Widget makers get a makeover

For makers of widgets--modest little pieces of software that let people do things like play games, annotate photos, or send "pokes" to each other on Facebook or MySpace--it seems the buzz has turned to a worrisome hush.

In 2007, there were venture capital funds set up solely to invest in promising Facebook applications (a word sometimes used interchangeably with "widgets"). A year later during tough economic times, some VCs are taking a cold hard look at any company that doesn't have a viable source of revenue, let alone one that relies just on one social network for visitors.

"We are witnessing a shift back toward balance versus the heat everyone had felt a year ago around the Facebook ecosystem that felt like it could be...the 'next new thing' with unbounded upside," said Bill Tai, a venture capitalist at Charles River Ventures.

"While that ecosystem is still interesting, it's become crowded and users have shown enough signs of app fatigue that the doors are closing," he added.

Tai isn't alone in that sentiment. The pullback among some VCs shows how fickle Web investing can be, given that the biggest developers in the social-network widget market, Slide and RockYou, raised tens of millions of dollars this year, giving them reported valuations of an eye-popping $500 million and $250 million, respectively. Yet even those financially stacked companies are working on ways to better educate advertisers, investors, and consumers about what they do. For smaller developers without those financial means, it's a far tougher environment and strategies are changing quickly, venture capitalists say.

Social-networking widgets and applications were initially hyped as the next wave of the Internet, or the atomization of the Web. That means that with widgets and apps, people can access a developer's games, news or content from anywhere on the Internet, particularly while they're hanging out with friends. When Facebook opened up its popular social platform to developers, investors saw the popularity of some easily built widgets skyrocket enough to believe that old mantra "if you build it, they"--in this case, the dollars--"will come."

Flixster, for example, is a movie-based social app that shot up the ranks on Facebook, and the company has raised more than $7 million in the last year to support its growth.

(Technically, industry executives differentiate between widgets as a piece of self-contained code that can be embedded to a page and contain content, for example, photo slideshows. Applications are also embeddable software but they're inherently social and interactive, e.g., embedded videos forwarded from friends, executives say.)

The prospect of investing in a Facebook app isn't so alluring anymore to some VCs. Several factors have converged to dampen the initial hype of social widgets and applications. The economy, for one. In an economic slump, advertisers are less willing to risk their budgets on new media that they don't quite understand. Another reason is that people can install, then forget about widgets without batting a lash, contributing to a high churn rate. Industry insiders peg the average shelf life of social widgets at between three to nine months (or as short as six weeks for game-like widgets.)

Facebook also hasn't proven for app makers to be the best place to build a sustainable business, despite its viral ability to thrust new apps to the top of the heap. Like its rival MySpace, it doesn't allow in-app advertising on people's profile pages, and a recent redesign of Facebook pushes apps and widgets from the profile page so that people could more easily forget them, industry executives say. (Facebook also recently replicated the feature of a popular Slide application called Top Friends.)

"What's unclear is: Can one application company on Facebook build a few-hundred-million-dollar business? I'm personally skeptical," said Navin Chadda, a venture capitalist with the Mayfield Fund, which is invested in Slide and widget distribution network Gigya.

"You need to be cross-platform. You need to control your customer. You need to be on Facebook, MySpace, Hi5, Bebo, and essentially have your app available throughout the Internet."

That said, Facebook also recently announced that through its fbFund (with Accel Partners and the Founders Fund), it has invested in several social application developers, including Podclass and ConnectedWeddings.

Just don't call it a widget
Still, social app companies are shifting strategies.

One thing that's quietly changing is the lingo. Turns out the word "widget" just doesn't cut it when you're trying to sell advertising to a big-name marketer or agency. It's also hard to convince venture capitalists hung over from the hype of widgets to invest, so application/widget developers are seeking to recast themselves as bigger players.

That means some companies are stepping away from the word "widget" altogether because it can imply a fleeting, lightweight commodity. Slide, for example, in recent months changed the language on its Web site and stopped trying to explain to advertisers what a widget is, according to the company's director of communications. It now describes the company as a maker of "social entertainment applications."

Snap.com, which is backed by Idealab and the Mayfield Fund, makes what some people might call widgets, which people can customize with photos or video for their blog. Tom McGovern, CEO of the company, calls Snap a maker of "personal media applications" and would prefer to say that it offers a Web service. He said that roughly 2 million publishers have installed its application on more than 10 million Web sites.

"For the non-Web-savvy, a widget company invokes negative images of a commodity product," McGovern said.

"A Web service is descriptive and people get it," he said. "At the same time, it doesn't sound from an investor perspective that you're investing in something that's shallow, and not indicative of the amount of time put into the technology."

Lance Tokuda, CEO of RockYou, said that although the company's Web page emphasizes the word "widget," he calls them social applications. That's indicative of the functionality and the fact that usage of social apps is much higher than a Flash widget that typically doesn't allow people to interact with friends, he said. An estimated 40 million people use RockYou's application Super Wall, for example, to send messages to friends.

His press representative said that "all of the language on the site will be shifting" as a result. The company is also developing a specific site for advertisers called RockYouAds.com to help marketers and publishers better understand what the company does, she said.

Next to its rival Slide, RockYou has among the highest installations of applications and widgets on sites including Facebook, Myspace, Hi5, Friendster, and Orkut. Tokuda said that it manages to get higher click-through rates than standard social network ads via RockYou applications.

"A lot of people are skeptical about how we're monetized...but growth is there and there's a lot of potential upside," Tokuda said. He joked about his rival Slide: "We're going to call ourselves 'super social entertainment applications.' No, we're using 'social applications.'"

For his part, Keith Rabois, vice president of strategy and business development at Slide, said that the company hasn't changed strategies. The company is spending much of its advertising sales budget on educating marketers, however. (It opened a new sales office in New York this year.) It's also focused on growth across all of the social networks, and Rabois said that the company may launch "a feature or two on the Web site."

"The best we can do is keep growing and make sure we're the destination of choice for advertisers," he said, acknowledging the larger macroeconomic environment.

Several venture capitalists said that the market is simply correcting itself and valuations will come down. A year ago, a Facebook application might have impressed a few venture capitalists with a few hundred thousand active visitors. Now, it wouldn't get the same response unless it was linked to commerce, or a way to sell goods and services in some way. Like.com, for example, helps companies convert traffic into direct sales leads.

"Businesses that are building traffic first have to show much larger traffic numbers or have a more thoughtful plan to monetize their business in order to be convincing," said Byron Deeter, a partner at Bessemer Ventures, an investor in LinkedIn and Yelp.

Forrester Research predicts that that money will start to flow in a few years. It forecast in a report late last year that ad spending on "emerging channels," which includes social media and widgets, will grow to more than $10.6 billion by 2012, one-sixth of the overall $61 billion spent on interactive marketing by that time. That's up from about $2.1 billion it expects in 2008.

Within emerging channels, the research firm forecasts that social media will drive most of the ad spending. In 2012, it expects ad sales to social media sites will be $6.9 billion, up from $1.5 billion this year and $600 million last year.

"This market is extremely confusing to marketers, some who even don't understand what Facebook is," said Charlene Li, a former analyst at Forrester Research. "The VCs are taking a step back, but what's the reality behind this, is that it takes a long time for marketers to understand where their customers are at."

Li added: "If you're just out there developing widgets, it's a really long shot to do that independently--that heyday is over. The fun-and-games widget, they'll be a long shot. The next phase is with utility--if it takes up space, it has to be useful."