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This Is Snowflake's Key Competitive Advantage

By Billy Duberstein - Nov 24, 2020 at 8:30AM

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And likely why Berkshire Hathaway invested.

Cloud-based data warehouse company Snowflake ( SNOW -4.47% ) was the hottest IPO of the year and a very popular buy among hedge funds in the third quarter. When I say "hot," that's actually an understatement. After initially pricing at $80, demand was so high that the pre-trading share price moved up to $120. By the time shares hit the market, they were 100% higher than even that nosebleed figure. 

As of Nov. 23, Snowflake has held those gains, with shares trading around $270 per share, a market capitalization of $74 billion, and a price-to-sales ratio of 142.  That's higher than even the most expensive software-as-a-service stocks. What could possibly justify this?

Snowflake has many fine attributes, but funds willing to pay up for shares today likely recognize this one key competitive advantage.

Two hands cradling an illuminated globe.

Snowflake benefits from network effects and high switching costs. Image source: Getty Images.

The Snowflake data exchange

Snowflake's cloud-native data platform consists of several products, including the core data warehouse, Snowflake's first product introduced back in 2014. Snowflake then expanded its capabilities into cloud data lakes, data engineering, data science, a data application feeder, and a data exchange.

Many investors recognize Snowflake's first-mover advantage. It's a pure cloud-based data warehouse that works across all three major public clouds, offering a usage-based business model and a unique architecture that separates storage from computing capability. However, it's the data exchange, introduced in 2019, that CEO Frank Slootman calls "the single most differentiating and strategic thing we do."

Snowflake's data-sharing architecture doesn't just work within a single organization. The data exchange also enables organizations to share data with other companies, or to monetize data by uploading it to the public Snowflake marketplace. This works as long as all parties are, of course, Snowflake customers.

Use cases

"Once data is in Snowflake somewhere, it becomes readily accessible to anyone inside Snowflake, across clouds, and across geographies," Slootman explains in this instructional video. This is even more impressive when one considers that sharing data doesn't necessarily entail relinquishing physical control of it, as multiple parties can access the same copy in a single location.

In the above video, Snowflake describes how the exchange has greatly benefited all parties tracking COVID-19 cases. Hospital systems with different tech architectures can report cases and ICU beds so that government authorities can track when cases may overwhelm local hospitals. While COVID-19 perhaps gives the most obvious use case for intercompany data sharing, one can also see how it could benefit companies across a supply chain. For instance, a machine supplier to an industrial company could track a customer's sales data in real time, then tweak its own output accordingly.

Two powerful moats at once

The exchange provides a powerful network effect for Snowflake that's normally seen in first-mover e-commerce and social media platforms. Once such a platform attracts a critical mass of users, it becomes valuable, which then attracts more users or vendors to the platform, which in turn draws even more customers, and on and on. By setting up this quick and easy data exchange platform, Snowflake appears to have that first-mover status in the data cloud.

While well-funded competitors may eventually catch up to Snowflake's technology, the data marketplace still gives existing and prospective customers reason to prefer Snowflake over competitors.

That network effect compounds the high switching costs that most enterprise software platforms enjoy. High switching costs mean that once an entire organization is trained on a certain software platform or all a company's data resides with one data vendor, it becomes expensive, difficult, and risky to extract that data and move to another vendor.

This "double economic moat" combined with a long growth runway is likely what has investors so excited.

My mind could be changed

When Snowflake first came to market, it seemed ludicrously expensive. There's still a lot of good news already priced in. However, with a greater understanding of these two powerful advantages, it's definitely on my radar in case of any pullbacks. If you believe strongly in the company's growth prospects, and if you have a long enough time horizon, it might not hurt to purchase shares with a small allocation today even at these nosebleed prices.

Investors will gain more insight when Snowflake reports earnings for the first time as a public company on Dec. 2.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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