Commercializing Web 2.0: Hype vs. Reality

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Commercializing Web 2.0: Hype vs. Reality

 

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.

Posted by Dharmesh Shah on Mon, Nov 27, 2006

COMMENTS

Great post - again. One thing I'd stress is that not all companies can survive on advertising dollars - thus, there will be another flush-out of companies trying to sustain themselves on ad revenue. Also, since many companies are taking venture capital infusions, they have to give back higher returns to their investors - with the abundance of companies fighting for the same pot of dollars, there will not be enough to go around to substantiate every investment in the market.

That said, there is a lot more money in the digital advertising budgets than in 2000. The advertising expenditures have risen dramatically in this area but has the number of companies vying for it?

Web 2.0 is great and fantastic - but at the end of the day, we all need solid business models. The IPO market is very hard for an early stage dot com - but I think we're going to start seeing some companies get that back on track.

posted on Monday, November 27, 2006 at 11:11 AM by Darren Herman


Point #1, I agree, but one more thing users are getting savvier in using the internet. Youngsters are more internet literate than before not just before. Meaning that you will find the space very partitioned between interest and age groups.

Point #2, although advertisements has played good role in many businesses, I don't see they will sustain much further with many startups counting on them. Google and other providers will be lowering their pay rate with the higher demand of startups on this model of advertising.

Point #3, I think a reach of a business model like point system where the user will either generate content or pay little for the service. This is much likewww.experts-exchange.com , which could be *now* pushed further with a huge and internet literate user base.

Point #4, Web as platform didn't stabilize yet, almost all services are pilot services testing the audience acceptance and innovative ways of using these services. So once big players find a high demand of some service it will be pushed further. Example, is the advancement happened in GIS products and providers after Google Earth success in that field.

About capital and money; I think the model of YCombinator is the new model that VCs should use. Instead of pouring a lot of money on small number of prospects, you partition your portfolio investment with larger number of prospects. But more important share the *failure* (and small probability of success) with them. That way another bubble on large scale will not happen. But rather high number of small failures we will see, which will not disrupt the industry as the first bubble.

posted on Monday, November 27, 2006 at 11:56 AM by Nader Soliman


I always receive good info on your site and want to thank you for that. But, as a guy doing his own start-up with little money able to set aside for conferences like the one at MIT, how do I get to these things that would help me the most?

posted on Monday, November 27, 2006 at 1:05 PM by Jeff


Jeff: Glad you are finding the site useful.

I undersand the need to conserve cash in the early stages of a startup.

If you're in the Boston area, there are several other conferences and informal gatherings (that are free for attendees) that you could attend.

posted on Monday, November 27, 2006 at 1:14 PM by


#3 is an interesting one - I'd like to believe most companies are aware of this slow phenomenon and are just trying to "strike while the iron's hot!" - That is - they want to think traffic, traffic, traffic! and when they hit a level, sell the company. (The entrepreneur version of pump-and-dump.)

Another important thing that these sprouting entrepreneurs (especially in consumer internet) hardly realize is that, at the end of the day, you're competing for ATTENTION of the user. They can only be looking at one thing at a time - what makes your site more compelling than Myspace or Youtube if you are in ANY way an entertainment site.

Just my penny.

posted on Monday, November 27, 2006 at 1:23 PM by Roj Niyogi


Roj: You made me wonder what the percentage of entertainment startups is to business service startups.

I don't have any dollar amounts to back up this assertion, but it seems like the number of entertainment startups is small in comparrison.

Does anyone have a ballpark metric for this?

posted on Monday, November 27, 2006 at 2:16 PM by Ryan Elisei


Great article once again Dharmesh. All the points are right on. I especially like the commentary on the IPO and VC climate. I think this is an important characteristic of the current investment sector that has kept web 2.0 somewhat in check. VCs and angel investors are not funding every web 2.0 start-up that comes there way, learning from the late 90s and forcing entrepreneurs to build real businesses on small amounts of capital. I also believe this trend is partially due to growing VC fund sizes requiring higher capital allocation for larger exits, but that is probably subject for another discussion.

I would add one opinion to your article. I believe, at least on the consumer side, there is tremendous confusion between web 2.0 and web 2.0 for teens. Much of the consumer activity to date has occurred in the teen sector and, I would argue, it has become over-saturated. Yet there are still a vast number of untapped opportunities in other demographics.

The differences between web 2.0 in the teen sector versus other demographics are interesting. Teens are spending hours a day online. Put up a cool site and you have a million users overnight. The challenge is retention and monetization. Teens leave as fast as they come, unless you somehow have cracked the nut of entertaining in a way that nobody else can. Furthermore, there is such a large inventory of daily page views within the teen demographic, CPM prices have been driven down significantly, creating a monetization challenge.

More mature demographics look a bit different. You are not competing with hours of online time. You are competing with busy lives. Therefore, some form of a user acquisition strategy is required, which is tough to keep economical. Furthermore, it is less about entertainment but more about utility. Users ask how it will save them time, money, or make their lives easier. Now, the plus is if you can convince adult users to adopt, they are more apt to stick around and not jump to any copy-cat that arises. Furthermore, the online inventory for many of adult demographics is limited and the spending power is much greater than teens. These dynamics can lead to a CPM many multiples greater than the teen sector, enabling a viable monetization strategy.

