Tough Times Ahead For The Web?

I was meeting with a web entrepreneur yesterday. It’s something I do at least five to ten times a week.

This entrepeneur said ‘but I worry that the coming downturn might have a negative impact on my business plan.’

Not ‘a possible coming downturn’, it was ‘the coming downturn.’

And I found myself nodding my head, not challenging that assumption.

Why is it that I feel a downturn coming? It’s not one single factor, it’s a combination of factors, some based on real factors, others based on fears and other emotions.

First, the economy seems rockier than it has in a while. The housing market is no longer a driving force, its weighing on the economy. The fed’s lowering rates in response but that makes the dollar and our markets less attractive to international capital. I have no idea if we are headed for a recession or not, but it sure seems more likely than it did a year ago.

Second, we are ccming into a presidential election cycle. The democrats are looking stronger than they have in a while. The Iraq war and Bush are unpopular. There will be a lot of uncertainty over where our country is headed until the end of next year. That uncertainty has traditionally been bad for financial markets

Third, there’s a looming crisis in the buyout business because banks have gotten more tight with credit. Less private equity buyouts will take one more positive aspect out of the financial markets

But none of those factors directly affects web/tech and the venture markets. But it does directly affect the psychology of the investors who fund the market and to a lesser extent the entrepreneurs who drive it

Then there’s the parallels with web 1.0. This is where emotion enters the equation. I started Flatiron Partners in 1996. We had the wind at our back for four and a half years and then we got headwinds in the summer of 2001. We started Union Square Ventures to focus on renewed opportunities on the web at the end of 2003. We’ve had the wind at our back the whole way. My mind is trained to expect headwinds soon. I don’t know that we will, but I can’t help but expect them

And then there’s the supply problem. The venture market in any industry (biotech, nanotech, green tech, comm equipment, web, etc) does best when the supply of new companies is relatively modest and the demand to invest in them is equally modest. Right now in web tech, we’ve got a huge supply of new companies and a huge demand to invest in them. That’s not sustainable forever

And we are getting to the point that some web 2.0 companies are going to start failing. VCs will keep bad investments alive for a while, but they won’t pour good money after bad forever. We’ve seen some web 2.0 companies close their doors and we are going to see more.

Finally there’s the question of what’s next? Is it semantic web? Programmable web? Social web? Yes, yes, and yes. But we are still seeing a lot of me too companies, slight twists on ideas that are now five years old. We are not yet seeing boldly new ideas, at least not enough of them to say we are now in web 3.0

Do we have to go through a shakeout to get to the next big move? I don’t know. I only know that’s what it took last time

So if you see the downturn coming as the entrepreneur I met with clearly does, what do you do? If you are a VC, I think you keep investing, but carefully. Its not a time to step on the gas. And focus on your existing portfolio, take gains where you can take them, and make sure you’ve got plenty of ‘dry powder’ for your portfolio

If you are an entrepreneur? Well that depends on where you are in your development cycle and what your goal is. If you want to spend the next five to ten years building your company, then raise a good amount of money and then put your head down and execute. If you are in it for the quick flip, get busy. That opportunity may not last forever

I know this post sounds gloomy. I am not certain we are headed for a rough patch. I am not sure of anything. But I think the probability of tough times ahead has gone up in the past year. And it seems to be creeping into our collective consciousness (or at least mine).

So let’s talk about it and if it comes to pass, let’s make sure we handle it better than we did last time.

#VC & Technology

Comments (Archived):

  1. turph

    My indicator for innovation is thinking about the last time I checked out an app, plug-in or widget. It has been awhile.

  2. Jim in Colorado

    My opinion is that a slowdown is definitely coming but it feels to me that tech will not get hurt like it did back in 2001. The downturn is being driven by Real Estate this time not tech. I feel my business, online advertising, will hold up well baring a severe collapse of the economy. Consumers will continue to buy more on the web and companies will continue to turn to the internet to find new customers turning away from old media. A bubble in tech drove the market down in 2001 but that is not really the case now.I think a bunch of the web 2.0 stuff is frivolous (i.e. the TechCrunch40 and the 40 variations of social networking/media) but good internet businesses will continue to thrive as real estate did through the last 2001 downturn.

