The Web 2.0 Entrepreneur Bubble

There has been a lot of conversation of late about how much easier it is to start a Web software companies these days. Open source and Moore’s Law are the principal drivers. Great stuff.

It’s springtime in the Internet and there has been a fresh rain. New seedlings are popping up. Great stuff.

Lots of disdain for dumb money because it’s “so easy” to start a new Web company these days on a server and a song…. the case for entrepreneurial minimalism.

But there’s a bubble that the web community isn’t talking about. Let’s call it the Entrepreneur Bubble. The Web 2.0 Entrepreneur Bubble is the flip side of the Web 2.0 Investment Bubble.

We all understand the calculus of the Investment Bubble –

Lots of investors looking to fund Internet Companies
+ cheap access to investable capital
+ relaxed financial criteria (call it business model) in screening
+ shared knowledge of the big tech trends (posing as proprietary investor insight)
+ relative inefficiency in finding potential investments because so many are ‘under the radar’

= many near-identical companies get funded
+ valuations rise in the beginning because everyone thinks they can get 20% of a big market
+ the abundance of similar companies raises the capital requirements so that some can break out by outspending

= shakeout when it becomes apparent that there are too many companies and investor expectations crash

And everyone concludes – Those Dumb VCs – They Should Have Known Better

But consider the case for the Entrepreneur Bubble:

Lots of talented developers wanting to found Internet companies
+ cheap sources of computing resources and personal time
+ relaxed financial criteria (call it business model) in screening
+ shared knowledge of the big tech trends (posing as technical innovation)
+ relative inefficiency seeing what other developers are building because so many are ‘under the radar’
+ the abundance of similar companies raises the need to find a barrier to entry / basis for differentiation

= shakeout when it becomes apparent that there are too many companies and entrepreneurs’ expectations crash

And everyone concludes – Those Poor Entrepreneurs – Too Bad They Didn’t Know Better

But the root causes are the same:

1. It is very easy to make the initial commitment (founding or funding)
2. Underestimation of how many had the same conclusion
3. Underestimation of survival requirements for the ‘too many competitors’ case

I think there is a real Entrepreneur Bubble these days in Internet software. Step A is seductively easy – buy some servers, write some code. Just understand that 10-100 other teams around the world are doing the exact same thing. How will you sustainably differentiate yourself? What will you do when 15 other similar sites appear in the next 12 months?

A thoughtful consideration of Steps B through Z may lead you to conclude (i) you can’t build a sustainable business, (ii) can, but need to invest far more time/money than you originally imagined, or (iii) building a small business is a lifestyle choice. All conclusions are equally valid, but don’t let the hype of the Entrepreneur Bubble confuse the decision.

To me this Entrepreneur Bubble feels like the PC software bubble in the early 80's. As the installed base of personal computers exploded, individual software developers founded companies because it was an order of magnitude cheaper than before. But as the field quickly glutted with dozens of similar companies in each category, the choke point became distribution, leading to the structure of the market we see today. Today's three person startup on LAMP is 1981's Pascal developer. The few that got rich did well. The many that didn't quit their day jobs did OK. And those who quit their day jobs and didn't get rich.... learned something.

Reduced barriers to entry always look attractive to the entrants. But once you enter, you are an incumbent.

Comments

[Neville]

With the technical people more autonomous this time around, and fewer VC's doing any gatekeeping, it would be a miracle if we found that the average start-up possessed a coherent long-term competitive strategy. Most of them will surely, as you suggest, prove to be 'unguided missiles' in this sense.

Consider, though, that it may turn out that this multitude of start-ups can do a lot less damage if they haven't been funded on the scale the VC's delivered in previous cycles. We may be looking at a pretty meteor shower rather than something capable of breaking through the atmosphere and making a big smoking hole in the competitive landscape.

[Peter Rip]

"start-ups can do a lot less damage if they haven't been funded on the scale the VC's delivered"

Neville, I suppose the damage to which you refer is macroeconomic (amplification of expansion/contraction in the business cycle). Fair enough.

