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.