Silicon Valley Bubble or Barrier for Web 2.0 Startups?

Who's got it right?  Are the new breed of Web 2.0 start-ups good investments now or are they over valued for what they propose to deliver?  Have the three musketeers of the new web- Google, Apple, and Facebook- created such huge barriers that it will be extremely difficult for start-ups to compete?  We'll try to provide some persective on these issues as we examine two recent newspaper articles which take very different points of view.
On December 3rd, the NY Times ran a front page article that caught my eye.  It was titled, A Silicon Valley Bubble Shows Signs of Reinflating
The main message of that article is that VCs, Angel Investors, and established companies are rushing to invest in "me-too" start-ups that imitate popular and succesful Web companies. The article stated that "companies producing software for social shopping, mobile photo sharing and new social networking are finding it easy to attract investors because no one wants to miss the next big thing."
For example, Yammer- a company working on enabling Twitter-like messages inside businesses- recently raised $25 million.  Un-named investors reportedly put close to $30 million into a niche blogging site called Tumblr. GroupMe, a new group messaging app for cellphones, raised $9 million. Path -an iPhone app for sharing only photos on a social network limited to just 50 people- received $2.5 million. Its competitor, Picplz, scored $5 million. And those are just within the last few weeks.
Perhaps, this article was stimulated by Google's reported rejected $6B bid for Groupon- a company that has come on very strong in the last year. The implication is that many of these new web companies are worth a lot of money- but are they fairly valued?
Could this be a replay of the dot com boom, stock market mania and subsequent bust? Not exactly.  This time around, there's no stock market bubble and the IPO market has been very subdued.  Instead, entrepreneurs and their investors are increasingly looking to large technology companies – like Microsoft, Apple or Google- to acquire their start-up(s) for cash.  Those three companies have about $90 billion in cash on their books. McKinsey & Company calculates that the largest software and hardware companies have enough excess cash on hand to buy nearly all of the tech industry’s midsize companies.
Yet, there are skeptics that believe the size of the prospective deals will be much smaller than those envisioned by the investors piling into these new age web start-ups.
“I think at the high end, it’s not that frothy, but there’s a lot of exuberance in the early-stage stuff,” said Chris Sacca, an ex-Google employee and current angel investor who has decided to temporarily hold off on new investments until valuations drift lower. “A lot of the valuations there don’t make a lot of sense.”
Jeff Clavier, Managing Partner at SoftTech VC said that over the next 12 to 18 months the real challenge for start-ups flush with venture cash would be proving they were worth the investment or risk having to fold their companies.  Mr. Clavier told the Times, “There may not be a big implosion, but down the road there will be a bunch of blood and tears. The music is going to stop and people will realize there aren’t enough chairs for companies to get the next round of financing.”
Just a few weeks ago, San Jose Mercury columnist Chris O'Brien wrote a piece that raised caution flags for Web start-ups.  Chris' article, A dark trend runs through this year's Web 2.0 tech summit expressed his conclusion from the seventh annual Web 2.0 Summit: 
"That the days when the Internet was a playground for startups with unlimited potential are disappearing. Instead, we are moving into an era dominated by a handful of new Internet titans more interested in fighting each other for power and influence than in delighting users with new innovations."
Chris says the environment for startups is a lot tougher now due to the dominance of the aforementioned web giants.  He states, "the struggle of the big players changes the opportunity for startups. It will be harder for a big idea like Twitter or Zynga to break through and join the elite. Instead, more startups will focus on smaller ideas like apps, or designing new features in hope they will be bought by one of the big players."
Web 2.0 Conference co-host  Tim O'Reilly apparently agrees.  During the conference, he said, "We're seeing something very, very different than we saw seven years ago when it was all explosive new greenfield territory. We are seeing companies that are big — some of these companies are swelling in size. We're entering a period of conflict on the Web, of intense competition."
So we have contradicting views on the prospects for Web 2.0 start ups that are pursuing new markets or market niches.  The Times article implies that there may be a bubble in the valuations for many of these early stage companies.  But the Mercury's Mr. O'Brien thinks that they face a stiff challenge breaking into the turf now held by the big three of Google, Apple and Facebook.  Which one is correct and what's your opinion?

And on a separate subject, should we rename Silicon Valley as "Web Software Valley?"  The term silicon is now clearly a misnomer as the only true dominant chip company is Intel (OK, maybe AMD which no longer has a fab).
Note that when I came to town (March 1970) this area was referred to as "Santa Clara Valley- the fruit orchard capital of the world."   No kidding!

0 thoughts on “Silicon Valley Bubble or Barrier for Web 2.0 Startups?

  1. It was the best of times; it was the worst of times…..for some reason, that line from Dickens kept going through my head as I read this article.  With the proliferation of open source and web 2.0 technologies it is easier than ever to start a technology-based business.  The folks at Groupon started their venture with WordPress blog, which is essentially free in terms of capital cost:

    The upshot is that, thanks the low-cost and efficiencies of "cloud-based" technologies, a small team can do what would have taken an army in years past.  Whether the companies that are developing these new applications and services are over-valued and are mere features, instead of complete products, remains to be seen.

    At the same time, we have a Silicon Valley unemployment rate at approximately 11%.  Some of this may be due to the overall economy, but is some of it also due to a fundamental restructuring brought about the very technologies this valley invented  

    This valley has always been about reinvention – from the wheat fields of the 1860s to the orchards and canneries that were fading away when I was a child-  this region once known as the Valley of the Hearts delight will continue to evolve.  

