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Web 2.0: On Bubbles and Business Models

Posted by Dharmesh Shah on Thu, Nov 30, 2006




As I’ve noted on many earlier occasions, a lot of the best content on this blog are reader contributions via their comments.  If I were you, I’d be looking at some of the comments to the more “strategic” articles as there’s usually one or two comments that are really insightful.

This week, in response to my “Commercializing Web 2.0:  Hype vs. Reality” article, I received what has been to date the most comprehensive set of comments from an individual that I’ve ever gotten.  I read the comments over several times.  Thankfully, these were sent to me via email (instead of just posting to the comments area).  I have the author’s permission to share a slightly edited version of the article with the OnStartups.com readership.  

So, our guest author today is Jeff Burchell ( toxic@doobie.com ).  What follows is an only slightly edited version of the email I got from Jeff in response to my article.  I think it’s well worth the read if you are interested in this topic.  My personal thanks to Jeff for taking the time to respond in such detail to my original article.  Thanks also for not leave this as a comment (smile).    [Note:  Jeff and I have never met  nor interacted prior my receipt of his email].

Final note:  The article is somewhat of a rebuttal to my original points (and should be read as such).  Where possible, I changed to points to questions to make things flow better.  But in any case, assume that I “kicked off” the conversation with a point or assertion and Jeff commented on it.  It’ll be easier to consume the article if you keep this in mind.

Web 2.0:  On Bubbles and Business Models

1.  Does More Internet Users = Larger Opportunity?

I don't know that Larger Opportunity is the correct leap of faith here.  While there certainly are more Internet users, they're either foreign (which is hard for a small US developer to monetize), young (don't spend money yet), or not savvy enough to benefit from some of the cutting edge technology.

The most valuable user profile for a new or disruptive technology project is someone who has been online long enough to recognize the value of disruptive technology.  In the earlier days of the commercial internet, the community was a self-selected bunch of people who were interested in technology -- they "got it" much more quickly than does the typical user today.

The exception to this is the teenager contingent, who grew up with technology, but are too young to remember a 28.8k PPP connection (and may not have even heard about the 300 baud BBS days).  These folks are an enormous market, but they're also extremely fickle, and very, very hard to monetize because they don't have much purchasing power yet.

If you are measuring success purely as a factor of page views or unique users, then having a larger population to target may mean larger opportunity.  But the larger online population has driven CPM prices essentially to zero.  If sustainable or profitable business is your measure of success, then the larger, more diverse online population is actually driving your revenue possibilities down, by increasing the amount of users you need to attract before making any real money.

There's a certain Signal-to-noise ratio that's inherent to any sort of crowd.  New internet users are more likely to be in the noise part of that ratio.  So yeah, the pool of people you can draw from is larger, but that doesn't automatically make it one iota better.  Your market might be the same size, and just harder to target among the morass.

2.  Is The Advertising As Revenue Model Now More Viable?

I don't think this is true at all.  There is substantial ad revenue being spent on the internet, but outside of a handful of huge, established properties, it's spread so thin that it's not really a viable model for sustainability.  Part of this is because of the move away from impression-based advertising towards pay-per-click.  Part of this is due to the squatters and ad farms who are gaming the system.  Part is the sheer amount of inventory available that is driving down the payoff per click.  The truth is, to be able to earn more than $1000 a month in pure advertising revenue, you need to be a very popular site, with users that actually act on ads, and/or you need to be able to cut exclusive deals (which means you probably need a commissioned ad-sales person, or someone acting as one -- which adds to your overhead). 

It used to be that if you were pushing 100k pages per day, you could count on enough revenue from Doubleclick and their ilk to pay a small number of people and cover your bandwidth costs.  Today, even though bandwidth costs have gone down, you need to be pushing ten times that number of pages to get anything other than a meager check from AdSense or YPN.  Bandwidth costs have not gone down by a factor of ten.  Technical or other hands-on staffing costs haven't gone down either.  If you're making $100 a month in advertising revenue, you have a hobby, not a business.

AdSense has brought many more sites the ability to collect tiny checks, but it's done so at the expense of the midsized sites (you know -- the ones that had proved their models, were making some money, and were in the best position to go public if that was their strategy).  To get to the point where you're serving 30 million unique users a month, you've had to go through many months of serving 1, 3, 5, 7 million -- where your costs are increasing, but your revenue possibilities are still crap.  The deck is totally stacked against organic growth, and if you can't make the leap from 1 million to 10 million exponentially, you're in big trouble.  The way to grow exponentially is through buzz and hype -- but organic growth is more about listening to what your users want, and actually giving them the valuable experience they're looking for. 

Which one of those scenarios is more "valuable" depends on how you and the marketplace define value.

