Innovator's Dilemma and the Cloud

In his seminal book The Innovator's Dilemma Clayton Christensen lays out the dynamics that allow start-ups to succeed. In short (and without doing justice to the depth of Prof. Christensen's ideas), the idea is that technological innovations initially represent too small of a market for large, established companies, which need to continue demonstrating a significant growth in percentages relative to their current revenues.

This, of course, creates an opportunities for new entrants, who often start with zero or very little revenues and therefore the emerging market represents a significant opportunity to demonstrate growth. One of the interesting concepts in Christensen's book -- and his later works that further develop the concept: The Innovator's Solution and Seeing What's Next -- is that in many cases the large incumbent vendors are well aware of what the technological future holds, but are unable to act appropriately because the dynamics of the business.

Cloud computing is now in that classic stage -- and the symptoms are everywhere. There seems to be little doubt in most observers' minds that cloud computing is a revolution and represents the future of IT, but turning this realization into a profitable business -- for both start-ups and established vendors -- is a different proposition altogether.

Low Visibility

One of the problems is that there is so little visibility as to the actual rate of cloud adoption. The hype is undeniable, but how significant are the revenues, and more importantly, how fast are they growing? Amazon, whose cloud services are perhaps the most significant indicators of cloud adoption, is intentionally -- and quite effectively -- hiding the finances behind AWS. The same goes for Google App Engine, Microsoft Azure and other cloud operations within larger vendors. And there's little to be learned from leading start-ups such as RightScale, who are of course privately held and keep their cards close to the vest.

One interesting case is Rackspace, the only company in the space that I know of that actually discloses its revenues from cloud operations separately. For example, in its Q1 2009 financials, Rackspace reported revenues of $134 million from its traditional managed hosting business and about $11 million from its cloud business. This comes out to a 16.5% growth rate from Q1 2008 for the managed hosting business compared to 145% growth for the cloud business (and note that part of the cloud business growth was due to the acquisitions of Slicehost and JungleDisk).

We can see The Innovator's Dilemma in numbers. While cloud is clearly rapidly growing for Rackspace, the absolute numbers are still small, and the company faces a dilemma of what part of the business to invest in.

And we can see this dilemma with other large vendors. In a recent interview with TechTarget, Mike Repass, product manager for Google App Engine said:

...rather than one big enterprise poster child, we'd rather have a hundred small web poster children, the kid in Brazil or China that wants to build apps on the web. It's very hard to build the pipeline to extract money from the big guys.

And we all know that in the long run, the real money is the enterprise, not the hundred kids in Brazil and China, and even Santa Clara County.

But then again, the future of IT is in the cloud. So what's a company to do?

Different Perspectives

Depending on the size and business of the organization we can see different approaches to the dilemma.

Established Vendors

The largest of vendors, such as Amazon, Google and Microsoft, have sufficient resources to invest strongly in cloud computing without compromising in any way their existing high revenue and profitability businesses targeting consumers and enterprises. Oracle is a different animal because of Ellison's declared disdain for cloud computing. But now many believe that Oracle's play in the cloud will be mostly through its recent acquisition of Sun Microsystems, which has been investing heavily in the cloud.

IBM and HP also both seem to be making noises in the cloud, the former more significantly than the latter. But much of their marketing and investment seems to be in a way that somehow tries to mitigate the Innovator's Dilemma, also known as internal and hybrid clouds.

But as we go down the food chain, we see that different vendors are responding differently. Yahoo has been mostly silent about its cloud strategy, despite some rumors and public job postings, which indicate that they are seriously considering it.

Today, I'm speaking at an event by Tibco about their new cloud offering, Tibco Silver. Tibco is introducing many of its existing middleware products as a hosted cloud service (btw, you can follow the event in real time on Twitter with the hashtag #NOWCloud).

But for many of the mid- to small-sized vendors strategies are all over the map and mostly amount to marketing. At most, they may have created AMIs, and some even back that up with pay-per-use pricing (such as RedHat/JBoss). Others such as SpringSource have remained fairly silent about cloud (although I hear insider rumors that there is something in the works).

For many of these vendors the solution seems to amount to trying to take advantage of the cloud buzz through symbolic marketing-oriented efforts, without having to make significant investments in a true cloud offering, and without disrupting existing business models.

Start-Ups

Theoretically, start-ups shouldn't have a dilemma. They should be going all out for the cloud with the hopes of either unseating existing vendors, or gaining enough traction quickly enough so that the large vendors will acquire them down the road. But in practice, things aren't that simple.

Some start-ups are pure-play cloud companies. In other words, the whole point about them is that they provide cloud offerings. For them it's of course a no-brainer. Examples of such companies include Twilio, Heroku and Rightscale.

But I am also talking to software start-ups that are having serious dilemmas about the cloud. Think of an application management software start-up that is ready to realease a next-generation product in the space, or think of Reductive Labs and OpsCode, the commercial efforts behind Puppet and Chef respectively. Clearly most of the business today is in traditional data centers -- but the future is in the cloud.

Transitions Are Hard

Now some have suggested that these companies should start selling to the traditional enterprise with the classic approach, and gradually make the transition to the cloud when the market is bigger. The problem is that such an approach is easier said then done. Several factors make it extremely difficult to make such a successful transition. Even if in some of these cases the actual products would require little investment to transition to a cloud-centric approach, these companies will have to battle market perceptions, company culture, customer concerns and re-forming the company's ecosystem of partners and channels. I will post a more detailed blog on this topic soon.

Bottom Line

At the end of the day, both large and small companies will have to make a gut feeling call. The considerations include what they believe the adoption lifecycle timeline of cloud is for their particular business and how much they have to lose (some companies' existing business is failing, so there's little risk in making s strategic transition -- but that's a very hard psychological pill to swallow). They also include company culture and ecosystem, and of course the level of ivestment required in the product. In some cases, the solution may be aquiring, merging or being acquired.

I'll discuss some of the topics raised in this blog in more detail in future posts.