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Web 2.0, Revenue Models and Profitability: A Web 1.0 Comparison
Not only are most of the hottest Web 2.0 startups unprofitable, quite a few lack viable revenue models altogether. This has led cynics like me to criticize these startups quite harshly over the past several years.
Twitter, for instance, is the perfect example of the prototypical Web 2.0 startup that has captured the hearts and minds of the Web 2.0 "community" but hasn’t captured any real money (outside of venture capital).
When confronted with questions about the financial viability of their hottest startups, Web 2.0 proponents usually have a similar response: Rome wasn’t built in a day. When Google launched, we’re reminded, it didn’t know how exactly how it was going to make money. For young Web 2.0 startups that are growing rapidly, we’re often told that growth and "critical mass" are more important than revenue models and profitability.
As we recently learned that Digg was still losing money on revenue numbers that look quite paltry, it occurred to me that Digg and some of Web 2.0′s other hot young startups really aren’t hot young startups anymore.
Facebook was launched in February 2004. Digg was launched in November 2004. Twitter was launched in July 2006. Facebook is almost five years old, Digg is just over four years old and Twitter is two and a half years old.
They all share a common trait: none has developed into a self-sustaining business whose financial future seems assured.
But Rome wasn’t built in a day, right?
When Google launched to the public in 1998, AdWords wasn’t a part of the "business plan." Yet in 2001 – the third year of its existence – Google was already turning a profit. In an August 2001 BBC article, it was reported Google had been in the black for the past two quarters and that the company wasn’t making a little bit of cash – it was making a lot of it.
Eric Schmidt’s words: "We are quite profitable. We are not talking about 1%."
And what of other brands created during Bubble 1.0 that went on to grow into large enterprises? eBay was profitable almost right from the start.
According to an old press release, Yahoo reported a negligible profit in Q4 of 2005 – before it went public. Yahoo was officially incorporated as a business on March 1, 1995.
In short, three of the most prominent creations of the first .com boom were able to generate revenue and profits much faster than their Web 2.0 counterparts.
This is quite curious for two primary reasons.
The Myth of the Lean, Mean Startup
One of Web 2.0′s biggest myths: it’s far easier and far cheaper to get a startup off the ground today than it was a decade ago.
Citing the wide range of mature, open-source technologies and the abundance of talent available today, Web 2.0 proponents have told us that taking an idea from concept to reality, getting it launched and growing it can be a cheap affair.
If that’s the case, one would logically assume that today’s Web 2.0 startups would have developed into lean, mean revenue-generating machines. Instead, we see the exact opposite.
Facebook has over 600 employees and has raised over $400 million in capital (and is reportedly still looking for another big capital infusion). Digg has over 70 employees and has raised $40 million in capital. Twitter has somewhere around 25 employees and has raised $20 million in capital.
In other words, Facebook is a bloated company that spends money like it’s going out of style. Digg is a bloated company that is losing money on a marginal amount of revenue. Twitter is, relatively-speaking, the leanest of the bunch and ironically, the only company in this trio that could realistically implement a successful paid subscription model. Yet founder Biz Stone believes a business model could be a "distraction" at this stage of the game. Given Twitter’s recent security mishap, perhaps he’s right.
The reality is that while it’s true that open-source technologies and a large pool of development talent make building certain kinds of Internet "products" cheaper today, building a product and building a business around a product are two very different things.
Instead of following the lean-and-mean philosophy that Web 2.0 proponents promote, Web 2.0′s biggest stars have opted to put revenue models on the back burner. Instead, they’ve raised large amounts of capital at exorbitant valuations under the guise of supporting "growth" and achieving "critical mass." They figured that the revenue and profits would come eventually but clearly that was putting the cart before the horse.
This approach was fueled not only by the overabundance of easy venture capital money that needed to be invested and the promise of YouTube-sized acquisitions but by a stark truth: scaling services like Facebook and Twitter is not cheap.
Facebook’s $100 million debt financing for the sole purpose of leasing servers highlights very well the fact that offering free, advertising-supported services to millions upon millions of people is not a lean and- mean undertaking. The popularity of "open platforms", in which services need to allocate even greater resources to support applications that third-party developers have created, only exacerbates the situation.
In short, the model exhibited by the poster children of Web 2.0 does not reflect reality. Not only have the people who run Web 2.0′s most popular services largely bought into the model of VC bloat, the very nature of their services does not permit them to follow a lean-and-mean approach as traction is obtained.
The AdSense Economy
If you started an advertising-supported online content destination in the late 1990s, life was a lot tougher than it is today in many ways.