The fact that Google and Yahoo own the ad networks has got to be a part of this.  By limiting the type of growth of midsize sites (either intentionally or coincidentally), their position at the top of the pyramid is safer.  And when someone threatens to get too big and actually become legitimate competition, well, then it's time to call in the M&A team.  I'm sure that it doesn't hurt one bit that the ad-networks are probably in THE BEST position to really know what a site's traffic is, when compared to other sites (since we all know that Alexa sucks).



3.      Can Economics Of User Generated Content Work? 

Creating content that drives a sufficient a significantly sized audience is still expensive.   GOOD user generated content is still not produced for free.  An obvious example of this is with the Podcast space and with "user generated" video sites like YouTube.  For every viewer of a vlogger on YouTube, there are tens of thousands of viewers of CBS's repurposed Late Show clips, or bootlegged clips of The Daily Show or Keith Olbermann's most recent rant.  These are all professionally produced shows, that cost thousands of dollars to produce (at union rates, no less).  Even lonelygirl15 is "professional" (in that she's a paid actress, and it is her and several other people's dayjobs).

CBS recently announced that its use of YouTube has raised ratings among its traditional markets.  The same is definitely true of MSNBC, though to my knowledge, they haven't published those numbers (but I'd bet that few people knew who KO was before seeing him tear into the Bush administration online, and some of those people have certainly become viewers).

CBS has figured out something obvious.  They could be hosting these clips on their own servers, on their own dime, and spend marketing dollars to tell viewers and non-viewers that the clips are there.  But youtube not only lets them host them for FREE, but brings them at least some audience for free.  That's marketing money that CBS doesn't have to spend, and now that they've seen the positive results of it, you can expect to see the other networks following suit. 

The same thing is happening at MySpace.  It once may have been a place for friends, and most of the profiles were real people, sharing real things.  Now, you can be Burger King's friend.  Over 100,000 people are.  Are there any profiles that are truly User Generated that have 100,000 "friends"?  The same thing is going to happen to Facebook any day now (users there keep getting invited to join "groups" that seem marketing-driven, if not downright spam).  Blogger is already a lost cause, with all the splogs.  and so on and so forth.

True UGC sites are small, serve niche markets, and don't make much in the way of revenue (think BBSes).  As soon as the large dollars start to flow in, the focus of the site shifts, and the non-paying users become less important than the paying users -- which completely breaks the UGC model away from "users are king" back to "content is king". 

And that's where it falls apart.  The truth is, good content is not easy to produce, and professionals will consistently outperform amateurs in writing or otherwise producing content that people actually want to consume.  There will always be exceptions to this, but the highly skilled amateurs tend to evolve into professionals (witness what happened with the blogs... we now have a handful of A-List bloggers who make their living as writers, and are receiving most of the revenue that's available to the blogosphere)

The merger of this is what makes reddit, and digg, and sites like metafilter so great.  You've got users (on some sites, smart users) that can help to steer you towards professionally created content that they find to be interesting.  You can use the wisdom of the crowd to find the best of what's out there.  That's different than amateurs producing better stuff than pros.  Call it user rated content, not user generated.

4.  Is There A Big Technology Disruption In Web 2.0?  
 
Oh, there's still disruptive technology.  It's just not really on the Web.

Sonos is disruptive.  Sonos plus Rhapsody is hugely so.  It's the fabled "Jukebox in the sky" realized, with a business model based on established rules of selling hardware at a small profit, and collecting ongoing subscription fees for a service that isn't available through other means.  Just wait until they start adding pandora-like technology to it.  Pray that they don't add payola-type technology to it.

VoIP wants to be (and seems to be getting a little more momentum, especially as we start to see hybrid devices, like cellular phones with WiFi, and landline-replacement devices that speak both POTS and VoIP.)   While Skype and futurephone and jajah are driving long-distance costs to zero for people willing to jump through some hoops, there's progress being made in making those hoops easier to navigate.

Video across IP is going to be a threat to cable, _IF_ the content producers are willing to play (which might mean it gains traction overseas before in the US).  Hundreds of thousands of people are already downloading TV shows via BitTorrent (jumping through hoops).  If someone made it trivially easy (and legal), they'd have a winner on their hands.  And if the TV networks saw it as another distribution channel (especially one for their mostly unused back catalogs), the viewers would love it.  But the key is content.  If Video over IP only has shows worthy of cable access, it's doomed (or it'll remain the realm of pirates), but if it's used as a means to (cheaply) distribute content that's already being consumed via more traditional media, it will only expand the audience, and give the users what they want -- more choices, more convenience, more control.


The NFL offers the Sunday Ticket package to US Satellite viewers.  For a couple hundred bucks, you can have access to all NFL games on any given sunday.  If you're not in the US, you can spend a couple hundred bucks and stream the games from the net, at virtually the same resolution that you can get from the satellite.  This is not heavily marketed, and it's clearly a pilot program, but it appears to be successful.  Apple is claiming some success selling sitcoms on iTunes (though why people watch TV on an iPod is beyond me).  If they can get their TV hardware out the door, they're going to increase their sales exponentially -- now if only they could get away from the pay-per-use model and into a subscription model.