    1. Jon Kelly

      I agree completely. I think you can’t lump the techcrunc40 crowd (frivolous is a great word for them) and what is going on with the web overall. I was there in bubble 1.0 and the biggest difference is that this time there are real advertisers with real budgets (like Progressive, Allstate, and GEICO in my industry) aggressively moving their budgets online. Direct mail is getting almost impossible and the web (even with CPC escalation) is a much better path for direct marketers. The real estate collapse will have no bearing on that trend.

  3. ErikSchwartz

    Same as always, keep your burn rate sensible and push towards cash flow neutral.Don’t take too much money or you’ll limit your exit opportunities.

  4. Farhan Lalji

    I think there are two economic challenges here. A macro challenge with the whole global economy – the iffy mortgages and the sale of debt all over the place and the presidential election are the inputs here. The second is a micro challenge within technology, which is more of a correction rather then a downturn. It happens in every industry, cycles, supply and demand balance out and the world is put right. The good will rise to the top of the economic cup, the bad will sink and we’ll all just get on with things.

  5. ppearlman

    all the doubt and worry i observing here is bullish

  6. Mitchell Fox

    Fred -I think you’ve got some great points here. This is a topic I’ve been sucked into, and written a fair amount on my blog as well: http://www.thestrategyfox.c…The grim image of the US economy is something that makes me feel great about the timing of my move to Europe, but also nervous about my options to move back to the Bay Area in a year.On the VC side, one addition is that valuations are likely to fall, and allow firms to provide capital under more favorable terms. That, in effect, could mean bigger payouts in a few years for the few startups that really do takeoff and succeed. Because in the end, a few always do become big winners.-Mitch

  7. Gerald Buckley

    All the more reason I feel companies focused on disruption and a compelling value will emerge from most kinds of downturns HUGE winners (Cubic Telecom’s Pat Phelan for instance).In a down economy what are people likely to do? Find ways to scale back? Do without? How does an ad bourne interweb fare? It’s going to get nailed right square twixt the eyes. Anything relying on indirect soft currency transactions (affiliate and channel sales, etc) is going to feel a massive downward pressure. The players who offer significant value within the transaction stream… actually have growth opportunities, believe it or not. I don’t think this is an isolated real-estate anomaly. This thing could have serious offshooting tendrils.Your entrepreneur is exhibiting some of that doubt you were talking about yesterday… Probably a healthy thing overall.

  8. Greg

    A strong, sober analysis. As much as tech entrepreneurs and investors say failure IS an option, that the low-cost and ease with which many startups get launched means less pain when they fail, there still is the psychological factor you mention. Maybe no one will be losing lots of money like they did in 2000, but when all these lightweight, feature-masquerading-as-a-company startups being failing in droves, the impact on the rest of the startup community will be big. Those who are truly committed to their ideas will stick with them, hopefully they’ll still be able to get funded and attract customers.

  9. Peter Cranstone

    Good… I’m tired of the whole “we’ll support it with advertising model”. Lets get back to the serious business of solving customer problems and generating sustainable, measurable, profitable revenue from volume. There are a lot of good business out there that have been passed over because of this Web 2.0 hype. Ridiculous amounts of money at silly valuations have gone to companies that will simply never make it. Only those who are willing to learn and adapt will survive – lets bring on Web 3.0 and here’s a hint, this time it’s going to be all about Mobile.Web 1.0 – Content and CommerceWeb 2.0 – CommunityWeb 3.0 – Context – and the junction of Content and Contact i.e. Mobile

    1. Darren Herman

      Buckle up your safety belt, we’re going for a ride

  10. RacerRick

    The TechCrunch20 er 40 is what makes me realize that we’re already in the downturn.Impression advertising is going to take a hit.

  11. AnnBernard

    Yesterday I was following the TechCrunch40 blogs and this same exact thought came to mind. Why? Because none of the businesses featured were truly innovative or at the edge of technology. None of the businesses represented the Web 3.0 or a step into the future. The web 2.0 is getting saturated and we still haven’t engaged new users into it or expanded the market.Innovation = GrowthInnovation sometimes means doing the same thing but in an entirely new way…this type of innovation is rare.Also, Web 2.0 focus has been heavily on the technology, not on the people…although, it was suppose to be about the people and interaction. The companies who will get funded and grow in the next few years are the companies who focus on the real human needs and desires.

