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Web 2.0 – Greater Initial Investments Required

Michael Arrington posted today on TechCrunch on the death of some Web 2.0 companies and the question of whether we are seeing another bubble burst.  He thinks not: “I think a few failures are direct evidence that we are not in a bubble and that the private venture markets are actually in the process of letting off a little steam to keep things rational.”

I think we’re seeing the beginning of a change in the required funding model for Web 2.0 companies.

Later in the post Michael (correctly) cites Digg, YouTube, and FaceBook as successful Web 2.0 companies that were started on a shoestring.  But that was then; this is now.

Fred Wilson posted a week or so ago that Web 2.0 companies are a gift to VCs.  His thesis is that companies require less initial capital now because it costs so much less for servers and service development than it did in the Web 1.0 days but that successful startups will still constructively consume capital (a good thing from a VC’s POV) as they grow to scale and commercial success.  Fred says: “What they figured out was how to build a web service for less than couple hundred thousand dollars (more than an order of magnitude less than people were spending at the top of the first bubble).”

Fred tells how he’s seen web 2.0 startups get more traffic in a day from favorable blog mentions than web 1.0 companies got in their entire lifetime from expensive portal deals.  So, he reasons, the cost of promotion is much lower than it used to be as well. 

I think Fred is right about the immediate past; I think he’s partly wrong about the future.

The first companies that figured out that you could launch a company on a shoestring because the cost of development was low and the blogosphere could be used for promotion were right and the good ones were handsomely rewarded.  The problem is that “everyone” knows that now.  There are a plethora of companies being started on a shoestring; there are a double plethora of fast imitators of each shoestring-launched company that begins to look successful.  After all, just as Michael and Fred have pointed out, the price of entry is incredibly low.

Moreover, it is no longer easy to get mentioned on blogs that count (for launching new products) like Michael’s TechCrunch, Fred’s A VC, or Boing Boing. Nor is it easy to get dugg significantly on digg or get a high ranking on del.icio.us. Low startup costs mean too many contenders.  New cottage industries plus associated scams have popped up to improve not only Google ranking but ranking on the social networking sites as well.

So, if you’re just now starting up, don’t get blinded by the successes of the first people to realize a platform could be built and operated on the cheap.  You already missed that wave.  Now, unless you are extraordinarily lucky or well-connected, you aren’t going to succeed in publicizing your new service and getting up to a critical mass of content or subscribers or both unless you raise or have enough money to create initial awareness or value.  There is too much clutter from which you must emerge.

You may have to spend money creating a valuable aggregation of content in order to attract subscribers in sufficient numbers so that they add additional value to the content and create network effect for your startup.  You may have to invest in advertising on blogs and other media; this isn’t nearly as effective as editorial mention but editorial mention is getting hard to come by.

I’m a nerd; I’d love to believe that building a better mousetrap is all that’s required.  This was somewhat true for the last couple of years; nerd nirvana.  But now the lesson that marketing Mary, my wife, is always drumming into my head is coming true again: you gotta market.  And marketing cost money.

There will be plenty of Web 2.0 successes to come.  But I’ll bet most of the ones that do succeed will have raised enough money in their first year to rocket themselves out of the clutter.  That probably means a few million dollars plus a very, very good plan to spend it.

Update: Changing Ingredients for Web 2.0 Success – Continued with Reader Help

Continues the discussion.

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jennysmith

A few initial reflections on the Web 2.0 in Australia event held yesterday… Overall it was a great success, with 100 over invited guests filling the KPMG conference facility, and all requests for invitations having been turned away over the last couple of weeks since we reached capacity. Everything ran smoothly on the day, and some great insights emerged.
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Dee Rambeau

Good post. Web 2.0 is such a broad catch-all that it deceives a bit when you speak about investment required. As we all discuss the requirements of development and marketing, let us not forget the cost of people. Depending upon the business model, the growth of the company and its revenue might depend upon good people. People cost more money than any software or marketing plan. If you're building a social network thingy to flame up and flip...then you probably won't require the investment in smart people as you grow, but if you're building a sustainable company that will eventually serve a lot of clients, personnel costs will ramp up awfully quick.

Scott Rafer

We brought a social network into public beta this summer and did fine with no budget. Marketing is critical; but for a social site, no-budget social marketing is the only kind that builds lasting value.

VC funding of social sites is best spent on product management and scaling. Except in very odd circumstances, VCs shouldn't invest unless the site already has early adopter traction and growth. VC-derived marketing budgets at launch don't help if the service isn't addictive. And if the service is addictive, spending marketing money at launch will not contribute to your success. You'll spend it on the wrong things as your users' passions will surprise you -- always.

Rick Burnes

A lot of what you're saying is based on the idea that TechCrunch, A VC and Boing Boing are the blogs you have to get mentioned on in order to succeed. That's not necessarily true. Many current startups focus on verticals where these blogs are irrelevant and the bloggers that do matter have far less Web 2.0 noise to deal with.

PaulSweeney

Generally agree with the comments and the main post. Quite wise. It would be very, very interesting to actually see quantifications on the "early mover marketing dollar advantages", over later stage imitators. For instance, you might have dollar measures and attention measures etc. Maybe Buzzmetrics might be of use here. Anyway, as you've said in previous posts "if you can't measure it....."....

Patrizia Broghammer

Everything is true and everything can be false.
It is more difficult or is it easier, is it more expensive or is it cheaper?
It could be both.
You have a great idea, but that is not all.
You have to convince the others that your idea is great, especially if you are the first and the only one to have that idea.
In the past all geniuses achieved glory after death, because they were so much forward that the contemporary people couldn't understand them.
So, if you fail, you can always think that you are either a genius or a simple failure.
And if you are successful you are just a normal guy who had that idea a little bit earlier than the others.

Regarding marketing, we must consider that there is one thing that never changes and that is that the day is ALWAYS just 24 hours of which the average consumer spends most working.
The "entertainment time" is more or less the same.
So, the more media you introduce, the more his time will be divided, or the more groups will favor one instead of the other.
Media are changing because people's tastes are changing (or vice versa) and marketing HAS to follow consumers.
Once a commercial on TV reached a huge number of people (especially when you had just one or two channels) now it does always less.
First because people get used to the same message and do not see it anymore, second because tastes are changing, third because people got to the Net more than to TV (young people).

So, you can be lucky and be successful or you can be unlucky and not being successful.
It is getting harder to forecast...

Matt

Interesting post and I agree with the comment. What fascinates me is that the companies that have had success all came from founders that were looking to solve a genuine problem that would make something easier and/or save them time. They focused on that and marketed it to the people with that problem, they're the best listeners.

You still have to practice good business sense and set a plan for growth. Banking on viral growth is like saying, "When I grow up, I'm going to win the lottery."

I say build the better mousetrap and focus your the time/energy marketing it to the cheese factories...

CrunchBack

Raising "enough money" as you say, is key. Sometimes the right amount is $0. None, nada...

Guys like Slide taking $20m for a service that anyone can copy - even if they are enjoying a network effect - is a great way for them to end up in the TechCrunch "deadpool." Where's the path to revenue and profitability in a lot of these lame investments?

For most Web 2 entrepreneurs, the path to riches is bootstrapping or lightly funding a business that has a real revenue model out of the gate. It ain't as cool as telling all your buddies about how you closed a round that makes you worth $30m on paper. But the paper's worthless and for most Web 2.0 VC investments will stay that way.

And Mary's right. Unfortunately, most Web 2.0 companies seem to feel that the social marketing, viral thing is all they need. No amount of money will create success for those guys in 99% of the cases.

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