Cloudfare increases pricing

I came across these interesting news today:

Seems like NET is increasing the price of its monthly plan by 25% and encourages users to sign up for an annual rather than a monthly subscription. I like this as an investor and I will be interesting to see their “pricing power” and if this has any impact on top/bottom line and especially churn. I also like the way they communicate such a price increase.

On the other hand, NET does most of its revenue with really big customers and I guess their pricing will stay as is (?). So impact of this news might be limited.

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As an investor, I like this move to Annual billing due to the benefits to Cloudflare growing their business, more easily and quickly increasing headcount and features. Im indifferent to the benefit to Cloudflare of being able to improve their managing some of their expenses, including their vast infrastructure, albeit, necessary. I doubt much in the way of effecting their bottom line.

Cloudflare Management-
We are making this change hoping most of you won’t pay us anything more than you did before. Instead, our hope is that most of you will adopt our annual plans — you’ll get to lock in the existing pricing, and you’ll help us further accelerate our network growth and pace of innovation.

Best

Jason

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The big benefit for Cloudflare of having companies move to an annual plan is much higher FCF.

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Hi @FinallyFoolin (or anyone)

I’m not following this part from above: “much higher FCF”.

Other than a one-time pull-forward or similar timing effect, how does Cloudflare shifting from monthly to annual billing increase free cash flow, especially if customers who shift to annual billing retain the same annualized rate, which is the incentive Cloudflare is offering (because monthly prices are increasing)?

My interpretation is Cloudflare would get a one-time pull forward of cash flow from customers making the switch to annual, a timing effect but not an increase in cash flow on an annualized basis. But for customers staying monthly, because Cloudflare is raising monthly prices, all else equal (such as Cloudflare expenses staying unchanged), cash flow would increase for these monthly customers.

Thanks in advance for any thoughts!

Cloudlfare blog (https://blog.cloudflare.com/adjusting-pricing-introducing-annual-plans-and-accelerating-innovation/)

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Hi @mostlylong, I believe that increasing cash-flow via working capital management is an ongoing process, and something that Cloudflare has historically not focused on much.

This signals a change.

If you look at the balance sheet, you’ll see that Cloudflare’s working capital management has not been great. So in stead of just seeing this as a one-time pull-forward, one can see this as a journey of improving cash flow by moving customers, over time, to pay more and more in advance, thereby increasing cash flow.

So yes, this one action is a one-time pull-forward. But next year after 15 January, when prices are up 25%, they will be in a position to then go after existing customers who have not converted to 1-year contracts, as well as new customers, and given them, say a 10% discount for taking an annual contract in stead of a monthly one. That’s still a 12.5% price increase from where they are now. This will again net a cash-flow benefit each time a monthly customer moves to annual. And for new customers, if the mix of annual vs monthly improves, so will cash flow. So that’s one ongoing motion: trying to improve the mix of new customers opting for 1-year contracts as well as converting existing ones, an action which will not be done in one fell sweep and will continue going forward.

Then, another motion could be to offer a 15% discount for moving to 2-year contracts and perhaps 20% and more dedicated service levels for moving to a 3-year contract, etc. This is in addition to managing accounts payable and receivable over time so that people pay you quicker and you pay them a bit later. You get the picture.

To see what is possible, compare NET to CRWD:

NET, $ millions 30 Sept 2022
Accounts receivable -127
Accounts payable 39
Deferred revenue 180
Net 92
Revenue for Q 253.9
% of revenue 36.2%
CRWD, $ millions 31 Oct 2022
Accounts receivable -485
Accounts payable 89
Deferred revenue 2,015
Net 1,619
Revenue for Q 580.9
% of revenue 278.7%

So, if they could get customers to pay upfront to the same extent that Crowdstrike has done (which was also a journey), they could get a large fcf benefit over time: 2.4 times quarterly revenue (287.7% - 36.2%).

-WSM

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I’m not an accounting guy, majored in it until my first accounting class and couldn’t switch to Information Systems/BPM/Operations fast enough!! So if I’m wrong with my understanding, hopefully someone will correct me.

IF all contracts are renewed at an annual rate in Q1, then yes, its a one-time event. However, if we have new & renewing annual contracts in Q2, well, that’s 1Q of FCF from next year’s revenue that now counts towards this year’s FCF number. Now Q3 rolls around new & renewed contracts get 2 quarters from this year and 2 from next year. Q4, 1 for this year and 3 Q’s from next year’s FCF gets included this year.

