Twilio is an API-first software company providing communications APIs for software developers to integrate SMS text, email, voice, and chat communication features into their technology stack. API stands for Application Programming Interface. Simply put, an API is software allowing for two different applications to talk to each other to carry out requests.
Twilio operates a usage-based model. This model creates less friction when business want to begin implementing Twilio's offerings into a new tech stack, as companies are not required to pay any upfront costs. The usage model allows for both businesses to grow together and incentives are aligned well between Twilio and its customers.
A developer at a company of any size can integrate Twilio's APIs into their communications applications quickly. Once integrated into a technology stack, Twilio's offerings are highly sticky. As such, Twilio has strong customer acquisition.
Twilio is making acquisitions to become an omni-channel offering of communications APIs.
Twilio faces a few risks, including margin pressure, lack of pricing power, competition, customer concentration, open-source options and the risk that all API-first businesses face which is large businesses creating internal customer features replacing the need for Twilio's services. However, we believe Twilio's competitive advantages and attractive pricing make these low or unlikely risks.
Twilio's advancements in bridging the gap between businesses' applications and telecommunications networks granted it a wide competitive advantage that has helped companies create a seamless customer experience.
Key Company Metrics
A set of metrics we constantly keep updated to monitor the investment thesis.
Twilio Super Network
Twilio's competitive advantages start at the core of the business - the Twilio Super Network. The Twilio Super Network is a web of connections on which all of Twilio's services are built. More specifically, it manages the connections that occur between the internet and telecommunications networks. Because this platform manages the connections between different types of infrastructure, Twilio does not own any physical network infrastructure.
The obvious advantage is a capital-light business model with low capital expenditure requirements. As a software provider, Twilio can focus its efforts on research & development and sales & marketing, two classes of expenses that are crucial for software businesses in the early stages of their growth stories. Twilio is no exception.
Perhaps the less obvious advantage inherent in the Twilio Super Network is the amount of interactions that occur on or through it. Since the Twilio Super Network is what enables its customers' (i.e., businesses that subscribe to Twilio services) software to communicate with global devices (i.e., Twilio's customers' customers), Twilio processes tons of consumer interconnections and data.
The optimization and cost of these communications are of utmost importance to Twilio's customers, so Twilio works to constantly refine these two areas of concern. Data is analyzed continually, and the more data that is processed through Twilio, the stronger the platform becomes.
Therefore, Twilio hosts a powerful network effect. The more customers that contract with Twilio for services, the more customer interactions flow through Twilio's critical foundational layer - the Super Network. The platform literally gets better over time, constantly optimizing services for businesses to interact and engage with customers, and improving costs through efficiencies.
Twilio differentiates itself by providing pre-packaged solution APIs. Instead of developers having to build out infrastructure that support their software and APIs, developers can simply build and manage communications and customer engagement applications on top of Twilio.
Twilio empowers developers via Twilio Studio, a visual workflow builder. Users utilize its easy drag-and-drop functionality and only need to write a few lines of code to create fully functioning applications using Twilio’s APIs.
Twilio's products are also highly flexible and create another powerful network effect for innovation. Developers have shown their willingness to build around Twilio's products - they are only limited by their imagination. The increased usage and mixing and matching of Twilio's services help to create additional use cases as an increasing numbers of development teams tap into the Twilio ecosystem to build out communications applications for their niche needs.
The company's success in attracting new customers through this network effect has allowed it to cross-sell its products. Twilio has high potential to convert most of its current customers, who are solely using its core communications-platform-as-a-service product, to longer-term, industry-specific solutions.
It is an opportunity Twilio has already begun taking advantage of, reflected by its dollar-based net retention ("DBNER") figure, which is well above 100%. This metric indicates that Twilio customers tend to spend more on the platform each year and face high switching costs as they become increasingly reliant on Twilio to power their communications applications.
Twilio can also attribute part of its industry-leading position to its first-mover advantage. The company was a pioneer in the cloud CPaaS industry and made it easy for businesses to engage with customers through various channels, such as voice, text, video, and email.
The company continues to stay ahead of its rivals. The IDC reports that Twilio’s platform provides the most features for any similar market offerings available.
Most large companies have the ability and resources to build Twilio-like functionalities internally. However, the significant level of focus and financial investments required to build these applications from scratch are hardly justified. It is far simpler, more efficient, and frankly more effective to build on a world-leading communications platform (i.e., Twilio).
Customer experience is an important pillar of many businesses today, and a tangible and highly valuable competitive advantage as well. This is where Twilio's business model shines.
Twilio helps businesses develop a comprehensive view of their customers and their ability to engage with them. It has effectively created a bottleneck business on which many companies rely on to have an edge over competitors by ensuring their customer experience is best-in-class. Twilio makes it easy for businesses to make customer experience a priority, and therefore, a source of competitive edge.
Usage-Based Business Model
For a typical software-as-a-service ("SaaS") company, revenues are generated from services that consumers subscribe to. In Twilio's case, the majority of revenue is generated from what is known as a usage-based model, whereby subscribers are charged based on the extent to which they use the product.
Developers can begin using the product out of the gate with no upfront cost and little training. This also means the platform is flexible enough to work with a variety of budget sizes, ranging from start-ups to the largest brands we know. Because Twilio runs on the usage-based model, Twilio can effectively grow with small, emerging brands. Developers build out their applications using Twilio in the early stages of their organization's growth story and so Twilio stays on for the ride. Twilio literally scales with scaling companies by being a foundational piece of these companies' successes.
The Twilio platform also poses high switching costs, as mentioned earlier. The Twilio platform becomes deeply embedded in a company's communications software, meaning Twilio is the foundational component to their software.
