It's extremely easy to spin up a virtual server on DigitalOcean Holdings' (DOCN +2.68%) platform. Pricing is transparent and obvious, and the platform is designed for ease of use. Newer products like the app platform, functions, and managed databases make things even simpler, abstracting away management and administrative tasks.
DigitalOcean's growth has been impressive. Revenue surged 33% year over year on an organic basis in the third quarter despite an uncertain economic environment. The average customer now spends nearly $80 per month with DigitalOcean, up 28% year over year, and 86% of revenue comes from customers spending more than $50 per month.
One area where DigitalOcean has lagged is data storage. CEO Yancey Spruill revealed during the third-quarter earnings call that storage revenue is a high-single-digit percentage of total revenue. Spruill noted that it's common for customers to use DigitalOcean for compute and an alternative cloud platform for storage. By improving its storage products, the company believes it can double the revenue contribution from storage over the next few years.
NYSE: DOCN
Key Data Points
Missing some pieces
DigitalOcean offers two storage products: block storage and object storage. Block storage allows customers to attach a chunk of additional storage to their virtual machines, which DigitalOcean calls Droplets. Each Droplet comes with its own storage capacity, and the block storage product allows this to be seamlessly expanded.
DigitalOcean's object storage product is designed for holding arbitrary pieces of data and serving them over a built-in content delivery network (CDN). This is useful for storing images, video, audio, static web assets, and software packages.
The average revenue per user (ARPU) from customers who use DigitalOcean's storage products is 25 times the ARPU from customers that don't. By making its storage products more attractive, DigitalOcean has the opportunity to grow its spending with customers who currently choose an alternative storage provider.
While the storage opportunity is significant, the company has some work to do. First, the block storage product doesn't play nice with some of DigitalOcean's newer products. The app platform, which allows customers to deploy applications without needing to manage underlying servers, doesn't support block storage at all. Any application that requires persistent storage is basically a no-go on the app platform.
This incompatibility with anything but Droplets also limits the appeal of DigitalOcean's managed database products. Because storage for a managed database can't be expanded without upgrading plans, some use cases just aren't going to be feasible. For example, a customer who needs a managed database with many terabytes of storage is out of luck, since the priciest plan tops out at about 1 TB.
DigitalOcean's object storage offering also falls a bit short. For one, it's more expensive than some competing products. DigitalOcean charges $0.02 per GB of storage, quadruple the price of Backblaze, and it offers no free tier. And while DigitalOcean has a built-in content delivery network, it's not nearly as full featured as the CDN from Cloudflare. Pairing Backblaze's object storage with Cloudflare's CDN, for example, is simply a cheaper and better option for most customers.
Increasing platform stickiness
Improving the storage products will go a long way toward making DigitalOcean's platform stickier. If a customer needs to look elsewhere for pieces of their infrastructure, that customer may not be as keen to expand spending on DigitalOcean's platform.
If DigitalOcean can convince more customers to add one or both of its storage products, that would make the prospect of switching providers more onerous. Ultimately, DigitalOcean wants to capture as much cloud infrastructure spending as possible from its customers.
DigitalOcean is aiming to grow revenue by at least 30% annually in the coming years. Growing the spending of existing customers will be a major component of that growth, and the biggest piece of low-hanging fruit is increasing the attach rate for its storage products. Investors should keep an eye on how the storage products evolve in the coming quarters.
