Business Brains

5 risks, 5 rewards of doing business with a startup

Posting in Finance

Having a startup in the supply chain could be the equivalent of a 'mini external R&D group.' Or, it could be a recipe for risk. Here are the pros and cons.

Is it too risky to give business to a startup?

That's the question posed by CIO's Stephanie Overby, who cites examples of business executives who were left holding the bag after the startups to whom they awarded business either collapsed or were acquired.

Executives interviewed are on both sides of the fence. There are good reasons why working with startups or smaller ventures is risky, yet there are also compelling reasons to engage with smaller vendors. (For purposes of this article, we'll keep startups and small vendors in the same category.)

In some cases, there may even be a policy that dictates a certain percentage of contracts be set aside for small firms -- such as the rules governing US federal government purchasing.

Here are 5 reasons why buying goods or services from a startup or small vendor is risky business:

  1. Startups may not be around long enough. As one executive told CIO: "Most startups...are under-capitalized and they can't survive any setbacks. As CIO, I can't afford to go with an innovative company that offers a neat product at a great price if I'm afraid they will go out of business."
  2. Startups may be too successful. Of course, the startup may not go out of business, but take off to success. That creates one of two whole different issues. The small vendor may be acquired by a less-attentive and more bureaucratic larger vendor. Or, as expressed by Christine Ferrusi Ross of Forrester: "These startups can become big players themselves. And the vendors can start to take on the characteristics [that executives] were trying to avoid in the first place."
  3. A lot of hand-holding is required. Startups or small vendors are still on a learning curve, and are still putting processes in place. Unfortunately, early customers are financing this learning.
  4. Startup vendors don't have well-established or experienced customer service processes. The vendor may not even have a formal support department yet, calls for support may even end up directed right to the CEO's office.
  5. Startup vendors' employees may be stretched thin in their responsibilities. This may make it difficult to follow-up on post-installation problems. As one executive told CIO: a vendor's staff members "may already be dedicated to support another customer or to get the next product release out the door, and access to those individuals may be walled off altogether."

But the advantages of working with a startup can outweigh the potential risks, and many of the executives Overby reports on 5 compelling reasons why it may pay off.

  1. Greater influence over product direction. For example, companies purchasing products or services from smaller vendors have considerable influence with those vendors -- versus the potential anonymity they may face from a large, established vendor.
  2. Higher-quality relationships. There's likely to be personal relationships with the smaller vendor's managers and product developers. Relationships aren't limited to visits by vendor salespeople at the end of the quarter.
  3. More financial leverage. Since things aren't set in stone  yet, startup vendors will have more flexible pricing and contract terms. There may even be a freemium for being one of the earliest customers.
  4. Faster implementations. Startups and small vendors typically are free to get to work on projects right away, unencumbered by complex schedules with obligations to thousands of customers, as a larger vendor may be. Plus, startups are likely to be more eager to establish a well-functioning customer success story as a reference.
  5. Fresh injections of innovation. The greatest advantage is the innovation that smaller vendors or startups may provide. They are more likely to be involved in a disruptive technology or business idea, thereby injecting fresh, new thinking into the customer's enterprise. One executive even refers to small vendors as the equivalent of a "mini external R&D group." As another put it:  "A lot of startups are not only solving the newest problems out there, they're solving them at a faster rate."

(Thumbnail photo: US Department of Commerce.)

Joe McKendrick

Contributing Editor

Joe McKendrick is an independent analyst who tracks the impact of information technology on management and markets. He is a co-author of the SOA Manifesto and has written for Forbes, ZDNet and Database Trends & Applications. He holds a degree from Temple University. He is based in Pennsylvania. Follow him on Twitter. Disclosure