TWLO: pricing pressure?

Some have argued that in the future due to commoditization from competition that we be see pricing pressure that will reduce TWLO’s margins. The argument goes that if a big customer like Uber can take business in-house or switch to a TWLO competitor then others may follow. I have argued that Uber is a special case because they have so much business with TWLO that they have an incentive to try to lower costs. In addition, being totally reliant on one vendor for something mission critical is generally not a good business practice. Therefore, I think that Uber is a special case.

In addition, TWLO can be used for all sorts of communication tasks. They’re adding a new feature or capability every 3.5 days. They have 50% of their staff in R&D making the product offering better and more useful for more and more use cases.

Now regarding Uber, the business that’s moving to Uber in-house seems to be lower value business. Here’s Lawson describing how different use cases can have higher importance to a customer: "I mean there’s a number of used cases that play in a company like Uber and the way they look at those use cases and what they value differ based on how use case works as well as where in the world it is. For example, if you’re doing a blast notification, your bulk notification to many thousands of drivers to get out on the road or something like that, you know there’s a different quality of service required than the SMS telling you that your ride is arriving, right. You expect that to be timely, you want it to get there, and it impacts the customer experience if it doesn’t get there on time. Whereas when you’re blasting out many thousands of messages that there’s some that don’t get there, it’s just a different quality of service that you expect from that sort of bulk type used case. And overall, we think there’s a lot of use cases and lot of opportunities inside of Uber and a lot of opportunities both on existing and new use cases and we’re working very effectively with the team there."

One analyst asked about pricing pressure: “One is pricing, you talked about to realign that pricing Uber and one with your bulk messaging, just curious have you had to realign your pricing with your other customers? I realize they’re less. They’re not as big as Uber. And then how would you characterize pricing in general?”

Answer: “yeah continually look at our pricing. So that’s one of the beauties of our business model and customers scale and grow. They know they can give better pricing, so as customers scale and move up, we do offer them a better pricing and that’s a continual process. Regarding the overall pricing, we haven’t seen any major changes to the overall pricing environment.”

Here’s some stuff on competition:

Just it’s been an interesting couple of months with one of your competitors suffering from I believe a 22-hour outage and another one of your competitors seemingly closing its doors to new customers and new projects and meanwhile your new customer additions continue to strengthen. So I’m curious from your perspective, has the competitive environment become a bit less intense or has it changed in any way in recent months? And just also how frequently are you winning new customers who have in fact suffered from poor quality with a competitor and therefore are turning to Twilio?

Here’s Jeff Lawson’s answer which supports that notion that TWLO’s investments in improving their offering is outpacing the competition:

Jeff Lawson: "yes, we do see customers who come to us from other platforms and due to struggle that a vendor might have because either lack of innovation or the availability of their solution. And so customers do come to us and value the things that we’ve invested in that make our platform extremely reliable but also an engine of innovation for them.

Enterprise small now but growing faster than the overall business
Jeff Lawson: “While enterprise relatively speaking is a smaller part of our mix today but growing faster than the overall. And so it’s a segment we’re very excited about. We think the enterprise opportunity is very large when you think about lot of that is with traditional enterprises and products that they bought traditionally. And so we see this as a very large opportunity for both segments, but enterprise is an exciting one that is growing extremely fast for us.”

So here’s the main points as I see them:

  1. Communication facilitated by TWLO can differ in complexity, difficultly, and importance to customers. That’s why TWLO has hundreds of R&D engineers creating new capabilities for customers to use. The more complex and important the communication flow is the more TWLO can charge and the stickier that revenue is. TWLO will lose some of the simpler tasks to companies like Uber but the growth in other customers, the growth in more complex communications will more than make up for the loss in facilitating some simple tasks.

  2. IoT and AI is only going to make communication between devices and devices, people and devices, and people and people more frequent, useful, actionable, important, and dependent upon an increasing number of factors and more information. I think this will drive the total available market will grow enormously.

  3. TWLO is investing heavily in making their offering more and more advanced. Most competitors will not be able to keep up. Some of the commentary suggests that competition is decreasing.

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<<<Twilio’s guidance for the third quarter suggests just 30% top-line year-over-year growth on the high end and its first sequential decline. Investors better hope that Twilio is being conservative again.>>>

PART ONE - VENTING AND ANALYSIS

I am the one (I believe - before it was a Rule Breaker recommendation) who brought TWLO to the attention of the boards we like to peruse. Actually made a fast double and sold out very near the top because I had seen a set up like this before (talking stock that had recently gone public and then turns around when the shares skyrocket and does a quick secondary benefitting mostly insiders) and sold immediately after learning of the planned secondary. I just knew that was the top. And so it was.

