Web 2.0 bubble?
Is current growth in "Web 2.0" companies indicative of another tech bubble?
What is Web 2.0
In order to complete the above thought, there must be a prior definition of exactly what “Web 2.0” is. As with many terms that subtly work their way into the public’s lexicographic consciousness, the definition of Web 2.0 has not yet found1,2,3,4,5 – and may never find - a final meaning.
The two originators of the term, Tim O’Reilly and Dale Dougherty, respectively Founder and then-Vice President of O’Reilly Media, first used the term privately in 2003 and then popularized it with the label of the inaugural Web 2.0 Conference in October 20041. The most formal working definition O’Reilly has set forth is in his September 2005 article titled “What is Web 2.0?” In it, he offers numerous factors that differentiate Web 2.0 websites from their earlier counterparts. They are: The web as a platform; harnessing collective intelligence; data is the next Intel Inside; end of the software release cycle; lightweight programming models; software above the level of a single device; and rich user experiences. If most of these qualifications don’t make sense to you, O’Reilly didn’t think they would either. His seminal explanation resorts to using examples: eBay, Flickr, Amazon.com, del.icio.us, wikipedia, Google AdSense and others. In fact, a perfunctory survey of articles about Web 2.0 shows similar use of definition by example1,2,3,4,6. Though seemingly trivial, this is an important point because it typifies the ambiguity in defining Web 2.0.
Slate.com points out that even Tim O’Reilly has difficulty explaining what Web 2.0 is. Most likely that’s for the same reason that defining it always resorts to including examples: Because it’s a term of convenience with different meanings to different people. Marketers have their definition: a new and improved Web; techies have theirs: a set of languages, protocols, and tools used to create the websites; and businesspeople have theirs: a website whose owners seek quick wealth by selling to a Google or Yahoo.
Another problem with precisely defining Web 2.0 is that – by all accounts1,2,3,4,5 – there is only a very permeable, thin line distinguishing certain Web 1.0 (a retronym) websites and Web 2.0 websites. Ebay, Amazon, and Google land on different sides of the definition depending on whom you ask. While all three require user generated content to maximize their benefits, they don’t have a blatantly viral, exponential, social networking aspect to them. Setting all this aside, what isn’t difficult to cull from the varied and variegated definitions is this set of facts: The biggest (and most famous*) Web 2.0 websites rely heavily on user generated content, have a user aided growth model, often don’t have a revenue model beyond ad revenue and often seek to make a quick liquidation play by being sold to a larger company.
If we can agree that the actual websites of Web 2.0 are often fundamentally different than the websites of Web 1.0, can comparisons drawn between recent Web 2.0 activity (development, funding, purchasing and public attention) and the tech bubble of the early 2000s be automatically dismissed? Or might this activity potentially indicate another bubble and a coming burst?
During the dotcom boom, prospecting entrepreneurs sought to capitalize by creating websites to sell every conceivable physical good possible. Famous examples are Amazon and books (successful), and pets.com and pet food (unsuccessful). Though many types of physical goods didn’t benefit from being sold online, their champions tried anyway. Currently, the rush isn’t to sell every type of physical good online. Rather it’s to gather every piece of user generated information possible7. This highlights an important difference between 2.0 and 1.0: 1.0 startups often required intensive capital for warehousing, inventory, information technology, employees, and office space. They also needed a large marketing budget to achieve preeminence faster than their competitors. All of this required upping the ante far more than investors and markets could sustain. Web 2.0 startups don’t have these requirements. Running this race requires only a viral idea and a handful of talented programmers who pride themselves on how little money they need. The main difference is orders of magnitude less capital needed to reach critical mass8.
In the days of Web 1.0, when someone used a website it didn’t necessarily mean that anyone else would use that website. In fact, it didn’t even guarantee that they would return to the website. However, because Web 2.0 startups measure critical mass not by sales revenue but by registered users, and because there is a viral, exponential nature to these sites, the result is that when someone uses a Web 2.0 site, there is a good chance they will recruit others to use the website. The difference is that while the growth of a Web 1.0 website was achieved linearly and agonizingly slowly, the growth of a Web 2.0 website occurs exponentially and success (or failure) –measured by registered users - is reached much more quickly and much more organically. Because of this, though there is a race to be first and biggest within a Web 2.0 niche, the inevitable shakeouts are happening before any IPOs (of which there have been none for Web 2.0 companies) and usually before a buyout.
Another major difference is the prevailing revenue model which necessarily stems from the large base of registered users. As a result of Google’s perfecting the AdSense system, Web 2.0 websites are generating modest but real sums of ad money. According to Emarketer Inc.’s projections, web ad spending will increase 34% over last year reaching $16.7 billion9. Though everybody involved understands that this can’t be the only means of generating revenue, in the meantime there aren’t any other reliable ideas of how to generate revenue10.
