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Sustainable Investment Authors: Pat Romanski

Related Topics: Apache Web Server Journal, Sustainable Investment, Startup Journal

Apache Web Server: Article

Web Services Startups

Web Services Startups

You must have seen them - they're everywhere. Despite the market climate, Web services startups are popping up like mushrooms after rain. With no time to lose, these companies are readying themselves to take on the industry gorillas. Who's going to win?

Much has been written about the evolution of the Web services industry, particularly with respect to the big players like Microsoft and IBM. We've all been told countless times how Web services are good for established platform vendors ranging from application server companies to integration and process management vendors. One interesting question is often evaded, however: How can startups make money in this world?

A Matter of Perspective
I wish I had all the answers. I don't, of course. However, my experience does give me a certain perspective. I've been part of the Web services "revolution" since before it had that name and we were just starting to experiment with XML for distributed application integration back in 1998. I've been involved with standards development in that space for several years (SOAP, JAX-RPC, etc.). I've lived through the Internet platform battles and I see a lot of similarities between those days and what's happening now with Web services. And now, as a venture capitalist, I have the luxury of talking to a never-ending streak of entrepreneurs trying to change the world with Web services.

Good VCs stay sharp because they're in constant contact with people who are smarter than they are. Now, having met with dozens of Web services startups and industry pundits, I feel I understand the space much more broadly than when I was at Allaire and Macromedia. Not having a corporate agenda through which to view the world is indeed eye opening. This is the perspective I hope to bring to this and future installments of XML in Transit.

Growing Big
It would be nearly impossible to talk in general about opportunities for all types of startups in the Web services space. Some type of filter needs to be applied. From my perspective as a VC, the filter I apply has to do with the magnitude of the opportunity. Venture-backed companies have to meet certain stringent performance requirements. VCs take on so much risk investing in startups that they have to be compensated with very significant returns. After several years of helping a company grow, a VC looks to make a five- to tenfold return on investment.

Here's an example. Imagine that it takes your startup $10 million to $20 million to reach a state where your investors can cash out. This means that you get acquired by a public company or that you go public. Assume that by that time, after several rounds of financing, VCs own two thirds of your company. For them to get that five- to tenfold ROI, your company must be valued at $75 million to $150 million for a $10 million investment and $150 to $300 million for a $20 million investment. Getting these types of valuations was easy several years ago. In the current market it's a lot harder. Given where valuations are at these days and where they're likely to stay in the future, it's easy to say that to be worth this much a startup needs to have revenues in the range of $50 million to $100 million or more. Top-tier VCs are only willing to back big plays.

Therefore, an interesting filter to apply when talking about startup opportunities in the Web services space would be whether the company has reasonable success of getting funded by such a firm. In other words, is the company going to have a significant and sustainable business?

Don't get me wrong. I'm not trying to make any kind of a value judgment about non-VC backed companies. Companies that never seek outside investor funding have equally smart people in them and work with equally exciting technologies. For example, several smart people can get together and build a great narrowly focused product that solves a real customer problem and gets acquired in a couple of years for a good chunk of money. They'll have done us all a service by accelerating development in the industry and will have succeeded financially as well. It's all good, but not something that a VC would typically be interested in. It's just not big enough.

Now that we've narrowed our focus to big and sustainable businesses in the Web services space, let's look at some common patterns they're likely to share.

Patterns for success
It's pretty amazing that, for the first time in computing history, the industry is taking more or less the same approach to connecting and integrating applications through Web services. However, thinking of Web services as a revolution in computing misses the point that, fundamentally, Web services aren't new. They're just the current step in the evolution of our thinking about distributed computing (see Table 1). Since prehistoric times and up to the 1980s we did this through custom RPCs and proprietary messaging platforms. In the 1990s we used COM, CORBA, Java RMI, and a number of XML-based approaches. We're starting the first decade of the new millennium with Web services. Ten years from now further convergence of application interaction patterns and the broad use of meaningful standards - for example, grid-related ones - will undoubtedly lead to new and interesting ways of doing distributed computing.

It's important to internalize this: Web services, just like XML, are not an end in themselves. They're tools for getting things done. Therefore, a key pattern for successful startups is that they must focus on some core capability that generates significant value by addressing real customer needs, and use Web services to enhance this value proposition. This may seem like an obvious point, but I've talked to several startups that have built great technology focused on Web services themselves without a tie-in to real customer needs. Technology for technology's sake has not made people rich.

Another reason why it's so important to think pragmatically about Web services is that despite all the hype, the Web services marketplace is going to evolve more slowly than most expect. In the current business climate customers are cutting costs. Fewer IT projects are getting funded. This leaves less money to support the efforts of pioneering startups. For your startup to succeed in this climate, it has to find ways to make money sooner rather than later. Some VCs may be willing to fund grand blue-sky ideas, but most will look to back companies that can quickly generate significant customer traction. This can happen only if the companies are building solutions addressing real customer needs. Web services become an enabler and an accelerator of these solutions.

One point of caution: unfortunately, many startups have equated the need for quick revenue growth with a focus on tactical or opportunistic Web services dimensions, typically expressed as following the general path of evolution of the Web services industry to feed on emerging demand, but staying six to 12 months ahead of standards and big industry players. On average, this approach doesn't work. It's too risky. The margin for error is too small. The sustainable competitive differentiation is insignificant. Don't do it.

