Web 2.0, Revenue Models and Profitability
Not only are most of the hottest Web 2.0 startups unprofitable, quite a few lack viable revenue models altogether. This has led cynics like me to criticize these startups quite harshly over the past several years.
Twitter, for instance, is the perfect example of the prototypical Web 2.0 startup that has captured the hearts and minds of the Web 2.0 “community” but hasn’t captured any real money (outside of venture capital).
When confronted with questions about the financial viability of their hottest startups, Web 2.0 proponents usually have a similar response: Rome wasn’t built in a day. When Google launched, we’re reminded, it didn’t know how exactly how it was going to make money. For young Web 2.0 startups that are growing rapidly, we’re often told that growth and “critical mass” are more important than revenue models and profitability.
As we recently learned that Digg was still losing money on revenue numbers that look quite paltry, it occurred to me that Digg and some of Web 2.0’s other hot young startups really aren’t hot young startups anymore.
Facebook was launched in February 2004. Digg was launched in November 2004. Twitter was launched in July 2006. Facebook is almost five years old, Digg is just over four years old and Twitter is two and a half years old.
They all share a common trait: none has developed into a self-sustaining business whose financial future seems assured.
But Rome wasn’t built in a day, right?
When Google launched to the public in 1998, AdWords wasn’t a part of the “business plan.” Yet in 2001 – the third year of its existence – Google was already turning a profit. In an August 2001 BBC article, it was reported Google had been in the black for the past two quarters and that the company wasn’t making a little bit of cash – it was making a lot of it.
Eric Schmidt’s words: “We are quite profitable. We are not talking about 1%.”
And what of other brands created during Bubble 1.0 that went on to grow into large enterprises?
eBay was profitable almost right from the start.
According to an old press release, Yahoo reported a negligible profit in Q4 of 1995 – before it went public. Yahoo was officially incorporated as a business on March 1, 1995.
In short, three of the most prominent creations of the first .com boom were able to generate revenue and profits much faster than their Web 2.0 counterparts.
This is quite curious for two primary reasons.
The Myth of the Lean, Mean Startup
One of Web 2.0’s biggest myths: it’s far easier and far cheaper to get a startup off the ground today than it was a decade ago.
Citing the wide range of mature, open-source technologies and the abundance of talent available today, Web 2.0 proponents have told us that taking an idea from concept to reality, getting it launched and growing it can be a cheap affair.
If that’s the case, one would logically assume that today’s Web 2.0 startups would have developed into lean, mean revenue-generating machines. Instead, we see the exact opposite.
Facebook has over 600 employees and has raised over $400 million in capital (and is reportedly still looking for another big capital infusion). Digg has over 70 employees and has raised $40 million in capital. Twitter has somewhere around 25 employees and has raised $20 million in capital.
In other words, Facebook is a bloated company that spends money like it’s going out of style. Digg is a bloated company that is losing money on a marginal amount of revenue. Twitter is, relatively-speaking, the leanest of the bunch and ironically, the only company in this trio that could realistically implement a successful paid subscription model. Yet founder Biz Stone believes a business model could be a “distraction” at this stage of the game. Given Twitter’s recent security mishap, perhaps he’s right.
The reality is that while it’s true that open-source technologies and a large pool of development talent make building certain kinds of Internet “products” cheaper today, building a product and building a business around a product are two very different things.
Instead of following the lean-and-mean philosophy that Web 2.0 proponents promote, Web 2.0’s biggest stars have opted to put revenue models on the back burner. Instead, they’ve raised large amounts of capital at exorbitant valuations under the guise of supporting “growth” and achieving “critical mass.” They figured that the revenue and profits would come eventually but clearly that was putting the cart before the horse.
This approach was fueled not only by the overabundance of easy venture capital money that needed to be invested and the promise of YouTube-sized acquisitions but by a stark truth: scaling services like Facebook and Twitter is not cheap.
Facebook’s $100 million debt financing for the sole purpose of leasing servers highlights very well the fact that offering free, advertising-supported services to millions upon millions of people is not a lean-and-mean undertaking. The popularity of “open platforms”, in which services need to allocate even greater resources to support applications that third-party developers have created, only exacerbates the situation.
