The last couple of years have seen an explosion of innovation on the web that has broadly been labeled Web 2.0. There has been a lot of debate about what exactly constitutes web 2.0 but what hasn’t received as much attention has been what changes have enabled these Web 2.0 companies to arise – what is different now from the mid 90s and Web 1.0. I think the change can be summarized in one (somewhat clumsy) word: Variablization.
Variablized Development Costs
In the 90s we used software development models, primarily waterfall models, where a usable product wasn’t available until close to the end of the development period. Most code was written from scratch, with little reuse or public domain code, and large teams were necessary.
With the popularization of agile programming methodologies, widespread use of open source software, greater ability to use offshore development resources on a consulting basis, and a culture of “open beta”, the costs of developing a website or web service have become both lower and more variable. Ideas that look promising but fail to capture user interest in beta can be identified much earlier and at much lower cost, and resources can be shifted to more promising avenues.
Variablized Content Costs
In the 90s almost all content was created by professional editors and writers, employed by companies. To launch, they had to create a critical mass of content, which cost a certain amount.
Recently, with lower expectations out of beta products, the widespread adoption of user generated content and emerging best practices in how to use user generated content, the costs of content creation have dropped dramatically and become variable.
Variablized Marketing Costs
In the 90s, there were only two ways to get a large number of users. The first was offline marketing – the famous Pets.com superbowl ad approach. Expensive, and with a high minimum level of spend required to break through the clutter. We all know how that worked out.
Overture and Google have changed that landscape. Their CPC model means that you can spend as much as you choose to gain new users, and that your marketing spend can be completely variable.
Variablized Distribution Costs
The second way to get a large number of users in the 90s was to get a distribution deal with one of the big portals – AOL, Yahoo or MSN. In those days, this was the only way to reach a large number of internet users effectively, and you typically had to sign up for a multi year, multi million dollar deal to do it.
The vast majority of Web 2.0 companies rely on advertising as their business model. I think this is because advertising is the one business model that has become variable (relative to the 90s). Back then, to sell online advertising, you both needed to have substantial scale, and you needed to have your own sales force.
Today, thanks to ad networks and CPC contextual targeting (not just Google’s adsense, but also Quigo, Yahoo’s Publisher Network and others), even the smallest of websites can start earning advertising revenue.
There have not been equivalent innovations for subscription and ecommerce business models, and as a result, we’ve seen far fewer web 2.0 companies that use those models.
These changes in cost structure are a useful lens through which to view the current startup environment. It’s been said before that it is cheaper to build a company than ever before. While that is partially true, it is not the whole story. Digg has raised over $10m, Youtube over $12m, Photobucket and Rockyou (a Lightspeed company) over $15m, and Facebook has raised over $275m. (With the exception of Facebook) while these are lower than the amounts raised by companies in the 90s, they are still large numbers. Variablization of costs only makes costs go away when usage is low. In other words, while it still takes money to succeed, it is cheaper to fail than ever before.
Luckily for VCs like me, that means that successful companies will still need to raise money!