These days whenever I run into colleagues, friends or new acquaintances, the first question I’m typically asked is “What do you think of this economy?” Rather than lamenting the drumbeat of negative economic news splashed across the headlines, my response has become consistently the same: “Well, it’s tough out there, but companies that have the right value proposition are still managing to sell and hit or exceed their numbers.” Some might just chalk this up to classic, VC Pollyanna-ism, but it’s becoming clear as we move towards the end of the first quarter of 2009, that it is indeed true in the world of commercial software.

So what value proposition is resonating with business customers? Not surprisingly, it’s two things: cost cutting and compliance. IT departments will spend money on a product/service if it takes cost out. A payback period that meets the historical internal hurdle rate is not sufficient – the product/service needs to take cost out immediately. Or, in the case of a compliance driven sale, the company is required to make the purchase because of regulation such as PCI. Goldman Sachs released their most recent IT Spending Survey this week and one of their top level themes reinforced our observation: “Top priorities for spending include “cost reduction” and other strong ROI or compliance related spends.” We at Madrona heard this articulated clearly going back to last fall at a roundtable discussion of nine Seattle-area CIOs we hosted and, if anything, it has become more starkly true in Q1.

This brings me to the second question I have been consistently hearing after the one about the economy – “Are you still making investments and, if so, what spaces are you excited about?” The answer to the first part is “yes,” we are absolutely still actively investing, making 4 new investments in the last 6 months. As for the latter, one area of great interest to Madrona (and many VCs) is cloud computing. Although arguably the largest trend sweeping IT, the term “cloud computing” has undeniably become overused and overhyped. Many companies have tried to hitch their train to the wave of hype without having real products and real customers to back up the marketing buzz. The reality, however, is that cloud computing is catching on with small companies and enterprises alike in a very real way. Not surprisingly because, in the near term, cloud services can deliver the cost savings value proposition that is critical to selling in this economy. From a VC perspective, the cloud is appealing because of its long term potential for disrupting the way software is delivered to and within businesses (it has already done so for consumers). The trick for an investor like Madrona is to find companies that have the team, the technology and the product that are actually delivering on this, rather than just attaching themselves to the hype.

Clearly large players like Amazon, Google and Microsoft are making bets on cloud computing. But what are some tangible examples of emerging companies that are excelling by leveraging the cloud, differentiating themselves from the big players, and selling primarily around the theme of cost savings? One Madrona investment that clearly exemplifies this trend is Apptio, whose Saas IT cost optimization solutions provide the added visibility into costs, utilization, and operations of IT services that CIOs need to readily identify cost saving opportunities. Another great example is Skytap, who delivers 100% self-service provisioning of complex IT environments – you can think of it as a virtual data center in the cloud – for dynamic IT labs.

Skytap enables companies to take advantage of utility-based “pay only for what you use” pricing to test their applications in the cloud, demo their software to prospective customers, and/or provide remote training. This means that companies can use opex for what has traditionally required capex for on-premise infrastructure. They are differentiated not only with their platform, which enables existing applications to run unchanged on industry-standard platforms, but also by their SaaS virtual lab management solution which enables IT control of costs while allowing self-service access to virtual environments by end users. With this value proposition and a robust product born from technology spun out of the University of Washington, Skytap has managed to cut through the hype and get significant traction with paying customers from large enterprises to start-ups even in this challenging market climate.

Given all this, it’s not surprising that Madrona and Skytap’s other major investors, Ignition Partners and WRF, closed a new $7 million Series B investment in the company last week. Skytap is selling successfully in this down economy with a strong cost-savings value proposition. They are a leading player in a large, high potential space, have a compelling and differentiated product, and a great team that is executing on their vision. It’s this type of company that will thrive in this down market and precisely the type of company in which Madrona will continue to invest.