Business Breakdowns
· Matt Reustle
[00:00:00] S0: It's a little tough when it's the machine learning. You don't have a scapegoat if it's just the machine. I guess you do. But nobody, in theory, gets fired over that. Or maybe the person behind the machine learning who codes that all up. But noteworthy. And as it happened over history, I do think it's interesting with businesses, whether it's Moody's during the financial crisis, Equifax with security breaches – where if it doesn't kill them, it kind of proves the moat or strength of the business in many ways and to all different degrees. But have there been historical outages, maybe not as impactful as that one? And any signal to whether they have material impacts, whether short or long term on the business?
· Sam Eden
[00:00:00] S1: There was one semi-recently. It wasn't as big as the one that happened recently. But there was an outage. And this actually encouraged some internal transformation or accelerated some internal transformations. So I mentioned earlier that Cloudflare is built on Cloudflare. They build a lot of this proprietary software to run their systems – for most of their systems, but not all of them. And this could include things like acquisitions or other things. When they're scaling up new products, they might borrow something. And what happened in the previous outage was there was an issue with a Google Cloud KV cache, like a small piece of the database, which flowed through some of their products and caused an outage. Again, it wasn't a security breach, it was just an error that happens. But what it did was they had an internal project to migrate off those third-party solutions. And that just accelerated that. So I guess it was not good, but they kind of turned it into a strength to increase the robustness of their systems.
· Matt Reustle
[00:00:00] S0: And I guess based on current growth numbers or more recent growth numbers, it hasn’t been too impactful on the underlying business performance. On competition, it feels like Zscaler is one that shows up in multiple categories, so I put them there. In Act 3, you mentioned the hyperscalers, which I think are worthy competitors for anyone to deal with. But in terms of the competitive risks and threats, how high do you rate that on the risk spectrum? Is it something that concerns you sometimes in a growing market? If you have one of the leaders, you usually feel pretty good that even if things move slightly, it's not going to be too material. Just thinking about the competitive threats and how fragile their position is versus being very strong and only strengthening.
· Sam Eden
[00:00:00] S1: My view is that it's a strengthening position. Say with Act 2, Zscaler has that incumbent advantage and that trust with very large enterprises. But it's a huge market and Cloudflare can, like their other products, start at the smaller end and work up to the enterprises. And it's starting to do that. What really benefits them is having that global network of all the products. They can use their Act 1 strength to prove their product, encourage adoption of their Act 2 products. One example of that would be, let's say you're using Zscaler for internal security. You send a request, it goes to Zscaler's machines and then to a website. But that website is going to be likely using Cloudflare. So it ends up going to a Cloudflare server anyway and then back. And so Cloudflare is in a really strong position. It's like, "We're processing all of this traffic anyway. Why don't we process it on the way out as well as the way back in? And that will improve your latency." Another difference would be just on their peering networks. So it's very hard for another company to have all these partnerships with all these ISPs around the world. Zscaler took a different approach where they peered directly with the apps, which is great for dense cities, but in certain markets, it doesn't work as well. And maybe an example just to highlight some of these differences would be Canva. So, thousands of employees around the world – Canva, the web design company. They employ a lot of contractors to help out with the design templates and things like that. And a lot of those contractors are based in Southeast Asia. Canva uses their Cloudflare Act 2 products to help with the access, because Cloudflare uses what's called an in-line service. So you don't actually have to install an agent or anything onto the machine, which is really important when you're working with contractors. You can give these contractors access to all of the corporate apps that they need without having to have them install anything. Because a lot of these contractors are based in markets where other competitors won't have direct peering relationships, Cloudflare can say, "Look, we've been improving the speed of this area for years.
· Sam Eden, Matt Reustle
These contractors can sign on, be secure, and interact with your product with low latency that's not going to slow anyone down." And that's a really strong value proposition that a lot of other companies can't speak to. [00:00:00] S0: Are there any other risks that really stand out to you just from a business perspective and the organization and some of the external factors sitting around it?
· Sam Eden
[00:00:00] S1: Two risks to call out. One is that second mover in Act 2 that we were just speaking about. They are playing a bit of a catch up, but there is a long runway to go and they're a solid contender there. So I think all the trajectory is very positive when you look at their product positioning, their channel partner growth and all that. But it's worth just calling out, just because they are the second mover. The other risk to call out is just their AI inference strategy and AI in general, because it is new and it does slightly diverge a little from their previous strategy. So that always adds some risk there. Because I mentioned earlier that all of their other services can run on all hardware, whereas GPUs are specialized for inference. With the ROI of their other products, it was split across all of their services. But the ROI of their GPU component, that's just from the AI inference. So it's a more concentrated ROI risk. Also, there's a slight difference in how the AI inference product came about, from their other products. A lot of their other products, they kind of emerged from what Cloudflare was doing internally. With the Act 3, they had to build these services themselves. They never planned on launching a developer product, but they saw the value in that and they released it. Similarly with Act 2, they saw that during the day, not many people are on websites, there were underutilized servers, so they could work with corporate security that was used during the day. And then during the night, there's all their website security. So they kind of saw these opportunities and built for them and went into them. Whereas the AI inference, I think they just saw the importance of the market and decided to go after it. It's still that single global network, but there is a bit of top-spin of difference in strategy versus their other product launches. That's worth calling out.