In short, the model exhibited by the poster children of Web 2.0 does not reflect reality. Not only have the people who run Web 2.0’s most popular services largely bought into the model of VC bloat, the very nature of their services does not permit them to follow a lean-and-mean approach as traction is obtained.
The AdSense Economy
If you started an advertising-supported online content destination in the late 1990s, life was a lot tougher than it is today in many ways.
Back then, the nascent Internet advertising market was starting to grow rapidly and while there were huge opportunities for those entrepreneurs who were able to navigate it successfully, the market’s immaturity posed a lot of challenges.
That market is much easier to navigate today and Web 2.0 has been the beneficiary of what I like to call “The AdSense Economy.” Thanks to AdSense, you can build an Internet product, launch it and “monetize” immediately by slapping up some ads courtesy of the friendly folks at Google.
In his article, “What is Web 2.0?”, Tim O’Reilly lists AdSense as Web 2.0’s equivalent to Doubleclick.
And for good reason. AdSense (and programs like it) have been the initial primary source of revenue for many of the Web 2.0 “startups” that have launched (many of which you’ve never heard of, many of which you’ve already forgotten and many which have already disappeared into obscurity).
In theory, programs like AdSense give Web 2.0 upstarts a key advantage over their Web 1.0 counterparts: they permit low-effort monetization. If you launch a new service and manage to attract 10,000 visitors in the first month, you can monetize that traffic with almost no effort beyond adding a few lines of code to your website. Google, ad networks and other online ad companies do all the heavy lifting finding and dealing with advertisers.
Yet being able to monetize doesn’t mean being able to monetize effectively and profitably. The truth is that programs like AdSense are quite underwhelming and any service with real scale is not going to achieve anywhere near the same kinds of results with AdSense that it would with a dedicated ad sales staff (either internal or outsourced).
Sure, you’ve seen photos of AdSense webmasters holding up a $100,000+ check from Google and there are individuals and companies who make lots of money with AdSense. But they’re the exception, not the rule, and most of them are running services that are conducive to success (read: not “social media” services that tend to suffer from severe ad blindness).
But taking a step back, this isn’t about AdSense specifically. It’s about the mature online advertising market and the hottest Jessica Biel pics.
Many seemed to have believed the fact that this market was more mature than it was back in the late 1990s would be beneficial to Web 2.0 companies. After all, the online advertising market today is much more efficient and consists of a much bigger pie. Young Web 2.0 startups looking to tap into this should have an easier time, right?
Wrong. Market maturity is a double-edged sword because today’s mature online advertising market is:
More sophisticated. Ad buyers know a lot more about what they’re doing today than they did 10 years ago. This can make it more difficult for young startups to sell directly to brands and ad agencies because, even though a lot of money still gets thrown around and wasted, by in large, brands and ad agencies have a much better grasp of the digital space.
More competitive. Brands and ad agencies have a lot of options. In growing markets with lots of competition and few barriers to entry, a common characteristic is that the strong get stronger. Even though the online advertising pie is growing, major companies like Google and top properties and networks that register with comScore and Nielsen inevitably take a larger chunk of that pie because they represent the best avenue for efficient allocation of online ad spend in a cluttered online world.
Growing slower. Inevitably, nascent markets eventually mature and as they mature, growth slows. While the growth of online advertising (and the potential for future growth) is still quite significant, this market isn’t a plane that’s still sitting on the runway. What does this mean? It means that even if online advertising spend holds up relatively well during a deep recession, naturally slowing growth that’s inevitable in a maturing market could make the situation feel worse than the numbers might otherwise indicate.
Today’s economic downturn is far different (and far more severe) than the downturn in 2001 and that previous downturn, while painful for many, was actually not as problematic for the online advertising market as it should have been. The reason: the market was still so young and growing so much that the natural momentum it had for growth offset the macroeconomic climate. Today, a more mature online advertising market coupled with a more severe downturn will not be beneficial for Web 2.0 companies that are under the illusion that online advertising is recession-resistant.
All told, The AdSense Economy is not been as beneficial to the bottom line of Web 2.0 startups as many had argued it would be.
Conclusion
As we head into 2009 facing one of the toughest economic environments in decades knowing that the fun and games are over, it’s time to face the reality: the Web 2.0 we have today is not the Web 2.0 we envisioned a few short years ago.
