Commercializing Web 2.0: Hype vs. Reality

Written By: Dharmesh Shah November 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:

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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