The biggest internet trend for at least the last two years has been the boom B2B Software-as-a-Service (SaaS). VC’s love SaaS companies because it’s a high-margin business, sticky, and easier to value due to recurring revenue being commonplace. In the chart below, it’s easy see what makes investors so bullish. The value propositions with SaaS companies is tied to the fact that more and more work and processes are shifting to the cloud. Engineers and companies using legacy software face increasingly difficult tasks and undergo time consuming projects. With competition at all time highs, companies need to adapt or die. Today’s 23% cloud-workload location shows that there’s still ample space left to grow. Given that every company today has to have some sort of digital presence, utilizing the right software tools is critical.
Software is delivered on a front end and a back end. The front end is what you see when you log into your Gmail to read this newsletter. The backend is all the things that happen behind the scenes (hence, “backend”) for your Gmail like storing old emails, writing a draft, etc. The backend is supported on servers that make said software distributable to the masses. (Note: I highly recommend looking through these photos of the Google data servers because they have a TON and they’re everywhere.) But with software everywhere, things like infrastructure, code and shipment volume, and scale have changed significantly. Most of this code is run on Amazon Web Services (AWS), Microsoft Azure, or Google Cloud (GCP). All of which have dozens of sub-apps that really enable code and data to sprawl. To cope with the growing complexity and size of development, DevOps was born. A DevOps resource’s main goal is to confirm software works at scale. While there are several aspects to their workflow/cycle, today I want to focus on the last step, Monitoring. (Big shout out to Justin Gage’s newsletter, Technically, for clarifying all of this in non-technical terms).
Monitoring is similar to watching your steak as it cooks. In theory everything should be fine, but you still need to keep an eye on it. Is the heat too high? If it’s on a cast-iron, do you have enough butter? Was it too cold before going on? Is it cooked through enough? Software development is similar in that after a product (e.g. an app) is launched, its impact to the server and its performance for users both have to be monitored. Datadog, a leader in the DevOps field, has made Monitoring significantly easier and enabled the function to thrive. It enables dashboards to be built for code and performance observation, issue alerts, and so much more. To boot, those dashboards can be designed for specific orgs - engineering, IT, product, etc. Now, if you consider the fact that only a low percent of that 23% of today’s cloud workload is actually monitored, Datadog gets a lot more interesting.
Datadog currently processes several billion datapoints every day. Its customers all accumulate millions of metrics and events, each of which results in something new to track and observe for Datadog. Per Muji over at HHHypergrowth:
The expansion of [Datadog’s] platform over the past 9 years has lead up to them providing what is called the “3 pillars of observability” (something Elastic also stresses). This means their platform can ultimately cover and analyze every dimension that software development teams want to watch in order to monitor their software stack and its usage.
3 pillars of Observability:
1. Infrastructure monitoring (System Metrics, Data Engines, Network Traffic, Containers, Serverless)
2. Log Management (Service Monitoring, Custom Triggers and Events)
3. APM (Application Performance Monitoring)
When you combine all of these pillars, DevOps gains visibility over an entire tech stack. In plain English, it becomes incredibly easy to find out what went wrong when there is a problem AND to find out exactly where it came from. When you consider how many companies operate millions of lines of code, break that code, and the runway still left for cloud-based software… there’s a lot to observe. Those billion datapoints will inevitably turn to trillions sooner than later. Datadog also has built tons of integrations into platforms like Jira, Github, AWS, and PagerDuty. That pliability across the most common development tools and the need for scalability puts Datadog in an envious spot. Datadog’s flywheel will continue to turn at a ridiculous speed thanks to how software and data proliferation will continue.
Taking a look at Datadog’s Q2 2021 financials, it’s pretty clear to see just how smoothly their flywheel is turning. Their revenue grew 67% from Q2 2020 up to $234MM for the quarter and now have 1,610 customers paying more than $100k a year. They had a health FCF at $42.3MM and are profitable for the year. They also shipped three new products. All of which led to a dollar-based net retention of 140%, which is industry-leading and frankly just freakish. The volume of customers using 4 tools tripled since this quarter last year. All of that goes to show just how comprehensive and necessary Datadog’s products are.
(Source: Software Stack Investing)
If you leave this with any takeaways, there are two pieces of information to consider when evaluating Datadog for its future potential. The first of which is the world’s trajectory towards software and Web3. As more and more of our life shifts online and in the cloud, all of the providers of that internet-based infrastructure will rely on companies like Datadog to keep their software running. Downtime costs a lot, and providers will want to minimize loss. The second takeaway is Datadog’s moat. They’re defensibility grows each quarter thanks to their flywheel and the stickiness of their business. Their dollar-based net retention metrics are at the top of the top decile of SaaS businesses. Hitting a DNR of 140% means that Datadog’s existing customers spent an additional 40% on Datadog’s products over the course of the year. That’s in addition to not losing customers.
Not too many companies can continue to resell to their existing customers at such a high velocity and not too many are so important in helping their customers scale. Datadog is positioned perfectly to lead the pack for years.