At the same time, there's hardware on the market today that does similar things (Netgear's eva700 comes to mind).  That device, with a fast enough connection, and some upstream support, could easily replace Cable TV or DirecTV and your video rental store.  Build it like the Sonos/Rhapsody system, charge a subscription fee, and you've got the ultimate Tivo (so wait, when I sign up for a season pass, I can get all the past episodes too?  Cool!), and an big fat threat to the cable monopolies (which the consumers hate anyway). 

Apple doesn't usually announce vaporware, so the preannouncement of the iTV is out of character for them.  I think they're scared of losing this market, and trying to convince the content providers that they will be in the market soon trying to keep them from signing deals with other vendors.  That's likely to make it difficult for a startup to compete fairly.



Point is, the “web as platform” is a powerful concept, but the implementation is still very, very early and nobody has really figured out how to divvy up the revenue that is generated (if there is any revenue).

Web as platform is a non-starter.  If I write a mashup using data from three sources, I'm relying on the reliability of all three of those sources (which opens me up to a lot of risk that I have very little control over).  Given that I may be competing with one or more of them (if I make their data more valuable, I'm probably taking some of their users), they don't have incentive to continue providing me with data reliably, unless they start charging me for the data.  But, we've come to expect that data on the web is free or ad supported.

Witness the Cease and Desist that was sent from Google to the Gaia project folks over the use of the Google Earth data.

5.  What Is The Impact Of Better Marketing and Distribution? 

This is the single *best* thing about "Web 2.0".  Smart people have learned that marketing isn't black magic, won't give you "hockey stick" returns by itself, and doesn't require someone who wears well-marketed $1500 shoes (and demands the salary to keep buying them).   If we'd known this in 1996, the first bubble popping might not have been so painful.

Good marketing is the creation of hype.  Good business is being able to realize the expectations of the people who hear the hype (and making sure your marketers are skillfully managing the hype that people hear, rather than just trying to generate it louder than anyone else). The first bubble was fueled almost purely by unchecked hype -- and a lot of that was driven by marketeers, who were often rewarded for it. 

A year ago, the Web 2.0 hype factor was much lower than it is now (and it appears to be growing).  If we don't get it back into check, we're totally doomed.



6.  Capital Efficiency:  It is now possible to get a new startup off the ground without raising any institutional capital.  

Which means it's possible to get a startup off the ground without having to defend your ideas and intentions in front of people who have heard lots of other ideas, and know how to choose the good ones, and can ask the questions that help you better refine your good idea into an awesome one. 

This one's a two-way street.  Sometimes the point of raising money isn't what the money buys, it's what the money brings with it, in the form of the rolodexes of your VCs, or the recommendation of a good infrastructure guy, or the validation of being selected out of a large group by a firm that's known to be selective.

Look at the often mentioned YCombinator.  Most of the people selected for YC are students at prestigious, expensive universities.  They're sending in ideas to YC to get living expenses for a few months -- but most of them already have access to that kind of capital (dude, ask your parents, or your friends' parents, or your rich uncle, or your old boss, or sell your car and buy a beater).

The thing is, it's not the money that YC gives you that's valuable.  Sure, it'll rent you an apartment and buy you a laptop.  There's some value in the business services that they provide (lawyers aren't cheap).  But what's really valuable is the name recognition that you get by being a YC-funded startup, and the people that Paul Graham and rtm can introduce you to.  There's no way we'd have heard of loopt already if they'd been bootstrapped (especially since we're so far outside of their target market).  There's no possible way that Reddit would've been sold before digg -- they'd still be building name recognition.


7.  Tighter IPO Market:  Unlike the frenzy we saw during the last bubble, there is no longer a pool of retain investors sitting on the sidelines waiting to jump on the next hot technology stock. 

Right, there's a pool of larger companies with currency in the form of their stock.  M&A is a very viable exit strategy (and always has been), and now that costs are lower to get a company off the ground, it's still possible to get a 10x or 50x return in a few years.  Where it used to cost $50M to build a company that could go public with a $500M market cap, now you can build a company for $10M and sell it to one of the big guys for $200M (or more).

That's still a frenzy.  It's just one with a different exit strategy.  And it's showing many of the same flaws (especially now that the returns are getting bigger).  Back in the dark ages, there were countless business plans that pointed at previous successful IPOs as validation that building a company with a negative revenue stream but interesting potential was a good bet.  In some cases, it was a good bet, but in most cases it wasn't.  However -- the validation of someone else's success, and the crazy groupthink going on at the time made it look like a much safer bet than it was.  And we're seeing that repeat itself.

Before the YouTube acquisition, the articles about YT were all about how unsustainable their business was, because they were spending a fortune in bandwidth serving video that was mostly violating someone's copyright.  And then, poof, Google comes in and saves the day (at a higher price than YT could've gotten had they tried to go public).  The acquisition didn't change YT's business model, but in many people's eyes, it validated it.  Suddenly, all the ink is about how ingenious YT is, that it shows we're in the middle of the next revolution.  It reads a lot like the ink before and after the Netscape IPO (or about Napster), and we know what happened there.

