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Business Impact

Cheap Infrastructure

Google’s App Engine is the latest service to reduce operating costs for Web startups.

Two weeks ago, Google launched a test version of App Engine, an infrastructure service aimed specifically at Web developers. The product is one of several offering cheap infrastructure to Web businesses, so that they can rent storage and processing power and avoid expensive hardware purchases. Experts say that despite lower operating costs, venture capitalists aren’t likely to change their funding strategy.

Ramu Yalamanchi, founder and CEO of hi5, says that changes to infrastructure have made a big difference over the years in terms of how startups operate. According to Yalamanchi, in 2003, when hi5 was founded, open-source software, such as the database system PostgreSQL and the Linux operating system, along with cheap components, made it possible for the company to get by with only $250,000 in seed money–a feat that wouldn’t have been possible just a few years previously. “Today, we would have looked very closely at Amazon S3,” Yalamanchi adds, noting that infrastructure costs are continuing to drop.

Amazon Web Services, including Amazon S3 and Amazon EC2, only charge companies for the storage and processing they use. As a result, explains Adam Selipsky, Amazon Web Services’ vice president of product management and developer relations, startups don’t have to pay for servers that sit idle much of the time, waiting for a sudden surge in traffic. Selipsky says, “That means you have to raise a lot less money from angels and venture capitalists, and the reduction of risk is very attractive to startups themselves, and very attractive to their initial backers.” (Angels are private investors who typically invest their own money in startups, as opposed to venture capitalists, who typically manage pools of money from a variety of sources.)

Google’s App Engine offers features similar to Amazon’s Web services. Tom Stocky, a product manager at Google, says that the company has given a great deal of thought to building an environment to help Web-based applications get off the ground quickly and grow easily. “Even the most proficient developers can get benefit here, because they get access to the same infrastructure Google engineers use,” Stocky says. For example, in addition to being hosted on Google’s servers, developers can use Google’s software to authenticate customers. App Engine, Stocky explains, also includes access to some of Google’s own methods for managing data, including the company’s load balancing algorithms and data storage systems that allow for faster access to data.

Reporter's Notebook: Erica Naone

Edward Roberts, founder and chair of the MIT Entrepreneurship Center and a professor at the MIT Sloan School of Management, says that given the lower initial costs of starting a business, people should “expect more startups.” However, he says that he doubts venture capitalists will change the size of their investments, since they need to invest certain quantities in order to keep their funds working to maximum capacity. “More startups may, however, get funded by angels or angel groups who have less money than the venture capitalists,” Roberts says.

Dharmesh Shah, an investor and entrepreneur who runs a website for software entrepreneurs, agrees that venture capitalists’ investment practices are unlikely to change as a result of cheaper infrastructure. “There’s no correlation between the amount of money an entrepreneur actually needs and the money a venture capitalist puts into the business,” he says. Shah explains that venture capitalists become personally involved with the companies they invest in, taking seats on boards and serving in an advisory role. They need to keep all their money invested, but they only have so much time for board meetings. As a result, it doesn’t make economic sense for them to offer Web startups less money.

Shah says he thinks that, rather than building infrastructure, many startups now use venture capital to build staff and increase research. He says that his own company, an Internet marketing system called Hubspot, based in Cambridge, MA, raised $5 million last July but needed only about $150,000 for infrastructure. Much of the additional money, he says, has gone into human resources.

Shah says that he sees human resources as a better use of excess venture capital than the advertising expenditures that were common during the last Internet bubble. He adds that outsourcing infrastructure “just makes practical sense, and allows the entrepreneur to focus on solving the problem the company set out to solve in the first place.”

Shah says that while outsourcing infrastructure does free up funds for other things, there are potential problems. He notes that using infrastructure services does put startups at the mercy of those companies’ pricing structures and whims. He adds that this could be a reason that larger companies have done better with these services, since they have a name brand to offer.

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