Back then, the nascent Internet advertising market was starting to grow rapidly and while there were huge opportunities for those entrepreneurs who were able to navigate it successfully, the market’s immaturity posed a lot of challenges.
That market is much easier to navigate today and Web 2.0 has been the beneficiary of what I like to call "The AdSense Economy." Thanks to AdSense, you can build an Internet product, launch it and "monetize" immediately by slapping up some ads courtesy of the friendly folks at Google.
In his article, "What is Web 2.0?", Tim O’Reilly lists AdSense as Web 2.0′s equivalent to Doubleclick.
And for good reason. AdSense (and programs like it) have been the initial primary source of revenue for many of the Web 2.0 "startups" that have launched (many of which you’ve never heard of, many of which you’ve already forgotten and many which have already disappeared into obscurity).
In theory, programs like AdSense give Web 2.0 upstarts a key advantage over their Web 1.0 counterparts: they permit low-effort monetization. If you launch a new service and manage to attract 10,000 visitors in the first month, you can monetize that traffic with almost no effort beyond adding a few lines of code to your website. Google, ad networks and other online ad companies do all the heavy lifting finding and dealing with advertisers.
Yet being able to monetize doesn’t mean being able to monetize effectively and profitably. The truth is that programs like AdSense are quite underwhelming and any service with real scale is not going to achieve anywhere near the same kinds of results with AdSense that it would with a dedicated ad sales staff (either internal or outsourced).
Sure, you’ve seen photos of AdSense webmasters holding up a $100,000+ check from Google and there are individuals and companies who make lots of money with AdSense. But they’re the exception, not the rule, and most of them are running services that are conducive to success (read: not "social media" services that tend to suffer from severe ad blindness).
But taking a step back, this isn’t about AdSense specifically. It’s about the mature online advertising market.
Many seemed to have believed the fact that this market was more mature than it was back in the late 1990s would be beneficial to Web 2.0 companies. After all, the online advertising market today is much more efficient and consists of a much bigger pie. Young Web 2.0 startups looking to tap into this should have an easier time, right?
Wrong. Market maturity is a double-edged sword because today’s mature online advertising market is:
More sophisticated. Ad buyers know a lot more about what they’re doing today than they did 10 years ago. This can make it more difficult for young startups to sell directly to brands and ad agencies because, even though a lot of money still gets thrown around and wasted, by in large, brands and ad agencies have a much better grasp of the digital space.
More competitive. Brands and ad agencies have a lot of options. In growing markets with lots of competition and few barriers to entry, a common characteristic is that the strong get stronger. Even though the online advertising pie is growing, major companies like Google and top properties and networks that register with comScore and Nielsen inevitably take a larger chunk of that pie because they represent the best avenue for efficient allocation of online ad spend in a cluttered online world.
Growing slower. Inevitably, nascent markets eventually mature and as they mature, growth slows. While the growth of online advertising (and the potential for future growth) is still quite significant, this market isn’t a plane that’s still sitting on the runway. What does this mean? It means that even if online advertising spend holds up relatively well during a deep recession, naturally slowing growth that’s inevitable in a maturing market could make the situation feel worse than the numbers might otherwise indicate.
Today’s economic downturn is far different (and far more severe) than the downturn in 2001 and that previous downturn, while painful for many, was actually not as problematic for the online advertising market as it should have been. The reason: the market was still so young and growing so much that the natural momentum it had for growth offset the macroeconomic climate. Today, a more mature online advertising market coupled with a more severe downturn will not be beneficial for Web 2.0 companies that are under the illusion that online advertising is recession-resistant.
All told, The AdSense Economy is not been as beneficial to the bottom line of Web 2.0 startups as many had argued it would be.
As we head into 2009 facing one of the toughest economic environments in decades knowing that the fun and games are over, it’s time to face the reality: the Web 2.0 we have today is not the Web 2.0 we envisioned a few short years ago.
The most popular Web 2.0 creations have not been cheap to grow and operate. They’re still struggling to find revenue models that will serve as the foundations of self-sustaining businesses and even those startups that generate significant revenue in absolute terms (namely Facebook) cannot justify the valuations they’ve been given. And profitability is still largely a pipe dream.
While it’s possible that Web 2.0 stars like Facebook, Digg and Twitter will turn things around, it’s quite clear that these companies are not like many of their hot Web 1.0 counterparts, which, despite having to battle challenges of their own, were able to develop viable revenue models and turn a profit relatively early on.
Given all this, for Web 2.0 proponents who continue to make the same asinine argument, "Don’t treat Web 2.0 like Web 1.0!", it’s 2009 and I concede defeat. Web 2.0 is not like Web 1.0. It’s in a special (ed) class of its own.