It seems a little presumptuous to talk about the death of the internet start-up in a period where we just saw a $19 Billion (with a B!) acquisition of WhatsApp. And it wasn’t that long ago where we saw huge IPOs from Zulily, Tableau and Zillow (and others!). If anything it looks like it’s the golden age of online start-ups. If anything we might be in a bubble, right?

All of that is true, so allow me to be a little more specific. I am claiming it’s a bad idea right now to start an online-only company. Companies like TripAdvisor, Yelp, Zillow, Facebook and Google are all obviously great companies, but trying to build a new company in that space today is a mistake. I am defining an internet company as a business that exists primarily or exclusively on the internet. It’s never been easier to build a new review site or an online tool or an online information product. Partly for that reason it’s never been harder to make that new company successful – and it’s all because of the marketing challenge.

Recently Tim Ferris interviewed a number of new ‘internet start-ups’ that are getting traction. Here is his post. I was ready to jump all over them as exceptions, until I read the post and found out all of them followed my rules about how to NOT be an internet start-up.

 

“It’s the product, stupid”
– Bill Clinton as I imagine him as a start-up entrepreneur

When I graduated from business school in 2005 everyone who wasn’t going into banking, consulting, real estate or strategy was going to be a brand manager – a marketer. Career preference for the latest class has changed dramatically. Instead of marketing, they all want to be in Product. Product is the new king – and for good reason. More and more marketing is being built into the product. Even if it’s not, marketing a good product is a lot easier than marketing a terrible one (and you feel better about your job too). Why wouldn’t you want to be involved earlier in defining the product characteristics and changes instead of just trying to promote whatever you are handed?

Unfortunately, “Build a better mousetrap and they will beat a path to your door” is the greatest lie ever told to an entrepreneur.

You can build the greatest product in the world, but if you can’t get people to try it, it will fail.

There are generally three ways to get people to try your product:

1. Paid advertising: Lots of people will accept your money to put your product in the hands (or in front of the eyeballs) of your potential consumers
2. “Free” advertising: Sometimes called “earned media”. If your product is interesting enough you might get talked about by the news media (note: You will usually have to pay someone to do this Public Relations). If your website is built well enough you can get listed by Google in their organic listings (note: You will usually have to pay someone to do this SEO Optimization)
3. Word of Mouth: Your product might be interesting enough or built in such a way that users automatically share their use of the product with other users. You still have the challenge of getting it in the hands of the early users, but you can always resort to #1 if this will really cause it to flywheel

Let’s tackle each of them in turn.

 

#1 Paid Advertising

If your product has strong monetization potential you can get away with paying for traffic, but most start-ups don’t (at least not initially, and at least not strong enough that they can use this to get any degree of scale). If you can build a product and advertise it so that every $1 you spend makes you $1.50 then I am wrong and you should go back to what you were doing (actually rush back to what you were doing! Find all the capital you can and throw it behind your product like crazy! If you need more capital send me an email. Let’s talk.)

In practice, even if your product has great monetization potential, it is very very hard to create an online product that you can advertise profitably from the start. At best it will require lots of testing and adjustments and re-adjustments before you will get close to this point. In most cases you never will.

Many online products don’t even have a plan for monetization. Their goal is to get scale and traction and THEN figure out monetization (Which reminds me a little of the early days of the internet – andthis South Park Episode). If you can’t make revenue off the top then you generally need to focus on techniques #2 or #3.

The most common online-only company these days is a ‘better product’ that turns around and sells someone else’s stuff. In this case you are basically building a “free” product that acts as an advertising vehicle for others (Kayak is a good example). The problem with these companies and using paid advertising is that you are in an “arbitrage” position. You are buying traffic from one source and then turning around and selling it to someone else (maybe after you qualify it). It’s not impossible to do this but it’s getting harder and harder.

Let’s say you have a better way to find a car to buy online. Your tool helps people figure out which car someone should buy and where they should buy it. You want to turn around and sell these customers to car retailers or manufacturers. Great. But how do you get the customers to begin with? If you count on paid advertising you can bet the best terms on Google will be things like “used cars” or “Buying a car in Boston”. Guess who you are competing with for those clicks? The same people you want to sell your customers back to! So you need to be willing to pay more than your customers do for a potential buyer, then qualify that customer somehow so you can turn around and sell them back to your marketing competitors. Impossible? Absolutely not. Really really hard? Yes.

