Palo Alto Fires Firewall Heard ‘Around the World.

Does anyone remember the shot that was heard round the world? It was recognized as the beginning of the Battle of Lexington and the American Revolutionary War. Palo Alto Networks’ major shift in strategy toward platforms could be the shot that rings ’round the firewall world.

Palo Alto Networks stock has been a favorite of cyber investors. Its stock is up about 400% since January 2020. However, it has had a rough week this week. Shares plunged 25% on Wednesday after the company issued weaker-than-expected guidance on major changes to its approach to selling its cyber portfolio.

Why the stock crash? The company’s earnings were good. Revenue rose 19% year-over-year (year-over-year), and it reported non-GAAP earnings of $1.46 per share for the second quarter, a 39% year-over-year gain. However, Palo Alto CEO Nikesh Arora told investors on Tuesday’s earnings call that Palo Alto is going to drive a major industry disruption by accelerating the “platformization” of cybersecurity with offers and incentives to bundle its many cyber products.

The inventory fell because investors heard: Price War! Let’s explain what this means.

Time for Firewall Fireworks

Arora is considered one of the most visionary leaders in networking and cyber security. Under his leadership, the company has carefully built a portfolio of cybersecurity and network security products through years of internal development, consolidation and surgical M&A. In addition to leading the way in selling next-generation firewalls, Palo Alto is a leader in the fast-growing Secure Access Edge (SASE) segment and has a strong foothold in zero-trust and cloud security.

One of the consequences of the platform — which means aggressively courting new customers to use the entire portfolio, not just the points products — was that Palo Alto lowered its revenue guidance, implying that it would subsidize new customer acquisition. This hit the stock hard.

This is the classic game: Short-term pain for long-term gain. Sacrificing short-term revenue for long-term market share gains. It could work. Let’s see why.

Let’s start with firewalls, which provide a basic network security gateway and are one of the most widely used cybersecurity products. Palo Alto coined the term next-generation firewall (NGFW), which meant firewalls that delve deeper into inspecting network packets to build a more complete picture of threats. Firewalls are a huge market, and this move has helped Palo Alto rise to the top, taking share from other bigger players. The firewall market is crowded and productive, with competitors such as Check Point Software, Fortinet, Cisco, and Juniper Networks—among others.

But Palo Alto didn’t stop there. The added software-defined networking (SD-WAN) in 2020 with the acquisition of CloudGenix, which helped serve as the genesis of the SASE market. Also, Zero Trust Network Access (ZTNA), Cloud Native Application Protection (CNAP), Cloud Security Posture Management (CSPM) and many other cybersecurity product acronyms. Networking major Cisco has been defeated by Palo Alto’s moves to consolidate the cybersecurity market into a more comprehensive portfolio. While Palo Alto has been steadily growing revenue at double-digit rates, Cisco’s efforts in the space remain in the single digits.

Evaporation of Cyber ​​Customer Experience Pricing

The cybersecurity market is now changing rapidly, something Palo Alto seems to have recognized. Firewalls, which are geared for more traditional infrastructure, aren’t as useful in the cloud, and the market is realizing that. Firewall rival Fortinet has had to cut its guidance twice in the past year due to weakening sales.

Cisco has also struggled to gain traction in cybersecurity, and its network security products aren’t selling as well as they used to. Here’s why: It’s about product pricing and evaporation, which Arora discussed on the earnings call. Cisco is known for consistently selling multiple product lines across its portfolio.

Arora said the company is going to invest aggressively to convert customers as the industry experiences increased “price fatigue”. They don’t want dozens of cybersecurity acronyms and dot products. They want a portfolio – a platform.

“We’re driving the platform and I think we need to do it faster,” Arora said on the earnings conference call.

Investors got scared when Arora talked about platform because they heard bundling and discounting. But he is thinking long term. He’s thinking about customers and how Palo Alto can get more market share. It’s time for the great firewall war.

The Firewall War will take a hit. Palo Alto is now guiding for full-year billings of between $10.1 billion and $10.2 billion, compared to previous guidance of between $10.7 billion and $10.8 billion.

Is platform acceleration available?

It’s a bold bet and a huge move. It reminds me of Adobe Systems’ landmark shift from licensing to annual subscriptions in the 2012 timeframe. The stock took a hammering and the strategy was questioned at the time, but it paid dividends in the long run. Adobe shares are up more than 500% since that change.

At a basic level, Arora described Palo Alto’s strategic shift as an “investment” to convert new customers to Palo Alto’s cybersecurity platform. This will come in the form of a wide range of incentives and a bundle of Palo Alto products, which range from firewalls to cloud security and SASE.

The theory behind creating a platform is that cybersecurity point products should integrate better and customers should be able to reduce management overhead by using products bundled into a platform.

“Now is the time … to accelerate the consumption of Palo Alto’s many security products,” Arora said. “Customers are facing cyber spend fatigue… platform adoption is the only viable option for customers.

Cybersecurity professionals are inundated with dozens, if not hundreds, of cybersecurity products added as acronyms. Pricing and administrative overheads for purchasing and managing these products separately add up. Palo Alto has identified a customer pain point that it can exploit against the competition by adding more value to its platform or portfolio package.

Arora said Palo has “validated” the platform in the cybersecurity industry and believes customers will turn to it in droves if it can pull off the change in strategy. It announced a bold goal of reaching $15 billion in annual recurring revenue (ARR) by 2030. On the earnings call, it said 79% of Global 2000 businesses have transacted on two or more components of Palo Alto’s platform.

“Our guidance is not a change in the demand outlook out there, our guidance is a consequence of us driving a change in our strategy,” Arora said.

In the long run, the strategy is probably right for the industry. Palo Alto has done a great job of assimilating one of the broadest portfolios in the industry. It can also more deeply integrate its products, which collect data from many different devices and use that data and artificial intelligence to drive more comprehensive cyber solutions. And it has a huge opportunity to make jaded cybersecurity customers happier.