At Seattle Startup Drinks last night an interesting rant happened to fall out of my mouth. What happened was that Colin Henry (no biological relation) made the observation that most web 2.0 companies appear to have all of the business value of a pile of horse dung (or something to that effect). As often happens, I lost all conscious control of my mouth and a whole string of observations and postulations just came rolling out.
I blame the beer.
It all started with the oldie but goodie, "How the hell do you monetize Twitter?" About two minutes later we had replayed from memory the entire history of this discussion and come to the "you just can't" conclusion. Now, I'm not going to go into it here, suffice it to say that charging for a service that relies on tipping point type network effects to provide value when there are many free alternatives is a recipe for going out of business.
But then I got to thinking... and when I returned to consciousness I found that the discussion had revolved around are these web 2.0 companies viable businesses, or simply features waiting to be acquired by a bigger company?
Once you start looking at it that way you have to start asking yourself, if the company in question is just a feature waiting to be acquired then why would they need a whole bunch of accounting, HR, marketing, sales douche bags? I mean really, if the point is to spend a year or two building a real nice, useful feature with open APIs and all that crap so that it can easily be integrated into some other company, and you know your exit is going to be acquisition, why the hell would a development team burden themselves (and dilute their stock pool) with a buncha business douche bags?
Holy crap, they do have a business model; Build a feature, prove it out in the market place, then sell their development work. It's like market proven outsourcing of development. My god, it is a brilliant symbiotic relationship between bigger companies and small agile development teams.
In fact, the more I think about this the better it gets. There has always been an aversion to risk and change inside of larger companies that makes it difficult for them to innovate. But small companies moving fast can build out a whole new thingie and try it out in the marketplace for cheap. And it just keeps getting cheaper to do this. With hosted email, accounting, turnkey servers (or services like Amazon's S3 and EC2) small companies can build out major stuff on the cheap. Things that used to be multi-million dollar development projects can be done by a couple of folks in co-working space for a couple of hundred thousand dollars.
The reward for the development folks is higher because it is not weighed down by all the business douche bags (note: this is not to say that all business folks are douche bags, merely that a disproportionate number seem to be in the wild). The acquiring company already has a buncha their own business douche bags so why do they want yours? They would just have to "buy them off" with severance and crap like that.
In a lot of ways this is a B2B rather than a B2C play even if the feature/product is aimed at consumers. This should be obvious when you consider that the monitization scheme is actually acquisition. The small web 2.0 company is selling development cycles to the large acquiring company.
I'm not sure right now what this means for smaller software companies following this model. I suspect that over time it means that valuations for the smaller non-traditionally monetized companies will actually go down since the valuation model has been skewed upward by the ones that have a traditional valuation model (i.e. someone is paying money for the services on an ongoing basis before acquisition).
Interestingly, acknowledging this non-traditional monetization model might give a VC or angel investor group a leg up on the competition. There are teams out there building what amount to features as companies who cannot get funded because of their non-traditional monetization model. In other words, they are vastly undervalued and a bargain provided you can select for them.
I suspect there's money to be made, both by investors and by small teams, with this model. It will be interesting to see if this plays out.
Hmm, interesting idea. The only potential problem is that once you've shown that a feature is useful and compelling, you need to worry about one of the bigger companies just implementing the feature themselves. Also, there is the non-trivial cost of integrating the "outsider"'s tech with your own.
It seems like the missing ingredient here is that the startup needs something special that cannot be replicated. That might be a large subscriber base, lots of apps written to use your APIs, etc. Getting that special thing is also key.
@jason - Pretty much any software (or business model for that matter) can be replicated. The thing that prevents a bigger company just building it themselves is the same thing that prevented them from building it in the first place... they're big. So much easier and cheaper for them just to buy up the little guy.
That said, you're absolutely correct that things like a lager user base (particularly with network effect applications) and such do form a barrier to entry for the larger company. On the other hand, they have deep pockets and can spend the time and marketing dollars needed to gain users.
I still think that this is a good way to look at a lot of the "un-monetizable" web 2.0 companies.
I like "lager user base"....richer and hoppier than pilsner user base.
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