Will the Recession Kill Web 2.0?

By JEREMY LIEW

The last fast few years have seen resurgence in Internet companies not seen since the bubble years of the late 90s. The growth of these advertising-supported "Web 2.0" companies has propelled online advertising sales to $21 billion from $6 billion between 2002 and 2007. But the last recession pricked the bubble in 2001. What will happen to this crop of Internet companies?

The broader economic recession has not spared the Internet sector. Online display advertising is projected to be flat to down by RBC Capital in 2009. It is hard enough for internet startups at the best of times. Which companies will come out of this recession the best?

About the Author

Jeremy Liew is a Managing Director at Lightspeed Venture Partners, and an active blogger on the consumer internet industry.

I predict that media buyers will focus on both a flight to quality and a flight to surety. This will benefit three types of startups: companies with large audiences, companies that sell direct-response advertising, and companies that offer valuable niche content.

In a period of uncertainty, media buyers will look to trim lower quality sites from their ad buys and focus on a smaller number of higher quality placements. Quality will likely be measured by both familiarity and scale. Sites with well known brands and meaningful traffic will remain in the ad plan. Just as no one ever got fired for buying computers from IBM in the 80s, so too no one will get fired for buying advertising from Google and Yahoo! today.

But big companies at scale and monetizing well, like Yahoo! and Google, are feeling the bite of the recession. Both companies have guided expectations downward recently. This is because they are already at full monetization scale, so there is no escaping the economy.

However, many smaller companies have built huge audiences that are just starting to be monetized. These are the companies that will see the most growth through the recession. Today they are not fulfilling all the potential demand for their inventory because they don't have enough sales people to respond to all the possible advertises. The simple act of adding more salespeople will benefit them. Examples of such companies include social networking site, Facebook, news aggregator Digg and widget-maker Rockyou. (Full disclosure: I am an investor, and a believer in Rockyou).

In an uncertain environment, advertisers will also want to shift more of their advertising budgets to direct response (the online equivalent of 1-800-number advertisements) and away from brand advertising. Much of the direct response advertising is ultimately sold on a CPC (cost per click) or CPA (cost per action) model, rather than the CPM model based solely on the number of ad impressions shown. This makes direct response more of a "sure thing" for advertisers.

Media companies who can apply behavioral targeting and other forms of targeting will be able to improve click through rates and conversion rates. Companies like Revenue Science, Azoogle and Tatto can better identify which customer to show each ad, and will benefit disproportionately.

In a similar vein, ad buyers will want to stick with the surety of their established methods for targeting brand advertising. This is and has always been to buy content adjacencies. The demographic and behavioral targeting that may work for direct response will be harder to sell to brand advertisers in the recession. It will be very hard to prove that these forms of targeting are more effective and justify a premium price. As a result, vertically focused content sites will have an advantage. Examples include the Health Central Network, Flixster and Like.com, all companies that have aggregated large audiences with a singular content focus attractive to endemic advertisers. (Full disclosure: I am an investor and a believer in Flixster).

So there is a silver lining to even the dark clouds of this recession. Certainly there will be many companies that suffer over the next few quarters, and some that will fail. But Web 2.0 companies with large audiences and the right advertising model will benefit from a flight to quality and a flight to surety. They may exit the recession even stronger than today. However, since many of these companies are not yet profitable, they will only benefit if – and this is a big if – they have enough funding to ride out the storm.

Write to Jeremy Liew at jliew@lightspeedvp.com

Original here