Wednesday, April 12, 2006

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.

3 Comments:

Anonymous Anonymous said...

“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.”


It never ceases to amaze me how this simple equation is left out of so many start-up business models.

It seems that in true Silicon Valley form, Web 2.0 has become the buzz category of the day, but the successful commercial implementation of online participation predates Flickr and Delicious. In fact Web 2.0 was successfully incorporated by so-called Web 1.0 companies such as Amazon.com (product ratings), eBay (seller/buyer reputation score), and Slashdot (message tagging). Among other things, these characteristics set these companies apart from rivals. So I think though while Web 2.0 may not be “new” per-se (unfortunate because “new” is such a powerful advertising concept, especially to entrepreneurs seeking investment), it seems that there is business substance at the heart of harnessing community participation for marketplace advantage. It seems at least that it has been an ingredient in the success stories of the some of the largest Internet companies.

Regards,
Bob
bobchandra AT grayboxx.com

April 17, 2006 2:33 AM  
Anonymous daniel nerezov said...

Robert,

That's an awesome post. It really strikes at this idea of decline in the cost of doing startups, which I find is more illusionary than realistic.

I do think, however, it will be interesting to see (hate to say it) Enterprise 2.0 entrepreneurs taking heed to the kinds of things you're talking about as they spear ajax, blogging, rss and mashups (oops, again) behind corporate firewalls.

Do you think the entire generation of enterprise software has to be replaced with these wiz bang new things?

July 09, 2006 10:14 AM  
Blogger Robert Goldberg said...

Daniel,

Thanks. Good points as well. Totally believe that there will be enterprise 2.0 applications built with the tools you describe. I think over time the will replace pieces of the legacy enterprise applications, but may never do so wholesale.

The current wave of SaaS applications are focused on doing what legacy apps did only with easy and speed of deployment. I think you will start to see SaaS applications move more towards improving productivity for the end user by providing a superset of functionality and maybe building on top of legacy apps, maybe not replacing them.

July 12, 2006 9:26 PM  

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