palantir-business-model

Palantir Business Model And Its Acquire, Expand, Scale Strategy

Palantir is a software company offering intelligence services from governments and institutions to large commercial organizations. The company’s two main platforms Gotham and Foundry, are integrated at enterprise-level. Its business model follows three phases: Acquire, Expand, and Scale. The company bears the pilot costs in the acquire and expand phases, and it runs at a loss. Where in the scale phase, the customers’ contribution margins become positive.

Origin story

Named after the Palantir stones of Lord Of The Rings, Palantir’s initial idea was to enable users within organizations served by its software to solve complex real-world problems.

Founded in 2003, by Peter Thiel (PayPal co-founder) and Alex Karp (co-founder and CEO), the company struggled to find funds in its first years of operations.

By 2005, Palantir didn’t seem the most appealing business for investors. As Karp highlighted in a TechCrunch interview, “Enterprise is a dirty word and that’s the business we’re in, and government is also not very popular in the Valley, [we combined] both.”

However, by 2010, Palantir secured a $90 million financing led by Peter Thiel‘s The Founders Fund.

In a 2012 TechCrunch interview, Karp highlighted, “in every large scale enterprise you essentially have this problem that you have data in different databases and it’s very hard for humans to actually interact with that data and what we basically do is we promote human driven synergies between humans and computers by integrating every data store you have any kind of data and any scale and we also provide privacy protection so that you only see the data you’re allowed to see..”

Mission, vision, and principles

Palantir core engineering philosophy is about augmenting human intelligence, rather than replacing it
(Image Source: Palantir website).

Palantir is not a conventional company for Silicon Valley’s standards (if not for the losses it still carries after over 15 years of operations), and the company highlights it.

There is a set of core principles underlying Palantir as a software company. Let’s look at three core ones, that make up the company’s identity and belief system:

  • Systems must incorporate privacy from the beginning of the design process. Palantir’s goal (as they highlight) is to eliminate the “perceived tradeoffs between privacy and utility.” That is why privacy is part of the engineering process.
  • Decisions that can affect individuals’ rights and liberties cannot be left solely to computers. As Palantir highlighted in its S-1 “rather than relying on algorithms that inhibit accountability, our software empowers humans to make informed decisions.”
  • Technology is not the answer to every problem. This means that Palantir will not try to automate processes that require complex decisions and that would carry important implications for humanity.

Those core values, as we’ll see, are embedded in the Palantir technology and business model.

TAM

total-addressable-market
A total addressable market or TAM is the available market for a product or service. That is a metric usually leveraged by startups to understand the business potential of an industry. Typically, a large addressable market is appealing to venture capitalists willing to back startups with extensive growth potential.

The total addressable market is one of the most interesting numbers for investors. Although in many cases putting a number of the so-called TAM is more of a bet than else, it might be a useful exercise to guess the future market size of your industry for two reasons. First, this will show investors how big might the market be, and thus their potential return. Second, that might also justify why the company is giving up profits today to gain more market shares tomorrow.

For instance, in its S-1 Palantir estimated its TAM (which comprises the estimation and assumption for its software across the commercial and government sectors at a global level) in $119 billion. This number accounts for all the countries where Palantir would be able to sell its software and consultancy (excluding the countries where Palantir chooses not to sell its software).

More precisely, the TAM broken down in commercial and government has been estimated as:

  • Commercial estimated $56 billion. Palantir multiplied the number of potential customers around the world (they identified 6000 companies with more than $500 million in annual revenues) with a contract value based on organization size and existing trends in customer spending that Palantir has recorded over the years.
  • The government estimated $63 billion. This includes (as the company mentions) “government agencies in the United States, its allies, and in other countries abroad whose values align with liberal democracies.” The assumption for this number starts by looking at the statistics from the IMF on public spending for several countries. From there Palantir estimated that of this spending 5% goes toward software and consulting services and expanding it from there. According to Palantir U.S. Government spending can reach $26 billion, where international government spending can reach $37 billion.