Now, people are using that success to justify spending a fortune on bandwidth, expecting someone to come in and save the day through a buyout.  While that's a great exit strategy for the few companies that can pull it off (which is as much a factor of timing, connections, and luck as it is pure merit), that's not sustainable either.

And while it helps the founders and investors, unsustainable business practices leading to a high-dollar acquisition doesn't actually help the business itself.  Just ask @home, Netscape, Hotmail, Inktomi, Go, Geocities, even Hotwired (which became Lycos, and has since all but faded).



So, what do you think?  Putting aside whether you like the term “Web 2.0” or not, do you think we are in (or entering) a new Bubble?  Or, have enough of the dynamics of the Internet industry changed to sustain some of the patterns we are now seeing these startups exhibit? 

We are well into a new bubble, and it will either start deflating in a controlled manner very soon, or it's going to pop in a spectacular fashion.

One of the biggest ways that I know this to be true is because of the veterans of the first bubble, and what they have to say from inside the bodies of the companies on the edges of this one.  I know people inside most of the big name 2.0 companies, and essentially all of the top 10 big-name 1.0 sites.   Most of the folks that I know, I know from the Web 0.95 days (and we were the ones that were still working during the lean times post Nasdaq-crash).  We've seen it all, many of us knew the first crash was coming, and most of the people that I hear from are seeing the same things happening again.  (Many people are reporting that lots of the people responsible for making the same broken decisions are NOT people who were inside the industry the first time around.)  The mistakes aren't as visible from the outside, perhaps (not as obvious as million dollar launch parties or 500 aeron chairs), but they're based on the same broken logic.   Product, ?????, Profit is no better today than it ever was.

People starting businesses today aren't talking about real revenue streams, or how they're going to build value (or even how they're going to solve a real problem that people really have).  They're talking about how they're going to build a company that'll be a target of an acquisition in 18 months.  That's bubble thinking.  In bubble 1.0, it was how to go public in 18 months.  Now we've learned that those days are over, but these days, there's money to be made selling your company to a public company, rather than directly to the markets.   (And remember, this is coming from someone who made some money selling a startup to a public company)

And thus, the bubble becomes self-inflating.  Those who got in early generally were solving a real problem in a new way and are now getting out with fatter and fatter checks -- and rather than being celebrated as a combination of innovation, luck and timing,  this is being used as a justification for more people to get in (and for more companies to get funded).  This draws in some that're capable, but risk-averse (like a VC firm that's ready to spend $2M on an idea that they wouldn't touch at $10M, or a sysadmin with a mortgage and baby who'll take a $80k salary, but not a $10k one plus equity).  Again, there's some success and some failures, but it's the success that we mostly hear about.  And then, the fact that so many people are all on the same (self-fulfilling "wisdom of the crowd") bandwagon becomes the justification that the bandwagon is not just a fluke, but a new way of doing business -- so people start getting in without really understanding the true dynamics.  And then, pop!

We're probably now entering the second half of "people think this is a new way of doing business" phase.  When the MBA students are building models based on monetizing a wiki (and they are),  and then actually expect to join a firm creating commercial wikis immediately out of school (or better yet, starting one -- despite having no experience with writing software or bringing it to market), you know the days are numbered.

I'm an unrepentant capitalist, and that's treated me well over the years.  If you can build a business that, once established, slowly earns money, and earns more with each new customer, then your limiting factor is your customers -- if you can build something that has sufficient appeal, you will eventually retire rich.  But if your business is one that isn't directly monetizing your customers, such that each new user actually loses you money (like YouTube and their bandwidth bills), then your limiting factor is your burn rate and the depth of your pockets.  If you can balance your appeal to users against your appeal to a potential acquire-er, perhaps there will be an exit event that will make you instantly rich (though the odds are very much against you).  But with each exit event, more and more people delude themselves into thinking that "It could've been me" and get fantasies of absurdly large payoffs.  It's that thinking that inflates the bubble (and increases the noise, making it less likely that your awesome product will get the attention it needs), and I think we're seeing more of that thinking than true innovation right now.

And in the end, it's innovation that wins.  Always.



Thanks again to Jeff for taking the time to share his ideas with the OnStartups readership.  If you have counter-points to Jeff’s, please leave comments and keep the discussion going.



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Commercializing Web 2.0: Hype vs. Reality

Posted by Dharmesh Shah on Mon, Nov 27, 2006



I’m scheduled to speak at the 9th annual MIT Venture Capital conference on December 2nd, 2006.  The title of the panel session I’m participating in is “Commercializing Web 2.0:  Hype vs. Reality”.  Details of the conference can be found here:  http://www.mitvcconference.com

Regular readers of OnStartups know that often the best content on this blog is not the material that I’ve written, but the ideas and commentary submitted by other readers.  I’m hoping this article drives some interesting comments and ideas from you (some of which I’d like to use in my presentation at MIT).