The second type of online-only company is a software solution of some sort. Maybe a tool that helps you better manage your finances that you pay a monthly fee for. First you need to build an awesome product – which is an expensive fixed cost. Now you need to recoup that cost somehow. Since your marginal costs are close to zero, you can either have a small number of customers you charge a lot of money or a large number of customers you charge a small amount of money. The most common method is to give the product away for free and then charge for a premium version (“Freemium”). This works if you have no competitors, but if you do, what do you think their reaction is going to be? They will either build a better product (forcing you to invest to improve your product) and/or reduce their prices. In economics a situation like this pretty quickly reverts to companies charging marginal cost. And what’s your marginal cost? Zero.

Are there ways around these problems? Of course. Kayak solved the arbitrage problem. Hootsuite is getting significant percentage of people to upgrade to their paid product. There are lots of solutions. But all of them are very very hard and have a low likelihood of success.

 

#2 Free Traffic

You are just going to build a cool product, people are going to link to you and then you will be found on Google. Your traffic (and your marketing) will be free and you can monetize the customers on the other side. This is how Yelp and UrbanSpoon and TripAdvisor all did it (although Trip did do a bunch of paid advertising in the early days to get themselves kick-started).

Well, the internet ain’t what it used to be.

First: All of those companies were really really good at SEO. They had some of the best people in the world doing SEO. And those great people had a big advantage: there wasn’t a lot of competition. At least not as much competition as there is today.

Let’s dive into the UrbanSpoon example.

UrbanSpoon was a restaurant review company who came of age significantly later than Yelp. They had a great team that built a great core product, but their product was only as good as the number of reviews they had. So they did two really smart things:

First, they created a badge system that automatically pulled reviews from food bloggers that put the UrbanSpoon badge on their site. And it gave all sorts of awards and leaderboards for bloggers that joined them. It turns out food bloggers are not in it for the money. They were more than happy to link to and provide content to a professional looking site like UrbanSpoon. This gave US both unique content and high quality links – both essential for SEO.

Second, they analyzed what their competitors were doing and found gaps. Yelp had a great site with content for every city plus the term Restaurants (Seattle Restaurants, Chicago Restaurants, Austin Restaurants, etc.) They were ranking at or near the top for all of those searches – as was CitySearch and TripAdvisor and dozens of others. It would have been very hard for US, as a new site, to compete with those entrenched competitors.

So the team looeds at where they could compete. It turns out that none of these competitors had content categorized by neighborhood. So UrbanSpoon built out thousands of neighborhood pages. Instead of one listing for Seattle Restaurants they had hundreds: Queen Anne Restaurants, Belltown restaurants, Ballard Restaurants, Fremont Restaurants, etc. Then they went further. They created pages for all of the cuisine types combined with all the neighborhoods: Mexican Queen Anne Restaurants. Thai Belltown Restaurants. Chinese take-out Fremont. And so on. But they weren’t done. They found lists of all the landmarks in every city and created pages for them as well: Turkish restaurants near the Space Needle Seattle. Moroccan take-out near the Hilton Hotel downtown Phoenix.

What they did is now called “building out the long tail.”

It worked. With their blogger content and links combined with their long-tail site structure they were able to own a big piece of the Google traffic, and then eventually, as the site became more popular, they were able to move in and compete head-to-head with Yelp on the “head terms”.

So if UrbanSpoon can do it, why can’t your start-up?

Because it’s too late.

The techniques that US used are now used by everyone. Yelp has pages now for ethnic cuisine by neighborhood and landmark. And so does the company selling cars and the company selling online education and the company selling whatever it is you think you want to sell.

