August 2, 2008 – 3:44 pm
Traditionally, if you wanted to setup an online business you needed money…and lots of it. With the advent of commercial Infrastructure as a Service (IaaS) providers the economics of the internet startup has changed….for the better.
In the past if you came up with the next ‘killer app’ you would be faced with a serious decision…do you try to build your business on a shoe string and risk the chance of being a victim of the Slash Dot effect or do you try to navigate the slippery road of equity investment funding. Entrepreneurs have travelled both paths, neither are fun and both are fraught with danger.
The business economics of the Slash Dot Effect are not new and certainly not confined to the internet. UK telephone company Talk Talk had serious problems last year when it announced it’s free broadband service…the company simply could not handle the number of queries. On the internet there have been many casualties but the general result is ridicule and perhaps business failure. The fate of a fully funded internet business is not guaranteed either. The internet is littered of stories describing how the entrepreneurial flair and energy was sucked straight out of the company by an evil equity investor.
The basic problem is that in order for your business to be successful you need to give your application an adequate provision of bandwidth, processor power and storage capacity…and properly defining adequate is the problem. If you try to save money you can end up with insufficient capacity. If you project to buy too much you might find it hard to raise equity funds.
The advent of IaaS has resolved this little issue. Now, instead of needing to estimate and purchase your capacity (bandwidth, processor and storage) in advance you can buy it as you use it, in a ‘pay as you go’ system. In our case we buy servers of several providers (AWS and Flexiscale) on a per server per hour basis. We fluctuate between having 20 and 150 servers (instances) running at any time. This business model allows us to compete with some of our VC backed rivals in our market as our capacity is not limited by our cash reserves!
Buying your capacity in this way not only gives you a cash-flow advantage it also gives you unlimited scalability. Online video website Animoto went from roughly 50 servers to needing more than 3,500 in three days. Imagine having to predict growth and get servers racked, stacked and online in time to meet the growth! While a hardware order like this would be a dream for DELL, I doubt they have that kind of stock readily available or indeed the logistics to ship and set it up in that time. The New York Times covered this in more detail.
Using IaaS you can scale in a very cheap way without serious capital investment. This now allows entrepreneurs to setup and start trading with very little funding…hopefully getting them into profit earlier and retaining more of the equity of their business. Indeed, this is now causing problems for VC’s as they traditionally justified their huge equity stakes (or excessive protection clauses in their subscription agreements) because of the high commercial risks. These risks can now be significantly lowered which can allow entrepreneurs drive a harder line.
Once the startup is trading and actually making money the economics can change significantly. While having unlimited scalability in a cash flow friendly manner is advantages in the early days it can often be cheaper in the longer term to transition the infrastructure in-house (or to a co-location facility). While this calculation is dependent upon how you application uses hardware (is it CPU intensive Vs RAM intensive) it is generally true. So, start-ups need to look at buying their own infrastructure after a period and start transitioning their applications. The ultimate goal is to move the bulk of the application to your own infrastructure and still use IaaS for any additional or burst capacity.
In my day job I am involved in transitioning some of our capacity from our IaaS suppliers to our own hardware. So, at the moment I am planning to setup several racks of servers in several data centres and installing commodity servers in clusters. Then using fancy traffic routing I plan to point our traffic at these banks for processing and then using IaaS to give us burstable capacity. We have effectively used IaaS to bootstrap our business into existence…something that would have been impossible in the past.
So where previously the startup had the ‘shoe string’ or ‘VC’ route they now have an additional option…the ‘bootstrap and transition’ route. The interesting point is that rather than being a disrupter for the traditional co-location market, I have found that IaaS is actually building demand for co-lo providers as it lowers the cost for start-ups and will eventually increase the numbers of them…thus building the co-lo market!
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