Product And Technological Model

Palantir has build two software platforms:

  • Palantir Gotham: this was Palantir’s first platform, the core product built for governments. The platform’s purpose is to identify patterns in very large datasets, or perhaps find valuable data to identify threats or execute responses to those threats at the government level.
  • Palantir Foundry: this works as s central operating system for the customer data.

Both platforms are vertically integrated software (they go from raw data following the entire data lifecycle).

To gain some context on how Palantir platform looks like, let’s give a look at the Gotham Platform, which is the core and first software build by the company.

Gotham

Primarily built for government operatives in the defense and intelligence sectors this platform enables users to identify patterns that Palantir points out are “hidden deep within datasets.” Those range from signals intelligence sources to reports from confidential informants.

Within Gotham, there are several interfaces built for different users within organizations.

Graph

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Graph provides a whiteboard-like interface for users to explore, visualize, and interact with entities, their properties, and their networks (Image Source: Palantir S-1).

Gaia

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Gaia lets users plan, execute, and report on operations via a shared live map (Image Source: Palantir S-1).

Dossier

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Dossier is Gotham’s live, collaborative document editor (Image Source: Palantir S-1).

Those above are just some of the key interfaces within Gotham.

Value proposition

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The various value propositions that each user gains from using one of the applications built within Palantir’s platforms: Gotham and Foundry. (Image Source: Palantir S-1)

Palantir has a different stand from many software companies. Where in most cases, scalability comes from the standardization of part of the service by developing features. Palantir remarks that it “builds software platforms that become part of the institutions [they] serve. And [they] believe that every large institution in the world has a problem that [its] platforms [is] designed to address.

In short, Palantir will design specific use cases that integrates well within the customers’ organization. And its use cases and value proposition can range from the district attorneys mapping complex criminal networks, to investigators receiving alerts on open cases, and soldiers on the field using the platform to evaluate and execute possible scenarios during a mission.

Key customers

Palantir has two main customer types:

  • Government.
  • Commercial

By the first quarter of 2020, Palantir’s platform was used by 125 customers. Those customers comprise some of the largest institutions in the world. The vertically integrated nature of both Gotham and Foundry makes it possible for those platforms to be used at all levels within the organizations (with simpler user interfaces as it gets used by less technical people within the institution or company).

From those key customers Palantir generated $742.6 million in revenue in 2019.

To gain a bit of context on types of Palantir’s customers, let’s look at three case studies:

  • Airbus uses Palantir software for its commercial aircraft support programs. Palantir claims the platform is helping Airbus with increased operational efficiency and productivity, and aircraft design.
  • bp (among the largest energy companies in the world) used Palantir software to build out a data and analytics platform for its oil and gas production team.
  • Credit Suisse uses the platform to integrate and analyze data from more than one hundred systems.

Revenue model

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Income Statements from Palantir operations. The company’s revenues were $595 million in 2018 and $742 million in 2019. And it reported losses from operations of $623 million in 2018, vs. $576 million in 2019. Most of the costs that Palantir runs comprise the cost of revenues (this is also due to the high level of customizations of the platform and service which each time requires a specific set up for the customer), sales and marketing, and R&D. (Income Statement from Palantir S-1)

Palantir’s two main segments comprise:

  • Commercial: primarily serving customers working in non-government industries.
  • Government: primarily serving customers that are agencies in the U.S. federal government and non-U.S. governments.
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Palantir’s revenue streams are divided in two core segments: Government and Commercial. As of the six months ended on June 30, 2020, Government revenues represented over 53% of Palantir’s revenues. Indeed, Palantir’s Gotham Software was the first platform developed by the company to offer intelligence services to institutions.

Palantir’s pricing model is based mostly on multi-year agreements. Those agreements comprise the sale of subscriptions to access Palantir software within its hosting environment with ongoing services (what is called “Palantir Cloud”), and software subscriptions in customers’ environments with ongoing services (what is called “On-Premises Software”). On top of that Palantir offers professional services (on-demand user support, user-interface configuration, training, and ongoing ontology and data modeling support).

