Memo to Entrepreneurs: Advertising isn’t a strong business model

I am proud to be a mentor for the Colorado TechStars program, and this evening we had our first mixer, a typical geeky mixup with poor acoustics and a male:female ratio of about 30:1. The mix was young entrepreneurs who won the TechStars competition and are now seed funded through the summer (along with gaining access to an array of very sharp advisors and mentors), the mentors, and other folk in the community who are focused on startups and business development.
A nice group and it was a good opportunity to both visit with some of my Denver-based friends and meet the young turks who are hopefully going to be building the next YouTube or Flickr in our proverbial garage.
Except for one glaring problem…

I estimate that I talked with about seven different startups this evening, roughly fifteen different entrepreneurs who are eager to dive into their business ideas full-time, to really devote all their energy into building Something Cool and Meaningful. Hopefully there’s the proverbial pot o’ gold at the end of the rainbow, but there was very little sense of people tilting towards a payout (or what we finance types call an “exit event”), which was nice.
But time after time, I asked “interesting idea, but how are you going to monetize it?” and received back flowery explanations that boiled down to “advertising” or, worse, AdSense. One group was even more disconnected, explaining that their goal was to build a large community of users, then they’d “figure out” how to make money.
Here’s a tip for all you budding startup junkies: A busy site can certainly make for a great hobby, a fun project to fiddle with, and maybe a few bucks at the end of the month, but (with precious few exceptions) that’s not a business.
Advertising? Well, you can look at the slow dissolve of the traditional media — newspapers, magazines, radio, broadcast TV — to understand the great risks involved in believing that someone else will always underwrite your efforts, someone other than your users. Further, while there might be high-flying estimates of future advertising revenue in the online world, it isn’t often highlighted that the competition is going to get tougher too. A company like IBM might spend millions on advertising, but their money is going to skew towards a small number of large sites, not a large number of small ones, meaning that unless you want to build a business on the nickel and dime PPC payouts of Google’s AdSense, AuctionAds, and related, you’ve got a fundamental problem in your business model.
How much smarter to have a business that has figured out a compelling value proposition, a solution that’s so slick, so useful, that users are happy to upgrade to a paid premium service. Not an awkward afterthought of useless tools for the less than one percent who upgrade, but something really revolutionary, something new and clearly cool. Unfortunately, there wasn’t much of that thinking embodied in the groups I met this evening, and while I remain highly enthused about TechStars, I am a bit concerned about the likelihood that we’ll see a bunch of home runs, or, heck, even a single or two out of the mix…
No question, it’s going to be very interesting to see how these companies evolve over the summer as various of us mentors and advisors try to hammer home the idea that the difference between a good idea and a real business is a reliable revenue stream, and that the best way to create that is to offer a compelling, valuable business service.
Then again, there are plenty of startups that were acquired without much more of a business plan than “get lots of eyeballs”, so maybe I’m completely off-base here. How important do you, dear reader, believe it is that a business have a clear and sustainable revenue stream identified in the earliest stages of its existence?

16 comments on “Memo to Entrepreneurs: Advertising isn’t a strong business model

  1. Dave,
    Wise words but one could say “isn’t that common sense’ — awh but doesn’t that fly out the window pretty quick (reminds one of the dotcom fools/horses!)
    but no doubt u’ll hammer some sense into them (and your fellow advisors) by the time they leave.

  2. As someone whose business makes a good percentage (a majority?) of its income from advertising, it seems odd you would try to deter people from starting businesses with advertising as their revenue model.
    There’s plenty of potential in advertising-based revenue models. Using traditional media as an example of why this will fail is hardly fair, considering most of the traditional media companies are currently in financial decline because they are failing to adapt to the changing state of media delivery; not because the idea of advertising as revenue model is fundamentally flawed.