Anyway, it will be a lot of fun to see where this web 2.0 wave takes us. Thanks for taking your part in shaping its future. Good luck at the conference!

posted on Monday, November 27, 2006 at 2:23 PM by Mark Roberge


Isn't Web 2.0 played out already? Even the New York TImes is on to Web 3.0. It's about time we start extracting useful information from the web and stop simply mashing up existing 2.0 functionality.

posted on Monday, November 27, 2006 at 7:47 PM by ADM


I would love to go, but the $395 registration fee exceeds my bootstrapped budget for rice and beans. Will the panels, speakers, et al. be filmed?

posted on Tuesday, November 28, 2006 at 2:12 AM by Ryan Morin


I believe that in general, we're not going to see the same kind of dot bomb fallout this time around. There will be a few people who have taken a gamble on startups that don't work out, but unlike last time around, we're unlikely to see mass layoffs. There are few companies that are hiring hundreds of people to work on startups that have no sustainable business model.

It's easy to think about this stuff purely in terms of capital, but I think it's important to factor in the impact the business environment has on the workforce, since that impacts business too.

Everyone talks about YouTube, digg, and the like because they are cool, fun, easily understood businesses. However, the reality is that 90% of business is the unsexy stuff, and that's where innovation will have the greatest impact. In this sector, I believe most of the gains have been in the form of growing efficiency in customer aquisition and servicing that is afforded by the internet. Reduced cost of putting things of the web plays a smaller role -- there is *much* room for innovation in that area. It is still far too hard for businesses to take advantage of technology -- even simple things like the web are hard for non-techie types.

posted on Tuesday, November 28, 2006 at 9:48 AM by rob


As always, good food for thought.

I find myself wondering about value. YouTube's value is not it's content but the eyeballs it delivers to advertisers. History -- from Nero and the fall of Rome to the savings and loan crisis of the 90's -- tells us that the balance between basic needs, greed, and entertainment is a delicate one. I agree with ADM that the potential value of Web 2.0, 3.0, or whatever you want to call it is ultimately in its ability to move beyond entertainment and provide the ability to extract useful information. Even if it's only segmenting eyeballs, at some point we need to be able to get more than the firehose response to every query or advertising attempt. Seriously, as YouTube grows exponentially, don't we lose the neatly segmented demographic that made it potentially worth so much? So, yes, I do think there's a bubble in here.

On the value front, Google is certainly a leader, not only in segmenting through adwords but with its newer quety parsing. A search for "weather" and "city name" brings a three day forecast as the first result; "define" and anything brings dictionary/wikipedia definitions first; and two airport codes brings flight search engines.
The tough question there seems to be whether Google is building a "standard" that can be adopted and used by all?



posted on Tuesday, November 28, 2006 at 11:16 AM by K. Krasnow Waterman


Dharmesh - Overall I think you have a strong list, as always. A few comments

#1 - Broadband and mobile web penetration makes for always-on connectivity. Reliable and fast makes the Internet dependable. Search, verifications and investigation become more intuitive. Using the web is woven more and more into essential everyday life. This social change drives people to instinctively seek and find a web solution. It is about the number of uses and not just the number of users.

Reality check: The portion of online retail business remains a small (but valuable) piece of the overall retail pie. Everyone, always on-line is a myth.

#4 - Practical mobile might be a technological disruption. Startups may have to target mobile devices (with incompatibilities and differences and usability issues). Apps that cannot be effective on a mobile platform may decline in popularity. Delivering non-intrusive advertising to mobile devices is challenging which may relate to point #2.

#3 - The better user content will not remain free. Example: Netscape now pays some of it's bloggers to generate content. The overall point is still valid that content costs will decline dramatically.

#7 - you wrote "because acquirers are generally much more diligent about assessing value than retail investors". I agree with the overall point that acquirers may do better (more focused) due diligence but I disagree somewhat with the definition of retail investors. I think that IPO purchases were more driven by institutional purchases, arbitragers and day traders, favored investors etc. which I wouldn't characterize as retail.

Acquirers are generally more diligent about assessing business fundamentals while IPO situations are more about stock "marketability" and short term investment appeal.

#5 & #6 & #7 are tightly coupled. Perhaps capital efficiency is really the core driver because it enables growing businesses that are responding to real, fundamental customer demand rather than contrived demand driven by IPO frenzy and legitimized by high-stakes marketing.

Capital efficiency and productivity are conceptually close (I am not an economist!). There are certainly productivity improvements (more apps/features for less money) so there is a more fundamental - lasting - change that was not present in the .com boom.


/andrew

posted on Wednesday, November 29, 2006 at 8:49 AM by Andrew Lavers


As Jerry Orbach said in Dirty Dancing, "When I'm wrong, I say I'm wrong." Watching the YouTube/CNN debate tonight made it clear that I was right that YouTube needed to move beyond entertainment to show its Web 2.0 value, but I was dead wrong in guessing whether it would happen. What an amazing event!

posted on Monday, July 23, 2007 at 9:24 PM by K Krasnow Waterman


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