Should you buy enterprise applications from a startup?

It's risky to buy software from a company that may not be around next year. But IT executives focused on innovation are readily doing so. Here's why.

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The rewards

CIOs who've bought from young ventures acknowledge the risks and the rewards and are eager to share best practices in making a startup partership work.

First and foremost, CIOs have to find the value in the new venture. "It's got to be something worth taking the risk," says Jonathan Gardiner, vice president of IT customer solutions for DHL Supply Chain Asia-Pacific in Singapore. He acknowledges that it may be difficult to find that little niche where startups fit, but he also notes that a number of startups originate "from people who were in the corporate world and who understand what an enterprise-level app needs to be" -- and not just from the newly minted engineering graduates that come to mind when people think "startup."

For Oliver Binz, an independent management consultant for IT and risk management based in Brisbane, Australia, startups for CIOs aren't any different than startups for investors. "They're always going to have higher risk than an established company, but you invest in one because the return is likely to be greater." But that also means you must apply other safeguards. "To take the analogy further, don't invest in a startup if you can't afford to lose your money or live with the consequences if it fails."

Multiple aspects of new ventures appeal to CIOs. Startups are hungry. To use a word that comes up a lot, they're nimble. They're also focused and responsive. DHL's Gardiner notes, "You can pick up the phone and directly call the guy who knows how the code works. You get a good level of response and agility when you use a startup. That is an upside."

CIOs may legitimately ask why -- if they just need someone to focus on a project -- they can't simply build what they need themselves. "Creating a startup within a corporate setting is a great way to innovate, but there will be distractions -- the processes, the way things are done, the sheer legacy of the organization," says Kaiser Permanente's Gardner, himself a veteran of two startups.

Making it work

When you're taking risks, never underestimate the importance of relationships. CIOs and entrepreneurs alike confirm that it's easier to connect when there's a trusted middle conduit. Red Robin's Laping says, "As open-minded as I am, I won't take a cold call." He only meets with startups he's met through a "matchmaker" called Trace3 that brings together CIOs, venture capitalists and entrepreneurs. That's important, he adds, because when you're looking for a startup, "it's not like you're going into a bar to pick someone up. I rely on my peer network or partners to tell me about someone they've run into" who can meet a specific need.

Pedigree counts too. That means looking at what venture capitalist firms or angel investors are backing the startup, or simply checking out the top executives' resumes. Notes Accenture's Sullivan, "The guy who started Nest came out of a well-established product company called Apple. It had processes, it had quality control and he took that knowledge along with some of its employees." Along the same lines, Oomnitza's Lozinski spent several years at SAP Labs.

Sometimes to make the relationship work, CIOs need to apply special dispensation. In a previous position, Peter Bowen, who now manages a team of consultants at Bedford, UK-based Telesperience Consulting, bought a billing application from startup Centenary Services (which has since been purchased by another company). Bowen's company promised to make payments on faster terms than it did to other suppliers in order to help the startup avoid cashflow issues. "Basically, we micro-managed the whole process," he says. "Buying from a startup can be good, but you need to make sure the fledging does not get killed before it has learned to fly. You should be prepared to provide a helping hand."

One of the biggest issues both CIOs and entrepreneurs cite relates to product support -- something that can overwhelm the startup and leave the enterprise frustrated. At Red Robin, Laping engaged San Francisco-based Firespotter Labs, which had developed an application for iPads named NoshList. It's essentially a self-service waiting list that texts walk-in customers when their table is ready. Though such a capability is more common today, Laping says, he believes that Red Robin was one of the first national chains to tackle this.

Even though he had "never had a support issue" with Firespotter, when Red Robin launched the NoshList pilot, Laping initially made it available to only 50 restaurants, with the proviso that the restaurant staff itself had to be prepared to provide support. Laping insisted that the employees use the chain's internal social network to share support questions and answers among themselves, rather than banging on his IT staff. Another method: Let the startup train IT staff to provide tier 1 support, while still relying on the startup for tier 2 support.

It's also a good idea to protect yourself through various methods of acquiring the code for an application in the event a startup fails. These include setting up escrow accounts for the code, or -- if the startup decides to take the company in a different direction -- setting up a plan to acquire early versions of the code so, if needed, the enterprise can integrate it itself into its own ecosystem.

CIOs may have to even go so far as to determine how working with untested companies may affect their reputation. "Think about whether it fits with your brand," advises consultant Galbraith. A conservative bank that's found to have used a security startup but still suffers a breach is not a story a CIO wants to see in the press.

"But if you're the Canadian space agency and you're using a grid-computing startup, that's okay," Galbraith says, "because you're supposed to be leading edge."

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