But yet Twilio still fascinates me, but I also hold it a grudge from last quarter. Can’t really say it was Twilio’s fault per se, as the market crashing 26% on it, overnight to this day seems rather excessive. But you know, in retrospect, how much do you want to wager that this very rapid secondary, that benefitted insiders, was timed to take place before the Uber announcement? Twilio had to know it was coming, but instead of giving any guidance in regard, they let insiders cash out, and then deal with the consequences.

So in some respects I hold a grudge. Not financially as I made money on Twilio, but I simply abhor behavior like this…

But you know, Lawson also has skin in the game.

The above quote is from a Fool article on earnings. The bolder part is where I think we are talking past each other. 30% growth would be a 10% upside surprise from guidance. That is alarming. Past growth figures be what they may, the future is where stocks are valued. Seems as if the market and most people think this 27% forward guidance is a deliberate low ball. This calls into question again the honesty of the company if that is so. As investors we deserve a good faith forward guidance.

PART 2 - QUALITATIVE ANALYSIS

This aside, I see two things:

(1) Gaucho you provide good qualitative evidence that Twilio is truly a Gorilla (and we can discuss this definitionally some other time - but I mean it in the structural sense of its competitive advantages) in this market. That is what got me excited about it to begin with when I discovered it prior to its IPO and immediately bought in.

What I predicted seems to be coming to pass, and that is that no other competitor could keep up with Twilio’s R&D, focus, quality, and all the rest. It is like AMD trying to keep up with Intel or Nvidia. It will never happen despite a lot of bluster and talk. Structurally, AMD simply cannot keep up.

The divide between Twilio and the rest just continues to grow. The dilemma being that a lot of Twilio’s legacy business is becoming commoditized. This business is where Twilio will face increasing pricing pressure. And Twilio has not hid this fact. I recall management stating that they don’t plan on making money on the commodity stuff (which is most of what Twilio does now) but it will be higher value features, and enterprise where Twilio will make their money. Break even on commodity, make profit on the value add features.

In this regard, no one can keep up with Twilio. And I believe the competitive field is weaning its way down and Twilio CAP is increasing in regard to its ability to deliver features and value add. Leaving the rest of the market to competitors to compete with Twilio on the more commodity elements, where there is simply not enough profit to be made to fund R&D and keep up with Twilio on the real profit centers.

(2) So if this is the case, and the market is growing so fast, why the low ball guidance? I think what is happening is similar what has happened in optical and in chips. As volume goes up, price per unit (say megabyte of data delivery or gigahertz of digital speed) goes down. In semiconductors under WinTel this created a ton of wealth. In optical and in hard drives, this created little wealth as the cost of each new mega unit of deliver declined faster than capacity being delivered.

Twilio is facing similar circumstances. Higher volume customers seem to have enough power over Twilio to gain volume discounts. Volume discounts decrease revenue growth, even if units of communication increase, the amount of revenue growth from this increase in unit volume will be less than the unit volume as Twilio discounts its volume business.

Well, I understand what I just said, but probably no one else ;(.

All in all, and I am interested enough again to look deeper, but it seems as if Twilio’s competition is losing ground, but also that Twilio’s revenues will grow slower than the total volume growth in the market due to the fact that Twilio will be required to give volume discounts.

This explains the dilemma of both increasing CAP while growth slows in what is otherwise a rapidly growing market.

But obviously my thoughts are scattered in regard to TWilio at the moment, but just thought I would put out this conjecture.

What I look for in a long term investment is a company with a high CAP. And Gaucho you make a good case that Twilio has that in spades in this market and that it is getting larger rapidly.

We also look for a large TAM that can be scaled into. The TAM may not be as large as we would want due to the need to volume discount. Thus the lower growth estimates. Will this market be more like semiconductors when continual lower pricing is offset by demand growing even faster? Or more like optical where prices fall faster than the rate of new capacity delivered.

Whichever the case, I am interested again due to the nature of Twilio’s competitive advantages that are only growing. The rest of this scattered picture is tbd after some more thought.

Tinker

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TWLO will lose some of the simpler tasks to companies like Uber but the growth in other customers, the growth in more complex communications will more than make up for the loss in facilitating some simple tasks.

Then how did Uber do this? I mean if TWLO is such a gorilla that the market has to have them, how did anyone find a work around and what exactly is that workaround?

As you recall, Bert had originally posted that there wasn’t anything special in their software but with the new add-ons, perhaps that has changed.

But it may just be that the true “enterprise” business will always lag because larger companies will always be able to do this cheaper than using TWLO based on their sheer volume…we raised this issue many months ago.

SO perhaps TWLO’s sweet spot is really the smaller players and they will need to service thousands upon thousands of them.

I still don’t think we are looking at a gorilla here…you cannot drop YoY growth to 27% and have a company like Uber leave you with ease…now if Uber decides it had to come back…might be different story.

Remember also Chris, last quarter they lowered expectations for this past quarter, so a beat was more in the offing.

I will also look over the earnings call and financials when I have a moment…but maybe trhe market had such a dismal view of their business that they rewarded them despite pretty lackluster guidance.

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