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In the rapidly evolving cloud computing landscape, observability has become a critical tool for managing software infrastructure. At the forefront of the observability market stands Datadog, a founder-led company established by Olivier Pomel and Alexis Lê-Quôc, and one of our current investments in the Global Tech Fund (GTF).
Sam Eden
In the rapidly evolving cloud computing landscape, observability has become a critical tool for managing software infrastructure. At the forefront of the observability market stands Datadog, a founder-led company established by Olivier Pomel and Alexis Lê-Quôc, and one of our current investments in the Global Tech Fund (GTF).
In this article, we aim to provide you with an appreciation of the observability market, Datadog’s effective business model, and generalisable lessons that can be applied to other technology companies.
The core of this article focuses on Datadog’s powerful growth engine that builds defensibility over time. This growth engine can be represented as a reinforcing loop of product superiority, efficient customer adoption, investment in engineering, and a culture that drives continuous innovations. We explain these concepts with reference to the following diagram that summarises Datadog’s defensible advantage.
Foundation: Attractive market
Firstly, what is Observability?
Any time you’ve seen or experienced a tech product not working as expected, you can trust that teams of engineers are working overtime trying to fix the issue. If that product has millions of users, thousands of deployment containers, numerous cloud regions and multiple software versions, finding the cause of errors can be like finding a needle in a haystack.
The best observability tools, like Datadog, help teams identify and fix issues as quickly as possible. They do this with dashboards, data, and collaboration tools that attempt to comprehend a system's internal state based on observed data.
Why is Observability an attractive market?
Observability in software engineering is not just a luxury—it's a necessity. As tech products scale, finding issues becomes more costly and more difficult. Datadog's tools help engineers quickly identify and resolve these problems.
The observability market benefits from strong tailwinds:
- Increasingly distributed and complex software architectures
- Migration from on-premise to cloud with long runway; currently, less than 15% of global IT spend goes to cloud (Gartner Market Databook, 4Q23 Update)
- Rising performance expectations in the digital age
- The advent of AI-powered code generation, adding layers of complexity
These trends align with customers' growth journeys. As customers scale, outages become more frequent and intricate. Datadog’s services scale with these increasing needs, allowing customers to focus on their business without infrastructure stumbles.
Datadog’s Unique Defensibility loop
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1) Product leadership
Datadog leads a competitive market with its integrated platform, unifying various observability product areas such as application performance management, log analysis, and infrastructure monitoring.
Unlike niche-focused competitors, Datadog offers a holistic ‘single pane of glass’ solution that strikes a delicate balance between complexity and simplicity. This unified approach caters to both technical users craving depth and management seeking clarity.
At GTF, we look for product leaders with multiple growth levers, and Datadog’s base platform architecture enables rapid deployment of new products, continuously reinforcing Datadog's market position.
2) Efficient customer adoption
Datadog's product-led growth strategy creates efficient customer acquisition. New users can self-serve the Datadog ‘agents’ to be operational in under 10 minutes with access to the multi-product platform. This frictionless entry point significantly shortens time to ROI and leverages "engineer love" to influence decision-makers for larger deals.
When management evaluates observability tools, they often find their teams already advocating for Datadog, armed with custom dashboards and hands-on experience well before competitors can even pitch their products.
This approach not only accelerates growth but does so with lower sales and marketing costs, a key differentiator in the market.
3) Product usage data from long tail
Datadog's product-led approach attracts a diverse user, which then informs product improvements. While the bottom 50% of Datadog customers contribute only approximately 2% of Datadog’s revenue, this long tail of customers is invaluable for product improvements. The challenges faced by smaller customers often foreshadow the needs of larger, high-revenue clients, and Datadog can learn from the over two trillion data points collected daily. By addressing these issues early, Datadog continually refines its offering, making it more robust and feature-rich across its entire customer spectrum. This data-driven approach to product development keeps Datadog ahead of market trends and user needs.