The most popular Web 2.0 creations have not been cheap to grow and operate. They’re still struggling to find revenue models that will serve as the foundations of self-sustaining businesses and even those startups that generate significant revenue in absolute terms (namely Facebook) cannot justify the valuations they’ve been given. And profitability is still largely a pipe dream.
While it’s possible that Web 2.0 stars like Facebook, Digg and Twitter will turn things around, it’s quite clear that these companies are not like many of their hot Web 1.0 counterparts, which, despite having to battle challenges of their own, were able to develop viable revenue models and turn a profit relatively early on.
Given all this, for Web 2.0 proponents who continue to make the same asinine argument, “Don’t treat Web 2.0 like Web 1.0!”, it’s 2009 and I concede defeat. Web 2.0 is not like Web 1.0. It’s in a special (ed) class of its own.
Good post, good substance, Drama. I enjoyed the comparison between the three titans of Web 1.0 and the “titans” of 2.0
As ever, an awesome article, but one little typo. I think you meant to write that Yahoo turned a small profit in Q4 1995, not 2005.
Brilliant as always.
FINALLY!!!! Some one fucking said it. And I better not seem some comment from a Snob 2.0 about how rev and business models don’t matter right now, because thats horse shit.
It’s amazing how many of these startups arent even really businesses!
Seriously, if I ran ANY project or business like I did some of these start ups I would have nothing but a bad rep and walking papers.
Think about this, if you had a dept of lets say 25 employees (the size of twitters staff according to this peice) and they worked on a project for 2.5 years, successfully launched it, and you had to pump money in it every day from the rest of your business only to have a meeting where the dept head tells you a business model isnt even on the fucking horizon right now, youd be outraged, betrayed, and feel like a pretty bad business man.
2.0 is not a business.
What on earth are *600* people doing at Facebook?
A really good read, articulating well some of the questions that I’ve been asking myself about Web 2.0 companies and their future. I’m increasingly concerned that a lot of these startups are going to start going under at short notice and their failures in their business models will leave a big hole to fill.
Great article. A “Lean and Mean” VC-funded startup is an oxymoron. They’re all trying to become the next Google. I think the promise of Web 2.0 is that technology and communication tools designed for the masses can be cheaply tweaked and focused for addressing real business problems in different niches. Solutions can be created through integration and customization rather than the relatively lengthy process of traditional R&D.
the web2.0 will not become sustainable until advertising2.0 is here. today we are trying to monetize web2.0 with ad1.0 which does not seem to work.
Very true, what amazes me is an Enron-style disbelief from people who say that sites like LiveJournal (who has just ‘reorganised’ to Moscow, leaving caretaker staff in the US, usually a bad sign) and Facebook are ‘too large’ and won’t be pulled at a moment’s notice.
Can you say ‘head in the sand’?
History, such as the last downturn which mostly affected the new online companies, proves otherwise – such bullish belief that the mighty cannot fall usually means the exact opposite, and tends to mean others get hurt in the process.
Now the hurt might be just data; blogs; networks; connections – but that does now have more value than zero, and in fact doesn’t really work in a capitalist sense of value, but certainly it’s not great.
Web 2.0 may fail, but it will take a lot of people’s data with it when it does – and will not be any warning, it’ll just go – *poof*.
I agree with you. These companies need to generate revenue and generate profits sooner rather than later. While I think it’s important to create a good platform that creates community etc. etc. it’s just as important to create a self sustaining business around the platform/ community.
Great post. And the thing that kills me is how many power users of apps like Twitter, lie myself, have literally BEGGED to pay them a nominal fee to get some of our favorite features back, like Track, or to offset the cost of SMS etc, and get NO response at all. I’m not made of money, but I don’t mind paying for things that are useful to me, either.
You cover a lot of territory in this article, and it’s well thought out. I agree with your statement:
“This approach was fueled not only by the overabundance of easy venture capital money that needed to be invested and the promise of YouTube-sized acquisitions but by a stark truth: scaling services like Facebook and Twitter is not cheap.” And the VCs who funded it took the risk to see if the service would work; I think the jury is still out on that one.
But I disagree with your conclusion. There is a big difference between “Revenue Growth” and “Cash Flow Management”, and I think you are combining the two.
