Dynatrace Is a Strong Operator in a Burgeoning Observability Space

Analyst

Malik Ahmed Khan

We have a positive outlook on Dynatrace’s prospects in the observability space. The firm’s products benefit from secular tailwinds driving an accelerating increase in data for enterprises to monitor and analyze. In our opinion, the firm’s sticky product portfolio, broad swath of products that cover the entire IT stack, and increased penetration in its target market have enabled Dynatrace to form a narrow economic moat around its business. 

As the volume of data increases, so does its impact on an enterprise’s decisions. More data brings greater complexity as firms struggle to monitor and analyze the copious amounts of data being produced by their operations. This increase in data and complexity, driven by cloud migrations and digital transformations, provides Dynatrace with a long runway for growth. We think Dynatrace, much like other vendors in this space, provides a vital service to its clients by allowing them to gather insights, triage issues, and improve their overall IT stack efficiency. 

While the observability space remains competitive, we think there are plenty of greenfield opportunities for Dynatrace to exploit in the near to medium term. The firm has also been investing heavily in its sales and research divisions, a strategy that we view as sound. We believe that customers, after onboarding an observability vendor, are sticky. As a result, Dynatrace’s investments in its platform and onboarding clients will reap benefits for a long time. 

As Dynatrace lands and expands its customer base, we are encouraged by its ability to upsell existing clients into adopting a multiproduct strategy. As a client adopts more Dynatrace modules, the firm’s entrenchment in its client’s ecosystem increases. This entrenchment subsequently results in a higher client lifetime value. The firm’s strong net retention rate is evidence of the upselling strategy’s success, in our opinion. With the ability to consistently add new customers and subsequently upsell them, Dynatrace has strong long-term growth prospects, in our view.

Business Strategy & Outlook

We believe Dynatrace merits a narrow moat rating owing to strong customer switching costs associated with its product portfolio. Dynatrace offers its customers a platform that can ingest, index, and analyze copious amounts of data while providing real-time monitoring and analysis capabilities. From a customer's perspective, using Dynatrace to monitor its entire IT stack allows it to create better business outcomes due to greater IT- and operations-related efficiencies. With impressive upselling and retention metrics, a suite of inherently sticky product-offerings, and a long runway for growth, Dynatrace is more than likely to generate excess returns over the next 10 years, in our view.

We consider Dynatrace a key competitor in full-stack monitoring and analytics. Full-stack monitoring, or observability, is a rapidly growing space. Modern-day clients leverage technology in their operations like never before. This increased use of technology relies on two of the most prominent secular tailwinds in software: cloud migration and digital transformation. However, with an increase in technology comes the coalescence problem, as various services within a company's IT stack may not communicate with each other, leading to data blind spots. 

Full-stack monitoring is a method of unifying and coalescing disparate parts of an enterprise's monitoring framework. FSMA providers seek to give enterprises a one-stop shop to monitor their entire IT stack, ranging from application performance to the end-user experience. An essential criterion in FSMA is a provider's ability to ingest large amounts of data, consolidate it, and then make meaningful inferences from it, leading to better business outcomes. The status quo before the emergence of FSMA was various providers focusing on specific parts of the IT stack. For example, an enterprise may have had one company monitor its application performance while another monitored its logs. This division of labor led to inefficiencies as IT professionals coalesced the outputs manually to construct a meaningful picture of the overall infrastructure's health and performance. FSMA providers now offer customers the ability to remove these data silos and monitor the entire IT stack from one consolidated platform. 

The two key secular trends, cloud migrations and digital transformations, lead to exponentially more data for the companies undergoing these changes. Often, this additional data is machine-generated in the form of metrics, logs, and traces that have to be monitored and observed. Enter FSMA vendors that allow firms to monitor their IT stacks and glean meaningful insights from them to provide better business outcomes. 

After an FSMA vendor is adopted by a company, it is vital to understand the costs of ripping and replacing it. First, firms often use an FSMA vendor to "standardize" their monitoring frameworks. This standardization includes deep integration of the vendor's product into its IT stack. This integration, which ranges from incorporating the vendor's code into the company's applications to developer training, leads to increased switching costs for the FSMA vendor's platform. While single sourcing can create obvious vendor lock-ins, we believe that by doing so, companies can capture efficiencies by allowing their developers to focus on mastering one vendor's product portfolio. 

