Web 2.0 Paradigm

Almost every one is jumping on the web 2.0 a.k.a. "The Return of the .coms" bandwangon, basically web 2.0 is all about social networking and thick web clients using some or the other Ajaxian techniques. Given the previous trackrecords of .coms (2000ish, when it went bust), one really has to think the business model behind this all, I was recently reading pretty insightful Russel Beatties' post around the same (aptly titled WTF 2.0) where he raises the same questions which I've been having since long...what's the business model of all these web 2.0 .coms which have mushroomed out of nowhere all of a sudden?

First things first, let's see how web 2.0 differs from web 1.0 (portals was the buzzword then) sites, I see two major differences:

1. The internet penetration: the majority of people now have faster internet connections like cable or dsl (think abt dialups then), so an Average Joe spends more of his time online.
2. Social networking: almost all the portals had very little or close to nothing end-user involvement, all the end-user was able to do was read through myriad of information and hence the end-user retention rate used to be pretty low and it wasn't attractive enough for the new user to create an account. Think web 2.0, be it del.icio.us or digg it's the end-user(s) that control the content: I like a news and want others to read, I digg it, liked a website? bookmark it at del.icio.us. Now it's all about sharing your(i.e. the end-user) knowledge, interests etc with the world, the current web apps just aid in orchestrating the information.
3. Mindset shift: Another differentiating factor is that the Average Joe is more comfortable now in managing a good chunk of his life and time online, for e.g. earlier a lotsa people used to be sceptical abt buying anything online but that number has come down drastically (think iTunes etc.).

Now to the main point, yes web 2.0 have a better user-retention model than web 1.0 portals but where's the cash inflow? Given that the domains and shared hosting is dirt cheap nowadays almost anyone from a college going kid to a homely mother of 5 can start a web 2.0 out of his/her pocket, no problems here, the problem comes when you get popular as Russell points out in his post. You've more requests & users than your shared host can handle, so now either you shut your shop or you invest some chunk of your money into getting a better infrastructure for site. So now we do have a pretty high TCO (good cash outflow without any inflow), so let's try to think of the ways of generating revenue, I can only think of 3 ways that you can generate revenue online and be profitable (not taking into a/c conning a VC to invest), listed below in order of profitability:

1. An Ad-Free and really free website: See point 4. Examples: 43things, technorati, del.icio.us etc.
   
2. Contextual Ads: Sign up for Google Ads or Yahoo! Ads or whatever and hope Average Joe's gonna be enticed enough to click on the ads enough number of times for you to make some good moolah (this might work if you're still on a shared hosting and the investment that you've made is pretty low). Examples: Digg uses this model by the way, this can't be their only revenue model, given that Alexa rates it among the top 500 websites they gotta have more than 1000....(fill in the remaining 0s) users which can't be supported on a shared hosting.
3. Sell something: Needn't be a physical product like amazon or ebay sells, could be some advanced features or goodies of your website. Example(s): flickr.
4. Wait for a bigger fish to swallow you: Given that some bigger fishes like Yahoo! are buying almost everything under the .com sun, build something niche (actually needn't be that niche either), get a good user base to boast off and start approaching bigger fishes whom you think might be interested in your thingie. There are few caveats with this though: first define the exit criteria pretty clearly, what if no fish takes the bait? then either be prepared to wait and shell out more from your pocket or shut your shop quietly (online users generally have a short memory span, they'd forget you and move on). Generally, the bigger fish would be more interested in buying "a company" which can exist on it's own than buying just the idea (ie your website & perhaps you), so point 4. is indeed your exit strategy then you might indeed have to look at conning VCs ;-). Think off the bigger fishes which might be interested in your kinda app upfront and define the technology platform based on that for e.g. it would be tough to sell a Java/Apache/PHP/Linux based web 2.0 app to Microsoft and equally tough to sell ASP/.Net/SQL Server based website to Yahoo! or Google. Examples: flickr, webjay, upcoming.org, orkut etc etc etc.