Bubble 2.0 startups will crash out before they cash out

Open ... and Shut It's possible your next startup idea will earn you $1bn, but don't count on it.

While there are some stand-out success stories in Silicon Valley, there is also a raft of startups pushing product features masquerading as companies. Some of these will be acquired by the likes of Zynga and Amazon, and some will go public. But most won't. In fact, building in the shadow of the giants in the hopes of getting acquired, or of beating them, is a losing strategy for the vast majority of companies.

Just don't tell that to Instagram.

Instagram should have been steamrolled by Facebook. Instagram, which provides easy ways to touch up and share photos, is a pygmy compared to Facebook's own photo-sharing service. More than 300 million photos are uploaded to Facebook each day, with 488 million active mobile users. For all the talk about Facebook buying Instagram to get mobile expertise, the acquisition feels more like a way to head off a competitor that quickly grew to 50 million mobile users, seemingly overnight.

Facebook apparently thought it was easier to buy Instagram than to compete. And with the company hovering around a $100bn valuation, that's likely true.

But most companies don't fare as well as Instagram. As Union Square Ventures principal Fred Wilson puts it:

Over the history of the institutional VC business (the past 40 years) the number of companies started every year that turn out to be worth billions sustainably is in the tens, not the hundreds. If you are looking for a billion dollar check in the startup game, you are playing for lottery odds. So if you are doing the startup game for money, and lots of it, you are in for a plate full of frustration.

This is particularly true for companies that hope to build features that will get acquired by the big web companies or even tech giants like IBM to round out their product offerings. Yes, Facebook, Groupon, and Zynga bought 21 firms in the first quarter of 2012, as The Wall Street Journal reports, and increasingly these are product acquisitions rather than talent acquisitions, but it's not smart to play parasite to a big vendor.

My last company, Strobe, was fortunate to get acquired by Facebook. "Fortunate" because there are a host of similar companies, from Parse to Sencha to a wide array of other companies that provide services around HTML5 frameworks. Motorola Solutions bought Rhomobile and earlier Motorola bought 280 North, but most vendors in this space will have to stand alone. Some will succeed and thrive. Most will not.

Sometimes a startup will perfectly complement a big vendor's product set or engineering talent, and an acquisition will make sense. But much more often, an acquisition will be too expensive or too unwieldy to justify.

It's the same in every corner of the tech industry. Take Cloudability, which makes a great cost-monitoring service for Amazon Web Services and a host of other SaaS and PaaS offerings. Amazon recently added billing alerts to the services it offers as part of Amazon Web Services, which directly undermines Cloudability's monitoring service.

Cloudability's chief executive Mat Ellis was quick to suggest that Amazon's service is inferior to Cloudability's and that while "it may have some features that are useful to your individual needs... it’s much simpler managing your budgets with Cloudability".

Perhaps. But surely this is just the first step for Amazon, with more Cloudability-style proactive alerts likely coming in the not-too-distant future. Amazon has shown a remarkable propensity to add new functionality to AWS at exceptionally low pricing, making it difficult to partner with the Seattle company. One day you're an indispensable value-adding, complementary feature for Amazon and the next day you're a superfluous add-on that must compete with Amazon on its own turf.

This really isn't different from Microsoft in its heyday, which consistently added partners' functionality into Windows to bolster its business. Facebook, Zynga, Groupon, and Twitter, not to mention old-school enterprise vendors like IBM, Hewlett-Packard, and Oracle, will sometimes buy startups to build out a product offering.

But far more often they will build internally rather than undergo the bother of integrating outside code and people. This is particularly true for platform vendors like Amazon and Facebook, where consistency at the platform level militates against acquisitions.

None of which is intended to dissuade anyone from starting a company, even those that simply complement bigger platforms. Rather, it's simply to echo the reminder that Wilson offers that the motivation for a startup should be "the love of the game [and] a passion for what you are bringing to market".

Because if you're doing it to get rich in the shadow of a platform giant, you're likely to get squashed. ®

Matt Asay is senior vice president of business development at Nodeable, offering systems management for managing and analysing cloud-based data. He was formerly SVP of biz dev at HTML5 startup Strobe and chief operating officer of Ubuntu commercial operation Canonical. With more than a decade spent in open source, Asay served as Alfresco's general manager for the Americas and vice president of business development, and he helped put Novell on its open source track. Asay is an emeritus board member of the Open Source Initiative (OSI). His column, Open...and Shut, appears three times a week on The Register.