Revenue ‘Quality’: All Money is Not Green

5 Feb

Dave McClure — entrepreneur, tech gadfly, angel investor and now venture capitalist — issued a blistering broadside to the industry in a recent blogpost on the impending death of a lot of ad-driven business models. To hear McClure describe it, except for a few acquisitions of interesting startups on the basis of enormous growth (eGroups, MySpace, Skype, YouTube, etc) or advertising potential (Admob, DoubleClick, RightMedia) “mostly the decade has been an uninterrupted string of uninspiring business models and small-time acquisitions of Web 2.0 startups filled with rainbows & unicorns, rather than those based on simple, transactional revenue models.” McClure follows that point with his belief that the start-up business model 2010 and beyond will rely, instead, on subscriptions and transactions-based revenue.

This issue touches on the topic of revenue ‘quality’ which I’ve grappled with for some time and that now (thankfully) I am seeing echoed across the investor and entrepreneurial community as a serious debate. As McClure points out well, start-ups have long been using some form of CPM and CPC ad-monetization as almost a given and it was accepted virtually without debate. This mantra has been showing its cracks for at least the past 4-5 years and has been truly under fire since about 2007.

Building web businesses whose sole purpose was to drive traffic, which would then hopefully be monetized through ad revenue, is just not the comforting and tenable business strategy as it was some time back. We have now seen multiple examples of web businesses that have built huge brandshare and mindshare through enormous, but temporary, spikes in traffic and usage only to see that traffic drop off dramatically through cannibalization by other market entrants or through user attrition. Attempts at stickiness and at building network effects through some facility can work to stem the exodus of users, but often those attempts by themselves rarely reverse the effects of a bad business model.

As regular readers of this space will be aware, one of our portfolio companies, Athleon, recently migrated to an all-pay subscription based revenue model. It was not a decision made lightly. That said, now with the benefit of a few months of hindsight, we can say that it was certainly the right decision for the company and was consistent with where the company needed to go in its evolution from a fun, free but somewhat noisy platform, to a professional-grade solution that delivered a best-in-class product to a serious community of users willing to pay for the benefits of membership. One of the hypotheses behind that decision was that the migration would naturally cause a significant user churn, but that those users were likely of minimal value to the company going forward.  We were hanging our hopes on the idea that 3,000 paying customers that loved the product were infinitely more valuable to Athleon as a company than 30,000 users who were unwilling or unmoved to pay for the service. As the company enters a new fundraising cycle, we maintain that this adoption of a subscription-based model will enhance overall valuation for the company because we posit that subscription-based revenue models are simply of a higher ‘quality’ than comparable ad-based revenue models. This is the case because many subscription-based businesses operate like a renewal business, so recurring revenue is far more predictable and certain, especially if the buying behavior of the customer set involves budgeting the cost of the service in their annual requisitioning process, as is the case with Athleon.

 As Dave McClure makes clear in his piece, the internet may strive to be the free, ad-driven egalitarian resource that has become so idealized in the culture but it certainly cannot work that way in most circumstances. Payrolls need to be met and, at the end of the day, goods and services need to be valued by the most obvious, crude and meaningful metric of all – hard-earned cash from users, not just advertisers. As the industry recovers, I expect to see valuations improve for many web businesses but I don’t expect to see a return to the kind of exit multiples of revenue some ad-based business were commanding pre-2008 market meltdown unless there are some significant changes in their core business models to expand far beyond just advertising.


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