Second, we believe IT decisions in a company are driven by its engineers, not its accountants. We do not think that companies nickel and dime their way to picking an FSMA vendor; typically, they will select the product based on the features most relevant to them. As a result, if an FSMA vendor can demonstrate its portfolio's value to a firm's developers and get them accustomed to its platform by incorporating it into their day-to-day workflows, its platform can be very sticky within an organization thereafter. 

Third, ripping and replacing an FSMA vendor can lead to data loss and security lapses. This risk is a genuine concern for firms using a vendor to monitor their entire IT stack. While competitors may offer a parallel migration that can somewhat allay these concerns, we do not see companies switching away from their FSMA vendors due to the risk of exposing or losing mission-critical data. 

Dynatrace, as an FSMA vendor, provides value by monitoring a business’ entire IT stack. By offering a host of products that tackle various segments such as application performance, networks, and cloud security monitoring, Dynatrace’s value proposition centers on its ability to capture efficiencies in a firm’s IT operations and save IT labor hours. 

A pertinent case study, provided by management, of how businesses can utilize Dynatrace’s platform is Kroger, one of the largest supermarkets in the United States. Kroger, like many enterprises, was using a hybrid multicloud strategy, which included multiple public cloud providers and on-premises servers. Kroger deployed Dynatrace’s full-stack monitoring platform to garner insights from the data sprouting from its IT stack. After deploying Dynatrace’s platform, Kroger said its weekly number of support tickets following the launch of an application decreased from 700 to around 7. Generally, we observe that vendors such as Dynatrace seek to minimize a client’s payback period by enabling them to cut costs or reduce mean time to resolution. 

When thinking about Dynatrace’s competitive landscape and positioning, we view the firm's economic moat as a result of strong switching costs, which can be traced to its entrenchment in a client's IT stack.

We consider Dynatrace a leader in full-stack monitoring, with its application performance monitoring product an area of particular strength. Generally, we view full-stack monitoring as a space conducive to the presence of economic moats. Dynatrace’s platform adapts to a customer's specific needs and can iteratively improve itself. As a company adopts Dynatrace’s FSMA offerings, we typically see a movement along the upselling schedule as Dynatrace is able to expand its impact within the company. Dynatrace’s platform adapts to a customer's specific needs and can iteratively improve itself. This process is a multistep game. Each successful step entrenches Dynatrace’s offerings even more as technical users become more accustomed to the monitoring platform that continues to improve. We see no greater evidence of this entrenchment than the impressive net retention metric of more than 120% since the company's initial public offering in 2019. 

We also think Dynatrace’s land-and-expand model enables greater entrenchment in a firm’s IT stack. As a firm spends more on Dynatrace’s products, it typically does so by purchasing more modules from Dynatrace. We view this expansion, as evidenced by the increased customer spending on Dynatrace’s products following adoption, as evidence of the platform’s stickiness. 

Dynatrace’s go-to-market motion aims at clients with revenue greater than $1 billion. This segment roughly includes 15,000 enterprises globally. Typically, these companies have complex IT needs with sprawling IT infrastructures that include multicloud and on-premises data centers. With this level of complexity, we expect most of these firms to onboard FSMA vendors to monitor their respective IT stacks. 

In terms of penetration, less than a third of these 15,000 target companies currently use Dynatrace in some capacity. While this low penetration provides Dynatrace with a long runway for growth, we suspect that the firm will run into tough competition against the likes of Splunk and Datadog. At the same time, we think that a sizable chunk of the market is still greenfield. This opportunity can allow Dynatrace to land larger clients without having to displace existing, well-entrenched FSMA vendors. Overall, we think that the competitive landscape is broad enough to accommodate multiple winners. This expectation is consistent with our view of economic moats in this space, with multiple vendors carving out a narrow economic moat in FSMA.

Narrow

Economic Moat

Dynatrace Inc

Dynatrace, Inc. engages in the development of a software intelligence platform, purpose-built for the enterprise cloud. The firm's platform utilizes artificial intelligence at its core and advanced automation to provide answers, not just data, about the performance of applications, the underlying hybrid cloud infrastructure, and the experience of the customers' users. It specializes in cloud ecosystem integration, incident and alert management integration, DevOps CI/CD integration, user experience and business intelligence insights. The company was founded in 2005 and is headquartered in Waltham, MA.

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Dynatrace, Inc. engages in the business of developing software intelligence platforms which are purpose-built for the enterprise cloud. The firm also focuses on cloud ecosystem integration, incident and alert management integration, DevOps CI/CD integration, and user experience and business intelligence insights. The company was founded by Bernd Greifeneder in 2005 and is headquartered in Waltham, MA.

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