Now you might be able to come up with some trick that no one has thought of yet (what UrbanSpoon did when Yelp wasn’t looking), and some of you might actually pull it off. But I sure wouldn’t bet on it. When UrbanSpoon was doing this SEO was a fringe skill practices by hackers. Now every company knows it’s fundamental to their business and they either have a crack corporate team in-house or they are utilizing a specialized consulting firm. Most company’s still aren’t very good at it – but it only takes ten of them to be better than you and you won’t be listed.

In fact even if you are better than all of the established companies, they will still have two things going for them:

1. They have history and you don’t. Google values history
2. They have a brand and you don’t. And Google is caring more and more about the strength of your brand (which I will talk about in the book when I get to SEO)

Basically you are outgunned.

 

#3 Word of Mouth

“Ed. My product is awesome. People will use it and then tell all their friends who will use it and tell all their friends.”

Again, this is possible. But unlikely. Even great music goes undiscovered. Read Duncan Watts’ Everything is Obvious (Once You Know the Answer) and get back to me. It’s really really hard to go viral. The only time I would give a product a real chance of this happening is if use of the product forces it to be virally spread (like early days of Farmville or the Executive Hoodie of BetaBrands). Even then I give it even odds you won’t make the leap. But if it’s fully built into the product (and not a social sharing button you hope people press at the end of the experience) then it might be worth taking a stab at it. And if you do, make sure you have a way to keep customers coming back after they shop/use once. How many of us checked off how many of “100 things to see before you die” and shared it with friends on facebook and have never checked out that company again (they tried. They have dozens of other “100 lists” you can work your way through, from foods to movies to beaches. But it was played out before they even really got started).

So if Internet Companies are not the right choice, what is?

Offline companies.

I’m not saying you should open a Subway Franchise (or even worse: a Subway competitor!). I am saying you should build an offline, real-world-product. And as you create your product keep the online portion of the experience front and center. I’m really saying there are three types of companies: Online companies, Offline companies and this new thing: “Offline companies with online optimized experiences”. While OCWOOE might be catchy for some people, I am going to call them Offline/Online companies, or Off-On-Cos).

When you look at most of the really successful online companies these days, they are actually OffOnCos. Fundamentally they are Offline companies that have been built from the ground up to incorporate online and/or mobile utilization.

What is Uber? It’s just a black car or taxi service. But they have a great ap that feeds you real time data that makes the entire experience better. If Uber was a tool to book taxies that they tried to monetize “later” they would be in a mess. Instead they have their own inventory fleet. They are an offline business that could have existed 100 years ago, but with a much better internet-enabled customer experience.

Have you used Postmates? They are a bike courier delivery service I live by. The only thing online about them is their app that I can use to book a courier (who also has a app on his phone to get my message and know what to deliver). Everything is charged automagically through my credit card. The experience is seemless (most of the time), but the company could have existed 100 years ago (and likely did).

I run marketing for A Place For Mom. We have 300+ local advisors across the country helping families make the transition for senior housing. We could have existed 50 years ago. Back then we would have done our marketing through magazines and television advertising. Today we still use TV and magazines, but the vast majority of our families come through optimizing our online marketing and website. We are an offline company with great online marketing.

A friend of mine created Raveable.com – a pure-play online company that aggregated and summarized online reviews. For his next company he is staying far away from being an Internet Company. Instead he is building a craft beer delivery service. Delivering craft beer not available in grocery stores could have been done (wait for it) 100 years ago. The only difference is he’s doing it with online-first in mind.

Tough Mudder is my last example. It’s not an online company at all. It obviously could have existed any time in the past. But they were able to leverage the power of social media and our desire to share how ‘tough’ we are on facebook to spread his message virally. The internet gave him marketing opportunities that didn’t exist before, but his product certainly could have.

 

When you are looking for your next big idea, take a step back and think about how you will market it and how you will deal with the extremely low barriers to entry we see in the online space these days. Then go back and look at an entrepreneurship or product development handbook from twenty years ago. Think about how you could create a real-world product to solve a problem or create an experience. Then spend some time to consider how that idea would work in an internet age.

Online-only companies were the low-hanging fruit of the internet age. But thankfully the tree has a lot of fruit, we just need to climb a little higher now. The next branches are all about solving real world problems thinking about the online experience first.

Disagree? Comment below!