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My idle thoughts on tech startups

Making $$$ on the internet

Lee Hower
September 11, 2006 · 4  min.

Reading Time: 4 minutes

There are fundamentally three ways to make money on the internet… there, I’ve said it 🙂

I meet folks time to time who seem to disagree with this notion, either because they conceive of some other modality for generating revenue with consumer-facing internet businesses or because they deny the existence of one of these three (usually #2 below). Of course there are always variations on a theme and I won’t deny the possibility of other real business models emerging over time, but as things stand today they are as follows.

1) E-Commerce
Of course our tendency is to use “e-commerce” mainly to refer to online shopping for physical goods, a la Amazon, but this bucket is a little broader than that. It also extends to digital content like iTunes and various brokering platforms for services (Expedia, Insurance.com, et al). There are of course a mix of pure play e-commerce companies and more traditional companies with “bricks-and-clicks” models or whatever you want to call them.

So what’re the fundamental improvements or innovations that the internet brought to retailing and commerce? Primarily convenience, selection, and transparancy. Each consumer has different preferences, but many find the online experience more convenient than visiting physical retail stores or purchasing via phone or mail order. Virtual merchandising (a printed “catalog” of all of Amazon’s SKUs would be the size of an encyclopedia set) and empowerment of broad new classes of merchants mean that buyers have a far greater range of products they can purchase. And transparancy of pricing and suppliers has advantaged many e-commerce companies… when’s the last time you called a travel agent to book a vacation? (business travel for large companies is a different story)

2) Advertising
Online advertising has gone through a monumental boom, a monumental bust, and now another monumental boom all in less than a decade. Again, as I conceive of it online advertising covers a fairly wide swath from display ads to search ads (and indirectly SEO) to lead generation to paid content (whether video or text, or what have you). Online ads can take a variety of formats but at the end of the day if a company is paying someone to make refererence to their product or service within the context of content accessed by consumers (freely or subsidised), it’s advertising. Fundamentally this model of aggregating an audience to sell advertising is not really any different whether your TechCrunch or Time Warner.

Even in this 2nd boom phase and post-Google IPO, there are still lots of folks (incl. a few “Web 2.0” cheerleaders even) who decry the notion of ad-supported business models as somehow far fetched. I hear it in meetings with folks, or see it on blogs like this comment “So much of the market is returning to the web 1.0 metric of eyeballs instead of building lasting value through revenue and profit.” Why on earth did MySpace get acquired for $580M+ and Facebook raise their last VC round at a $500M valuation? Uhh… it’s the (ad monetizable) eyeballs, guys. It’s true that you have to have lots and lots of eyeballs (and/or be able to segment your audience in ways valuable to advertisers) to build a very large ad-supported business. And it’s also true that the way we count eyeballs (things like unique users or time on site are becoming as relevant as page views, thanks to AJAX/Flash powered browser experiences) and the way that we sell eyeballs (e.g. various CPM, CPC, CPA pricing structures for display ads), and even where we find “eyeballs” (like here or here), continue to evolve. But having lots of eyeballs is in fact quite valuable, given that there are billions of dollars being spent advertising online.

The advertising/media model is hardly revolutionary but it undoubtedly works, particularly at scale. What the internet has brought to the ad world, besides just a new medium, is greater precision in targeting and measurability. Most other forms of media like TV, radio, or print are in some way broadcast in nature (i.e. target by programming demographics or MSA) whereas online advertising can (at least in theory w/ use of registered profiles, cookies, etc) enable advertisers to more narrowly segment audiences by geography, age, activity, or other factors. And the ability to more precisely measure impressions, clicks-thrus, and other metrics has greatly enhanced advertisers ability to understand ROI. These two factors of improved targeting and measurability have also expanded the universe of potential advertisers. The small kitchen remodeler down the road was unlikely to do a great deal of traditional advertising in the past beyond a yellow pages listing, but now he might try Google AdWords given that he can cost-effectively target a narrow audience who he knows are looking for “new cabinets in Boston” for instance.

3) Premium, User-Paid Services
Many folks think that everything on the internet must be (or should be) free, but in fact there are lots of things that people are willing to pay for online. Everyday lots of money changes hands between internet businesses and people looking for a date, playing games or otherwise entertaining themselves, or even simply simply accessing content they find valuable. Some users will even pay for a higher tier of access or service for what are otherwise free services (i.e. extra storage or ad-free content).

The internet hasn’t created any particular innovation here, per se. And we as consumers still seem more willing to pay for premium content or services in the offline world than the online.

Some companies incorporate some combination of these three as part of their business. Google is a top 2 or 3 online media property itself by virtue of Google.com but also an ad broker for millions of other websites large & small. LinkedIn generates revenue from a combination of #2 and #3. Skype arguably has an emerging business model which involves a little of #3 today, but could conceivably involve #1 and/or #2 in the future now that they’re part of eBay. And there have been a few successful companies which have been built by providing enabling products or services to consumer internet companies, including one of my former employers, as well as various successful business-focused internet companies.

This post has become rather lengthy as is, so I’ll do a follow-up post on implications of this… but the fundamental point I wanted to make is simply that there are a few broad, established revenue models for consumer facing internet companies.


Lee Hower
Partner
Lee is a co-founder and Partner at NextView Ventures. He has spent his entire career as an entrepreneur and investor in early-stage software and internet startups.