The second key pattern of building a successful startup is not specific to Web services. You must maintain a strong link to your customers over time. You need sustainable market positioning that will evolve as the market changes. Again, this is common sense, but doing it well requires deep understanding of the Web services industry and solid intuition about its evolution. This is how you can stay ahead of incumbent players that are slowly adopting Web services and position against competing startups, both of which will be trying to take away your customers.

Most startups don't live a long time. History speaks for itself. Few large, successful software companies are more than 10 years old. Most companies either disappear or get acquired for little. Building a large company isn't easy. It's a lot harder to evolve with the market and with customer needs than it is to build a product that does something well at a given point in time. The Web services landscape is rapidly changing. What seemed like a great idea 12 months ago may make little sense today. With product cycles running six to 18 months, startups have little margin for error. Therefore, an extension to the second pattern is the need to build a highly adaptable organization. It takes great leadership to do this.

In short, Web services must enable or enhance a core capability that is key to a product or service that meets a pressing need (see Figure 1). For long-term success, startups must keep delivering significant value over a sustained link to their customers. Here's my litmus test for a startup in this space: If Web services didn't exist, would the core features of its products still provide significant sustained value? If the answer is Yes, then there's a real business there that can be accelerated with Web services. If the answer is No, this doesn't necessarily mean that the startup won't be successful. However, it does suggest that the company faces significant market evolution risk because it may be operating too close to the core Web services infrastructure. Its value proposition is likely to be subsumed over time as incumbents add native Web services support.

Some examples
Let's look at some examples of applying this way of thinking to opportunities in the Web services space. We can start with the most obvious one: connecting applications using Web services. This was all the rage in 2000 and 2001. The customer need is clear: companies have been trying to get their applications to communicate for decades. The core technology is software that can expose applications for remote access. Web services provide a common interaction mechanism. Marry SOAP and WSDL with this technology and you have a Web services engine. Add to that some development and deployment tools and some management capabilities and you have the initial product offerings of companies such as Cape Clear and Systinet (to pick two out of a large pack).

Now, have startups made lots of money selling Web services engines? I don't know of any that have. To see why, we can apply the model we developed. The customer need is still there. The perceived value, however, has been eroded by commoditization. Many products now have the ability to expose components as Web services. On top of this, there are multiple open-source Web services engines, for example, Apache Axis. Most important, all the major platform vendors have this capability built into their products. The value proposition has eroded, and so has the link to the customer. Web services are typically exposed in one of three ways: (1) directly out of packaged applications, (2) via custom application components running on application servers, or (3) through message brokers. Well, the packaged applications vendors are slowly but surely getting on the Web services bandwagon, and, as already mentioned, the application server and messaging vendors are leading the Web services charge. If customers already have Web services capabilities when they buy an enterprise application, an application server, or a message broker, why would they buy a Web services engine from a third party?

This example is a classic case of one of the most common antipatterns of startups: focusing on a short-term opportunity and ignoring the consequences of inevitable changes in the industry. In general, if a startup is in the business of Web service-enabling some capability X, and it doesn't own or have control over how X is implemented by its customer, it will likely end up in trouble.

It's okay to focus on a short-term opportunity to generate traction, but you have to know when to move on to adjacent markets and you must move quickly. This is what, for example, both Systinet and Cape Clear are trying to do. They started by providing Web services engines and related tools. Now they're moving away from this space toward providing service integration capabilities and deeper infrastructure focused on quality of service (QoS). Will this work? If the companies have strong and insightful leadership, and if the near-term economic environment improves and supports more advanced applications of Web services, the companies may be well positioned.

The same argument that we applied to companies that focused on Web service connectivity can be applied to startups targeting service discovery, integration, and orchestration. These are not new concepts either. They've been around for a long time under various names: directories, naming services, EDI, EAI, workflow, BPA, B2B. There are a number of established players with both capital to defend their position and customers to deliver enhanced products to. Also, the platform vendors that didn't have offerings in this space are using Web services as a means for entering these markets. Sure, a startup now may discover, integrate, and orchestrate applications better with Web services, but what is its long-term sustainable position? Does its embrace of Web services give it a fundamentally defensible position with respect to vendors that are using legacy technology? Will it be able to achieve critical mass in the time it takes for established players to achieve similar capabilities? Will it be able to win and keep new customers even when Web services discovery, integration, and orchestration become mainstream several years down the road? Does it have what it takes to stay three steps ahead at all times?

It's no longer easy to get acquired or go public in a couple of years. In the current climate it can easily take three to seven years for this to happen. We're talking about a marathon-length course that startups have to run at sprinting speeds, a challenge that strains even the strongest of companies. And, of course, the general rule of entrepreneurs is to assume that if they woke up one day with a great idea that would change the world, it's likely that some other people woke up with the same idea that day. Since I'm now in the position to look at many startups, I can assure you that there are many competitors in the race that have more similar approaches than they realize. Companies start the race from different points but are aiming at the same finish line. This phase is going to be great for customers of Web services-enabled products, albeit also very challenging for ISVs and startups trying to leverage these emerging technologies.

I don't mean to sound pessimistic. There are lots of opportunities for building great companies. The next installment of XML in Transit will focus on some of the ones I see. In the meantime, send me an e-mail and let me know what kind of Web services startup you are excited about.

More Stories By Simeon Simeonov

Simeon Simeonov is CEO of FastIgnite, where he invests in and advises startups. He was chief architect or CTO at companies such as Allaire, Macromedia, Better Advertising and Thing Labs. He blogs at blog.simeonov.com, tweets as @simeons and lives in the Greater Boston area with his wife, son and an adopted dog named Tye.

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