    1. Dorian Benkoil

      So, you’re saying at the technological forefront AND focusing on people? must a business really be at the forefront of technology? or just use it wisely with an innovative idea – regardless of whether it’s technologically very innovative.

  12. Marc Brandsma

    I don’t see an end to the supply of Web whatever.0 companies as long as users keep rampaging from one service to the other with no obvious rationale behind. VCs may achieve the one/ten ratio if they bet on the best teams combining technical skills and some execution capabilities. The current internet market is very contrarian as one where it’s better to bet on the jockey. And the advertising market growth will keep all this nice brownian cloud in motion until advitisers realize that its is as improductive as a plain old TV commercial (that won’t happen soon, self consistency you know..). Add that “traditional” boring prehistoric businesses flourish these days (e-commerce, remember?), and you have a receipe for constant growth.And there are plenty of other opportunities: greentech, telco 2.0 (how to deconstruct the monolith), open source wireless. Not enough to diversify squarely but still promising enough to entertain the LPs. And the exit market seems to have substitute trade sale from market value inflated internet companies to plain old IPO. Even if credit becomes harder to get from banks, you can still rely on investors with rosy glasses, to some extent.May be you’re anxious because of the general lack of seriousness of all that. After all, none of these services/technologies has had a deep impact on our societies. We’re still waiting for the thing that will change our life like wireless did. Good news is that plenty of entrepreneurs try to find it in all domains. Let’s move forward.

  13. Sean Ammirati

    Hi Fred,Alex (and many of us after him) have been proposing we’re in a digestion phase on the web.http://www.readwriteweb.com…By the way, I’d still love to interview you for our podcast – Read/WriteTalk.- Sean

  14. Zach Coelius

    I agree, I responded on my blog here.The key indicator I am watching are adwords prices. If they start to dip it will hurt everyone.

    1. Jim in Colorado

      If the adwords prices drop affiliate marketers will step in and start to make money the cheaper traffic with direct response and lead gen ads. Might hurt google some but web marketers will fill the void, in my opinion.

  15. WayneMulligan

    For well capitalized investors/companies the coming “shake out” won’t really impact their business dramatically. Reason being, the model under which many of these web companies are built – advertising – is at much more sustainable levels than it was “last time”. We don’t have CPM rates being arbitrarily inflated and not matching real customer acquisition costs.Making an argument for an all out crash is like saying network television is going down the tubes because we’re going into a recession. Just like network TV, the web as a media platform has become an integral part of every company’s advertising strategy and budget. They can quantify benefits now.Will we run into a recession? Like Fred said, I dunno. But I do know that the goal of every entrepreneur reading this should be to continue innovating and executing, and every VC should be looking to fund the best and brightest of this bunch. We’re past the “proof of concept” stage in this medium – so for us, it’s gotta be business as usual.

  16. Brett Williams

    Let’s subtract the ABCP (asset backed mortgage paper) crisis from the equation, what do you think then? I know it is somewhat of a moot point, because the fallout from the ABCP debacle will stretch into most if not all facets of the economy, but for a moment, let’s pretend it wasn’t there.With that subtraction, what do you see? Do you still see the environment that lead to the the collapse of Web 1.0?A month or two ago, this debate was raging through the bolgosphere, and I took the side of yes, there is going to be a hiccup, a big one. Then I had a moment or two where I wondered, maybe not (this is before ABCP came to total light). Now, all I’m reading about is software as a service, particularly office applications. Today, Yahoo shelled out $350 million to buy an application provider, which, after I look at it’s product offering, I believe Yahoo really paid for a spreadsheet online authoring tool, to keep pace with Google.Will any of these online office application tools ever take the place of something like MS Office? I don’t believe they will, at least not in the current form of being hosted by a third party. With the current setup, this product offering is a counterintelligence nightmare. The reason why I offer this example is that this is a sign, to me, of over exuberance, the true sign of an upcoming bubble burst – I believe A. Greenspan recently said something similar in regards to exuberance.

