Scouring the Business of Technology

Cloud Computing 101

Courtesy: GigaOM

Cloud computing has been a key enabling factor in the latest generation of web startups, letting them start with small amounts of capital and scale quickly in response to demand. Startups don’t care about a lot of the factors that slow adoption of cloud computing. New startups don’t own anything yet, so they don’t have a legacy investment in physical infrastructure. They also don’t have IT departments, who often have a stake in the old way of doing things. So, if you want to see what the future of IT infrastructure looks like, look at what startups are doing today.

Cloud computing is more of a pricing innovation more than a technological innovation. After all, cloud computing is really just virtualization (a la Xen or VMWare) that’s hosted by somebody else. The technology isn’t such a big deal. The mind-blowing thing is the ability to pay for computing like it is a utility. This offers two big advantages over owning and operating your own hardware, and even over renting servers by the month.

Advantage 1: Success-Based Scaling

When something is a utility, you pay for it based on the amount you use. System use is hopefully related to revenue-generation (if not, be afraid! This means your startup doesn’t have a business model), so cloud computing costs fluctuate in tandem with revenues. If you have big infrastructure costs this month, it’s because you have big revenue this month. This is a big advantage when compared to dedicated hosting, where you’d pay for the maximum capacity that you might need this month. A startup can do “success-based scaling,” and have many months of minimal costs (and no revenue), before finding product market fit and starting to grow rapidly. As it grows, it will have real infrastructure costs (possibly higher than with dedicated hosting), but it will also have revenue that it can use to pay for those costs.

Success-based scaling reduces the risk of launching a startup, and reduces the capital required to do so. A startup might never find product-market fit, or it might be a hit for a few months and then turn out to be a flash-in-the pan. With cloud computing, you can quickly scale up to meet demand, and you can scale back down just as quickly.

Advantage 2: Cash-Flow Positive Infrastructure

When something is a utility, you pay after using the service, instead of before you use it. Think of the difference between when you pay your rent and when you pay your phone bill: that’s the difference between dedicated hosting and cloud computing. For a business, the chance to delay paying for something until later is a big deal. Because revenues typically take time to collect, the business normally has to have a fair amount of cash on hand to continue to function while it waits to be paid. Even a very profitable startup that is growing rapidly might have trouble paying its bills because it simply hasn’t collected the cash from its customers yet!

A simple example will make this clearer. Imagine a small startup that is making money with Google AdWords. With dedicated hosting, the startup would have to pay the “rent” for their servers at the beginning of the first month of operations. But the money from AdWords won’t hit their bank account until the third week of month two! That’s 50 days of time, or two full months of infrastructure, that has to be paid for before the can get paid by AdWords. Contrast this with what would happen if they hosted on Amazon Web Services (the biggest provider of cloud computing). The bill for the first month of operations is due at the end of the first month, not the beginning. The credit card payment for the money spent at Amazon is due toward the end of the next month, several days after the money from AdWords has arrived in the account.

Advantage: Startups

What these two advantages mean for the startup using cloud computing is that its business has the potential to be inherently cash-flow positive. When your infrastructure costs track how many customers you have, and when you can collect money from those customers before you have to pay vendors, your need for outside capital dramatically decreases, and the risk of running out of cash goes down dramatically.

Cash is the oxygen of business, and cloud computing allows companies to inhale the oxygen (by collecting revenue) before they exhale (pay their vendors). No wonder that in the last few years, web-based startups have grown like weeds even as the broader economy collapsed!

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