Web 2.0 Business Models, Friend or Foe?

Why Making Money is a Good Idea

Lately I’m seeing more and more Web 2.0 catch phrases in business plans and pitches. Here are some examples:

• “if we build a better application users will find us”
• “we have a viral application that will have exponential user acquisition growth like (insert your favorite social networking success story)”
• “all we have to do is aggregate a large enough audience and (insert your favorite big media or online company) will acquire us and they will figure out how to monetize the audience.”

For me this is déjà vu all over again. We can all recall similar attitudes, familiar market conditions and even identical applications, services and content from the Web 1.0 era. Apparently I’m not the only one noticing this either. My friend Mark Pincus has a nice post noting similar observations. The famous philosopher George Santayana once wrote “Those who cannot remember the past are condemned to repeat it”.

But wait you say, things are different now. Certainly there are more people with internet access on a computer or mobile device, increased penetration of broadband, virtually ubiquitous wifi, new user modalities are being more easily adopted. Syndication technologies are making distribution easier and real cash flows and profits are being generated by a growing number of companies. New development and deployment technologies tools have lowered the barriers to bringing new services and content to the market.

The barriers are so low that there is an explosion of new web 2.0 companies; countless new companies each week. Hundreds of bloggers devote themselves to keeping up with the dizzying pace of innovation. It’s made it almost impossible for even those of us “Inside Baseball” to keep up. Imagine how challenging it is for the average consumer.

So how do you compete in this noisy environment? Obviously you must have a compelling product or service, but that is just a way to convert and retain users, not acquire them. The one exception is if you truly have a “viral” application that markets itself. Before you jump to the conclusion that “yeah, I got one of those”, sit back and consider the number of successful companies you know that were truly viral. The count will probably be less than the fingers on both hands. Now consider the number of successful internet companies you know of, that count is going to substantially exceed ten. Now consider what the common denominator might be in all those companies. I think upon reflection you will find that it was a well thought out business model where the life time value of the customer substantially exceeded the cost to acquire them.

In today’s crowded environment even if your product is viral, you are going to have to compete for users with other companies offering similar or seemingly similar products. You will have to spend considerable marketing dollars to compete for the minds of those users. The vitality and viability of your business will not only depend on being able to differentiate based on features for the consumer, but critically on your ability to acquire users for less and monetize for more than your competitors.

The conclusion I’ve come to is that even if you think its going to be viral, it probably isn’t. Far better not depend on it and plan to build the business the old fashion way. Create a vision and business model that has a realistic chance of being profitable.

This will give you the economic power to build your business faster than your competition. Having a business model and marketing plan that converges on profitability is key to achieving that success. One of my fellow VCs, Will Price, has an interesting post, Marketing Best Practices, on how to construct a marketing plan that addresses some of the issues. I'll review various Web 2.0 business models and their virtues as a future topic. Until then, consider building an appropriate business model for you business.

When things get tough, (or even if they don’t) that business model could prove to be your best friend.