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Why Web Companies Have Trouble Making Money
 

Why can't some of the most popular start-ups on the Web translate users into dollars?

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Selling and bringing in revenue is a challenge for any business, but parts of the tech sector seem particularly challenged on this front. As I mentioned in a recent post, many--including some of the biggest names, such as Foursquare, Pinterest, and Tumblr--have first focused on building an audience and only then on monetizing.

The theory goes that the most difficult thing to do is get people to come to your site or use your service on a regular basis. Once you've got the traffic, of course you'll be able to find a way to make money. Only, that often proves more difficult than many entrepreneurs assume.

I put some questions to Erik Gordon, managing director of the University of Michigan's Zell Lurie Institute for Entrepreneurial Studies, who examines sales, marketing, and business development for high-growth start-ups.

Why is adding on monetization after getting users so difficult?
Many users feel betrayed. They think they're the ones who made your service a success by contributing content or their presence. Now you want to charge them to participate in something they built for you.

It also is a big change in culture. It goes from being a collegial, friendly relationship to a commercial relationship. It's like inviting a friend over for dinner, asking her to bring the fish and the wine, and after she cooks it with you, asking her to pay.

Advertising is a tempting revenue strategy in these cases, yet online ad inventory keeps growing and prices keep dropping. Are ad-driven companies setting themselves up for defeat?
Mere ad space is a cheaper commodity than dirt. Unless you can target precisely to people who are likely to attend to the ads and act, you offer little value to advertisers. Fifty million visitors who don't look at ads is worth no more than 500 visitors who don't look at ads.

Facebook has been successful to some degree in getting real income, but it's at a low rate of monetization per user compared to Yahoo, let alone Google. What should the company have done differently?
Facebook is fighting cultural and use case problems. People go to Facebook to check on friends and, at most, to get recommendations from friends, not from advertisers. People go to Google for information, not for socializing, and as long as the ads are clearly delineated as ads, they don't resent them--and they even click on them. Social is powerful but it is a constraint on how commercial you can become.

What are the pros and cons of becoming a data platform for others, like Foursquare seems to be doing?
If you want to be in the data platform business and sell your services to people who don't compete with you, it can be a great business. If you are in another business and have a data platform whose value is that it gives you a competitive advantage in that other business, once you sell your data platform services to others you reduce that advantage. If the data platform business could be bigger and more lucrative than your original business model, do it, but realize that you will become a different company, with a different business model.

How do these companies get past their original structure and find a way to sustainable revenue? Will they see the growth that investors originally expected?
I wouldn't invest in a company that doesn't have a sensible plan for monetizing its efforts. That means I miss out on a few great opportunities and pass on a lot of money-eating failures. Most companies do not succeed it pivoting from their original structure to a profitable business, so starting with a structure that builds in a path to profits is more appealing.

IMAGE: nohodamon/Flickr
Last updated: Mar 26, 2013

ERIK SHERMAN's work has appeared in such publications as The Wall Street Journal, The New York Times Magazine, and Fortune. He also blogs for CBS MoneyWatch.
@ErikSherman




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