Switching to a different CPaaS provider would not only require re-training of developers and users, result in potential downtime as the organization builds out its new communications applications, and require substantial financial resources to complete, but it could also frustrate customers who become familiar with the Twilio-powered communications applications. This would especially be a negative experience for customers of a business if they collectively perceive the new communications applications to be less effective than before. It is hardly worth the risk - "if it ain't broke, don't fix it" applies to communications platforms in this case, especially as Twilio continues to optimize and create cost efficiencies.
Segment (The Acquisition)
In 2020, Twilio acquired Segment.io ("Segment"), the market leader in the customer data platform industry, for $3.2 billion. This helped Twilio branch out from solely providing API services. Twilio now has a leg up in customer engagement services.
Segment enables firms to measure the impact of Twilio on their operations by connecting their Twilio data with other customer data they may collect and store internally.
The Twilio-Segment integration also provides valuable insights that businesses would be unable to obtain using Twilio products alone. For example, in the past, it may have been difficult for a business to see the proportion of customers that log into a the business's app after getting a text message from that business.
Segment also helps Twilio make its automated customer interactions smarter. Now, through Twilio, businesses can use the data they collect to target communication channels that are the most effective for each user and personalize their content.
The combination of Twilio and Segment allows each segment (no pun intended) to build more defensible businesses in their respective markets (i.e., communications and customer engagement) and makes the "buying" (i.e., subscription) decision much more appealing than "building" for both current and prospective customers.
Twilio will continue tapping in to the developer community to accelerate adoption. Not only is there a major opportunity for first-time adopters (i.e., developers not yet on the Twilio platform), Twilio can also cross-sell existing developers and increase awareness or explain potential use cases outside of what those developers are currently doing. The opportunity mainly lies with those developers that are perceived to be underutilizing the platform. In simple terms, there are ample opportunities to expand enterprise penetration and keep the DBNER metric high, which ultimately will continue to fuel high revenue growth.
Twilio boasts a supreme partner network that gives it an edge over competitors. This partner network can also be leveraged to fuel growth. According to Twilio's official partner showcase site, Twilio has partnered with over 200 organizations. These partners include Deloitte Digital and PwC in Twilio's "strategic tier", and plenty others in the Gold, Silver, and Bronze tiers. These tiers are classify Twilio's partners based on Twilio's business, certification, and performance requirements. Twilio can lean on this growing partnership network to expand globally in underpenetrated and unpenetrated markets outside North America and increase lead generation through its meaningful and mutually beneficial relationships with its partners.
Twilio is guiding for solid margins over the long run. If the company executes strongly on its strategic objectives listed above, management believes Twilio can achieve steady-state gross margins consistently between 60% and 65% and operating margins over 20%+. The gross margin expansion and reduction of research & development ("R&D"), sales & marketing ("S&M"), and general & administrative ("G&A") expenses as a proportion of revenue will fuel healthy operating margins that will drive profitable growth. Twilio also expects 30%+ annual organic revenue growth over the next few years, and we believe Twilio will remain a low double-digit organic revenue grower for some time.
Pricing Power & Margins
Today, Twilio's gross margins are relatively low for a software firm, and operating margins are negative as the company continues to spend tons of money to develop and market its products aggressively.
While this is expected for a company in its high-growth stages, like Twilio, the true economics of the business are obscured and effectively "not real" until it happens.
Although management has aspirations to get gross margins to a steady state of 60-65% and operating margins to 20%+, the timing and feasibility of achieving this is frankly unknown.
On the bright side, Twilio has shown some degree of operating leverage over the last decade, bringing operating margins closer to positive readings.
Gross margins have also been declining over time, making the 60-65% long-term goal more ambitious by the year. This is potentially indicative of a pricing problem in that pricing increases have not kept up with the direct costs associated with running the platform and services for Twilio's customers.
Twilio's pricing is reasonable in our view, however, the usage-based model might be particularly sensitive to pricing increases. There could be pervasive customer frustration, especially large accounts that typically witness high volume usage.
Overall, we believe Twilio's plan to under-earn over the short run is justified. Growth, spurring the network effect, and winning increasingly larger accounts and capturing underpenetrated markets are all priorities - these all require short-term sacrifices in the form of poor profitability.
Big Partnerships and Customers
As Twilio partners with more companies to provide it with enhanced communications capabilities, it creates an increasing deep reliance on these partners to continue to drive leads. If these partners stop using Twilio services to the same extent or drop it completely to create their own internal solutions, Twilio's lead pipeline may be severely impacted.
Additionally, Twilio tends to carry quite high customer concentration. This poses a large risk if any of these large companies decide to develop internal solutions. For example, in 2017, both Uber and Facebook decided to reduce their spending on Twilio by developing their own in-house functionalities.
This took a heavy toll on Twilio as both companies were lucrative customers. We believe Twilio should constantly be looking towards creating differentiated products that cannot be mimicked in-house, as well as diversify through growing with small- and medium-sized enterprises.
Despite being an innovator, Twilio has introduced competition into its industry.
In a competitive environment like this, it typically comes down to pricing and ease of product implementation. Twilio may have been in the industry for over decade now, but if a company comes in with a cheaper pricing structure, it could adversely impact Twilio's business.
For example, Bitrix24 is a free alternative to Twilio. If Bitrix continues to expand its business while keeping it free or extremely low cost, Twilio may face major growth headwinds.
Twilio's strategy to expand its omnichannel capabilities is strategic in our view as a way to keep distance between itself and competitors. This is assisted by strategic mergers and acquisitions ("M&A") and we believe this M&A activity is wise and a critical part to the total growth strategy.