Sure, the first year or so, the FCF GROWTH is a one-time event, but FCF will stay elevated because the “new normal” for FCF will be higher than it is today. Especially if there are more than 2 year renewals.

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As much as increasing cash flow, I see this as a way to “more closely map our business with the timing of underlying [upfront] costs” (Prince’s words). Annual subscriptions provide a lot more visibility into cash flow trends.

This suggests NET will be paying more attention to managing investment, leverage, and cash flows going forward. As a shareholder, I’m good with that. NET is big enough now it’s time to put its money where its mouth is as far as leverage and cash flows.

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There is one other thing to consider with a change like this. Quite often, when a company changes its licensing model and increases prices, it’s due to a change in the underlying business fundamentals that need such changes in order to keep growing at existing levels.

If this is a primary reason for the changes, they may start operating in a manner that puts a relatively higher priority on massaging deal numbers and a relatively lower priority on selling the best product.

While I haven’t put much thought into whether or not any of this should apply to Cloudflare, I just wanted to bring up the fact that there could also be some negative consequences to these changes.

Regardless, it’s always good to be invested in companies that could increase prices by 25% and not see customer fallout.

DJ

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A lot of great thoughts have already been shared on this one.

I generally also expect positive Cashflow (and Revenue!!!) effects. One-time spike, but also ongoing improvements:

  • More of the revenue will be available upfront, not only in monthly chunks after each “monthly service” has been provided. This way, NET can already invest the money (e.g., into their infrastructure), before they would normally receive it via monthly payment. Stocknovice pointed to the relevant words of Prince nicely: We need to invest up front in building out our network, and the main reason we’re making this change is to more closely map our business with the timing of our underlying costs.
  • They also raise prices for new customers by 25%, so also all new customers will pay more. For monthly and for annual plans. This should translate into positive $$$ revenue impact.
  • One potential headwind I see is that NET is already experiencing FX headwinds and needs to discount some customers due to the strong USD as mentioned in their last CC. If they increase overall prices, I am wondering how this will play out for non-USD countries, who are already experiencing “price increases” through the strong dollar. Or even for customers struggling in general. However, I expect these headwinds to level out at some point.
  • One general remark about annual vs. monthly plans: It can potentially have negative Cashflow impact since annual subscriptions are cheaper. And, if customers are loyal independent of the billing period, a business would lose out on this money (i.e., the discount for annual upfront payment). However, this does not take into account the benefits of upfront liquidity. So, absolute effects might be offset by that to some extent. However, I don’t see this issue with NET: Overall prices will be raised, also for annual plans. For existing customers, they would only lock in current prices (but not discount current prices) by switching to annual.

So, overall, I like their move because:

  • Increased prices should translate into more Revenue and Cashflow
  • FX headwinds might be expected, but should become less of an issue at some point
  • They haven’t increased prices in 12 years, and thanks to all the new products and capabilities, it seems about time they adjust their prices, so these reflect the additional value created in those 12 years (+ account for inflation etc.).

How much impact it will actually have, and if the exact timing is chosen wisely considering the current scrutiny and customers already shifting to free and pay-as-you-go tier, needs to be seen.

But generally, I think it is a sensible move and signal they start caring more about CF (and revenue growth).

Best & Happy weekend!
Lisa

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Some thoughts on NET price increases…

  1. For a long time, NET has evolved as freemium model + low cost disruptor (Prince has been a student of Clay Christiansen)… this meant that NET has always underpriced their offering
  2. In the past, I have had a couple of anecdotes from NET customer / users on how incredibly low they charge for the value the bring, including a large enterprise customer… its almost that the sales team sets the price and forget to raise with higher bandwidth, usage etc.
  3. I feel like this price raise is coming in with the new CRO who is experienced with other hyper growth companies and understand the value NET brings to the customers and looking to monetize…
  4. If so, I would think they will find a way to increase monetization on large customers as well… this bodes well for NET over next few years as they get more $ for existing products on top of huge increase in number of products developed and adapted by customers

Overall, this can also set domino effect in the cloud / enterprise SW market as these vendors may look to increase monetization as one of the ways to counter their slowing organic growth.

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