This long tail product improvement engine is similar to two other GTF companies: Cloudflare and Monday.com. If you would like to learn more about either of these companies, please reach out.
4) High willingness to pay
Datadog commands premium prices in the market, yet continues to gain market share – a clear indicator of high willingness to pay. This pricing power stems from Datadog's rapid product development and the comprehensive value delivered by its integrated platform.
Premium prices + increasing market share = high willingness to pay
Datadog strikes a productive balance between customers wanting to pay less, but still expanding usage. Maintaining this balance raises the bar for their product’s effectiveness, accelerating product innovation while capturing value.
The company's growth is fuelled by a consumption-based pricing model that scales with customer value, resulting in impressive net revenue retention of more than 115%. In addition to existing customer expansion, over 30% of recent incremental revenue came from new customers in 2023, indicating ongoing market penetration.
5) Research and development investment
Datadog's efficient customer acquisition and high willingness to pay create a powerful funding engine for R&D. The company significantly outspends competitors in engineering investments, laying the groundwork for long-term product superiority. This heavy investment, coupled with insights from a diverse customer base, enables Datadog to innovate rapidly, expanding into new categories and staying ahead of evolving market needs.
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6) Multi-product expansion
Datadog's platform approach enables rapid development and deployment of new products, outpacing competitors in category expansion. From security products to 'shift left' developer tools and 'shift right' offerings like Product Analytics, Datadog ships fast and isn’t afraid to experiment with new product areas and abandon unsuccessful projects.
To assess the rapidly expanding product portfolio, Square Peg analysed Datadog’s product release notes. The graph below shows the number of unique product areas included in the product releases over the last seven years and highlights the impressive development pace of their platform.
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Customers are rapidly adopting these new products, consolidating more use cases within Datadog's ecosystem. This expansion increases product stickiness and amplifies the value derived from Datadog's single-platform solution, creating a flywheel effect of adoption and expansion.
Datadog’s defensible advantage: a reinforcing loop
Each element of Datadog's growth engine is formidable on its own. Combined, they create a reinforcing loop that strengthens over time. As the product improves and expands, it attracts more customers, generating more usage data and funding for further investment. This virtuous cycle not only produces best-in-class metrics but also continuously widens Datadog's moat, making it increasingly difficult for competitors to catch up.
Foundation: Team and culture
None of Datadog’s defensibility would be possible without a strong culture. At GTF, we place heavy emphasis on how team and culture contribute to sustained success. Two unique elements about Datadog’s culture to highlight are:
- A clear, consistent north star focused on breaking down team silos. Datadog's consistent ‘north star’ focus is supported by founder-led leadership and has led to the market's best-in-class single platform solution.
- Deeper accountability for product leaders. Alongside the standard product engagement metrics, Datadog’s product managers also considers commercial metrics. The transparent pricing of products creates a very clear commercial signal for product managers to ensure product creates tangible value for customers. This commercial focus creates a pseudo-profit-loss requirement for product owners, which is not common for many tech companies.
This culture, deeply aligned with end-user needs, is difficult for competitors to replicate.
If customers aren’t willing to pay for a product on a standalone basis, then it’s not creating enough value
Outcome: Best in class metrics
Datadog's unique approach translates into superior financial performance. Datadog is among the industry’s strongest ‘rule of 40’ companies with a combination of strong free cash flow margin and healthy revenue growth. Further, Datadog has consistently produced positive free cash since 2019 when they had less than 5x of today’s revenue. This means that they didn’t have to pivot as much as their peers during the 2023 focus on margins.
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Datadog's success isn't just about having a great product—it's about creating a self-reinforcing system that continually widens the gap between itself and competitors. For investors and industry observers alike, Datadog offers a compelling case study in building lasting advantage in the fast-paced world of enterprise software. Its ability to align market trends, customer needs, and internal capabilities into a cohesive growth engine sets a new standard for defensibility in the tech industry.