  17. Jeremy Epstein (jer979)

    I’m not suggesting that you should be anything but your normal, candid, honest self, but the thought crossed my mind if, someone like you, with such reach in terms of numbers/audience (relatively speaking, I suppose) may now have the influence to create (in part) a self-fulfilling prophecy.I read your blog b/c I have respect for your opinions about the Internet and VC world [we’ll leave politics out of it! 🙂 ] and I just wonder if people may say, “hmmm, Fred thinks this way, so maybe he’s right, which means I should cut back on spending,” and then the cycle begins.Maybe I am giving you too much credit (nah!), and definitely don’t want you to be anything but authentic (another reason we read), but just a thought I had.BTW, I am going to a DC event w/founder of tonight. should be cool.

  18. MD

    On the supply side, word is that percentage of graduating MBAs joining start-ups is back near record levels. Compound that with the 4-year roll off of Google employees (due to IPO stock grants vesting) and there’s about to be way too many people working on the “next big thing”…if there isn’t already.

  19. vruz

    you can benefit from some winds helping you get there faster, but ultimately the ship has to be able to stay afloat and navigate alone.the new crop of web 2.0 opportunists will come and go, just as the 1.0 ones did, no surprise there, the actual innovators will remain because they’re in it for life.the very moment you see them in fervent displays of X.0 exhuberance believing the laws of free market don’t apply to them, you know they’re oh so toast.if you create actual value, it sooner or later shows, good business is always good business and that will never change.

  20. gedcarroll

    I think that you are one the money, we are also due a cyclical downturn on online advertising rates based on those changes which is going to hit all those ‘triple A’ businesses (arrogance, AJAX, Adsense) partly driven by economic uncertainty and the fad-driven nature of marketing.

  21. Ted

    Part of the problem is undoubtedly people who are in the game for short term profit and not for creating long term value. This has always been the way of things… Fred, are you part of the problem, or part of the solution? This is something we can all ask ourselves.

  22. Jon Callaghan

    Hi Fred,Great post. I think you’re spot on. It is eerily similar to last bubble. wrt deals: lots of me-too companies, fuzzy value delivered to niche “tail” customers, feature building. . On the investor side, an all-too familiar urgency around most deals, fear of missing the next big deal, and a rush of capital to fund anything around certain markets.Most disturbing to me is that which killed us last time: fragmentation. Fragmentation of talent across companies, fragmentation of capital across a marketplace, and fragmentation of ideas, time, and attention.The challenge is that while the micro dynamics are disturbing, the markets around the web (video, commerce, media) are large, hyper-growth markets. Broad infrastructure changes, adoption and proliferation of web apps, the massive shift in media to the web, and a long overdue enterprise IT upgrade cycle create disruption and opportunity.So we’re investing, (but carefully) and sticking closely to our strategy of early and very early with exceptional people.

  23. Aaron Mentele

    Might be a stretch to assume that a soft time for Web 2.0 entrepreneurs would trigger a soft time for the web economy at large, or vice versa. There are a lot of online players that don’t need funding (or adsense checks) to make things happen.

  24. Chris Marstall

    Don’t forget about Y2K … that was a huge factor in how dramatic a collapse web 1.0 suffered. unbelievable sums were being spent on IT to fix a single bug, and the spigot was turned off all at once in the first quarter of 2000. Within a couple of months NASDAQ had collapsed and the “dot com” boom was over.I don’t think there’s a comparable coeval phenomenon this time around, so I think the downturn won’t be as pronounced (plus i think it could still be years off).Also I agree with vruz – true entrepreneurs won’t be phased by it, they will just keep on trucking. and the best will have cool jobs during the downturn 🙂

  25. Don Jones

    Just like there are established companies that do well (or better) during a recession, there are startups that offer better value for the same price (or free) than existing solutions – the old substitution concept.My own company, VentureDeal, offers better information for the same money. I think it will do well if there is a recession.

  26. Joe

    The only thing that worries me about the pending doom is that everyone’s predicting it. It’s the conventional wisdom. It must be wrong.

  27. David B.

    Quite the opposite, Joe. Everyone saw the Web 1.0, Real Estate and debt bubbles. It wasn’t a secret. Coolidge didn’t run in 1928 because he knew the economy would collapse and didn’t want it on his record. These things are obvious to anyone brave enough to be honest with themselves and with the numbers.To me, everything is either monstrously overvalued, such as Google, or a flat-out Ponzi scheme (Facebook, Twitter). People here are optimistic, and that’s great, but it’s also the demographic of early adopters. I think it’s naive. In the end, it has to be about business; it has to be about value. And I see little true value around.