“Revenue Growth” covers activities subscriber revenue, advertising revenues, etc. “Cash Flow Management” includes things like leasing server capacity, building security protocols into your service stack, marketing and advertising spend, etc. Two different focus areas that use two different skill sets. That’s why the CEO, COO and CFO roles are separate functions.
You actually CAN start a business for a much lower cost now than you could 10 years ago, due to a more robust outsourcing market with a broader range of capabilities. Absolute costs of Technology are way down – you can buy/lease more compute capability at a lower price point now than you could buy/lease comparable capability 10 years ago. However, you still need to spend money on growing the business.
I agree that companies like Facebook, Twitter, etc. need to do a better job monetizing their offerings (there’s that favorite Web 2.0 phrase again!). But Twitter & Facebook can establish and mature their business models over time. They can easily set up a subscription model & start collecting money. They’ll lose some subscribers, but those numbers will stabilize – and so will their cost structure. Then they can grow service features w/that user base over time. I think LinkedIn has been doing a good job of this over the last few years.
Personally, I think the .com boom lulled many people into thinking all you need is a napkin business plan and $3 Million dollars and you’ll have overnight success. Now those people are scratching their heads wondering why it’s not working. The investor ignorance back then was only surpassed by the heard mentality they followed. And, “Users” in the Web 2.0 world can be just as meaningless as “eyeballs” in the Web 1.0 world.
Start-ups in any industry typically need funding to grow out of the ground, and very often to reach the next one or two stages of growth. However, you still need paying customers who pay on time. You need employees who are going to collaboratively focus on building the company, rather than on whether or not they are getting Soy lattes every morning. And you need your management who knows how to build and run a business (or are teachable enough to do so). Ultimately, capitalists enterprises are there to provide increasing value to investors & shareholders – and that means profitable revenue in the near-term, and a good financial exit in the long-term. That’s it.
Good post; it provided a nice reminder and good food for thought this morning – thanks!
well written. I want to second the comment by @Leslie Poston – there are subscription opportunities for Twitter, Facebook, etc that many power users, (and premium services that even non-power users) would be happy to pay for. Will 2009 be the year the value-add services shed their paralysis to introduce these fees? The market overall would benefit from more transactions and in my informal surveys there’s a real market opportunity.
Good and critical article to consider. But so what if most of the Web 2.0 applications disappear? A lot of them did in Web 1.0 too. Remember Kozmo, Urban Fetch, and infamous Pets.com? Those companies helped change our lives forever and transformed business models in all industries and spectrums: e-commerce, online advertising and online acquisition were not really there. Perhaps the biggest change this time is how companies service and communicate to their customers, and how news are generated and distribute.
You could never launch a Twitter today — it wouldn’t make it to the middle of the year and you’d have better luck finding the meaning of life than you would finding a vc or investor to sink funds into it. That’s saying a lot right there. Ugh.
This is an awesome write-up!
All my doubts about the revenue model for the nearly daily launched this.com that.com, have come to reality.
That is to say, there is no model per se apart from the the dwindling online ads.
I’ll be hooked to your posts. Keep them coming.
“FINALLY!!!! Some one fucking said it. And I better not seem some comment from a Snob 2.0 about how rev and business models don’t matter right now, because thats horse shit.”
It’s only horse shit if you didn’t time the market well. To win this M&A game, where you could sell profitless or even revenue-less websites for $100 million (see Powerset), you had to time the market just right. Now it’s too late for the most part.
Gone are the days where you could make a website that doesn’t have any profit or revenue at all and get a search engine to buy you simply out of fear that if they don’t, their competitor will snatch you away. This was the magnificent story of Powerset, and Cuil probably thought it could duplicate it, but it mis-timed the market. And when you mistime the market with this much cash at stake, you really fall flat. In order to time the market well in Web 2.0, you really had to examine who cashed out of Web 1.0 at the right time and why and emulate them.
“the web2.0 will not become sustainable until advertising2.0 is here. today we are trying to monetize web2.0 with ad1.0 which does not seem to work.”
Advertising 2.0 is a figment of your imagination.
Thier revenue models will have to offer some real value added services away from the hype of the virtual goods and services being offered althoug they currently do contribute a fortune to their bottom line. I sincerely believe that any social network that offers some tangible real value and charges a small fee to their users, users will pay for this service as long as it provides a value to them
What about adding value to users contents and getting them to rate and control their contents?