Confluent Cloud bolsters ‘data-in-motion’ vendor’s Q1 results

Derek du Preez Profile picture for user ddpreez May 4, 2023
Summary:
Confluent CEO uses the company’s first quarter earnings to outline how its cloud-based platform is superior to Kafka on-premise.

Image of a hand touching a cloud
(Image by Tumisu from Pixabay )

Confluent - the company that provides a commercial offering of Apache Kafka and is spearheading the concept of ‘data in motion’ - has delivered a strong first quarter earnings and appears to be weathering the tough macro conditions well. The vendor’s Q1 2023 earnings were bolstered by growth in the Confluent Cloud platform, outstripping growth elsewhere in the business. 

Last quarter Confluent CEO Jay Kreps announced that the company would be shrinking its workforce by 8%, with a focus on efficiency savings in order to meet operating margin targets. 

Key numbers for the quarter include: 

  • First quarter revenue of $174 million, up 38% year over year

  • First quarter Confluent Cloud revenue of $74 million, up 89% year over year

  • Remaining performance obligations of $743 million, up 35% year over year

  • 1,075 customers with $100,000 or greater in ARR, up 34% year over year

Commenting on the numbers, Kreps said: 

These results are a testament to the mission critical nature of our platform, our strong TCO value proposition, and the solid execution of our team despite a volatile macroeconomic environment.

Over the last year, Confluent has continued to show very strong gross retention, even through a substantial change in the economic environment, including abrupt changes in interest rates and economic slowdown, significant drop in funding for private tech companies, and the recent challenges in banking. 

Environments like this show which products have true durability and which are simply fads are nice to have. 

Cloud vs open source economics

It’s that “durability” that Kreps took time to discuss with analysts on this week’s earnings call. He said that what drives durability for Confluent is multi-faceted, including it being a platform that acts as an interchange between multiple teams and applications (as opposed to for just one app), making it more ‘sticky’ in the enterprise. However, the main point Kreps wanted to highlight was the economics of Confluent Cloud using the Kafka platform, as opposed to deploying Kafka’s open source system on-premise. 

He said: 

Initially, it might seem that a customer, when faced with budgetary pressure, would want to migrate off the cloud data service back to open source. Open source after all is free. Why isn't this happening? It is no doubt in part due to the comprehensive features and functionality our platform offers.

You would imagine the customers might choose to forego better functionality when faced with severe budget pressure. Why isn't this happening? The answer to this may be somewhat counterintuitive. A cloud data service has the opportunity to not just be better than an open source offering, but also be meaningfully cheaper.

To understand this, Kreps said that it’s important to recognize the cost structure of self-managed data systems - where Confluent offers self-managed software and a cloud service. Kreps said that Confluent has worked with thousands of customers both on-premise and in the cloud to analyze and compare the cost structure of open source, self-managed software, and a fully managed cloud service. 

He explained: 

There are two easily quantifiable areas of spend around a self-managed software system. The first is the cloud infrastructure for running Kafka. This spans compute, storage, networking, and any additional tooling needed to keep Kafka up and running smoothly. These costs tend to increase rapidly, eventually representing the largest portion of cost when usage is at scale.

The second is the software engineers and operations people responsible for configuring, deploying and managing Kafka. Like any data system, and particularly like any large scale distributed data system, Kafka requires full-time staff to manage it, and the cost of these individuals is significant, particularly for people managing Kafka.

Kreps pointed to a 2022 study that listed Kafka as the fifth highest paying technical skill in the market - which of course makes it challenging for companies hiring teams with experience to manage Kafka. He added: 

The larger tech companies that have built significant streaming platforms around open source Kafka have teams of 20 or more engineers attending to their data streaming platform.

It's not inevitable that a cloud service will improve on these costs. After all, if we were running the same open source software and operating in the same way, our costs would be no different from theirs. However, Confluent has rethought the problem from the ground up and has built a deeply differentiated stack that's able to drive compelling savings in both of these areas.

Kreps went on to say that Confluent Cloud has been built in a way to drive significant savings, including true multi-tenancy, intelligent tiering of data between memory, local storage and object story, sophisticated data balancing, and optimized data replication. He said: 

These significant architectural advantages combined with thousands of small continual optimizations in every layer of the stack help drive our significant cost advantage in operations. Those who have watched our gross margins progress over the last few years have observed this continual progress at work as we've continually driven additional technical improvements and improved utilization from multi-tenant operations as cloud has become a bigger and bigger portion of our revenue base.

We've gone to great lengths to ensure we are TCO positive across the customer journey from their first use case to a large scale central nervous system. We believe this TCO advantage is not just a factor in driving retention. It will also help us drive far greater monetization of the user base of open source Kafka. 

This is a point often missed by investors looking to make analogies from on-premise open source models to the cloud, which in fact are quite different.

Kreps concluded: 

Traditional on-premise open source business models offer a premium product with better features for more money. As a result, they typically are able to capture only a fraction of the open source users as paying customers. 

A cloud product, however, isn't just replacing the free software. It's also replacing the expensive infrastructure and people costs. This is driving a general mindset shift among software engineers and IT departments who are increasingly looking for managed services first, trying to avoid ongoing operations wherever possible.

As this shift takes place, we think there is an opportunity to grow from our modest penetration into the hundreds of thousands of open source Kafka users to a much more complete coverage. 

My take

A concise pitch from Kreps for the future of Confluent Cloud, which is clearly the priority. We look forward to hearing from customers at the company’s event later this year about their experiences using Confluent Cloud, as opposed on the on-premise data platforms. 

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