Wake-Up Call for Web 2.0

As fantastic as it may seem, web-based companies may finally be growing up. While there will always be a time and a place for entrepreneurial bullishness, it has become clear that a story will only get you so far. The name of the game is now profitable growth.

Take the recent decision of Groupon to postpone its float. For a time, the online coupon business seemed to hark back to the excesses of the dotcom days, recalling memories of business-owners boasting about their ‘burn rate’ (ie haemorrhaging cash). That’s simply not going to cut it anymore, especially when a company is seeking third-party investment.

In the public space – and, to be fair, in private equity too – investors aren’t in the mood to be wooed by tall tales of world domination if the business model is based on a mythical approach to profit and loss. Even Facebook has delayed its IPO to 2012, preferring to concentrate on products and ward off competition (notably from Google) by evolving from a social network into a ‘media hub.’

For wiser heads, this only confirms what should be blatantly obvious. “The fundamentals of what makes a business successful haven’t changed at all. It’s cash, cash and cash,” comments Don Elgie, founder and CEO of PR and communications business Creston plc. “To deliver cash you need to be making profits. If you forget that, your business will fail regardless of whether you’re online, off-line, half-line or through-the-line.”

Froth, anyone?

For those companies that remember this basic principle and fully capitalise on the digital revolution, there is a real opportunity to become one of the blue-chips of tomorrow. Ian McCaig, the Deputy Chairman of energy saving company First Utility and former CEO of Lastminute.com, says: “People are placing very large bets on businesses with established user bases, but you’ve still got to make money off it.”

And money can be made – by the bucketload. Web-based advertising keeps outpacing traditional channels, online shopping is now a fact of life and, increasingly, companies are waking up to the value of subscription-based models.

For some, however, the rapid pace of change makes it hard to identify the wheat from the chaff. Aside from the largely successful LinkedIn float in May (so far, at least), nervous investors have viewed web-based companies as leprous propositions.

Sam Smith, CEO of the broker, finnCap, suspects that the foundations of these companies are often decidedly brittle: “The internet remains a free-for-all with very fluid customer base. Look how quickly people deserted Friends Reunited and MySpace. There are fears that Facebook will go the same way, as Google+ comes on the horizon.

“It’s cheap and easy to set up a business on the internet as there is infinite room on the www. high street… [Many are] very simplistic social networking games with a repetitive format that we think people will tire of long before they justify the IPO valuation … these are fads, not long-term business models.”

It’s a point taken up by Steve Muylle, Criticaleye Thought Leader and Professor at Vlerick Leuven Gent Management School in Belgium: “Return on investment is still controversial, particularly with social media companies, and many are struggling to understand their company’s potential for profit, the revenue drivers and monetisation models. You need a solid story in terms of what the future uptake will be, whether the figures can demonstrate this and whether the brand will be enough to sustain it.”

Keep it (virtually) real

Again, though, this is true of any business, not just those of the Web 2.0 generation which seem to be tarnished by the dotcom disasters of yesteryear. Today, at least, there is a fast-evolving infrastructure, not to mention a ready and willing army of consumers. “Internet businesses now have global reach and proper members and subscribers, rather than huge levels of random incomprehensible traffic, which was a characteristic of 2000,” says Ian.

Of course, every business must be able to tell a good story in order to generate excitement. The companies that flop are the ones where the spin outgrows the reality of the business model. That’s when ‘burn rate’ suddenly sounds like a buzzword to be proud about.

George Tovstiga, Professor of Strategy and Innovation Management at Henley Business School, says: “We don’t yet have all the elements of an appropriate revenue model in place. Some appreciation of the value proposition, from a user’s perspective at least, is coming together, and this may be driving the more speculative heightened investment interest and excitement.”

While Groupon’s decision not to float is another sign that the public markets are deeply troubled, it might equally be an indication of a saner view emerging about what a business should be about and how it can deliver. After all, it doesn’t matter what sector you’re in, the principles of running a good company remain the same.

Please get in touch if you have any comments about the issues raised here.

I hope to see you soon.

Matthew

www.twitter.com/criticaleyeuk

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