But my point was microeconomic. If you get "sucked in"to the Entrepreneur Bubble, only to fail, the personal economic consequences are the same whether you raised $5 or $5M. In fact, if you believed all you needed was some personal start-up capital, you may actually take on more risk and be worse off.

If the guy next door goes out of business, it's a recession. If you go out of business, it's depression (with apologies to Harry Truman).

[Daniel Nerezov]

Hi Peter. Great post and I look forward to this blog really taking off.

It seems that many vcs (at least those who blog) share your concerns for what's going on with Web 2.0.

As an entrepreneur, I am entertained to find deals closed daily around ventures whose sole business model is getting bought at some indeterminate time in the future.

I don't think this is a problem as long as you guys and the company founders agree that you are not building a real business, but gambling on some very long shot which might, or might not work out.

If I were the vc, I would push that argument to severely lower pre money valuation and take a larger chunk of these things- which are really nothing more than a roll of a dice.

What I am saying is that I understand that you don't feel comfortable investing in business who have no barriers to entry and fail due diligence in at least 10 other ways - just don't think of them as businesses.

If the founders don't actively sell anything to anybody and the whole thing is some AdSense supported song and dance - it's not a business, comming from where I am from. I'd invest in it, but good heavens would that equity have to be dirt cheap.

[Neville]

Peter,

No, I wasn't talking about macroeconomic disruptions caused by overfunding.

Nor was I addressing the point in your comment, "the personal economic consequences are the same whether you raised $5 or $5M". This isn't consistent with my own experience. We have found it easy to lay off essentially all of the downside economic risk associated with our start-up precisely because the dollar cost is now so low.

I was referring instead to the potential for a raft of start-ups to disrupt the economics of a specific business if they haven't received big gobs of VC funding versus where they have. My point was that 'bootstrap fratricide' may turn out to be a brief firework display, over and done with quickly by comparison with the extended trench warfare which has sometimes resulted from 'VC fratricide'.

This strikes me as a good thing all round, as the early competitive triage in many markets will be driven more by who can gain traction with customers than by who did the best job of selling a story to their VCs.

[Regnad Kcin]

It is very clear that most entrepreneurs and technology developers do not provide a business model or value proposition. They become so excited about the technology that they forget the clients and the investors. There is no liquidity event, let alone strategic development path. There is no continuity path, should the development path stall; let alone no revenue stream. There are no partners. There is no smart money to guide the entrepreneurs and technology developers.

The missing ingredient is banal business minds to take the profound and innovators into the marketplace of ideas to the people who want the services. Most all the time the inventors must let go to get the process going.

More often than not technology developers fall prey to the bankers who do not care what is under development but will build platforms from the spoils. In the case of the data web, “i-name” development there is no clear voice, no clear objective provided by the authors.
The Global Launch is pushed back time again. But what is the Global Launch except many developers, dreamers and several charlatans with a dream?

[Chris Yeh]

Peter,

Your post is extremely insightful--it does an excellent job of highlighting the differences between the current bubble and the last one. However, one thing which I think it doesn't take into account (and I can understand how difficult it is to stuff more than one thought into a post and keep it coherent--a problem I face all the time) is the fact that lowering the barriers to entry and cost to serve actually increases the size of the pie.

When product development becomes dramatically cheaper, it becomes possible to serve new markets that the older, more expensive approach could not. There are certainly more AJAX calendars being developed than the market could ever support, but that's a case of entrepreneurs who lack imagination.

If entrepreneurs avoid the pitfall of the last bubble (pile into whatever is hot and hope to get bought--see the Webmail wars of Web 1.0), they will see that the entrepreneurship bubble allows them to profitably serve niches that a venture-funded organization could never target, due to the need for a larger liquidity event.

This to me is the true power of another hideously overused cliche, the long tail. That is, instead of launching yet more broad social networking applications, entrepreneurs find specific niches that are completely unserved and cure those pains.

It may not build billion-dollar companies, but if you don't need VCs, you don't need a billion-dollar exit.

[TechCrunch]

Peter,

The fittest survive. They always do. More competition just results in better, more pure ideas from the winners.