So, in order to kick-off the discussion, I’ll begin with some of my personal ideas on the “Hype vs. Reality” topic.  Based on readership interest and feedback, I’ll plan to post an article on a few of these themes later this week.

Commercializing Web 2.0:  Hype vs. Reality

First off, I’m going to refrain from trying to spend time defining what Web 2.0 is (and isn’t).  I’m not particularly fond of the term, but I didn’t pick it and have now gotten used to it.

So, here are some my thoughts on how we might determine whether this is hype or reality – and as you might guess, the answer turns out to be a little bit of both.

1.  More Internet Users = Larger Opportunity:  Compared to the time of the dot-com bust, there are many more users now on the Internet.  More users means more potential traffic and in theory, more revenues.  One could argue that some of the Internet startups that crashed during the last bust were simply ahead of their time.  But, one could also argue that although the potential audience has grown (i.e. the demand-side of the equation for web-based content and services), so has the “supply-side” – there are still lots of startups hoping to grab the attention of this audience.  The question is, has demand grown faster than the supply?   

2.  Advertising As Revenue Model Now More Viable:  The online advertising industry has evolved significantly.  Systems like Google’s AdSense make it possible for even websites with minimal traffic to participate in online advertising revenue.  You no longer have to be generating hundreds of thousands of pageviews before you can start making any money through online advertising.  In fact, many startups can start making some money within a few days.  What gets forgotten, however, is how little this money is (generally < $1,000 month for most startup websites until they really start getting some traffic).  Also, I’m still not convinced that websites planning to generate significant revenues through advertising will be able to do so with the simplicity of something like AdSense.  I believe most of the higher-end Web 2.0 companies are striking independent deals with major advertisers or advertising networks and reaching well beyond Google and the more recent Yahoo Publisher Network.  Nothing wrong with this, but once again, it requires resources on the part of the startup to find the right advertising partner and negotiate deals.   

3.  Economics Of User Generated Content:   Though advertising has been a reliable way to make money in traditional media like print and television for a long time it has always had one irritating quality to it.  Creating content that drives a sufficient a significantly sized audience has been expensive.  It also requires that the media companies constantly invest in creative talent in the hopes of locking in ratings or subscribers.  With Web 2.0, it is now possible to take one of the biggest components of cost out of the equation.  Let the users create the content!  Nowhere is this more visible than YouTube, which was recently acquired by Google in a well publicized transaction amounting to $1.65 billion (yes, that’s billion with a “B”).  Though user-generated content is clearly working for folks like YouTube, one thing I’m concerned about is the sustainability of this model.  I would argue that there is a non-zero probability that over time, users become savvier and savvier and ultimately become unwilling to simply give away their content (particularly the type that drives lots of revenue) to startups or large commercial enterprises.  Similar to what happened with Google AdSense and blogs, I think the economic incentives will begin to kick-in and users will start demanding a cut of the action.  This will dampen the “easy money” scenario that is prevalent in so many user-generated content business models.  But, that’s just my opinion, I could be wrong.

4.  Lack Of Big Technology Disruptions:  Unlike the first wave of the Internet where there were some major leaps in the technological landscape, this time around, the changes are a bit more subtle.  The only two real technological factors associated with Web 2.0 right now are AJAX and “web as platform” The benefit of AJAX is clear.  It makes browser-based applications almost tolerable from a user experience perspective.  The “web as platform” model or “mashups” is taking multiple existing web applications exposed as services and combining them into creative new applications.  The benefit of the “web as platform” is that it opens up an abundance of new opportunities for innovation.  In theory, this is true.  In practice, once you actually start trying to build one of these mashups, you don’t really begin to appreciate the challenges of unreliability, lack of service level agreements, lack of clear (or any) pricing and in many cases (like with most of the Google web services), lack of ability to create any commercial applications at all.  Point is, the “web as platform” is a powerful concept, but the implementation is still very, very early and nobody has really figured out how to divvy up the revenue that is generated (if there is any revenue).

5.  Better Marketing and Distribution:  Gone are the days where startups have to spend hundreds of thousands of dollars launching and promoting their new product.  It is now possible to get a fair amount of visibility (at least within early adopters) very early in the process via blogs and search engine marketing (like Google AdWords).  A great example is TechCrunch which has emerged as an efficient path for smart, innovative entrepreneurs to get profiled and get immediate exposure to tens of thousands of interested early adopters and investors.   