To recap, Palantir revenue model is broken down in two main customer types:

  • Government.
  • Commercial.

Two main products/vertical software platforms:

  • Gotham.
  • Foundry.

And three main types of service for each product:

  • Palantir Cloud.
  • Palantir On-Premises Software.
  • Professional Services.

Cost structure and distribution

As a software company, Palantir has to make sure to stay on top of innovation on its industry, distribute it to the customers that might benefit the most, and at the same time keep a cost structure that helps its revenue generation in the long-term. With that in mind, we’ll look at three core cost segments:

  • Cost of revenue: what does it take to Palantir to sell its software, in the first place?
  • R&D: what does it take to Palantir to keep innovating, improving its software?
  • And sales and marketing: what does it take to Palantir to keep properly distributing its software?

Cost of Revenues

Cost of revenue primarily includes:

  • Salaries.
  • Stock-based compensation expense.
  • Benefits for personnel involved in performing O&M and professional services,
  • Third-party cloud hosting services allocated overhead.

For instance, as more customers are brought in, this cost of revenues might increase, as it will require an initial set up for those new customers. Those costs might be reduced over time as Palantir gets integrated within the customer’s organization. And as a result of negotiating better terms with third-party hosting companies for cloud space.

Research and Development

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The cumulative investment in research and development in the last years. As more resources are put into R&D the more the Palantir platforms become solid, thus offering a better service to those customers coming later (Image Credit: Palantir S-1).

An enterprise software company is successful if it’s able to build a software solution that its own customers are struggling to build. That is one of the core elements of a strong enterprise offering (otherwise the customer might opt for building up its own proprietary solution).

Palantir is an engineering-first organization, where (as of 2019) over 38% of its full-time employees were engineers (on a total of 2,391 full-time employees).

As Palantir’s platforms are highly integrated within the customers’ organizations, its engineers work directly with customers, across several functions, to meet the challenges they have.

Sales and Marketing models

Palantir business model is built around three key stages: acquire, expand, and scale. This translates into identifying new customers and expanding our partnerships with existing ones.

As Palantir points out its acquisition strategy targets large-scale, hard-to-execute opportunities at large government and commercial institutions (the kind of customers that most enterprise companies might avoid, due to the high acquisition cost, and difficult technical feasibility).

This acquisition strategy, in theory, works also as an entry-barrier to potential competitors. The complex deal, investment, and technical integration required to acquire the kind of customers Palantir is after, which requires substantial human capital to tackle the complex technical problem and financial resources.

This is definitely one of the key aspects, that makes it harder for a new competitor to emerge, as the new project might require such a substantial resource (and there is no guarantee that the project will eventually be successful) that a few companies will be willing to take such risk.

Therefore, the whole Palantir acquisition strategy is counterintuitive, as it targets exactly the kind of customer/project that none (or a very few) else would be willing to undertake. Palantir instead goes after those projects, actively seeking them out.

Once the customer has been acquired, Palantir will expand its contract value horizontally, to include more divisions or functions within an organization, or vertically to add more users and groups.

As customers go through the expansion stage, it starts the Scale phase, defined as those customers that in the calendar year brought in more than $100,000 in revenues with a positive contribution margin. Palantir defines its contribution margin as the revenues less its cost of revenue and sales and marketing expenses associated with the acquisition of the customer.

Therefore, the clients who entered the scale phase are those who start to have a positive contribution margin (the customers brings in more revenues than what it took to acquire, or maintain them).

Understanding the Palantir cost structure

Given its counterintuivie strategy of going after large-scale, hard to execute projects, where technical feasaiblity risk is high. Palantir will anticipate the cost and take the risks for those initial projects (initial project might carry little to no costs to the client to be acquired) who might take months to execute.

This will result in a cash-burning cost structure (at least in the short-term) where the cash is anticipated as substantial acquisition cost, and it will be repaid (if the customer is acquired) over the contractual life.

