MattMaroon.com

David Oscarmeyer Hansson had a good post on the 37signals blog today about the end of the traditional Web 2.0 business model, i.e. get a bunch of users by not charging and hope to make money off of advertising. I’ve never been a fan of that model myself. I’ve started two internet companies now, with a total of four different products. One of them (the most successful at the moment) uses what is known as the “freemium” business model, letting customers use the product for free and then selling them some other things optionally. The other three all charge everyone (though in all three, the fee is hidden as part of another transaction, similar to a poker room, which is still my favorite business model). All three are still around, in various degrees of repair, and two of them are rather old by internet standards.

As one shrewd angel once told me, only 100 companies can get into the Alexa Top 100. A lot of people say things like “no company that gets enough users goes out of business” which is true if you set the bar high enough, but largely only because VC funding and acquisitions have propped them up. Without Google’s bucks (or those of another similarly large acquirer) I’m highly skeptical YouTube would exist in its current form, even discounting the settlements and litigation fees.

So the question people ask is “if that’s so, why don’t those companies go under?” There are two answers. One is that they do. Where’s broadcast.com now? It got bought and later shut down. They had a pretty tremendous share of traffic back in their day. Lots of dotcoms that didn’t charge (and plenty that did too) got a ton of customers and failed to make money. Anyone who was paying attention 8 years ago could rattle off a dozen.

The other answer is that the internet has only really been in business for 10-15 years, and it’s spent all but a few of them buoyed up by irrational exuberance. Even if you assumed it to be true that at some point we’d discover that making something people want wasn’t the only thing you have to do, you wouldn’t expect to have done so yet. It’s too early, and when people first started saying repeating that mantra it was way too early.

DHH says the days of giving things away are numbered, and I tend to agree. There’s a simple cause and effect chain that led to a lot of free websites, and it’s pretty easy to see how it will unravel.

1. Founders adopt that business model because it’s attractive to investors and helps them raise funds. Everyone wants to own a chunk of the next Google, and Google is free. In fact the vast majority of the Alexa Top 100 is free.

2. VCs and angels are attracted to the ad-supported model because a high percentage of the companies that get acquired for the big bucks (like YouTube or MySpace) or even some that IPO (Google, Yahoo) use it. The reverse is not true though, as there are probably 1000 startups that set out to make the top 100 for every one that succeeds, but it’s a very common logical fallacy to assume that it is.

3. While IPOs are pretty much dead, big companies acquire startups for two reasons. One is that the founders have a lot of talent, in which case it really doesn’t matter what their business model is. Google doesn’t need a business model, it needs great employees (or at least it did). These are generally small purchases that investors often dislike because they don’t get much return.

Another is that it has a lot of users that the acquirer feels it could monetize. YouTube fits into that category. The acquisitions of these types of companies will stop when acquirers start having to shut down startups they paid millions or billions for and couldn’t manage to turn a profit on. Some will be forced to out of economic necessity, and even the Googles of the world that could afford to subsidize a lot of crappy products indefinitely won’t. And every time they’re forced shut down some crap like Broadcast.com, they’ll think even harder about the next Skype.

The recession is the straw that has broken the camel’s back. The third domino is already falling, and it might take a short while for the other two to be knocked over in turn, but it will happen. High volume, ad-supported web businesses will always exist, because in certain areas (search for instance) they just make sense, but they’ll cease to be the sole aspiration for the vast majority of internet startups.

This entry was posted on March 9, 2009 at 11:10 pm and is filed under tech . You can follow any responses to this entry through the RSS 2.0 feed Both comments and pings are currently closed.