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Does Web 2.0 bubble have a silver lining?

Not all of today's Web start-ups will survive. But the relatively low cost of getting one going means Web services are being developed fast.

Hundreds of technology executives and investors will congregate this week to take the quickening pulse of Internet entrepreneurship.

At the third annual Web 2.0 Conference in San Francisco, dozens of industry players will gather to break down topics like Internet infrastructure, Net neutrality, mashups, data protection and the future of video. Among those on hand at the city's Palace Hotel will be Amazon.com CEO Jeff Bezos; Facebook CEO Mark Zuckerberg; Lotus Notes creator Ray Ozzie; and Marissa Mayer, vice president of search products and user experience at Google.

For industry players, many of whom lived through the dot-com crash, the surging wave of new Web companies and the corresponding media buzz can mean only one thing: an investment bubble where too much money is chasing too few good ideas.

But for any similarities to the late '90s Internet craze, today's Web 2.0 buildup is a kinder, gentler bubble, say entrepreneurs and investors. Yes, the flourishing Web start-up scene will create some train wrecks. But because people can start companies for relatively small sums compared to the tens of millions doled out during the dot-com heyday, the crashes won't hurt as many.

Along the way, some Web companies will endure and make online software (also called software as a service), more compelling and viable for consumers and businesses, say entrepreneurs and investors, an admittedly optimistic bunch.

"A lot of companies will fail, without a doubt," said Joe Kraus, who co-founded Web portal Excite in the mid-1990s and JotSpot, a wiki company that Google acquired last week. "But users really benefit because the innovation space is being explored a lot more quickly."

Acquisitions by Google and other Web heavyweights like Yahoo and Microsoft are helping to fuel entrepreneurial creativity.

The purchase price of privately held JotSpot was not disclosed, but Google last month bought 20-month-old video-sharing site YouTube for an eye-popping $1.65 billion in stock.

"A lot of companies will fail, without a doubt. But users really benefit because the innovation space is being explored a lot more quickly."
--Joe Kraus, co-founder of Excite and JotSpot

Big-dollar acquisitions may remind people of the public stock market entries of many profitless dot-coms in the 1990s. But people say new online business models are more mature, and give today's Web start-ups a better shot at longevity.

Automated Web advertising is more sophisticated and monthly subscriptions to hosted applications are proving themselves out, particularly to business customers at companies like Salesforce.com.

"Business model innovation is the biggest difference between Internet phase one and Internet phase two," said Brad Silverberg, a former Microsoft executive and partner at venture capital firm Ignition Partners. "It used to be everything was about eyeballs but there was no way to monetize it. Today there is and that's why this is more durable."

Silverberg argued that new software companies will not be able to enter the packaged software market, which will be dominated by incumbents like Microsoft and Adobe. Instead, the race among crafty entrepreneurs is to deliver a hosted service that strikes a chord with consumers or business customers.

Two geeks in a garage
Activity in Web-related start-ups is on the rise. The number of "Web 2.0" investments from venture companies rose to more than 130 in the third quarter of this year, compared to 107 in the same period last year, according to the National Venture Capital Association and PricewaterhouseCoopers.

A number of technical advances, such as the Web development technique AJAX and wide-scale adoption of broadband Internet connections, are allowing software engineers to build more compelling online applications.

New businesses today have access to free open-source software, relatively cheap hardware and powerful development tools. With more Web sites providing programmatic access to outsiders, developers can also build mashup applications that combine information from multiple Web sites.

Add it all up and the money and effort to launch a Web company has gone down substantially, compared to only a few years ago--a shift with implications for both entrepreneurs and their financial backers. John Girard, founder and CEO of hosted content management company Clickability, is now considering another round of funding. The quest is vastly different from when he started the company in 1998.

"Today, like then, money is pretty easy to come by. We're thinking about the $7 (million) to $9 million dollar range for the next three to five years," Girard said. "In 1999 dollars, that would have been a $55 (million) to $65 million plan."

"Web 2.0 in the consumer world is frothy but it's not eating up capital like the old days."
--Gordon Ritter, co-founder, Emergence Capital Partners

In addition to cheap building materials for technology outfits, viral marketing techniques, such as providing a free version of software or relying on word-of-mouth adoption, keep costs down.

As a result, the financial models behind many Web start-ups have changed--and investors are being forced to change strategies.

"Most venture firms have built their DNA and fund sizes around funding product-based business models, which means that you have to put a great deal of money into the first version," said Gordon Ritter, who co-founded Emergence Capital Partners to focus on hosted software companies. "And only after 18 or 20 months do you get the product out the door and see if it sells."

Venture investors these days are either looking to invest relatively small amounts--say, less than $5 million--to incubate small companies. Or they can invest bigger sums later to expand a company with an existing customer base, said Silverberg.

Recent evidence of the "cheap company" trend came last week when Charles River Ventures, one of the oldest investment firms in the country, launched a program to give out $250,000 loans to get new company ideas off the ground.

Angel investors--typically cashed-out former entrepreneurs--are more influential these days as well because their seed capital can be enough to launch a company, noted Kraus.

Like a 'Long Tail' bubble?
Yet even with less money at stake--involving professionals, rather than retail investors buying public Internet companies--there are some warning signs.

Mike Koss, a former Microsoft executive and angel investor, earlier this year joined Seattle-area start-up BlueDot, a site that allows people to --a product area that already has many alternatives, including Delicious, which was bought by Yahoo.

Koss is optimistic that people's desire to share Web content--one of the ideas behind the Web 2.0 model--will create room for large companies with scalable technology.

But the company is not taking a "if you build it, they will come" attitude, he said. It introduced Web advertising earlier this year to test its business model, which hinges on gathering data on users' interest for advertisers.

"A lot of Web 2.0 companies are ignoring the revenue model completely now. The VCs (venture capitalists) are telling them to get the eyeballs and we'll figure out how to monetize later," Koss said. "We hope to pitch to VCs that we really understand the business model."

Another sure sign that business is getting overheated is the behavior of recruiters in Silicon Valley, said Clickability's Girard.

"It's the recruiter activity that scares me the most," he said. "If we don't call within half an hour of a Craigslist job posting, it's too late. The recruiter's already called and told them not to talk to any companies."

Ritter has decided to focus on business customers with so-called Office 2.0 services, rather than the more speculative consumer area. A subscription-based business model, rather than one based on volume advertising, provides a fairly clear picture of when they can be profitable--assuming existing customers continue to subscribe, he said.

Generally speaking, many entrepreneurs are wary of not spending too much money and repeating the excesses of the dot-com days. Clickability, for example, cut salaries for everyone to $60,000 for a while to survive the downturn.

Whether that hard-learned fiscal discipline will remain is still an open question, however. In the meantime, many think the rapid creation of consumer Web services will raise people's product expectations both at home and in the office.

"Web 2.0 in the consumer world is frothy but it's not eating up capital like the old days. It's almost like a 'Long Tail' bubble," said Ritter, referring to the Long Tail idea of targeting goods to niche markets. "It won't take the economy down like the bubble did before."