Using startups brings rewards -- and risks

Steve Kelman sorts out the pros and cons of hiring startup firms for government contracts.

The new issue of CIO magazine, a trade journal oriented mostly to private-sector CIO’s, has a fascinating article by Stephanie Overby in the new issue, called “The Risks and Rewards of Using Startups.”  This is an issue government IT managers face as well, with the added element of pressure to meet small business goals and a perception by some small-business advocates of government bias against small firms.

The CIO article is long and detailed, and, as its title suggests, presents a very balanced picture of upsides and downsides .And just about all the upsides and downsides apply to government as well.

The upsides of dealing with startups are three: price, innovativeness, and responsiveness.

The article is pretty up-front in noting that a clear advantage of dealing with startups is that they are typically considerably cheaper than larger, established firms .This is both because their costs are likely to be lower (less overhead, for example) and because they provide advantageous pricing to get their foot in the door and show what they can do. In today’s federal budget environment, that is no small advantage, and it should definitely be something very much on the government’s mind .The problem in a government context is that small startups sometimes expect to be able to charge the same prices as their big competitors, despite the challenges (noted below) of working with them .That doesn’t add up .Government should expect to get services from these firms at a lower cost, and startups should expect to charge the government ultra-competitive prices.

The second advantage is innovation and new ideas. Startups, the CIO article notes, “are answering the technology questions that older vendors won't even ask.”  This is of course also a big advantage, especially in areas such as cyber where new answers are definitely needed .One problem is that startups in the government space often are simply me-too body shops that seek to survive on set-asides, rather than the kinds of innovative Steve Jobs-in-a-garage startups that people often think about when they hear the phrase “small business startup.”

The third advantage is responsiveness. "When you're working with one of the behemoths, you might get a quarterly visit or someone asking you at the end of the fiscal year what they can do for you. That drives me crazy," one CIO quoted in the article says. "With a startup, there's a much tighter interaction. You know the engineers and the owners, and they're actively involved in how things are going."

Against these advantages must be weighed problems. Most obviously, startups can go bankrupt, leaving the government holding the bag .More generally, the private firms quoted in the article note that the organizations that “partner with them have to do a lot of hand-holding throughout the relationship.” Furthermore, as the CIO of the British National Health Service ( a government-owned entity) notes, "there is relatively little third-party validation out there that [a startup] product can deliver,"  and therefore the customer needs to do more technological validation themselves .Both of these situations may often be really serious problems for government’s ability to use startups, since deep technical talent inside the government to hold hands or do technical validation may be exactly what the government is least able to do.

The CIOs quoted in the article are, like their counterparts in government, concerned about the financial viability of startups with whom they do business .The article reports that CIOs “often have certain metrics or guidelines for assessing financial viability. Who is funding them? Are more than half of their users paying customers? How many recurring contracts do they have? How much cash flow is there? "

The CIOs mentioned in the article have different approaches to how they use startups, taking advantage of the rewards in light of the risks .One states:  "We're not [working with startups] for parts of the business that are small or insignificant. We're doing this with vendors that will have the ability to truly be transformative for us."  But another says:  "Startups are a good way to experiment at the edges of your priorities and position your company as an innovator,"

The article notes that customers often focus on the risks posed by startups, but dealing with bigger firms brings risks of a different sort.” The desire for lower risk pushed a lot of CIOs toward the bigger players with deeper pockets and more money for R&D. But they gave up one risk for another," says Christine Ferrusi Ross, research director at Forrester. "They traded the risk that a smaller, newer vendor would somehow fail for the risk that they would be held hostage to a supplier with whom they have no leverage."  On balance, as I read the article, I conclude that agencies can and should look for places to make use of startups, especially where budgets are tight or the need for innovation is great .But startups, rather than just complaining or relying on set-asides, should also be thinking about how to alleviate some of the challenges a relationship with them can create for the government customer.

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