Outsourcing IT and Technological Differentiation: Evidence from Digital Startups

Written by Michael Impink, doctoral candidate in Strategy at New York University Stern School of Business.

How do high-tech startups benefit from outsourcing development of their information technology (IT) assets versus developing IT assets in-house?

With the advent of cloud services, firms are able to lease subscription-based cloud IT services (from technology firms such as Amazon Web Services (AWS), Google Cloud Platform (GCP), or Microsoft Azure), adapt the base IT platform through co-invention, and develop their products on that leased infrastructure. Outsourcing IT, that is, accessing high-quality cloud IT services, is less expensive than internal IT development. This enables a narrow organizational structure and focuses the startups’ product on a single platform.

When firms make IT assets in-house, they must hire specialized technical labor, purchase computing hardware (e.g., servers, mainframes) from many manufacturers and distributors, acquire physical space to house their IT infrastructure, and sign long-term IT services agreements. These activities increase a startup’s initial capital expenditure. It also expands the firm's structure horizontally and enables product development independent without being tied to a single platform.

Is there a tradeoff between efficiencies gained from outsourcing and the ability to differentiate digital products? This is the question that Michael Impink, doctoral candidate in Strategy at NYU Stern School of Business, examines in his new paper, “Outsourcing IT and Technological Differentiation: Evidence from Digital Startups.”

Mr. Impink provides the following findings and key takeaways from his research and paper.

“Outsourcing IT and Technological Differentiation: Evidence from Digital Startups” by Stephen Michael Impink (2022, New York University Stern School of Business Working Paper)

Summary

“Outsourcing IT and Technological Differentiation” finds that when using a cloud platform, development tools that programmers use to code an app become more similar to other startups, saving time by avoiding compatibility issues. This time savings creates a tradeoff within the startup, enabling it to redeploy programmers to focus on other priorities: data analytics capabilities. Data analytics capabilities become more diverse, enabling startups to cultivate more robust data, which aids in product differentiation and startup growth. Startups using cloud providers with greater market share (i.e., market power) experience a larger effect of adopting a cloud platform: adopted tools are more standardized, and adopted data capabilities are more diverse.

Policy Relevance

Cloud service providers can impact the type of technologies that firms use by making certain technologies more or less compatible with the cloud platform.

• Short run: Standardized tools from cloud providers save programmer time that can then be invested in collecting and curating data resources, enabling startups to differentiate and compete.
• Long run: Large proportion of startups develop in a single platform (AWS, 65%), which could provide a single cloud provider with market power, impacting the type of technologies startups adopt.

Background

• Since the advent of cloud services in 2006, firms have been able to procure IT assets from a single large technology firm instead of working with many technology firms to build their IT solutions in-house.
• Reliance on cloud providers has even been more pronounced for high-tech startups that lack the resources to invest capital in buying servers, hiring IT consultants, and building their app development frameworks in-house. Once an app is developed on a cloud platform, it is difficult and costly to move it to a different platform.
• Over the past decade, venture capital investors, recognizing the reduced initial cost of startups adopting cloud-based platform services, have been able to fund even more startups for a similar total investment amount.

Main Points

• A startup’s choice of cloud provider may impact its choice of future partners and technologies.
• Cloud providers may influence the technologies that startups adopt by:
  • developing certain technologies and tools,
  • determining whether to share technologies and other complementary resources with partnering startups, or
  • controlling which technologies are compatible with their cloud platforms.
• Standardized tools from cloud providers save time, enabling startups to focus on developing data capabilities. Data capabilities are particularly important for artificial intelligence (AI) startups as data are direct inputs in AI production.
• More diverse data analytics technologies relate to having more diverse products.
• Large technology firms could change technology compatibilities on their cloud platforms or share certain resources to influence innovation, with ramifications for differentiation and competition in the long run.

Read the entire article: “Outsourcing IT and Technological Differentiation: Evidence from Digital Startups” by Stephen Michael Impink (2022, New York University Stern School of Business Working Paper)

Michael Impink is a doctoral candidate in Strategy at New York University Stern School of Business. His research focuses on AI startups, digital entrepreneurship, and the impact of digitization on organizational structure. He will be joining HEC Paris as an assistant professor in the Strategy and Business Policy department in July 2023 and will be affiliated with Hi! Paris, AI for Society.