Will Web 2.0 Go Pop? A Guest Post from Microsoft’s Don Dodge

6/2/08

Is Web 2.0 headed for Bubble 2.0? That was the subject of a debate at the TiECON East Conference on Friday. Fred Wilson (Union Square Ventures), Nabeel Hyatt (Conduit Labs), Brian Balfour (Viximo), and I had a lively discussion and arrived at some very different conclusions. Xconomy asked me to write them up, and I’m cross-posting them here and at my own blog.

All booms go bust—Business runs in cycles. All big booms have been followed by painful busts. The market is ruled by two things: fear and greed. Greed fuels the boom, and fear prolongs the bust. Fear is very powerful. Everyone starts to question their own beliefs. But fear is temporary, greed is permanent. We have all pretty much forgotten the Dot Com Bubble. Greed and optimism always overcome fear and lead to a new economic boom.

Hundreds of smaller successes—Fred Wilson believes there will be hundreds of companies with smaller successes, not a few billion-dollar successes. Facebook and MySpace get all the headlines but hundreds of smaller companies with $50M in revenue and $20M in profit will be successful. But will VCs invest in these companies? Lots of VCs look at Web 2.0 companies and say “I like the concept, and I like the team, I’m just not convinced it will generate VC level returns at exit.”

Capital efficiency matters—Web 2.0 companies can be launched for far less money than ever before. Many don’t take VC money at all. The point is that capital requirements and operating cost structure must be commensurate with the opportunity.

Is advertising the only revenue model?—Too many startups point to Google and Facebook as evidence that advertising is the best path to success. They fail to understand the scale (users and page views) required to make it work. Most social network sites generate CPMs of $0.40 or less. To generate $1M in ad revenue would require 2.5 billion page views. Not many sites attain that scale.

Freemium model—Free services like Flickr, TypePad, and others provide a free service with premium upgrades for more storage, more features, or other services. This model works as long as the marginal cost of providing the service is close to zero. Conversions from free to paid run about 3 percent to 5 percent, so the revenue from paid subscribers must cover the cost of all the free service plus provide a profit. Think of the cost of free service as marketing costs…and make sure it fits your business model.

Virtual or digital goods
—The cost of goods and distribution costs of digital/virtual goods is almost zero. Ringtones, avatars, icons, virtual flowers, widgets, virtual cards, and lots of other products are producing big revenues (and profits) for web companies. Socializing online is similar to real life. We want the same sorts of fun, impulse items, and entertainment online, and we are willing to pay a few bucks for them. The gross profit on these impulse items is huge.

New models?—Social networks and word of mouth recommendations are powerful. All the demographic data, ratings, attention data, profiles, and social connections will enable new ways to target advertising and ecommerce. Advertising is annoying when it is irrelevant, but very helpful when it is timely and relevant.

Facebook’s Beacon attempted to leverage the social network and user intentions into a new advertising and revenue model. It didn’t work, but something like it will emerge that strikes the right balance between privacy and convenience. Being able to selectively opt-in or out is critically important.

One panelist said “Privacy doesn’t matter anymore. If it did, Facebook, MySpace, and YouTube wouldn’t exist. This is the ‘Full Monty’ generation.” The trend is certainly in that direction, but the Facebook Beacon experience suggests we aren’t there yet.

Conclusions?—Web 2.0 and social networks have already changed the way we interact on the Internet. There have been some successes like Facebook, MySpace, and YouTube, but future successes are likely to be smaller.

Valuations and expectations are reaching “bubble levels.” New revenue models will emerge that leverage our social interactions. Most business cycles run for 10 years, and we are in the early stages of this social network cycle.

MacroMyopia, the tendency to overestimate the short term impact and underestimate the long term results, is evident today. It is similar to the hype cycle: a period of early hype, followed by disillusionment, followed by real payoffs and impact. It happens in every business cycle. The question is, where are we now in the cycle?

Don Dodge is director of business development for Microsoft's Emerging Business Team. Follow @

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  • http://www.wecando.biz Ian Hendry

    A really interesting piece. As CEO of a Web 2.0 business I agree with all of it. There is no doubt a large number of companies in the Web 2.0 space have an appeal to geeks only – micro-blogging is a great example of that. However, turn a Tweet into a broadcast of an urgent business need, for example, and suddenly could could find others in the business worls taking noticem but even prepared to pay to receive it (this is what we call a Biz Need/Feed on our site). There are ways of making money from Web 2.0 for sure, but the neat ideas need to start being applied to business problems to see money being made.

    Ian Hendry
    CEO, WeCanDo.BIZ
    http://www.wecando.biz

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  • http://www.miraclestudios.in Miracle studios — web design company

    I think ….web 2.0 is for IT Nerds….

    It’s not for common man

  • http://alfinans.ru Brony

    However, turn a Tweet into a broadcast of an urgent business need, for example, and suddenly could could find others in the business worls taking noticem but even prepared to pay to receive it (this is what we call a Biz Need/Feed on our site).

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