Financials
Looking at different financial indicators paints a mixed picture. Using the Nasdaq as a bellwether of hype in the overall technology sector shows that the Nasdaq is around the same level it was in 1998 (2300-2500)11(Figure 1). A more realistic comparison is between now and one, two and five years ago because of emerging public awareness of Web 2.0, insiders’ awareness of Web 2.0, and as a comparison to the end of the first tech bubble, respectively. Comparing the Nasdaq’s to its lowest recent point, September 2002, its percentage growth has beaten both the Dow Jones Industrial Average’s and the S&P 500’s (Figure 2), though this percentage growth is an exception achieved only because of the depths to which the Nasdaq had fallen. Compared to two years ago (Figure 3) and the past year (Figure 4), however, the Nasdaq has been outpaced by either the Dow Jones Industrial Average or the S&P 500. Clearly, Web 2.0 hasn’t caused any frenzied excitement in the market.
Another factor that needs to be analyzed is venture capital spending. Except as specified, all of the following figures come from Dow Jones VentureOne12. Investing in Web 2.0 financing rounds in the first half of 2006 was $262.3 million in 49 companies compared to $199.1 million in 51 companies in the entire 2005. But taken in perspective, this is only a very small part of all venture capital investments this year: $13 billion in 1213 companies. Further, the average Web 2.0 investing round was $4.4 million, still smaller than the $7.5 million average investment round for other companies. So though there is an increase in investing in Web 2.0 companies, the increase isn’t a disproportionately large amount of total venture capital as it was in the first tech bubble. Additionally, according to PricewaterhouseCooper’s MoneyTree report13, recent total investing levels are approximately the same or even less than total venture capital invested in the quarters leading up to the first tech bubble (Figure 5). Also, VC investing has remained at almost the same level13 since Tim O’Reilly first coined the term three years ago (Figure 6).
Finally, even with the staggering purchase prices of YouTube, MySpace, and others, this is a quickly maturing investment market. While 75% of Web 2.0 companies funded last year were in the seed stage, only 65% of funding this year is for startups12. Combined with the overall growth in funding for Web 2.0 companies, this implies more later stage funding. Also, while none of last year’s funding was for profitable companies, three of this year’s fundings are already generating profit12.
Inarguably, there is an increase in startup and funding activity of Web 2.0 companies. This is very reminiscent of the hype that preceded the first tech bubble’s burst. Nevertheless, the business models of the current companies are very different than the models of the earlier companies, most importantly, in the amount of capital needed to achieve victor status. Furthermore, the level of interest, as judged by the stock market indices and recent venture capital funding, isn’t negligible. On the other hand, there is no frenzied stock market activity and “irrational exuberance” being displayed this time around. And the payday this time isn’t a quickly launched IPO but a bid to be bought by the big guys9.
As with last time, few companies will survive the shakeout, but which ones will, will be known much sooner. Companies such as Google, Yahoo, Microsoft and even News Corp. and Viacom have already shown interest in purchasing (or have purchased) Web 2.0 companies; though without a clear plan to realize profit. Cryptic comments from Google and Microsoft2 indicate that perhaps the value lies in using these sites synergistically to be a provider of both content and medium or as platforms (for example Fox.com’s presence on MySpace or Disney’s soon to be relaunched web portal with streaming content). Vertical integration isn’t a new play. On the other hand, the race between these companies is more of a defensive one14 and has almost reached its end: very few companies can afford to pay the prices being demanded by these unproven businesses with unproven business models, and even those that can are wary of entering a bidding war14.
Finally, and this is important, we’re hypothesizing about a bubble arriving less than six years after the previous horrid affair. Individuals, investment firms (such as Hummer Winblad Venture Partners9), and even companies born of that era (such as Yahoo and Google14) still remember the raw lessons learned from playing the previous round like chickens without heads. Many are approaching this with timidity and maybe even common sense.
A new business model is attractive. A new business model whose product automatically creates excitement about itself is sexily attractive. But don’t confuse hype for a product with hype for investing in the product. Cooler heads have and will continue to prevail9,15 and the benefits of the anticlimactic, almost finished Web 2.0 shakeout – a characteristic of all business and technological revolutions5,9 - will continue to arrive at the public’s doorstep8 more quickly. Now, a Google, Microsoft, Nokia, Apple, Yahoo, News Corp, Viacom big boy tussle? There’s a Round 3.0 I can’t wait to see. May the best player win!
