10x 2.0

The traditional venture capital invests disruptive technologies that provide a 10 fold improvement and generate 10x return.  However, Web 2.0 consumer internet companies are not based upon disruptive technology, but potentially viral models of participation.  The consistent pattern is sharing control to create value.

Measuring the disruption in performance terms proves difficult and is an opportunity for research.  I have not found a way to measure the lower cost (zero marketing budget) of user acquisition and lower churn through virality and network effects.

But you can measure the impact of disruption.  Craigslist cannibalized the Bay Area classifieds market by $60 million by 2004, when they had $6 million in revenue.  This is asymmetric competition against models that provide less freedom to communities.  Consumer internet startups generally require 10x less capital to get off the ground (although not consumer, Socialtext was seeded with only $5k and six months of sweat, as an extreme example).  Realizing a 10x return with a developed community and functioning business model should be a layup.

But if this model requires 10x less investment, the lingering question is how $1B venture funds invest enough.  Or how much time even a small fund can spend with its portfolio.  The IPO window remains practically closed and burdened with $2M in new SarBox operating costs making it less attractive.  M&A is out of control and potentially furthered by the need for venture firms to exit earlier to make the model work.

We are in a bubble, that is representative of our times.  It began with Google's acquisition of Blogger, and it might have peaked with the rumored $2B valuation of Facebook (hinting at the cyclical tip from consumer to enterprise).  I'm not sure there is a lack of failure in this bubble, or if we just need to give it time.  There definitely are more plays in each category (e.g.  well over 200 in social networking or social bookmarking, possibly over 200 funded in video search).  I've said for a year that this bubble is build to flip.

The problem is there are too many companies being created that have no aspirations to be companies.  Most survey the feature portfolio of tier 1 and tier 2 acquirers and are precision guided towards flipping within 18 months.  Many make no attempt at generating revenue and most that do generate revenue from the advertising of other startups, let alone demonstrating a business model.

A dirty little secret for those actually building these things into businesses is that generating community value takes time.  Beyond the blog bump and 53,651, a community that stays with you and grows virally is tough to achieve.  Today's successful ventures are twice as old as the 18 month window.  They were born when it was a shitty time to create a company, were largely either hacks cast out openly to serve an immediate itch and community (e.g. Blogger, Six Apart, Technorati, Newsgator, del.icio.us) or almost accidental creations that caused a business model iteration (Flickr).

Today the problem is microventures optimized to flip are flopping, but they are too small to see.  It isn't just that VCs are taking the risk of the bubbles.  For every funded company, there are 10 with the sweat and tears of entrepreneurs that fade to black.

This is not all bad.  We are in the risk business.  There is creative destruction with tight iterations that provides a base of vibrant innovation for the economy.  But structurally, this bubble is attracting increasingly less experienced entrepreneurs (and investors) chasing the wrong incentives. 

Comments

[vinnie mirchandani]

Ross, there is another dimension. on the new economics I wrote about this a few months ago at

http://florence20.typepad.com/renaissance/2005/10/economics_in_ne.html

If you and other new entrepreneurs have even a 3X or 5X advantage (not 10X as you say the build out takes a while) compared to a few years ago, why are bigger vendors not emulating your economics. Why don't they outsource development to others like you?

Or are they and just keeping the margins to themselves?

[Don Park]

You nailed it Ross. The neighborhood streets are being taken over by noobs and newsy pimps.

[Andrew Fife]

"Socialtext was seeded with only $5k and six months of sweat"

What is 6 months of sweat worth? The founders living expenses are essentially personal investments in the company that likely dwarf the $5K.