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July 10, 2020, 7:10 a.m. EDT

‘Moats’ will make all the difference for cloud companies as tech costs come under pressure

A durable competitive advantage could mean sustainable stock gains for some cloud companies

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By Beth Kindig

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Twilio, Box, Dropbox

Box /zigman2/quotes/208773138/composite BOX +0.99%  and Dropbox /zigman2/quotes/205896836/composite DBX +1.97%  are cloud-storage companies mainly for internal teams, whereas Twilio is customer-facing with the risk of costing valuable downtime should a competitor not have equal coverage. To switch from Twilio, you have to port numbers, negotiate contracts with a new carrier, determine if the carrier covers all of the countries needed for your applications, and that the call quality and sending SMS is reliable.

In 2017, Uber /zigman2/quotes/211348248/composite UBER +3.33%  had a $60 million annual run rate with Twilio and decided to source different vendors. Even at this level, the company did not build the capability in-house and still remained with Twilio for high-performance messaging. Eventually, Uber migrated to Twilio’s main direct competitor — MessageBird. Despite chipping away at Twilio since 2011, MessageBird has about 15,000 customers compared with Twilio’s 65,000. The company has been able to do this by serving the developer market and building out an extensive API library and documentation in which telecom features are integrated through a few simple lines of code.

When looking at the net revenue retention rate, Twilio has been above the 120% line for many years, with some banner years of 150. (The rate measures the change in recurring revenue from customers over time.) As of 2020, Twilio leads the SaaS category with a 143% rate .

The advantages of neutrality

The ultimate high-switching costs are at the infrastructure level. While software companies will battle it out this year, especially the horizontally integrated and the vertically integrated, infrastructure companies can rest easy. Hundreds of cloud software companies crowd the public and private markets, yet they all funnel into cloud infrastructure.

As John Dinsdale, chief analyst at Synergy Research Group, said, the leading hyperscale data center operators “are better positioned than most types of companies to ride out the crises.” He went on to say that hyperscale firms would see substantive tailwinds.

Amazon’s /zigman2/quotes/210331248/composite AMZN +2.49%  AWS, Microsoft’s /zigman2/quotes/207732364/composite MSFT +2.28%  Azure and Google Cloud (sold by Alphabet /zigman2/quotes/205453964/composite GOOG +1.17%   /zigman2/quotes/202490156/composite GOOGL +1.14% ) have high switching costs, with products like Okta /zigman2/quotes/210420951/composite OKTA +5.71%  specializing in being independent and working across any cloud environment. The moat that Okta seeks to establish is to provide identity access management no matter the private or public cloud environment.

There are a few reasons companies are more likely to go with a proven brand like Okta for identity access management (IAM). For one, IAM allows access to the company’s most critical systems and assets. Also, in order for IAM to work effectively, chief information security officers (CISOs) must put all of their eggs in one basket. Therefore, a best-of-breed independent solution can create a moat by being flexible and reliable. To accentuate its agnosticism, Okta recently came out with end-to-end password-less access that works seamlessly across iOS, iPadOS, macOS, Android and Windows.

That said, moats are really only proven by how long a company lasts, and few cloud SaaS companies have a long tenure. There is an informative article from Jerry Chen, a partner at venture-capital firm Greylock, in which he looks at Salesforce’s /zigman2/quotes/200515854/composite CRM +2.18%  moat and concludes the company is built on “deep IP [intellectual property],” “benefits from economies of scale” and “over time accumulates more data and operating knowledge as they get deeper with a company’s workflow and business processes.”

Perhaps the highest switching cost in technology is training employees and developers. Adobe /zigman2/quotes/200389143/composite ADBE +2.59% , like Salesforce, has certified experts and owns file names, such as PDF or PSD. Content creation must be transferable across operating systems and devices. Adobe Acrobat, despite being a cheaper product, facilitates a halo effect for Photoshop, Illustrator and the broader suite by helping Adobe’s files become ubiquitous. The education around Creative Cloud would take years to replace, and this is why the product can demand premium pricing.

Developer constraints

MongoDB /zigman2/quotes/203302825/composite MDB +6.69% , due to becoming a universal NoSQL option, is in the lead for most-wanted database skills. Being agnostic certainly helps, meaning that the competition between Oracle-owned MySQL, Microsoft-owned SQL Server and Amazon-owned DynamoDB helps MongoDB because it is neutral and does not compete with those companies across other, more lucrative revenue segments.


https://www.revealera.com/

When Microsoft hires employees, it will not advertise for DynamoDB experience, but it will seek MongoDB experience, helping MongoDB establish itself as a universal database program. Similar to Twilio, MongoDB has maintained over 40% revenue growth for most of its trading history and often reports above 50% and even 70% revenue growth, such as in one period last year. This kind of consistency above 40% with surprise earnings beats, despite massive competitors such as Amazon’s AWS/DynamoDB, is only possible when you have a moat of some kind.

Alteryx /zigman2/quotes/202651591/composite AYX +5.03%  is also a heavily advertised job skillset for citizen-data scientists. Alteryx charges a premium price. It will be determined this year if the pricing structure remains resilient long-term as tech budgets come under review.

Overall, cost-benefit analyses will be pertinent in the immediate term, and moats may be evident only in the long term. Those who trade on price will have immediate gratification while those who take the time to analyze moats may have bigger gains and more restful nights.

The writer owns shares of TWLO, MDB, MSFT and OKTA.

Beth Kindig is a MarketWatch columnist and San Francisco-based technology analyst with more than a decade of experience in analyzing private and public tech companies. She publishes a free newsletter on tech stocks at Beth.Technology and runs a premium research service.

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Beth Kindig is a San Francisco-based technology analyst with more than a decade of experience in analyzing private and public tech companies. She publishes a free newsletter on tech stocks at Beth.Technology and runs a premium research service.

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