Overall business model and go-to-market approach

Let’s give a look at the whole business model and business strategy for Palantir.

Palantir’s business model executes in three phases

  • Acquire.
  • Expand.
  • Scale.

It’s important to point out this is not a linear path. Customers might go from acquiring to scale. And others might go back from scale to expand. Given its aggressive acquisition strategy, where pilots are in most cases covered by Palantir.

In some cases, if the pilot turns out to work, the customer might go from acquire to scale, quickly. In other cases, it might take time before the customer and account goes from expand to scale, thus producing a positive contribution margin to the company.

To gain a bit of context on the current allocation of customers among the three phases, by 2019, most customers were in the Scale phase, which produced over $565 million, where customers in the Expand phase produced over $176 million, and customers in the Acquire phase, only produced $0.6 million.

Breaking Down The Acquire Phase

In the acquire phase, Palantir makes the pilot extremely compelling for new customers, as it offers the pilot implementation at little if no costs to them. Therefore, Palantir operates the account at loss. Palantir considers an account in the acquire stage if it doesn’t produce more than $100K in the respective year.

Breaking Down The Expand Phase

Our investment in this second phase is often significant as we seek to understand the principal challenges faced by our customers and ensure that our software delivers value and results.

An account/customer enters the Expand phase when it generates more than $100K in revenues in the respecitve year. In that phase, once a first pilot has been validated, Palantir invests further to intergate the platform as much as possible to the customer’s organization to tackle the key challenges of the customer.

Also in this phase, Palantir operates at a loss.

Breaking Down The Scale Phase

In the Scale phase, as the software has been installed, configured and implemented across the entire organization, customers become self-sufficient (some perhaps also start developing software and applications running on top of Palantir platforms). At this stage the cost of revenues, in respect to the revenue generated decreases substantially.

This is the stage where the customer starts to have a positive contribution margin, therefore, from here, going forward, the customer relationship becomes profitable (unless of course the contract is redefined and new use cases developed, which makes it go back to the Expand phase).

To gain a bit of context, in 2019, Palantir generated over $565 million in revenues from customers in the Scale phase, with a contribution margin of 55%. This means that 55% of the revenues are in excess to those used to cover for fixed and variable costs to the scaled customers.

Thus, this gives Palantir more flexibility, in investing this money back to push more customers in the Acquire phase, and to invest more back in the Expand phase.

Key takeaways

  • Palantir is an enterprise software company that runs vertically integrated software solutions offered to both government and commercial organizations, providing intelligence across the whole company/agency.
  • Palantir’s revenue model is broken down into two main segments (Government and Commercial), two main products (Gotham and Foundry), and three key products, platforms and services (Cloud, On-Premise Software, and Professional Services).
  • Palantir’s go-to-market/acquisition strategy is counterintuitive, also for an enterprise software company. Indeed, Palantir targets complex, large-scale projects, with a high technical feasibility risk, where it bears all or most of the pilot costs. With this sort of approach, Palantir operates with high entry barriers for competitors, and it makes it compelling for new customers to join in, as the company offers a solution to problems that the government or commercial organizations haven’t been able to tackle.
  • Palantir vertical integrated software is then implemented (potentially) across the organization’s various departments and to a larger and larger users’ basis. That is why Palantir software has various user interfaces, from more complex, and skewed toward a technical audience, to much simpler, skewed toward non-technical users.
  • Palantir’s business model operates primarily through three phases: Acquire, Expand, and Scale. In the first two phases, customers go through a pilot (Acquire), and if the pilot proves successful, they move to a second phase (Expand). In both phases, as Palantir proves the project’s technical feasibility, and it customizes it to expand it across the whole organization, it runs those projects at a loss. In short, it has a negative contribution margin. As the customer/account moves to the Scale phase, its contribution margin becomes positive, and potentially improve over time.

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Published by

Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which target is to reach over two million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get in touch with Gennaro here