This article probes the implications of cloud computing for financing very rapidly distributed internet-based services and products. It contains rough, inadequately researched thoughts, sparked from discussions at the recent CloudCamp Scotland. On this page:

Cloud Computing

Cloud computing is poorly defined. Offering computer resources as a service. Across a network. Probably the internet. I prefer Frank Gens’ description – a “grid-utility model”, that anyone can use. Grid computing is the use of lots of individual computers as one. Utility computing is paying for computing resources as you use them. So instead of investing in lots of private computing capacity, one simply buys computing resources from an internet-based cloud of (effectively infinite) computing resources, as they are needed.

Benefits

What’s the advantage?

Most private computing resources are woefully under-utilised. A typical buisness’s computers lie idle while employees are sleeping, and are probably only partly used when they are working. Most websites/services are hopelessly over-resourced to accomodate occasional peaks in traffic. And then promptly collapse when the peaks transpire to be bigger than anyone expected. Sharing huge clouds of computing resources between many users – each with their own peaks and troughs – logically allows the total current demand for computing resources to be met with far fewer computers. Utility charging provides the mechanism that translates “fewer computers” into “lower cost”.

But there’s far more to cloud computing than “making existing things more efficient”.

Hyper-Virality

I define hyper-virality as the near-instantaneous adoption of a service or product by consumers, distributed through a pyramid of social connections.

It is the theoretical end-point of many current social internet trends: That ideas, optimisations, and methods that enhance the efficiency or well-being of humanity, move around the world ever faster than before. The actions of a handful of dominant, successful, or somehow innovative “thought leaders” are copied by those they lead, who are in turn copied those they lead. Since all the people on the planet are connected to each other by a surprisingly small number of links (you know someone, who knows someone, who knows someone, who… not many more times to link to everyone), distributing something down to absolutely everyone is potentially easy.

In an extreme case, a service that really is, the greatest thing since sliced bread, could almost instantly be benefiting billions of people. Clearly this level of hyper-virality is theoretical. The whole notion of absolute hyper-virality may itself be nonsense: That any one idea can be so clearly the best thing to do, that almost everyone is immediately prepared to adopt it. But in a limited way, it is already happening:

The best current examples of the concept are probably Facebook applications. These are still far from hyper-viral, but do demonstrate basic behaviour: When a user starts using a service, that user automatically informs their “friends”. If the service is desirable, those friends start using it, and in turn, inform all their friends. It is already possible to grow from no users to millions of users in a matter of weeks.

With traditional computing services, it is very difficult to scale computing resources up fast enough to keep pace with that growth in demand. Even if you can find enough machines, you probably cannot organise and configure them. You would need to anticipate millions of users and plan sufficient computing resources beforehand. And probably anticipate the wrong number – either be left with a lot of unused, but costly resources, or be unable to meet demand.

Cloud computing solves this problem, because precisely the right amount of computer resources are available, with costs always in proportion to the amount of resources used.

(Well, actually it is not yet a complete panacea – some caveats are discussed later.)

In concept, this “agile deployment” of internet-based services to the cloud, enables true hyper-virality to occur, since it creates the ability to deliver the ultimate product or service to everyone, almost instantly. This becomes far more important if we assume that our economies are becoming highly intangible entities, which primarily function over communications/internet-type services (see a Socio-Economic Environment based on Nothing) – most economic activity will occur in this communications/internet-type environment. But even if we don’t accept that assumption, the cloud potentially changes how we finance internet-based services.

Funding and Revenue Models

In a hyper-viral environment conventional business plans need to be rethought. A wild guess at future usage won’t do: “Somewhere between 3 and 3 billion users, with growth occurring sometime between today and the next decade”. That’s already a real dilemma for anyone developing a mass-market internet-type application.

Instead one needs to answer the question: How do I rapidly scale to meet demand? At the very least covering marginal costs (operating costs).

Broadly, there are 2 solutions:

  1. A revenue model that earns money in proportion to usage, with ultra-efficient cash-flow, that allows increasing revenue to immediately pay for increasing operating costs.
  2. An ultra-efficient capital market, that will invest in proportion to growth in usage, pending the later establishment of revenue streams.

Both approaches differ from what we tend to do now: Convince someone to invest some money, and hope we’ve established enough growth/revenue/”something good” by the time we’ve burnt through the cash.

Some fairly basic revenue models fit the first method well, such as display advertising or subscription-only services. In others models revenue may lag behind growth slightly: Premium versions of services that don’t earn money until users have enjoyed a free trial, or methods that rely on first building user engagement or trust, such as micro-transactions.

There is a risk of bankruptcy due to slow cash-flow: If your advertising revenue is still written on a cheque, lost for weeks in the postal or banking systems, what do you pay the cloud computing bill with? Fortunately, both incoming revenue and outgoing costs tend to lag behind by about the same amount. Cloud computing tends to be billed after use, not before, so everything is delayed by the same arcane business payment practices. But there’s still an element of Russian Roulette to whether the credit or debit clears the system first.

Parts of the financial system have the potential to be ultra-efficient. For example, in minutes, stock markets can adjust to changes in relative demands for capital. Except that such markets are dealing in established businesses that investors have some understanding of. Even high-risk investors, such as venture capital or private equity, may be unable to respond fast enough to new hyper-viral investment opportunities.

Note that established organisations will face slightly different problems to new entrants. For example, a historic focus on capital expenditure and fixed budgets may require structural change to occur within the organisation.

