Business Breakdowns
· Matt Reustle, Sam Eden
[00:00:00] S0: Would it be like WordPress might have Cloudflare? [00:00:00] S1: It's more like maybe a Cognizant, a CDW for security, like Tata and all these consulting and professional services groups. So they'll help with the sale and then help with the implementation as well. These are whole companies on their own, so the relationships with them are really important. So Mark Anderson, the new CRO, brought in a new head of partnerships, Tom Evans. And he has a long history in these cybersecurity partnerships. Worldwide channel sales lead at Palo Alto Networks. So he has this big Rolodex to pull from. The results of that are quite impressive. The channel partner-led growth in the last few quarters has been growing around 65% year-over-year for the past two years. The percentage of incremental total revenue from partner channels has gone from about 20% to over 40% of incremental sales. So it's a really important driver of their growth. And there's a long runway too. Just to really highlight how important this channel is, for security, Cloudflare's current channel partner revenue as a percentage of total revenue is about 30%. And if you contrast that to Zscaler and Netskope, they're almost at 90% of their revenue going through channel partners or channel-referred partners. So there's a long runway to go. It's a relatively new motion. So I would say they're just getting started there.
· Matt Reustle, Sam Eden
[00:00:00] S0: Those channels are always interesting. It's kind of like an external sales force in many ways that can do the work on behalf of you. Do they give any sense of whether the margin looks materially different through the partner channel versus the other buckets? Sometimes you get lower margins associated with that because there is, in theory, a middleman involved. But do they provide any disclosure on that? [00:00:00] S1: They don't give too much because it is different depending on the partners and you might have different contracts. Typically what these partners do though, is the large-scale resellers will basically take a cut. But some of the larger ones, most of their revenue is actually from the professional services and implementation on top. So they're not trying to skim a product fee. They're more interested in the professional services that go on after the sale. So that just helps with the negotiation, and it can protect their margins. Quickly on margins, these Act 2 products, they're the highest incremental gross margin part of the business. It's a high willingness-to-pay buyer of security, and you're using your existing network. So very strong margins in that part of the business as well. [00:00:00] S0: Maybe we can get into the financial business model and some of the spreadsheet details. I think you referenced you're looking at over $2 billion in revenue on an annualized basis today. How is it split out between those buckets? You may have referenced it in passing, but just to give a clean snapshot of that.
· Matt Reustle, Sam Eden
[00:00:00] S0: Maybe we can get into the financial business model and some of the spreadsheet details. I think you referenced you're looking at over $2 billion in revenue on an annualized basis today. How is it split out between those buckets? You may have referenced it in passing, but just to give a clean snapshot of that. [00:00:00] S1: They don't split it out exactly, but you can estimate – if you split it between the Act 1, the Act 2, and the Act 3 products, that $2 billion is majority of Act 1. It's their bread and butter. And you could estimate maybe roughly two-thirds of their revenue is from Act 1, maybe 30% from Act 2, growing quickly. And then Act 3, it's still a bit smaller, but growing very quickly as well. [00:00:00] S0: In terms of the customer base, I'm assuming most customers or at least a large percentage of the revenue are using multiple products. I think your point in terms of the large accounts being 1.5% versus 75% of revenue kind of gets to the power of large customers. But is that the case where the majority of customers are using or majority of revenue is coming from customers that are using multiple products? [00:00:00] S1: That's exactly the case. And they have over 55 revenue-generating products, so a long product sheet and customers with more than 10 products is the fastest growing revenue category. So that's exactly the case.
· Sam Eden, Matt Reustle
[00:00:00] S1: That's exactly the case. And they have over 55 revenue-generating products, so a long product sheet and customers with more than 10 products is the fastest growing revenue category. So that's exactly the case. [00:00:00] S0: Offering a freemium model seems to be ingrained in their DNA. How have they managed that over time, in terms of continuing to offer a product that attracts users and potentially gets them into the funnel over time? What does that look like?
· Matt Reustle, Sam Eden
[00:00:00] S0: Offering a freemium model seems to be ingrained in their DNA. How have they managed that over time, in terms of continuing to offer a product that attracts users and potentially gets them into the funnel over time? What does that look like? [00:00:00] S1: We spoke a lot about the freemium model for how they got started, and they've really kept that in their DNA for Act 2 and Act 3 as well. The way they do it as well, it's quite strategically different to some of their competitors. On Act 1, they don't really charge for volume. Their free users can actually get unmetered DDoS protection, free bandwidth for CDN. This is really generous. What they actually charge for is complexity. If you want specialized rules and special bot management setups. But that means if you're a website that constantly gets attacked with high volume, they're not going to charge you extra. They're not going to punish you for that. That's one interesting part of their different strategy, for at least for the Act 1 products. For Act 2, quite generous as well, up to 50 free users. But then Act 3, their freemium product as well, you can very realistically set up and build a sophisticated app without paying much at all. And that's actually what we have done at Square Peg internally. We've built some quite sophisticated AI products to ingest a lot of our research, create dashboards, and have a full AI interface, built on Cloudflare. And it generates an enormous amount of value. And our Cloudflare bills have been remarkably low.
· Matt Reustle, Sam Eden
[00:00:00] S0: Interesting that an investment firm can do that and fit into that category. Is there a way to capture what's subscription-based versus that – you mentioned the complexity, does that still fall under a subscription? I'm just trying to get an understanding of the contractual nature versus the usage-based nature, which I'll bucket complexity into that if it should be. They're not charging based on volume necessarily, but how do you split that up? [00:00:00] S1: It is slightly different per product group, but for Act 1, it is a contract. It's a subscription tier. So you pick a plan, pro tier, business tier, or custom enterprise tier. And you're paying that flat monthly rate for that tier. And it includes a bunch of things. You would upgrade a tier when you need more enterprise features – whether it's those complexity rules, special splitting of traffic and things like that. Not on volume for Act 1, at least. Act 3, those developer products, that is more usage-based pricing. No egress fees, but the usage-based pricing for how much you use their services. [00:00:00] S0: Putting it all together on a margin, however you would look at this, what do margins look like for Cloudflare?