb, say, cyberattacks or those DDoS attacks is just unmatched. And a recent example they gave in one of their earnings calls is they won over a large customer because their DDoS protection capacity was over four times the two legacy competitors combined. It was over 30 terabytes per second that they just easily absorbed because they'd continually built out this network. So they can serve the long tail and now these high willingness-to-pay enterprise customers. That's one product evolution within their original product set. They're able to evolve just from those web security products, to this whole new market of internal cybersecurity.