6.  Capital Efficiency:  One of the great things about software startups (even before Web 2.0) was that they’ve been relatively capital efficient.  Now, in addition to more efficient distribution channels as described above, several other factors have come together to drive the capital required to launch a Web 2.0 startup even lower.  Hardware is cheaper.  Infrastructure and bandwidth (via an abundance of hosting providers) is cheaper.  Systems software like operating systems, databases and development tools can now all be had at minimal (if any cost) via open source options.  And finally, the availability of a global talent pool has driven some of the product development costs lower as well.  All in, it takes a lot less money to launch a web-based startup these days than during the Internet boom years in the late 90s.  This capital efficiency is great news for entrepreneurs.  It is now possible to get a new startup off the ground without raising any institutional capital.   

7.  Tighter IPO Market:  Unlike the frenzy we saw during the last bubble, there is no longer a pool of retain investors sitting on the sidelines waiting to jump on the next hot technology stock.  In fact, the IPO market is relatively tight.  As such, there’s no longer that incentive for VCs to pour money into questionable startups and ultimately get their return by pushing these companies into the public markets.  Now, the most likely path is some type of M&A transaction with a larger player (as we have seen with MySpace and YouTube).  This dramatically reduces the chances of this being Bubble 2.0 because acquirers are generally much more diligent about assessing value than retail investors.  Deals like YouTube will continue to be reasonably rare.

So, what do you think?  Putting aside whether you like the term “Web 2.0” or not, do you think we are in (or entering) a new Bubble?  Or, have enough of the dynamics of the Internet industry changed to sustain some of the patterns we are now seeing these startups exhibit?  Are venture capitalists “ahead of the game” in their understanding (hence more and more money getting invested in these deals) or are we already seeing over-funding?  Would love to read your thoughts and ideas in the comments.  Thanks in advance for helping me get ready for my presentation at MIT.



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Beware The Web 2.0 Walking Dead

Posted by Dharmesh Shah on Fri, Oct 06, 2006




Back in Bubble 1.0, um, I mean Web 1.0, when a startup failed to take off, it generally died a relatively clean and definitive death.  We all knew the company was dead because the assets were sold or auctioned, the servers shut down and the service rendered unavailable.

Now, with Web 2.0 companies, it seems that there is a risk of what I would call the “walking dead”.  Walking dead are companies that have essentially died (but have not quite been put to rest).  There is no longer effort being put into the software.  The founders have lost interest.  Support is no longer available.    In most cases, this is not a big deal.  A lot of these startups have a limited number of users anyways, or are providing a non-critical service – but not always.  Besides, one could argue that if they’re not really dead (i.e. still operating) it doesn’t really matter if the software is no longer being enhanced or supported (as long as it’s useful).  

Thoughts On The Web 2.0 Walking Dead
 
First, there are factors that increase the likelihood of the walking dead phenomenon in a Web 2.0 world:
  1. Lack of Investors:  In Web 1.0, many startups could (and did) raise outside capital – sometimes lots of it.  As a result, once it was determined that the startup was not going to “take off” as the investors expected, there was usually a reason to actually shut-down the company and write off the investment.  There was no reason for the investors to let the startup continue operating and carry the liability if there was little chance of a meaningful exit.  They were better off shutting it down.  Startups without outside capital (which represents a lot of the Web 2.0 startups today) don’t have this external pressure to have a “clean” shut-down.

  1. Lower Infrastructure Costs:  It takes a lot less money now to operate a hosted web application than it did back during Web 1.0.  Hardware, bandwidth and storage are all cheaper.  There’s an abundant supply of hosting providers (keeping competition high and prices low).  Open source has reduced the cost of systems software like operating systems, web servers, programming languages and databases down to near zero.  As such, it doesn’t take a lot of money to keep a Web 2.0 company “running” anymore (assuming there is no more human effort being expended).  Humans are still expensive (relatively speaking).

  1. Advertising Efficiency:  Now that online advertising has been made much more “efficient” by the likes of Google (and now Yahoo! and Microsoft), it is easier for startups to generate at least modest revenue through a semi-successful website.  Often, these revenues can be sufficient to cover the infrastructure costs mentioned above.  When this is the case, there is little reason for the company to actually die (it continues to exist as the “walking dead”).


There are also a couple of factors that decrease the likelihood of startups becoming the walking dead:
  1. Easier Exits:  One thing that argues the opposite of the above points is the availability of simpler exit paths for startups.  For example, I know of at least four startups that offered their assets up for auction on eBay.  By making it easier for startups to find a potential acquirer, they are more likely to do so.  Further, if they use a public vehicle (like eBay) for seeking an exit, it is likely that their users will know it.

  1. Perpetual Hope:  As the number of Internet users continues to grow and we see new “shifts” in the online advertising space (more competition, better models), startups can often have the chance to be rejuvenated.  There are enough cases where companies that to be “dead” later became alive again (with new capital, a new strategy and a new hope for exit).    Though this certainly gives these companies a chance to be reborn, this also increases the chance for the “almost dead” companies to hang-around while holding on to that hope.


