Contributing to the collective good isn’t a metric that we investors often include in our analysis of companies. This is what I generally label as “karma” – a bucket of activities taken on by companies (some more than others) that don’t appear to be directly related to a business goal. As investors, these activities may help us feel good about our companies at a superficial level, but can also raise questions about financial discipline. For some investors, these activities evoke visceral responses like “this is a business, not a charity.”

Observing this behavior, how can we investors evaluate the benefit of these kinds of activities for our companies? ESG tries to address this thematically, but the scope is generally limited to specific applications, focusing primarily on limiting environmental impact, improving human rights, diversity or consumer protection. It also encompasses corporate governance, cajoling leadership and employees to ensure they act ethically, are trustworthy and transparent. ESG has mostly been used as a tool to guide some investment funds and for companies to demonstrate their support of the environment. Lately, ESG initiatives have been tainted by accusations of inflated claims and greenwashing.

There is another aspect of this corporate benevolence that manifests in particular industries, revolving around making contributions that generally benefit all participants in the industry. Participants could be other companies selling products or services in that industry or the general consumer using those services. Some companies in the industry actively make contributions that improve its reach, efficiency, compliance or scale. Often, these contributions are made at the company’s own expense, without a clear transactional return (they aren’t being paid for this work). While the company’s motivation appears altruistic on the surface, it can be tied to general business drivers, like making their industry’s services easier to use, safer or more productive. If we dig, we can uncover an expectation of some generalized benefit that will translate into more revenue or profit down the road. This work can even be justified in spite of competitors’ benefit as well.

In the Internet industry and those companies powering its underlying software infrastructure, companies have many ways they can contribute. These can manifest in a few broad forms:

• Helping move the industry forward by donating something that all providers can use. Examples include participating in standards bodies, contributing code through open source or solving a common problem and giving away the solution.
• Hosting free services for the industry’s consumers. For end consumers, contributions can represent free services that help protect, secure, speed up or otherwise improve the end user experience.

In these cases, the provider company is taking a bit of risk competitively. They are allocating resources to work that isn’t directly revenue generating. Worse, they may be helping a competitor, if for no other reason than the competitor avoids that expense. The competitor may get a free benefit without cost, and then is able to report a slightly better operating margin as a result.

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Some companies choose to ignore these risks and operate with an open, altruistic bias. They may simply believe in “karma”, that their efforts will be rewarded down the road because the universe is fair. Other companies operate only in their self-interest and eschew any activity without a clear ROI. I think the most sophisticated companies are those that can operate under the umbrella of altruism, but have clear goals and expected benefits under the covers for these activities. They have identified business outcomes from the work and have metrics associated with them.

As investors, we hear about these types of mission-driven activities from companies and have to evaluate the value of these contributions. It is possible for a company to get so wrapped up in their mission that they don’t generate profit or forgo revenue opportunities. A pure capitalist approach would justify avoiding this kind of work or letting competitors spend their money on it.

We can examine some historical evidence that software companies (whether consumer Internet services or infrastructure providers) can benefit from these activities. The largest technology companies with real staying power over the past 20 years have demonstrated these traits. Google is likely the most noteworthy, basically building the Android ecosystem and sharing the code behind major software infrastructure building blocks, like Kubernetes, Chrome, Go and Bigtable. Netflix, LinkedIn, Uber, Facebook and others have sponsored or contributed to major open source projects. Even the more proprietary companies, like Microsoft and Apple, support standards bodies and critical infrastructure projects (Microsoft runs GitHub as an example).

AWS, which has historically had an antagonistic relationship to open source projects, is now emerging as a major contributor to those projects which it hosts. Matt Asay just published an insightful summary on TechRepublic of this shift. He referenced a popular Tweet regarding an AWS engineer who cracked the Top 10 list for contributions to Apache Kakfa. The image below shows ranked Apache Kafka contributors for the prior month.

Why would companies engage in this activity and how can we investors tie it back to business value? Can we be objective about the benefits, evaluating whether they are throw-away investments or have a real expectation of driving some future financial gain? I think there are several important benefits to consider besides generalized goodwill, which will impact real financial metrics over the long term.

• Shaping standards towards their strengths. Most categories of software technology involve standards for inter-operability, development tooling and shared infrastructure. Standards bodies establish protocols for Internet communications, browser feature support, security and open interfaces between components. By actively participating in establishing standards, a company can shape them to align with their competitive advantage. Google’s leadership in establishing the Android Open Source Project had obvious benefits to their mobile phone strategy.
• Builds trust with customers. If a company is making investments in generalized infrastructure and demonstrating leadership in standards bodies, technology leaders at customer companies will notice. This builds confidence in the provider’s staying power, influence and technical competence. As these leaders make purchase decisions, I think a perception of contributing to the general building blocks and guardrails for a technology segment will factor into their evaluation.
• Gathers data or insights that improves a commercial service. By provisioning a free service for the public, the provider can gain insights that shape other aspects of their business. These could be valuable signals about consumer preferences that then feed content personalization or ad delivery (Gmail, Google Maps). Or, the free consumer services make the provider’s other commercial products more effective, like Microsoft GitHub for broader developer tooling or Delta Lake and MLflow from Databricks for data science support.
• Attracts talent. There is a war for engineering talent within software companies, as demand far outstrips supply. Magnifying the challenge for companies is that the impact gap between great engineers and mediocre ones is increasing, as more building blocks are available off the shelf, allowing a truly great engineer to be 10x more productive than a team of mediocre ones.

