Betting on technology startups

It's a dilemma every CIO has to confront sooner or later: stay with your established software vendors, or buy from an unproven start-up. You know what you're going to get with Oracle Corp., SAP AG or Microsoft Corp., but buying from them can become another step toward getting locked into a single rigid platform. Going with a start-up, on the other hand, can help you control your own destiny in today's open computing environment. Being the first to have the right technology may also give you a sizable competitive advantage.

But in an industry where the failure rate for start-ups hovers around 40 percent, how does a savvy CIO determine when to go with a start-up and which ones to bet on? Here are a few guidelines:

Focus on Pain and Profitability. If you're going to take a chance on a start-up, the new vendor should be addressing a major pain point that directly translates into profitability.

For example, in an informal CIO survey my company, Trinity Ventures, recently conducted, roughly three quarters of executives listed "improved storage management" as one of their top three priorities. One CIO said that without the right storage system, his company's IT resources wouldn't scale to match the business' expected 60 percent revenue growth for that year. Given the lack of alternatives from major vendors, this CIO said any system would provide a large enough incremental benefit to offset the risk of working with a start-up.

For a US$1 billion company with a 5 percent after-tax profit margin, putting the storage framework in place to allow for an additional 1 percent revenue growth would justify a $1 million initial investment in a start-up product or service.

Decide Whether To Be First. The next question is, "What is the cost of delaying the decision?" Here, astute CIOs work as part of the senior strategy team to determine different likely scenarios of market changes and competitive responses.

Evaluate the Assets. If you decide that the benefits of success are large and the cost of delay is great, you now want to focus on minimizing risks. At this particular start-up, does senior management have the expertise necessary to get the job done? Has the company attracted strong financial backing? Does it have other customers? Is it willing to craft a contract that has the potential for early wins and early outs? If there are development delays, can you stomach the situation or find alternatives?

If the start-up can't pass this test, you may want to look elsewhere. If it can and you choose to do business with it, be proactive about building a solid relationship.

A key first step is to quickly identify a project manager who has a vested interest in the project's success. You should also be prepared to dedicate internal resources to helping the start-up build the best product for your customers. You'll find that the stronger the relationship, the more influence you'll have in shaping the start-up's long-term strategy, which in turn will lead to long-term benefits for you.

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