I don’t think this Web 2.0 “walking dead” is a major issue.  As I mentioned, most of the startups that might be classified as “walking dead” are not providing critical functions without which their users could not continue to live productive, meaningful lives anyways.  The number of users impacted by one of these startups is almost by definition small (because if a given startup had a large number of users, they’d likely be living anyways).  I just find the concept intellectually interesting. 

What do you think?  How would you know if one of your favorite Web 2.0 applications is the walking dead?  Would you care anyways (or would you just use it while it was alive and find something else if it happened to be put to rest)?



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Speaking At The Mass. Tech Leadership Council on Web 2.0

Posted by admin_onstartups.com admin_onstartups.com on Sun, Sep 17, 2006




I am scheduled to speak at a Mass. Technology Leadership Council event this week.  The topic of the event is “Web 2.0 – How Will It Impact Your Business?”.

If you plan on attending the event, please leave a comment and let me know.  Feel free to grab me after the event and say hello.  (I’m finding more and more people in the Boston/Cambridge area that are OnStartups readers).

Registration fee is $80

Tech Trends Forum: Web 2.0 - How Will It Impact Your Business?
8:00 - 11:00 a.m.


Foley Hoag Emerging Enterprise Center
Bay Colony Corporate Center
1000 Winter St, Ste 4000
Waltham, MA

Web 2.0 encompasses a whole collection of tools, architectures, interactive styles and cultural characteristics. Are you wondering:

- What is different about Web 2.0?
- How will Web 2.0 impact my business?
- What tools and technologies enable the new Web 2.0 capabilities?
- Are you using or enabling mashups?
- What old problems can be addressed differently and more effectively in the Web 2.0 world?
- What new business opportunities does Web 2.0 offer?

Details of the event can be found here:

http://function.masstlc.org/programs_new/event_single.cfm?eventid=724




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Web 2.0 Crashes: Another Startup Being Sold On eBay

Posted by Dharmesh Shah on Thu, Sep 07, 2006




First, there was Kiko (which was widely covered all over the blogosphere, including here at OnStartups.com).

Now, we have HuckABuck being offered on eBay:  http://cgi.ebay.com/ws/eBayISAPI.dll?ViewItem&ih=008&item=180023313880 ..  This one looks like it’ll be quieter (current high bid is $9,100 and the reserve hasn’t been met).

I’m going to be that most of you have not even heard of HuckABuck.  So, why am I writing about it?  Because I found a number of things about this particular transaction interesting.

Here are the things that kind of piqued my interest (and that I filed away in my brain for future consideration):
  1. I was amused by the opening sentence of the eBay offering:  “We are proud to be offering HuckABuck.com, a Web 2.0 search interface for sale”.  They’re actually proud of having to auction off the company on eBay.  Now, if they had a ton of users that would be one thing.  But, they don’t.  See below.

  1. The product is what I would call a search engine aggregator (so it goes and searches for you on the primary search engines and customizes the results).  Relatively broad target market.

  1. Got some positive mention in the blogosphere, as they noted in the eBay listing.  If it hadn’t been the fact that they had been mentioned on LifeHacker and Seth Godin’s blog, I would have figured it was just a couple of guys that whipped out some Ruby On Rails code over a weekend.

  1. Despite the above two points their daily page views were still less than 3,000 on average. 

  1. Because of this, their average advertising revenue is only $1/day.  [Web entrepreneurs take note:  This is a company that had actually launched a product, had relatively broad appeal, got some positive press and that’s all they could manage to generate.  Traffic generating and advertising revenue by AdSense is not easy].

  1. Seems the team was at it for about a year (which seems to be about the time it takes for some Web 2.0 founding teams to get bored of their idea).  Why are they selling it?  “We have several projects that we are currently working on that are demanding more of our time, and we want to find HuckABuck a new home with owners who can take it to a new level.”  For some reason, this irks me.  If you’re running a startup, you shouldn’t have “other projects” that are demanding more of your time.  A startup is an all-consuming process.  If you start straddling multiple things, you’re almost predestined to fail.  It’s hard enough to get a startup off the ground when you’re totally focused on it.  It’s almost impossible if you’re juggling multiple projects.


I wasn’t a HuckABuck user, so I can’t attest to whether they actually created a cool product or not (just tried it out now while writing this article, and it didn’t really blow me away).

Moral of the story:  Clever Ruby On Rails code, some honorable mentions by A-list bloggers and a potentially sexy product are not enough to make a successful startup.  

It’ll be interesting to see how much this one goes for.  My guess is not that much.  Then again, I didn’t think Kiko would sell for over $250,000 either, so what do I know?



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Why Web 2.0 Is Like Pornography

Posted by Dharmesh Shah on Wed, Sep 06, 2006

 



Recently, I had the opportunity to present to CommonAngels on the topic of Web 2.0.  CommonAngels is a prominent Boston-based angel investor group of which I am a member.  As part of the preparation for this meeting, I tried to figure out how to define Web 2.0 for those that were new to the concept and meme.  I couldn’t do it.

