Selling shovels to Web 2.0 gold miners

Venture capitalists are spending big on start-ups that are peripheral to sites like MySpace, Facebook and YouTube. Companies such as Panjea, Vuvox, Mixpo and Share2Me give fans of Web video and photo-sharing the ability to easily reformat or repost multimedia content that's already floating around out on the Web. These little companies are taking a page from the old saying about the California gold rush: It wasn't the gold miners who got rich, it was the guys who sold them the shovels.

"Everybody keeps trying to get people to come to a new place, whether it's a new social network, new tool, whatever," said Mike Blackwell, CEO of Share2Me. "It's possible to do that, but generally that's really hard and takes lots of money and lots of time."

Of course, more than a few companies applied that "sell the tools" logic to the dot-com boom and, while a few did make a go of it, many spectacularly failed for two main reasons. First, there's lots of competition to do business with the big Internet companies. Second, building a business entirely dependent on advertising sales--as some of these start-ups are trying to do--is even harder.

It's difficult to measure exactly how much venture capital is going to these "peripheral" Web 2.0 companies, but there's little question money is going into the sector. In 2006, through the third quarter, $28.93 million was invested in media, content and information start-ups, according to VentureOne. That's out of $455.47 million in venture capital spent on Web 2.0 companies, including peripheral tool makers. By comparison, in all of 2005, $17.25 million was invested in the media content category.

"I think a lot of VCs are deluding themselves, in my opinion, as if something is so different now than in '99," said Pete Sinclair, a partner at Leapfrog Ventures. "There are exceptions: There are companies that have sound business models underlying them. But a lot of these companies just don't measure up to that standard."

Don't forget about revenue
This seemed true of some of the startups at the recent Demo '07 conference in Palm Desert, Calif., where 68 hopefuls tried to wow an audience of potential investors, analysts and journalists with their fledgling ideas.

In that start-up crowd, the media-sharing tool sites were betting on embedded contextual text or banner ads, or were looking to establish partnerships with specific sponsors. But many of them hadn't quite nailed down exactly how they plan to make money.

Take Mixpo. It's a multimedia player for sharing original video, photos and audio, and is aimed at people and businesses who want to promote themselves online. Mixpo is backed by the Madrona Venture Group, an early investor in Amazon.com.

Though selling ads is part of the plan, as well as perhaps offering another licensed version to businesses, "it's fair to say the exact monetization around the idea is not clear," said Matt McIlwain, managing director at Madrona Ventures. But give it time, he said. It's an early-stage start-up, and there are far more online advertising opportunities today than there were eight years ago.

As online ad spending has increased to $16.4 billion, (a more than 40 percent increase between 2004 and 2006, according to eMarketer) so too has the number of products vying for those online ad dollars. Though "the pot may have gone up by 10 times," he said, "the (number of) people going after that pot went up 100 times."

The YouTube model
The best hope for many of these Web application start-ups formed around a single feature is to get acquired, Sinclair said. "That only happens if your feature is technically sophisticated enough that it's not easy to duplicate, and that's not true of most of these companies," he said.

Seth Alsbury, CEO of Panjea, agreed. He will officially unveil Panjea.TV, a tool for creating music video channels that can be embedded on MySpace or blog pages, next month. However, he is aware that many others could easily mimic the product.

"The technology's accessible," Alsbury said. "There's no rocket science here. Thankfully, Panjea's filed a comprehensive set of patents, but that's not going to stop anybody."

Aware that their technology is easily duplicated, but not keen on flipping their company to Google, these companies are hoping for long-term survival by establishing a recognizable brand.

YouTube is the obvious example. In a very short time, the name became synonymous with video sharing. The site was purchased by Google last year for $1.65 billion in stock. But it wasn't its revenue Google was presumably after, as much as the 30 million visitors who watch and upload video clips each month.

Share2Me is following a similar--if likely more modest--path. Share2Me provides a button that can be embedded into a Web browser. When it's clicked, it enables people to share pictures, text, URLs and video via services such as Gmail, Facebook, MySpace, Hotmail, Yahoo Mail and AOL. Instead of trying to draw people to a new destination, Share2Me is trying to link its brand name with online media sharing, Blackwell said.

But building a viable brand is expensive and far easier said than done--a lesson many companies have learned the hard way.

"In 1999, that's what everybody thought they were doing," Sinclair said. "It's doable, but it's very challenging."