    1. Hundreds, possibly thousands, of young, intelligent, hopeful computer science graduates blindly tune their focus to the hype incessantly promulgated by the media that the golden path to success is web 2.0 technologies etc. 
      While Facebook and Zynga certainly can establish themselves as small, profitable outfits, their valuations are utterly rediculous.   
      They have not solved hard engineering problems.  These companies barely add an atoms weight of new ideas, innovation, and engineering brilliance.  The closer you are to a real product, requiring real engineering, and real innovation, the further VC and angel will look at you.

      1. Dear Rediculous (why is your name spelled wrong?)

        Your comment resonates very well with me, but I have to try to be a bit more balanced and objective in what I post.  But not in this reply comment where I'm going to be brutally frank:

        I have been told that "infrastructure" has become a dirty word for both entrepreneurs and VCs/ angel investors.  That's because no one wants to invest in telecom or distributed computer infrastructure companies- at least not in a US based start up.  Yet that's where the core engineering skills are needed.

        All the mobile apps, mobile payments, games, e-commerce, etc have nothing to do with science or engineering.

        The key telecom engineering skills of transmission (coding, modulation, demodulation, filter design, regenerative repeaters), error control/ OAM, routing and switching, algorithm development, and protocol design are generally not needed in industry and certainly not by web 2.0/social media/mobile apps software companies.  That's because there are very few established companies doing these tasks (e.g. Cisco and Juniper in the switch/router space and semiconductor companies or ASIC Divisions of large companies for other telecom functions, which are now realized in silicon).

        For me and other telecom/ computer old timers the demise of innovative new network infrastructure (access, inter-office, and core network) represents a COMPLETE ECO-SYSTEM COLLAPSE, with no recovery in site.

        Bottom Line: Traditional electrical engineering skills don’t seem to be needed by most equipment or semiconductor companies anymore, and certainly not by the web 2.0 start-ups!

  2. One blogger strongly believes there's a bubble in web 2.0 startups.  Damien Hoffman writes:

    "Unfortunately, it looks like a lot of people will watch their angel investments go bust. As the Nasdaq rebounded and Silicon Valley got its groove back, a huge wave of wannabes have started tossing bets at any Web 2.0 company with a sweet deck or glossy user interface. As with all investment cycles, once the “dumb” money starts piling in, it’s only a matter of time before smart money bolts like lightening and the newbies feel the thunder.

    “But,” you say, “Web 2.0 has so much potential! How can it burst?”

    First, if the stock market goes sour or the economy slows, revenues will decline and M&A will slow (or cease). Therefore, the creative destruction phase will wipe out more investors.

    Second, and this is the one I believe will hit hardest, many Web 2.0 businesses will crash in value because they are merely features (Cf. defensible value-adds). For example, all of these are features which you too can compete with by simply hiring someone on ODesk (for an inexpensive wage and no equity): comment plugins, URL shorteners, social feed aggregators, analytics platforms, productivity solutions, etc.

    If you don’t have a barrier to entry (e.g., patent, trademark, complicated engineering, high startup costs, etc.), the Invisible Hand is on its way to bring 10 more copycats into your niche."

  3. Great article!  What do the TiE Angels think about the outlook for Web 2.0 companies?  Is it all about new forms of collaboration and photo/video sharing or something else?  Have any Web 2.0 companies presented to TiE Angels?  If so, what was their deliverable product or service?

  4. Thanks Alan for a good article! It sure will stir some debates (we like debates) on the topic.
    I don't think the Valley should drop it's name.. Silicon Valley is no longer about a specific  techonology type.  It's about all  technology types,  innovation, risk-taking , optimism,  free-markets and free spirits. Combine that with a great  culture of educational excellence, abundance of capital, encouragement and support from society. And its continued impact globally. No wonder the whole world has come up with a designation of "Silicon This Or That" in their own locations.

  5. It's more like the entire web industry has been ignited by social networks, giving users a strong incentive to finally jump on and begin using the network as a necessary part of their lives.   We've seen this cycle before in the advance of voice networks — it was only when everyone you knew had a phone that it became critical to have one.   This geometric growth has created a shift in human organization.  Gone — or soon to be — are a myriad of industries (publishing, music / film distribution, postage, groceries).  Next, as the need to actually move atoms begins to decrease, expect the automobile and transport industry to fail.   Soon, we'll all have vestigial legs!

  6. First, I think we should retain the name Silicon Valley, even though this place keeps re-inventing itself and now has little to do with semiconductor design and almost notthing to do with semiconductor manufacturing/ fabrication.

    Second, I think older people don't use social networks very much.  Personally, I use Facebook to stay in touch with my family and to promote IEEE ComSocSCV as well as the SUNY@Stony Brook N CALIFORNIA Alumni Association.  I use LinkedIn to connect to several business colleagues.  Twitter to push info on new articles I've written as well as a news feed from my favorite newspapers and magazines.  I do like social networking web sites like and where I"ve been the moderator and manager. 

    So I'll pass on all the new age, location based social networks, shopping, and photo sharing sites.  I think those are still for teenagers or twenty somethings 

  7. In the mobile Internet space, the big theme is to combine location with something that would be useful for the subscriber on the move.  There may be some niche markets in that space, but would it be a 1 trick pony for the startups that suceed?  What would they offer next or as a follow on product?  Would their solution work on multiple platforms/ mobile OS's?

  8. Thanks for a very analytical and insightful article!
    It seems there are a lot of me-too startups pursuing: mobile apps, e-commerce, gaming, and other types of niche market web software.  Even if they're successful, what will be their follow on product?  And if there is none, how much is a 1 trick pony worth?

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