This is why I think Web 2.0 is like pornography.  I can’t really define what it is, but I know it when I see it.

So, instead of trying to define Web 2.0, I thought to cover some of the attributes and aspects of “Web 2.0ness”.  Clearly, not all of these criteria need to be met (for example, I don’t believe that a startup just has  to have AJAX to qualify as a Web 2.0 startup.

So, here are the things I think of when I think of Web 2.0.  This is intended to be an intro for those that don’t read TechCrunch, are not Web 2.0 startup founders and otherwise don’t follow the trend (but are still curious).  If you’re a Web 2.0 expert, you can safely stop reading now.

Attributes and Aspects Of Web 2.0
 
The history of Web 2.0 is a little strange because the term was coined before it actually had a definition.  Subsequently, various industry pundits ascribed various things to Web 2.0.  Rather than try to come up with a singular definition, I would describe Web 2.0 as a combination of technology and social approaches.  More broadly, I think of Web 2.0 as being the “next generation” of what can be done on the web.  

            1.  AJAXAJAX (asynchronous JavaScript and XML)   This is the technology that makes it possible for browser-based (or as I like to say, “browser-bound”) applications to behave more like regular desktop applications.  Rather than having very little “software” running on your desktop (and everything being on the server), AJAX allows parts of a web page to communicate with the server and update specific parts of the current page.  The result is a more responsive web experience.  Though I agree that AJAX is an important technology, I don’t think that it is necessarily a requirement for a Web 2.0 application to use AJAX – though most can and do.


            2.  Web As Connected Platform (Mash-ups):  One of the interesting things about the current generation of internet applications is that many are exposing their capabilities via an API (application programming interface).  This allows other application developers to use the functionality and data of multiple existing web applications and create a new service that combines them.  The result is a “mash-up” of multiple web applications that offers a new experience and new functionality.  


        3.  Advertising Revenue:  Making money on advertising on the web is nothing new.  There were many startups in the “Web 1.0” generation that sought to acquire traffic with the hopes of monetizing it.  But, two major things have changed.  First, there’s a lot more traffic on the web now then there used to be during the last bubble.  More and more users are coming on the Internet, and they’re doing more and more on it.  As such, there’s more traffic to monetize.  Second, the process of connecting advertisers to end consumers is now much more “efficient” with platforms like those offered by Google and Yahoo!.  As a result, Web 2.0 startups have several alternatives of monetizing web traffic – without having to negotiate deals with individual advertisers.  
        4.  Long Tail Effects:  This is a bit of a complicated topic and deserves an article in and of itself, but I’ll simplify a bit.  Coined originally by Chris Anderson (and now the topic of a popular book), the long tail is about how the “blockbuster hits” can be overshadowed by the aggregation of a large volume of “niche” offerings.  For example, the revenue generated from the bestsellers on Amazon may be overshadowed by the revenues generated by the hundreds of thousands of books that only sell a few copies.  The Internet makes it possible to change the economics of certain industries, making it possible to leverage long tail effects.


        5.  User Generated Content:  This idea is a good lead-in from the long tail concept.  If we accept that the value (could be measured in terms of website traffic) from aggregating lots of “niche” content can exceed the value from the “big hits” (like CNN.com), then the challenge shifts to the production of this niche-market content.  One way to solve this problem is to have the community generate the content itself.  An example of this is YouTube, an online video sharing site.  Thousands of niche videos get uploaded to YouTube every day.  These videos in turn generate traffic as other users view them.  By using UGC, companies can capture the value generated by the long tail.


        6.  Social Networking:  Social networking is about software that allows individuals to connect to each other and form online “networks”.  Usually, the purpose of social networking websites is the same as other types of web 2.0 startups – to attract traffic which can be monetized.  The oft-cited example is MySpace which is targeted at teens and was acquired by NewsCorp for over $500 million.  I see two big advantages to leveraging social networks:  First, because of their very nature, they tend to spread virally (as it is in the community’s interest for the network to expand).  Second, once a certain “critical mass” is achieved, it forms a formidable barrier to entry.  Another example of a social networking startup is LinkedIn, which is targeted at professionals.  LinkedIn is rumored to be profitable now.
From an investor’s perspective, I think Web 2.0 startups represent a significant opportunity.  However, the level of risk is pretty high.  It takes a fair amount of traffic for advertising-based startups to break even and many categories of Web 2.0 startups are already very saturated.  So there will be a large number of companies looking to close M&A transactions with a reasonably small number of acquirers.  Unless we have some high-flying IPO (like YouTube) that opens up the public markets again for web-based startups, M&A will continue to be the most likely exit path for investors.  Further, the landscape is shifting quickly, so it’s hard to really predict what’s a fad and what’s a potentially profitable trend.  Most of the Web 2.0 startups out there haven’t been around long enough to really get any true insights on what’s going to work (and what’s not).  Examples like MySpace and Facebook help, but are still only one small piece of the Web 2.0 puzzle.
 



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