March 10, 2014

Amazon Web Services (AWS) is a $1+ billion unit of Amazon’s and – as a capital intensive business – is able to leverage the low cost of funding of its parent. AWS is the definition of the public cloud provider: low-cost computing available on-demand, billable by usage and giving the appearance of limitless scalability.

In what surely must constitute a bold statement, a relatively young cloud hosting provider firm called DigitalOcean has raised $37 million of Series A venture capital financing with a stated goal of directly challenging much larger market-leaders. The financing is newsworthy because well-regarded VC firm Andreessen Horowitz led the round and provided a board member. The investment valued the company at $153 million.

DigitalOcean highlights a serious strategic trend for large and successful technology firms. A market innovator develops a new product; customers flock to it; financial success and market acknowledgement follow; new entrants appear, leveraging a fast pace of technological innovation and ample VC funding; the new entrants target specific weaknesses that are by now structurally “locked in” to the market leader and – sometimes – the market leader stumbles and a new force emerges. Sometimes new entrants are large corporations (to pick a truly Canadian example, think Apple and Google versus Blackberry) and sometimes they are true start-ups (think of the havoc wrought by VMWare in the server market).

DigitalOcean’s insight appears to be that both AWS as well as more “service-heavy” cloud hosting providers such as Rackspace do not offer a simple, community-minded interface for users.

DigitalOcean’s business model is therefore to combine positive attributes in this domain (more on this below) with low pricing and a business model that accentuates the on-demand, scalable, usage-based-billing attributes of public cloud computing.
DigitalOcean promises that – with a few mouse clicks, less than a minute’s worth of mouse click and a commitment to a mere $5 monthly service fee – customers can set up a “droplet” (a slice of a virtualised server). The standard droplet (and there are several sizes) comes with 1TB of bandwidth and 20GB of storage. Usage is billed by the hour. In effect a start-up can test a new app, paying for it by credit card. Likewise a corporate developer can try a new solution out, put it on his credit card and bill it to his expense account. A customer can run multiple droplets, and droplet sizes can be adjusted more or less instantaneously. DigitalOcean has stated that it takes less than a minute to set up a droplet.

As noted above, DigitalOcean seems to set out to create a different customer “feel”. A communitarian spirit and a favouring of simplicity seems to infuse the marketing approach. The product still requires some technical skills (though it is admittedly much easier to set up and manage an in-house virtual machine) but the website is kitted out with discussion boards and customer-produced how-to videos. In effect users share best practices and practical tips. This community-building effort presumably builds goodwill, cuts support costs and provides real-time market feedback. DigitalOcean’s customer interface is designed to be attractive to the key target audience: the developer community.

If this sounds abstruse, it is worth noting that Beyonce’s innovative, on-line album launch late last year depended on DigitalOcean’s service. This generated millions of visits a day. Another customer is running over 100,000 droplets for their end users, having built their entire business on an integration product hosted by DigitalOcean. The firm now runs over 5,000 servers and is signing up 1,000 customers a day.

Given this robust growth it is hardly surprising that the capital will be used to continue to invest in infrastructure. The company runs out of leased data centre space in New York and San Francisco as well as foreign outposts in the data hubs of Amsterdam and Singapore. It remains to be seen how DigitalOcean will fare, but venture capital is increasingly willing to make large investments in David versus Goliath challengers.