The last point may be the most important. While salary helps, top engineers are often mission-driven and want to know that their work will have real impact. They seek out companies that are perceived as leaders in their category. Opportunities to contribute to open source, build their personal brand by publishing their work, participate in standards bodies and speak at conferences are all important. Companies that can attract and retain this type of talent will realize greater innovation, faster product delivery and a novel architecture that is easily extensible and resonates with other developers. Customers will be impressed by their expertise and intuition, making sales support calls easier and more creative. Cross-selling becomes seamless as the company can respond to customer needs quickly by delivering new offerings in adjacent categories or quickly rounding out the rough edges in their product suite.

It is important for a software company to build their developer brand. While this can appear on the surface to be a pointless marketing exercise, generating “buzz” in the developer community lowers hiring costs, improves retention and of course attracts more applicants. Having a greater hiring pool naturally allows the company to select the best talent. The result is much like the difference between inbound and outbound marketing, as popularized by CRM company Hubspot. Inbound marketing applied to engineering talent recruitment is a methodology that attracts candidates by creating valuable content and unique experiences that appeal to them.

On the flip side, companies that aren’t performing this inbound marketing function will have more difficulty attracting top talent. They may do so occasionally, by paying a high salary, but then retention becomes a problem. These companies have to rely on “outbound marketing” techniques, through aggressive recruiting efforts and undo pressure on hiring managers to “build a world class team”. Eventually, the talent spigot slows and the company begins a gradual death of innovation, market leadership and financial performance. They might rely on costly acquisitions to bring in fresh talent, but the true culture of these companies quickly becomes evident and those engineers depart as soon as their retention clauses expire.

For investors, this framework can be applied to evaluating technology stocks. Companies can be screened for an active publishing presence (blogs, industry media, conferences), contributions to open source, participation in standards bodies, provision of free services and general buzz. If a company appears to be engaged in these activities, it is likely they will build or maintain their leadership as they become a destination for talent. If a lagging company is being considered as a value play, these factors may help understand if they are truly undervalued by the market or simply experiencing talent disintegration.

To provide an example, I will draw on Cloudflare, as they publicly promote these activities and metrics on recruiting. Cloudflare’s mission is to “help build a better Internet”. While that tagline could be construed as a nice marketing play, Cloudflare actually does the work. In their case, the “work” involves supporting open initiatives and protecting Internet traffic in ways that don’t directly contribute to their revenue growth. While we investors might categorize this as a charitable donation without a clear ROI (and hence pointless), I think it leads to indirect, but tangible value.

Cloudflare provides numerous examples of this type of activity. Project Galileo protects free speech by supplying DDOS mitigation to web sites associated with social, political and environmental causes. Their 1.1.1.1 app allows individual consumers to securely and privately connect to the Internet, as well as benefit from faster connection speeds. Cloudflare Research is closely tracking post-quantum cryptography methods, working with NIST and contributing to IETF standards proposals. They recently collaborated with Google and Shopify to move Early Hints forward to speed up web site content delivery. They even teamed up with Apple on iCloud Private Relay for secure Internet browsing and Private Access Tokens to replace CAPTCHAs.

Cloudflare’s CEO highlighted these efforts and the perceived benefit on their Q1 earnings call:

We build that app (1.1.1.1) and give it away to consumers for free as the world’s largest testbed for a key component of our Zero Trust solution. It turned out in what was an increasingly difficult network environment inside Russia, citizens there wanted to see what was really going on, installed the app in order to access Western media.

Now we won’t make any money on this.So some of you may wonder why am I telling you about it during the earnings call. Because it turns out doing the right thing and being there when someone on the Internet needs us has always been core to Cloudflare and has always turned out to be good business for us over the long term. It’s why I love my job. Successfully operating inside the hostile network environment that is Russia today makes our mobile app better for our enterprise Zero Trust customers.

Ensuring Ukrainian critical infrastructure stays online means we can stand up to the biggest nation state-sponsored attacks for our largest government, financial services, and other targeted customers, and briefing government on what’s about to happen proves the power and unique insight we get from our global network. We’re in the trust business. We always have been. And in Q1, we built a lot of trust in a lot of quarters.

Even in what I believe will prove to have been the hardest quarter for the industry since Q1 of 2020. Trust is the secret to why we continue to grow paying customers in a record pace. It’s why we received 133,000 job applications and saw attrition actually tick down, while many others are struggling to hire. And why we continue to have a seat at the table in conversations around the future regulation of the Internet alongside today’s Tech giants.

Cloudflare Q1 2022 Earnings Call

While often nebulous, I think including consideration for these seemingly altruistic activities should be an important component in evaluating software companies for the long term. Acquisition and retention of engineering talent will emerge as a differentiator going forward, particularly as the hiring environment becomes even more challenging. Don’t get me wrong, we investors expect our companies to make money and have to be objective about financial performance. But, if a company can find a way to deliver both scalable business growth and make a broader impact on their chosen industry, it creates a unique combination of drivers for their long-term success.

NOTE: This article does not represent investment advice and is solely the author’s opinion for managing his own investment portfolio. Readers are expected to perform their own due diligence before making investment decisions. Please see the Disclaimer for more detail.