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Web 2.0's Startup Fever

Software toolkits and cheap hardware have led to the comeback of the garage startup. But this time the boom is more rational.

If you’re Web-literate, you can organize more and more of your life around Web-based tools and services given away by a host of young startups. You can keep your social calendar at Eventful or Upcoming, organize your to-do items at Gootodo, store a gigabyte’s worth of documents at Box.net, read the news (or write your own) at Newsvine, find hours of video entertainment at YouTube or JumpCut, create and share Web bookmarks at Diigo, create podcasts and audio memos at Odeo, publish blogs at Wordpress or Xanga, and share your photos at Flickr or Buzznet – or Riya or Bubbleshare or Zooomr. All for free. And that’s just the beginning of the list.

This explosion of new Web sites – a phenomenon often dubbed “Web 2.0” – is great for all kinds of Internet users. But how long can this new crop of startups survive without charging for their products?

The answer, in some cases, may be not long. Simply put, many of these outfits, much like their dot-com predecessors in the late 1990s, don’t have business models. The most common revenue source in the Web 2.0 world is contextual advertising – but, as some analysts point out, the nickels and dimes earned when visitors click on ads provided by the likes of Google’s AdWords barely bring in enough to cover the costs of Web server hardware. Consequently, some industry watchers believe that a shakeout is likely within the next 12 to 24 months.

The winnowing of Web 2.0 won’t be as bloody as the dot-com crash of 2000-2001, though, simply because these companies never accepted much venture funding and have far fewer employees. What’s more, the underlying technologies won’t disappear – more likely, failing companies will be bought up by slightly larger competitors in a wave of consolidation.

Nevertheless, there are simply too many new Web-based software services – 300 and counting, according to some analysts – chasing too few users for all of them to prosper, say observers such as Rafat Ali, editor and publisher of digital-media news site PaidContent.org. “Will 90 percent of these companies be around two years from now? Probably not,” he says. “Everybody knows that, because we’ve been through that once before. But at least there are germs of innovation, which the bigger companies can take in.”

The oversupply of Web 2.0 startups is partly due to the much lower overhead needed to sustain a modern Web business. Innovations such as Ruby on Rails, a software toolkit for building database-backed websites using AJAX (Asynchronous Javascript and XML) interfaces that resemble sophisticated desktop applications, make it easy for a small team of programmers to build advanced Web-based services, while the costs of Web server hardware and Internet bandwidth continue to drop.

“Way too many startups are created each day, because the barrier has been lowered to a bare minimum,” says Jeff Clavier, managing partner at SoftTech Venture Consulting, a Palo Alto, CA, firm that works with early-stage startups. “Anybody who has the money to rent a server for $100-200 per month can actually write a Web 2.0 application, put it up, start sharing, and make a name for themselves. So there is not a dot-com type bubble, but there is a ‘geek founding’ bubble.”

These new companies have a few ways to subsist, typically advertising, charging extra for “premium” services, and collecting affiliate fees for driving shoppers to sites like Amazon. But ask a Web 2.0 CEO about his company’s business model, and he’s as likely as not to say “contextual advertising.” The advertising model, usually through Google’s AdWords program, seems to be the most common gambit. It’s the planned or existing main revenue source for dozens of Web 2.0 startups, such as new photo-sharing site Riya, which plans to display ads related to the subjects in its users’ photographs.

But consultant Clavier and others say that early-stage companies should see AdWords as a minor, transitional revenue source. “There’s nothing wrong with being ad-supported, but you can’t assume that AdWords will get you all the way to building a big company,” says Clavier.

Companies can survive the Web 2.0 boom, Ali says, by doing one of two things. They can attract the interest of larger companies, who buy a technology and bring in its developers rather than developing their own version. Flickr, Delicious, WebJay, Konfabulator, and Upcoming, for instance, have all been acquired by Yahoo. Or else startups must acquire so many users that they gain an insurmountable lead over competitors, as YouTube seems likely to do in the video downloading market. Or they can do both, of course, like MySpace, which has more than 50 million users and was purchased in July 2005 by Rupert Murdoch’s News Corp.

But others argue that even the less successful Web 2.0 companies will be able to survive on their current revenue sources – mainly because they have simple needs. “The vast majority of these companies do not need revenue – because they don’t have any expenses,” says Seth Godin, a Web marketing strategist and author of the widely read Permission Marketing. “The people are doing it for love or in their spare time.”

Three months ago Godin launched his own Web 2.0 company, Squidoo, a kind of “citizen’s Web directory,” where experts in areas from video blogging to vegetarianism publish “lenses,” or guides to the best related content on the Web. Squidoo earns money through a combination of Google AdWords ads and Amazon affiliate fees: it advertises links to items on Amazon or eBay and is paid a commission whenever a click on one of the links leads to a purchase.

The company splits these affiliate commissions, and most of the subject experts (“lensmasters”) donate their take directly to charity, Godin says. “Most Squidoo lensmasters aren’t in it for the money.”

Not surprisingly, Godin is a dissenting voice in the chorus of experts predicting a mini-crash. But he does acknowledge that some Web 2.0 companies will fall by the wayside. “I don’t think we’re going to see the shakeout we saw at the end of the other bubble, because there are different rules now. But I believe that some of these companies have delusions of grandeur in terms of how big and how profitable they are going to get,” he says. “You can’t have 30 profitable companies in a business where only two can be moneymakers.”

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