And I think you agree (I may be wrong) that VC (or other) money isn't necessarily a way to improve your chances. When I look at inform.com, a 55 person company with plenty of money that gave birth to an abomination last night, all I can do is compare it to Memeorandum, a one person (1!) that is changing the web.

[Peter Rip]

I totally agree. Scale and venture capital are not guarantors of success. Most companies should NOT take VC; nor should VCs invest in most companies.

Yes. Markets are Darwinian. My point was merely being alive does not improve your chances of survival. Being one of many that are born probably increases the survival hurdle. You have to be the fittest, i.e., have a sustainable advantage. Rarely is it access to capital. Access to capital comes because you have it.

[TechCrunch]

The increasing size of the TechCrunch "deadpool" certainly suggests you are correct. :-)

[Alexander Muse]

I agree. Great post.

[Victor]

No one should be surprised that entrepreneurs and VCs fall in love with the same set of ideas. Most read *exactly* the same materials, go to the same conferences, went to the same schools, listen the same "pundits,", live in the same areas, etc. Our brains are filled with the same Venn diagrams with identical overlaps.

[Simon Brocklehurst]

Peter,

You're right - the Entrepreneur Bubble is very real. A big problem here, I think, is that whilst there may just possibly be lots of talented developers out there, most of them seem to have no idea what problems to solve.

If you look at the big successes to come out of "Web 1.0" - like Google, Yahoo!, eBay - companies that went from zero to tens of billions valuations in a few years - they did something new. I'm disappointed by how many "Web 2.0" companies seem to be tackling old problems - me too/better versions of e-mail, browsers, document creation etc. - for which we already have pretty good solutions.

More on this on my blog in an entry entitled Wassup With Web 2.0?

[Michael McDerment]

I have to laugh...I went to a blog last night and read about how a guy had been "inspired" to start a "web services" company. Close to three years into mine - (and still inspired!) - I find all this enthusiasm a little misguided. Build a business, not a Web 2.0 company. Remember the bubble? This piece sums it up nicely...

[Michael McDerment]

I have to laugh...I went to a blog last night and read about how a guy had been "inspired" to start a "web services" company. Close to three years into mine - (and still inspired!) - I find all this enthusiasm a little misguided. Build a business, not a Web 2.0 company. Remember the bubble? This piece sums it up nicely...

[Michael McDerment]

I have to laugh...I went to a blog last night and read about how a guy had been "inspired" to start a "web services" company. Close to three years into mine - (and still inspired!) - I find all this enthusiasm a little misguided. Build a business, not a Web 2.0 company. Remember the bubble? This piece sums it up nicely...

[Martin E]

Great piece- as an employee of a company five years into the SaaS world I can tell you that developing the application is almost ancillary to creating a successful business. With the web 2.0 buzz we've watching literally dozens of potential rivals come out of the woodwork with cool AJAXed little apps thrown together by 2-3 person skunkworks. However monetizing, scaling, bringing to the real market (i.e. businesses who could care less about web 2.0 but need solutions)and generating revenue and a strong user base are not only difficult challenges but do not even appear to be issues these companies are concerned about.
It all came to a head when one of the web 2.0 'stars' left us a message wondering if we could host their product because they couldn't handle it...
It's fun to watch but reality still lurks behind the curtain.

[Christopher Salazar]

Wow, this is a great post. I recently attended a presentation by Guy Kawasaki, who introduces his 10 step process of becoming a successful entrepreneur. You can view my notes here:

http://e-bizz.blogspot.com/2006/02/10-steps-of-entrepreneurship-guy.html

Let me know what you think!
Christopher Salazar

[Shawn McCarthy]

Great blog, considering I just quit my day job to focus on my software business.

I guess you can say it's do or die time!

[Anil Tandon]

The Web 2.0 is clearly evident in the Indian online travel market. Atleast half a dozen companies have already been funded with another dozen in the que. Most of them began with the same product/service lineup but are slowly beginning to differentiate. Anyways with the internet userbase in India at about 5-6% of the population the valuations are far fetched.