  3. A fair point, Jake, but the difference is that I am not building a multi-person business or planning on seeking venture capital down the road. Is advertising a possibility for a small shoestring startup? Sure. But that’s not what we’re talking about and that’s not the focus of the TechStars program either.
    Further, since you ask, a quite significant percentage of my income comes from non-advertising sources, more traditional revenue streams for a management consultant…

  4. I think I agree with both you and Jake.
    We need to change what we call the “advertising” business, because that metaphor is hopelessly defined by newspapers and other media. If everything looks like a hammer, …
    Jake, your business is much more than advertising. I send people to you to get knowledge. I send them to you to get expert opinions. I send them to you to save me time.
    It would be rare for me to find a newspaper or TV station that I could do that with. When someone wants to know about some kind of digital media, the generalized pap (think Kim Komando) that is out there in traditional channels is pretty much useless. Driven by the idea of serving the largest possible audience and offending the fewest people, there will never be much value in the information.
    JLMB is very clearly focused, even though there’s a lot there. It’s also very clearly the opinions of an expert, and rarely seems to be rah-rah or driven by a vendor. And the tone is very different from what you’ll be hearing from Katie Couric or the lovely Kim.
    That’s why I’d advertise on it. Because of the context, because of the cachet, and because of the community.

  5. Hi Dave,
    I have a similar problem with clients who only want to use email to communicate with their customers. In spite of overwhelming evidence that delivery is getting worse on a daily basis.
    If email were taken away their business would tank.
    I’m curious how you persuade your clients to use ‘diversified’ marketing?

  6. Ok Dave you’ve dragged me into this from your email newsletter .
    I’m helping a start-up business newspaper which is extremely tightly focussed on a section of Greater Manchester.
    I really believe businesses that want to reach businesses in that part of Manchester will want to buy advertising through it. Therefore estimated revenues were identified before getting bank funding.
    I think estimated revenue helps with investors. And should make the entrepreneur more comfortable. However, as you know entrepreurs are about risks too and sometimes you just have to believe in making something work and going for it.

  7. I’m wondering how these start-ups all made it into Techstars without plans for revenue streams other than advertising, or it sounds like at least in one case, without even that! Were these really the best that were out there?
    – Jeff

  8. I was product manager at CompuServe for many years. We recieved hundreds of proposals for new services every month and the one attribute frequently overlooked was Promotions. People still seem to believe it “If you build it they will come!” There may be one or two of those services every few years, but with the millions of web sites out there, it takes more than luck!

  9. TechStars is not about picking the perfect business and revenue model. It’s about picking great founders who value mentorship so much they’ll drop everything else for it, and supporting them any way we can. It’s hard to judge them two days into things. Hopefully you picked up on the fact that they’re all bright, motivated, and passionate founders who are focused on problem areas. Business models will evolve – that’s why great mentors like you are involved!

  10. Sitting in Boulder as I write this, I wonder at the ultimate viability of the concepts being honed at TechStars – are these seasoned founders or first timers? If they’re the latter, what’s the downside to a Meebo-style $12m round of funding for a concept with a 1000ish Alexa rank and no obvious business model? Given exit strategies are leaning more toward acquisition by Google/Yahoo/Microsoft/etc and not IPOs, wouldn’t expanding the advertising reach of those corps be enough to justify a focus on advertising supported ventures? Or are you suggesting that the 2.0 bubble is waning, (seems like it’s at about a May 2000 point relative to the first .com wave) and we’re going to actually have to be creative and find some way for someone to actually pay for something and stop dropping the ‘e’ from our .coms?

  11. To me it is just amazing that programers build businesses and get funded. I create value in business and would never think of actually coding a website. Not sure why coders think they can pull off biz models.
    Another way to look at it. In the long run, these bizs are giving something away to attract users. What advertiser can really monetize that well?? The ‘customers’ won’t pay the primary biz but they will click through and then pay?
    Luckily, I don’t have either of these problems.

  12. I worked at a startup recently for a year.
    They had a pretty decent app but were going for the sm. biz segment and had the typical freemium business model.
    I wrote a fun little video site / app on the side.
    1 year after the day gig startup launched, with 3 co-founders + 1 full-time developer, we were only at $2100 / mo. in revenues on the freemium model.
    At the same time, 6 months after launching my little side project, spending just a few hours a week on it, it was already doing $2k per month in revenues (almost pure profit).
    Just one small example. The CEO of the startup had never worked in advertising-based companies so he had no clue how much you can make from them, if they go over even moderately well. (20,000 – 50,000 daily uniques, any more is pure gravy)

  13. How is it that the biggest player on the Internet is an advertising-only model. Of course an advertising-only model is valid, in fact it’s the norm for most content publishers.

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