Where Are The Profitable VC Funded Web 2.0 Startups? - Page 3
But enough about Faceboom. The more generally interesting business issue highlighted by their story is that Capital Expenditure ("Capex") does matter for web ventures. In fact, it is a mission critical issue, with good software design at the heart of the issue.
Servers Are An Operating Expense For Web 2.0 Ventures
With user generated content, you don't pay people to create content that you use to generate advertising revenues. So your operating costs are R&D (developers), advertising sales and all those senior management overhead lumped into the General & Administrative (G&A) cost bucket. I don't really understand what 1,000 people do at Facebook, but that is another story.
As you scale, people costs should not scale. Servers do need to scale. That is where Facebook must be suffering from some sloppy early software design. That is fine, the initial win is all about user traction and a scalable design is secondary. But today it is a critical issue for Facebook. It is also a critical issue for any venture starting out today. Spending a few bucks early on to get a scalable architecture seems sensible. This is not rocket science, any competent software architect knows how to do this.
Should Servers Be Outsourced Or Leased?
Capex sounds old-fashioned. Why buy servers when you can lease or rent? If Facebook leased rather than bought servers, they could have positive free cash flow even at the lower end of their revenue forecast. The credit crisis will make leasing a bit tougher. Renting via Hardware As A Service (HaaS) is the ideal route for startups you benefit from the scale of the HaaS vendor. But it is unclear how the economics scale for the buyer? It is unclear whether Amazon AWS or any other HaaS is a serious option at Facebook's scale (or the scale of any VC funded venture that is nudging profitability).
Scale Or Profits - The New Choice?
It seems that ventures that can see a fairly quick way to profitability, simply ignore the VC route. The feeling seems to be mutual. VC look at a lot of the businesses that got to profitability and say "too small".
So, you have to choose either big and unprofitable or small and profitable? That does not make sense. If that is true, is this an issue with Web 2.0 models? Some VCs have seen this as a failure of IPO markets, meaning that public market investors won't trust unprofitable ventures promising they will be profitable in future. This "won't get fooled again" view is natural after the Web 1.0 bubble burst.
Trade sales for unprofitable ventures are unlikely to be the solution in the next few years. Not good trade sales at any rate (fire sales are technically trade sales, but they are not a good result). The buyer will be much less willing to fund losses because their investors will be less willing to fund losses for an uncertain period of time. If the venture is close to profitability it does not need to exit and nobody wants to exit in a down market unless they have to. VC have plenty of cash so this is not a financing issue, if the path to profitability is clear.
Maybe profitability for a lot of Web 2.0 ventures is really close? Maybe it just takes longer for Web 2.0 ventures to get to profitable - but that they will be fantastic cash cows when they get there?
Image: mlitty
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Bernard,
Great post. This is a great analysis of the current Web 2.0 business.
About your discussion about big business vs. small business and profitable vs. nonprofitable, I have a feeling that there is an essential piece of picture that is losing in the current infrastructure. In normal sense, when a company is growing, its capability of making profit should increase with its growing. However, it is not the case in Web 2.0 industry. It means that there must be a way to help reduce some redundant cost in many Web 2.0 companies that make many of them turning around from nonprofitable to profitable simultaneously. I have some thoughts in my mind though it is not well organized at this moment. Maybe I would share with you later.
cheers, and thank you for the great post.
Yihong
Is Amazon AWS a serious option?
Of course it is- why wouldn't it be?
I think $200mm for servers is extremely strange(and yeah...1,000 employees?!!).
Especially in a world where: "...given the failure of Beacon and declining CPM rates on social networks, my guess (it is only a guess) is that Facebook revenues will be at the lower end of their forecast or even below.".
Now I like Facebook. It's a terrific service and my only concern with it is the same one you're voicing: even for a service as awesome as FB, what will it take to achieve profitability? Or are the backers going to continue backing it in the -hope- that sometime in the not-so-near future, it'll all have been worth it?
I keep going back to the most popular service on the Internet today: YouTube. If YouTube's having a tough time turning profitable, even with Google backing 'em up, then that's something worth taking a good hard look at.
Maybe you're right....maybe it does take a while for web 2.0 services to show profitability. But is our landscape built to forgive for that long?
Or are the "gritty entrepreneurs" better off, short-term and long-term, whether it's a credit crunch or milk 'n honey? ;)
Either way- super post. It makes for excellent thought-fuel. Thank you!
PresenterNet has been boot-strapped since 2005. Only founder case (around $600K) was used and it continues to be profitable. The time has come though for serious investment if growth is to be obtained.
Is Amazon AWS a serious option?
Of course it is- why wouldn't it be?
I think $200mm for servers is extremely strange(and yeah...1,000 employees?!!).
Especially in a world where: "...given the failure of Beacon and declining CPM rates on social networks, my guess (it is only a guess) is that Facebook revenues will be at the lower end of their forecast or even below.".
Now I like Facebook. It's a terrific service and my only concern with it is the same one you're voicing: even for a service as awesome as FB, what will it take to achieve profitability? Or are the backers going to continue backing it in the -hope- that sometime in the not-so-near future, it'll all have been worth it?
I keep going back to the most popular service on the Internet today: YouTube. If YouTube's having a tough time turning profitable, even with Google backing 'em up, then that's something worth taking a good hard look at.
Maybe you're right....maybe it does take a while for web 2.0 services to show profitability. But is our landscape built to forgive for that long?
Or are the "gritty entrepreneurs" better off, short-term and long-term, whether it's a credit crunch or milk 'n honey? ;)
Either way- super post. It makes for excellent thought-fuel. Thank you!
Bernard,
Excellent post. I've also enjoyed your recent Enterprise 2.0 posts. These subjects are related. I think that a lot of consumer Web 2.0 startups were funded in a mini-bubble created by Myspace's game-changing sale to News Corporation. VCs were excited by the allure of replicating that success and funded some good ideas and many not-so-good ones.
Although less sexy, I think Enterprise 2.0 startups have a better chance to turn a profit. As enterprise plays, VCs will judge them with a higher standard and demand actual customer traction and accelerating revenues. Startups with demonstrable market acceptance will actually get funded and have a clear road to profitability. At that point, it's more about ramping sales with an aggressive sales team than having to guess about viability.
Economic downturns are difficult environments for entrepreneurs. But they are also the times when the truly outstanding entrepreneurs, ideas, and businesses shine. Talent becomes more widely available as other less viable startups lay off staff. For VCs, some of the best returns have come from investments during economic downturns. Terms are more favorable for VCs during "buyers' markets."
I think this is an exciting time! Carpe Diem!
As someone who recruits for these start-ups on site, they get dumber and dumber every year