Web 2.0 and Two-sided Markets

Last Friday Andrew Chen wrote a great article about ad-supported websites. His thesis boils down to the following snippet.

The key thing here is: The users of your website are not really your customers. Instead, the entire process of gathering eyeballs is just to sell to your ACTUAL customers, who are the ad agencies and advertisers. Get it? Your Web 2.0 consumer startup is actually a B2B that sells inventory to brand advertisers.

Subtleties

He brings up a worthwhile point, which is that many developers looking to make the next hot thing don't really understand the role advertisers play in their ecosystem. For developers business development, marketing, and advertising are all dirty words. They certainly don't view themselves as trafficking in attention, even though many if not most hot web properties make money by selling their users' attention to advertisers.

This is one extreme — marketing and advertising are dirty and our first duty is to our users, not our advertisers. Andrew's is the other — if you're making money through advertising then you're going to have to serve them above your users.

As it happens the situation is more complicated. Media companies, which I define as companies that sustain themselves by buying and selling attention, exist in a two-sided market. This includes ad-supported companies. (Yes, Facebook and Google, you're media companies, not technology companies.)

Here's a diagram that describes the economics of an ad-supported media company

In a two-sided market both sides can and do affect the other. Most developers are at least tangentially aware of this when they express fears that ads will drive users away. But if you do it right the relationship between you, your audience, and advertisers can be symbiotic rather than oppositional.

A good example of this sort of relationship is my former employer, Sugar, Inc. On occasion advertisers will pay to dress up the avatars that live at the top of their content sites like PopSugar.

The audience likes it because they enjoy fashion and it adds personality to the site. The advertisers like it because it's a unique value proposition and it attaches them strongly with Sugar, Inc.'s brand. And Sugar, Inc. likes it because it makes them money.

Creating Value vs. Stealing Value

It comes down to this: it's possible, if you're clever enough, to create situations where everyone wins, even if you're an ad-supported media company. And your goal as an an entrepreneur should be to create value.

To create value it's important to align your interests with your customers. This might be more difficult in a two-sided market since, in effect, you have two sets of customers.

But as Andrew points out there are other economies that are possible in the Web 2.0 world, such as e-commerce, subscription fees, or virtual goods. These might be easier if they're appropriate, but it's a mistake to think that supporting yourself through advertising automatically makes you an enemy of your audience.