Astute readers will note that I have only addressed funding after a product or service’s launch. Cloud computing and virality won’t make it any cheaper to actually develop that product/service to the point where it is ready to be used. I hope to return to the topic of iterative product development on the internet in a later article – I contend that less time should be spent trying to develop a “finished” product before launch, and instead design should gradually iterate improvements on a live, “permanent beta” product or service. A logical extension of agile development into the iterative specification of the product itself.

Exploding Intangibles

Corporate finance still seems to be biased towards physical assets. This is great for factories: You can add up the value of all the machinery, materials and stock – all the physical stuff – and discount it all year-to-year. But if the most expensive physical asset is the coffee machine, classic accountancy tends to struggle. Highly intangible companies are not new – plenty of businesses are built up around intangible assets, like brands or franchises. And methods have evolved to account for the value of these companies, even if the process is inherently less precise.

What’s not clear is whether a rapidly expanding, but totally intangible, business can gain access to any conventional forms of finance. Our hyper-viral, cloud-based internet business didn’t even exist last month, and (because of the hyper-virality of unknown potential competitors) might not exist next month. So what is additional investment secured against? The coffee machine? While it is easy to point towards the rise (and fall) of major technology startups that have grown to be stock market-listed within a few years, the ultimate hyper-viral business would want to make that leap almost instantly.

Can finance move as fast as hyper-viral businesses? Current practices suggest not. But that misunderstands the potential advantage in fast-paced hyper-virality: Everything can move faster, including the return on capital. Invest for a few months, instead of a few years. So perhaps the challenge shifts to creating “stuff” that better informs capital markets, which can then react appropriately to other sectors?

People

Does this work organisationally?

Is it naive to assume that one individual can ever develop a solution that can gain mass-appeal, without significant help? Just as at the start of the first internet bubble, many believed that “2 kids in a garage” were going to destroy established businesses. While small developers do sometimes come to dominate emerging markets, most historic business empires remain in tact. And if that help takes time to organise, won’t that human organisational factor limit the speed of virality, giving existing organisations significant advantages over lone individuals?

Perhaps there are just to many unanswered questions? Technology and capital is easy – people are far more complicated!

Curiously, if people both define the structure through which hyper-virality occurs, and are the reason why hyper-virality isn’t quite as fast as it might be, it will be people that naturally establish a happy equilibrium. It would be limited by people, not technology or capital.

The Caveat

A small caveat: Cloud computing cannot yet deliver all its promised potential.

For example, by consensus the cloud does not handle database-driven applications well, particularly where a lot of data is being written (presumably we need to radically re-think the way databases work). Techniques for scaling resources within the cloud, to meet rapidly changing computing demands, are still evolving. It is not yet as automated as it sounds. There are a plethora of concerns related to issues such as security (by consensus, more perception than actual problem), and standards (some commentators suggest inter-operability will be resolved through clever use of APIs, much as different database software were made to “talk” to each other).

Ownership and privacy is a potentially important, but poorly explored issue: Logically a handful of huge cloud computing providers could gain considerable control and influence over the creativity of individual developers (much as early-modern “publishers” historically came to dominate people that worked as printers).

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5 Comments

  • I’m a little wary about “wrapping entrepreneurs up in cotton wool”. To my mind, the process should involve making mistakes and learning from them. The further one goes down the “help and advice” path, the more closely one resembles an employee (albeit a junior partner in an “innovative” parent company).

    I think “help and advice” is where venture/angel capital most clearly differentiates itself from private equity – “founder risk” is a significant component for the first group, yet tends to be removed by the second group. So it is probably inevitable that venture/angel will continue to carve out that support niche, even when dealing with business ideas that aren’t terribly capital-intensive:

    The 3 successes your example cites are all Facebook/iPhone games. That won’t surprise anyone watching this sector. Yet these businesses typically only need financial support for short-term cashflow. 3-6 months of development by “3 guys in a garage”. Add a few months between customers appearing and yielding cash.

    (As an aside: This is where “high street” (local business) banks should be. It just requires analytics/accounting that move at light speed. It is possible that someone like Facebook will eventually realise a role as a micro-financier – although the transition from a high-risk tech’ startup to minimal-risk (erm) banking sector would be tricky. This becomes very interesting given their ability to internalise value within their platform. In effect, their own currency and economy. And at some point after that, a quasi-corporate state emerges, that controls the activity of more value-generating people than most sovereign territories.)

    I see incubators (and similar) more as schools. Communities of like-minded people, as much as places of training. Logically this is where venture/angel capital goes once capital isn’t needed. Yet it’s also a cross-over point between the public and private sectors. In the US, a “train now, pay later” (where only the successful pay) model might work. In the UK there’s a tendency for government to intervene and “do it for free”.

    Of course neither matches the underlying technological change: The possibility that yesterday I was a hobbyist, and today I need to know how to run a business with a million customers. Cost control by the end of the week, managing decline within the month. The type of business cycle that would normally take decades.

    We’re constrained by a fundamental truth: That humans evolve a lot slower than the technology. Humans are probably what limits the “technological singularity” I implied in the article.

    Instead, there’s potential for a “we’ll run your business for you” service sector: A variation on contracting out or establishing franchises. It’s a lot more viable once you consider that most of what generates value is now intangible. Except that a good intangible idea still needs to be both protected and sold. The “English” system of rights protects yesterday’s good idea poorly. Rather, it stresses the creation of large pieces of property, which the “peasants” can work on. Maybe King John lacked foresight?

    Perhaps intervention shouldn’t be rapidly teaching people to run businesses at all? Rather focus on making it far easier to protect less significant properties than is currently the case – and then allow other people or services (who are already good at that stuff) to make money from that property. Not the complete answer, and raises a lot more problems, but it points to a potential area of activity that isn’t immediately obvious.

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