Web 2.0 Bubble? Please.

This post by leadership expert David Piccione makes a shoddy argument that we’re headed for another “technology crash,” an opinion he admits will be unpopular given all the “hoopla” surrounding Web 2.0.

This argument, although not new, is wrong.

Essentially, Piccione argues that outside market forces augur an impending bear market, and that this bear market will somehow be magnified through the technology sector in general and, more specifically, through businesses based on the principles of Web 2.0. By his account, the central reason for this “magnification” is that, by and large, these companies are overvalued by the VCs and private investors who have staked them. 

First things first: I would readily agree that outside market forces (primarily tightening credit markets, a weak housing sector, and high energy prices) have hurt the growth of the US economy and these forces may together trigger a smaller correction in the major stock markets.  That’s a given.  But what is not apparent to me is how and why Web 2.0 companies will be subject to a much more pronounced “crash” than the rest of the economy. In addition, saying these companies don’t have value is just plain silly based on how many people (millions) use their products.

Here’s a couple snippets to shed some light on Piccione’s argument: 

“Given the conditions outside of Web 2.0, what kind of security do we have within that will shelter us from a market correction? The truth is, our industry is speculative right now – as it was in 1999. Look at the leaders – Facebook, mySpace, Digg, YouTube. Being ad-based, each of these companies generate no income from those actually consuming the product.”

What Mr. Piccione seems to be telling us here is that if a company generates revenue through ads, it is somehow less secure than if they directly sold a product or service. But that’s only true if you have developed a lousy product. The companies that lost out with an ad-revenue model during the dot com bubble failed because their product was lousy, and advertisers finally sobered up to that fact and pulled their ad dollars.

Mr. Piccione, and others, need to work up a new definition of what “consuming a product” means today.  It no longer requires a monetary transaction in the traditional sense of the word.  People “consume” MySpace by the millions every day.  MySpace provides a product (an architecture through which people can meet and share information) and as long as they continue to innovate and produce a product that is better than its competitors, they will continue to generate revenue through ad sales. 

Piccione writes: “Facebook and mySpace are only as valuable as the next big thing. In other words: they are fads…eventually investors – be they VC’s or acquiring organizations – want to see some growth in their investment. With a fad-based industry, all value becomes speculative and opinion based. In order to make money, investors need to assume that tomorrow, the perceived worth of the product will be higher. Let’s pick on Facebook a little. Facebook now needs the next investor to believe it’s worth $2 billion at least. – invest $1 billion, recoup $1 billion. Sorry if I laugh a little.”

Don’t apologize — as long as you can can first explain to me why these entities being ad-based means they have no future and are vulnerable to a catastrophic crash ? Do companies pay for ads with fake money? Last the newspaper industry checked, the Web 2.0 companies have been making, and are poised to make, millions – or billions in the case of Google – from ads. How can you say a company that has the ability to reach the attention of 30 million people does not have value? (Or 100 million in MySpace’s case.)  Saying users in the consumer space have to pay for software and services in order to be financially viable shows an utter lack of understanding of how consumer technologies on the web work. As open source expert Bernard Golden showed in his post last week, Bill Gates’ declaration that Google doesn’t make money off software is not germane to the discussion of Google’s entry into the software space. In fact, as Golden points out, Google ironically mimics Microsoft strategies of old (like when the software giant offered IE for free on Windows and, well, we know what happened with Netscape).           Maybe it’s just because I’ve grown up in media, but ads are good business. Moreover, ads are integral for software companies to integrate into their business model (and not just for the sake of Keeping up with the Google’s ) The future software company will run as a cross between a media company and a software company. You offer software and related products for free, thus attracting eyeballs, and you charge people for access to those eyeballs. From there, further hybrid models can emerge, like charging for spiced up editions  (Google Apps has been doing this with its premier edition, charging $50 a user per year).    

In a new and open economy, companies that produce the best software will be ones that offer their services for free (or near free), find a way to subsidize it by other means (say, ads), then offer advanced functionalities on top of them that will drop additional revenue to the bottom line. Again, this is  only a precarious business model if you have a lousy product or poor management or both.

A lot of Web 2.0 companies are ahead of the traditional companies when it comes to this (yes, a hackneyed example, but Google comes to mind). In addition, this model ensures that their software will be the best around (because it if isn’t, you have millions upon millions of users who will tell them so).

The only bubble that will burst in the technology industry right now are companies that fail (or refuse) to see this trend and who fail to listen to the power of consumers.