Works Cited
1. Boutin, Paul. Web 2.0. Slate.com: March 29, 2006. http://www.slate.com/id/2138951/. Accessed 11/1/06.
2. Levy, Steven and Brad Stone. The New Wisdom of the Web. Newsweek Magazine: April 3, 2006. http://msnbc.msn.com/id/12015774/site/newsweek/. Accessed 11/1/06.
3. Madden, Mary and Susannah Fox. Riding the Waves of “Web 2.0”. Pew Internet Project. October 5, 2006. http://www.pewinternet.org/pdfs/PIP_Web_2.0.pdf. Accessed 11/1/06.
4. Wikipedia. Web 2.0. http://en.wikipedia.org/wiki/Web_2.0. Accessed 11/1/06 at 15:12.
5. O’Reilly, Tim. What is Web 2.0? O’Reilly Network: September 30, 2005. http://www.oreillynet.com/pub/a/oreilly/tim/news/2005/09/30/what-is-web-20.html. Accessed 11/1/06.
6. Sorkin, Andrew Ross. Dot-Com Boom Echoed in Deal to Buy YouTube. New York Times: October 10, 2006. Accessed 11/5/06 on Lexis Nexis Academic.
7. Meyer, Julie. Small is Beautiful for the Net Giants. The Observer (
8. ZDNet. Does Web 2.0 Bubble Have a Silver Lining? 11/6/06. http://news.zdnet.com/2102-9588_22-6132563.html. Accessed 11/8/06.
9. Gaither, Chris and Dawn C. Chmielewski. Fears of Dot-Com Crash, Version 2.0.
10. White, George. Bubble Machine. Daily Deal/The Deal: September 18, 2006. Accessed 11/5/06 on Lexis Nexis Academic.
11. finance.yahoo.com.
12. PrimeZone Media Network, Inc. Web 2.0 Companies Garner $262.3 Million in First Half of 2006, Gaining Ground in
13. PricewaterhouseCooper.com. http://www.pwcmoneytree.com/moneytree/nav.jsp?page
=historical.
14. Lowry, Tom and Robert D. Dorf. Smart Move or Silly Money 2.0? BusinessWeek Online: October 12, 2006. http://www.businessweek.com/technology/content/oct2006/
tc20061012_597662.htm.
15. Waters, Richard. Internet Newcomers Find Valley Hard to Crack. Financial Times (
References
§ BusinessWeek Editors. The Web According to Ballmer. BusinessWeek Online: October 16, 2006. http://www.businessweek.com/technology/content/oct2006/tc20061011_908546.htm.
§ Deagon, Brian. Some Froth, But No Clear Bubble. Investor’s Business Daily: October 12, 2006. Accessed 11/5/06 on Lexis Nexis Academic.
§ Fost, Dan. Digital Utopia. San Francisco Chronicle: November 5, 2006. Accessed 11/5/06 on Lexis Nexis Academic.
§ Fost, Dan. The People Who Populate Web 2.0. San Francisco Chronicle: November 5, 2006. Accessed 11/5/06 on Lexis Nexis Academic.
§ Glover, Tony. How Much is $15 Billion Really Worth in Cyberspace? The Business: October 12, 2006. Accessed 11/5/06 on Lexis Nexis Academic.
§ Hazlett, Thomas. A Web of Bubble Blown Out Of Proportion. Financial Times (
§ McCrone, John. Riding the New Dotcom Wave. The Dominion Post (
§ PR Newswire Association Inc. Garage Technology Venture’s ‘Art of the Start’ Conference for Entrepreneurs to Feature Fireside Chat with TechCrunch Editor. Accessed 11/5/06 on Lexis Nexis Academic.
§ Web 2.0 Timeline: http://www.scill.de/images/Web20buzztime.gif. Accessed 11/8/06. Accessed 11/8/06.
Appendix
Figure 1. Nasdaq, DJIA, and S&P 500 1998-Present
(Source: finance.yahoo.com)
Figure 2. Nasdaq, DJIA, and S&P 500 September 2002-Present
(Source: finance.yahoo.com)
Figure 3. Nasdaq, DJIA, and S&P 500 Nov. 2004 - Nov. 2006
(Source: finance.yahoo.com)
Figure 4. Nasdaq, DJIA, and S&P 500 Nov. 2005 - Nov. 2006
(Source: finance.yahoo.com)
Figure 5. Total VC invested, 1997-Present
(Source: www.pwcmoneytree.com)
(Source: www.pwcmoneytree.com)
* Interestingly, the biggest sites are often the most famous precisely because they’ve succeeded at reaching critical mass by utilizing their Web 2.0 strengths more quickly and adroitly than their competitive counterparts.
