Web 2.0 = web app + 2 founders + 0 revenue

I was meeting with a very successful VC firm in Boston today reviewing new companies and ideas. One of the partners asked me to characterize Web 2.0 startups. I said, half jokingly, "I think Web 2.0 stands for a web app, 2 founders and zero revenue." But, they all have an advertising model in mind. Read Techmeme any day and you know what I mean.

The Wall Street Journal has a story today "Investors to Web startups: Where's the advertising?"  The story basically says that VCs are nervous about funding anything other than ad supported consumer applications.

Venture capitalists tend to be fans of ad-driven sites since advertising revenue theoretically covers the cost of giving away a Web service free, and free sites attract users much faster than sites that charge money. Such sites are typically also cheap to run because there is often no need for customer-service agents or costs for physical goods. So such companies can have high profit margins if they succeed. Many of today's hottest Web properties are based on the online-ad model, including Google Inc., which pairs ads with search results, and social-networking site Facebook Inc.

Don't get me wrong, I love Web 2.0 apps, social networks, widgets, and UGC (User Generated Content) sites. I use lots of them everyday. But applying a one-size-fits-all revenue model to these ideas is just wrong.

The first thing to remember is that not all page views and users are created equal. Meaning, some page views like SERPs (Search Engine Result Pages) are very valuable and can be effectively monetized with CPC ads, but other page views are essentially worthless or low margin. Simply counting up page views or unique users doesn't necessarily translate to revenue.

There are lots of other revenue models that can make sense for web based applications and services.

Freemium - The Freemium model, upselling from free to premium services is a good model. Many of the widgets provide a free service with options to buy premium services such as more detailed traffic statistics, more powerful services, enhanced customization, or higher levels of service.

Transactions - Direct selling to your audience, affiliate marketing ala Amazon.com, finders fees, or percentage of sales, are all good models for certain types of services.

Subscriptions - Yes, people will buy subscriptions to software, services, and high quality content. There are some great businesses built on subscribers.

Advertising can be a component of any revenue model that includes a large targeted audience, but it shouldn't be the only path. There are only so many ways to split the advertising budget pie...and the big guys are getting most of it. Web 2.0 entrepreneurs need to think creatively about all the possible revenue streams.

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Comments

[Entries of Confusion]

Great post, Don. I suspect that too many startups, and hence VCs, are relying on advertising as some kind of magic bullet.

Also, the "Web 2.0 = web app + 2 founders + 0 revenue" equation is fantastic, and so true in many cases ;-)

[TechDumpster (living in First Life)]

Don - I appreciate the post. These are some smart comments. I find Web 2.0 sites useful but advertising is only the right model when you have a few things:

1) Tremendous scale
2) No to low willingness to pay
3) The usage of your product is not going to make or break someone's career

[Godie]

Go mobile! People subscribe to ridiculous plans nowadays and don't get any aside from messaging. Where's the content? Ringtones, wallpapers, etc.. is all but fads.

[Anthony Kuhn]

Don:

Enjoyed your new Web 2.0 math equation! I think the folks over at Skype might understand a little bit about the downside of not having something concrete to offer users besides a service based on an infrastructure completely out of its control. I'm not against Web 2.0 businesses, I just think a little common sense would go a long way towards helping startups realize that things can go awry in a hurry when the Internet goes down, if that's what your service or product relies on for success. I cross-posted your piece at http://www.innovators-network.org which is a non-profit dedicated to small business, venture capitalists, IP specialists, and entrepreneurs with a focus on using technology. Visit us and help grow our community.

Best wishes,

Anthony Kuhn
Innovators Network

[Andreas]

Burn rate was popular word in the late 90's. The word might not be that popular today, but having a high one seems to be.

The majority can't rely on VC money being easy to get for years. There needs to be more balance between money coming in and money going out.

Andreas
Multigames.com

[Will]

Don,
Great post, very insightful. Looking at it from your perspective, it makes sense why VCs want to back ad based businesses. The only problem is that the pie is only so big and can only be sliced so many ways, that eventually (by that I mean sooner than later), there will be nothing left.
I think web 2.0 companies that rely on additional revenue streams are the better companies to invest in. Just my 2 cents.

Will