Service businesses are great for boostrapping. You find one customer, get a little cash, use that to do a little marketing, find a few more customers, get a little more cash, and it feeds and feeds on itself until the next thing you know, your plate is full of customers and you never had to borrow a dime or take any investment money. The problem of course is that service businesses don't always scale very well.
Scale. That is what you want in a business. You want the ability to scale efficiently. One of the reasons that Web businesses are so attractive is the scalability factor. As a web company grows, the marginal cost of serving another user is low, and rising to the top of organic search results has a self-reinforcing nature to it. If you can get to that point, you become very difficult to dislodge as king of the hill. Can you make it to that point, though? That is the real issue.
I started thinking about this the other day while looking at an arbitrage situation. I am a huge fan of behavioral economics and much of research in the field examines arbitrage situations and how you can profit from investor irrationality. The challenge with arbitrage is whether or not you can hold your position long enough to make money. Just because everyone knows two asset values are going to sync back up doesn't mean anyone knows when that will happen. Irrationality can last a long time. Can you make it to the payday? Tough to know. But let's turn our attention back to building a web company. My assertion (and feel free to disagree if you don't think this is true) is that web companies that have the potential to become large scale businesses don't grow the way other businesses do. I'm not talking about a business that gets to the point where it can employ you full-time and that's it. I'm talking about a business that can hit a 7 or 8 figure revenue number, has multiple employees, and is profitable.
Making money online is a popular topic, but web businesses rarely grow the way, say, a carpet cleaning franchise might. I think that to be successful online you need to catch a fad, have lots of financing, or be willing to work for free for a long time. Here are the pros and cons of each approach.
Fads – Fads are an excellent way to make money online. You launch a website and it explodes. You don't need any financing. You make money from the first month you run the site. But can it last? Fads are very difficult to identify and successfully exploit. Timing the top to make sure you get out is also difficult. And repeating the play – having a second successful fad business – is rare. You could waste a lot of time chasing fad after fad if you are too concerned with trying for that easy money.
Financing – If you want to build a business for the long-term, and you want to build it on the web, you probably need to start before your idea reaches mainstream. It would be tough to build a photo-sharing site right now and steal users from Flickr and Photobucket. You have a better shot at success by going into a market that is relatively new online. But to do that takes money. You have to spend time building your product for months and months while cash is only going out. It's great to be able to have that kind of patience and to focus on doing things right. The downside is that only a small percentage of potential web entrepreneurs have the kind of idea, abilities, background, and connections to raise money for a venture. If you bet your company on the idea that you can raise money for it, you could end up spending all your time raising money and no time developing your product. By then you could have lost some market segments, or a large group of potential customers to competitors.
Free – I think this is the way many many web companies start – somebody working for free. I believe that's how Delicious was started, and I know that is what the guys at Profilactic are doing. It's probably the best strategy for building a large company for the long term, but much like our arbitrage situation, the issue is how long you can afford it. Can you stay on that shared server? Can you keep working nights and still focus on your day job? The key, I think, to a successful web company that starts with free labor is to love working on it. Passion leads to success.
So where do you stand with your idea? Which model are you going to pursue? With a $200,000 small business loan, you can do a lot with a franchise or some sort of local service company. You can probably reach profitability at that level, and grow it into something in the 7 figure revenue range. But on the web, $200K is sort of a no-man's land. It's enough to hang yourself, unless you are riding a fad in which case, you probably didn't really need the money.
When you set out to do business on the web, you need to understand not just where you are, but where you are going. And then you have to figure out which of the three Fs will get you there. It's never easy, but picking the right plan of growth, the plan you are comfortable with, is a good step in the right direction.