  28. Ibod Catooga

    Mainly, what I think about the web is that I like to poop on cats. And I like to Grey Poupon cats. And the thing about cats is that they scream in agony when on a ham sandwich made by C+C Music Factory. Because a music factory produces music that sounds like it was made in a factory. Collectivism never worked for anything but termites, but my boss is not a termite, so on with the Thermite.Once in the world a chicken read a book by Dostoevsky. The chicken was not happy with the translation into Navajo (all chickens speak fluent Navajo so the farmers can’t understand them plotting their Revolution Most Fowl) so the chicken translated it herself. It was a very fine translation except it did not compile on the Amiga so Steve Jobs had to h4x0r the codpiece so that buglers would give an elegy for Pol Pot.Anacreon wrote monody. He liked a wicked party.Do — Do — you flagellate like I do?

    1. JT

      seek help now!

  29. TimWalker

    Good, sensible stuff here, Fred. As I just wrote on my blog ………what you say about “dry powder” is universally applicable, whether we’re talking about Warren Buffet (bargain-hunting galore at the moment) or a sensibly run household. The folks who get burned, during times like this and in the possible forthcoming slump, are those who don’t tend to the basics of being sensible with cash and leverage while building sustainable operations.The details of execution are sometimes rocket science, but the basic principles — whether in Web x.0, mortgage financing, or whatever else — usually aren’t.

  30. Aruni

    Well having founded one VC backed tech company that survived the last downturn and is still operating (I am no longer with the company). I think change is in the air. From my perspective as an entreprenuer, downturns can be great times to start companies. It may be harder to get funding but it forces you to be creative and let’s you appreciate the value of TIME in the equation of start-up life. You have to be leaner and provide unique products. Plus the give everything away free model is probably not going to work for long especially taking into mind what others have said regarding Google Adwords. I think advertisers are going to hire resources to find the right places to advertise instead of or in addition to things like Google Ads. I’ve already had people buy direct advertising on my blog posts at and I don’t show Google Ads on any of our sites. I experiment with placing ads myself but I’m not very good at it…throwing money away…feels a bit like gambling if you ask me. IMHO:Web 1.0 = ASP (my first company fell in this category — hardware and web software)Web 2.0 = ASP + some fancy new technology with the term social network attached to it focused more on the general pop, bloggingWeb 3.0 = ASP for businesses, end consumer, 3D internet, social networking, with a focus on internet based applications that take the next steps of moving from a PC/computer based app (Word, Excel, etc.) to the Internet.

  31. Bill Koslosky, MD

    I think Web 2.0 is over. Anything really remarkable done because of it? Aren’t social media, folksonomies, user-generated content completely played out? It’s time to think about a better way:http://billkosloskymd.typep

  32. alan p

    Maybe it takes a shakeout to stop people funding the me-too ventures?

  33. Alexander Ainslie (@AAinslie)

    At the end of the day one has to have a recession proof revenue model. Everything else is window dressing!

  34. JT

    (From interview in Portfolio Magazine) Mark Cuban: “We have reached a point of diminishing returns with today’s internet. The speed of broadband to your home won’t increase much more in the next five years than it has in the last five years. That is not enough to work as a platform for new levels of applications that will require much, much higher levels of bandwidth.Think of it this way. Way back when, electricity changed the world. It was the platform for everything electronic that we do today. Do you get excited about electricity or is it just a utility? Maybe old people who remember the advent of electricity still get excited about it. No one else does.The internet is in the same position today. It’s no longer an exciting platform for societal and business change. It’s a utility. It’s something that is exciting to people who remember the old days of the internet.The only way to change that is to upgrade the platform for bandwidth transport across the country to a minimum of 1 gigabyte per second throughout to every home. At that point kids will come up with new and unique applications that we can’t imagine today. That’s when it becomes exciting. Until then, it’s dead and boring.”

    1. fredwilson

      I posted my thoughts on that comment a while backIt might be dead and boring to mark, but not to meFred