Fred Wilson of A VC has written a really well articulated post called, "Point Solutions vs. End to End Solutions" that raises the question of whether the Web 2.0 mantra of lightweight "point solutions" that can be stitched together by consumers are preferable to end to end solutions that are provided in fully baked form by the service provider.
You can read his post and reach your own conclusions, but I would re-frame the question somewhat. Underlying his post is the question of whether Web 2.0 companies (see my earlier post on what the hell Web 2.0 is) can deliver enough best of breed differentiation and compelling-ness to grow into large standalone companies. If they can, then the space will be "VC worthy."
If they can't, then venture financing will be unavailable to these companies, the space will give rise to a bunch of niche providers and their best prospects will be to get acquired by a major portal (at whatever the market will bear) or more likely, be run as a cash flow business.
As I was chewing on this one, I was struck by a few thoughts. One is that the above scenario feels pretty consistent with what you would expect from The Long Tail, where the mass-market provider sits at the head, and the multitude of serviceable but small market niches collectively make up the (long) tail.
To be clear, this scenario isn't meant to suggest that such companies would be cruddy businesses with limited growth prospects, just that they wouldn't be VC finance-able. In fact, because these businesses are more narrowly focused on the needs of a specific customer segment, product and service offerings are likely to be meaningfully differentiated, and consumers are more likely to pay a premium for that differentiation.
Moreover, the loosely coupled nature of Web 2.0 application service models means that the cost of customization for the provider is likely to be pretty low relative to monolithic application development models.
As such, this is a great outcome both for the long tail consumer, who will in effect have what feels like a customized solution at a commercial off the shelf price, and for the long tail provider, who can target naturally adjacent market opportunities without significant re-engineering of their offerings (ala the beachhead and bowling pin strategy articulated by Geoffrey Moore in Crossing the Chasm).
So how might VCs play this one and what strategy does it suggest that Web 2.0 upstarts pursue?
I think for the venture community it suggests one of two things. One is that it becomes a lot harder to seed new companies targeting the "mass" consumer market on the premise of unlimited growth potential.
This is because the mass consumer has proven time and again that they will default to following the crowd versus specifically searching out best of breed. This obviously favors the Googles, Yahoos and MSNs of the world, inasmuch as they already have a large crowd, and the downside of Web 2.0's emphasis on open standards and open APIs is that incumbents can be fast followers and still get a good seat at the party. This forces a re-factoring of investment/return underwriting criteria.
Or two, it forces crafting a strategy that I dub "hit them where they aint," an axiom of Wee Willie Keeler, one of the best hitting players from the early days of baseball. In hit them where they aint, venture capitalists formulate an investing strategy around funding companies that target market opportunities that the portals are unlikely to chase on their own. These are market opportunities that at first blush don't fit the "mass" definition, which is all about satisfying the needs of the lowest common denominator.
By contrast, in segments where being best of breed and highly specialized from an integration, usability and workflow perspective is a game changer for the consumer, Web 2.0 upstarts can grow in a (relatively) protected environment since little of the corporate DNA of the portals suggests an ability to satisfy the needs of this type of customer.
Three customer segment types come to mind that seem to pass the sniff test. One is the prosumer. Prosumers are a different breed. The blogger who has assessed the different blogging tools before settling on TypePad or WordPress is never going to default into using Yahoo 360 or Blogger. And last time I checked, Six Apart, makers of TypePad, were booking some serious coin. For that matter, Apple has created a whole generation of digital music prosumers around iPod and iTunes.
Two are offerings targeted at creating online spaces, such as services that manage the flow of information between the boundaries of work, home and mobile, or value chains between consumer, vendor and sales/support channel, and virtually all of the offerings that will emerge to address the needs of small and medium sized businesses, an area where Salesforce.com has done pretty well.
Finally, there are verticals like data services built around health and finance, or professional services built around accounting, law or graphical design. If you read, "The World is Flat" by Thomas Friedman, it is hard not to see the Web 2.0 model catalyzing the emergence of eBay-like marketplaces where such services are sought, bought, sourced and staged.
Ah, the naysayer, is probably thinking, "Wait a minute, are we still talking about consumers? This sounds like B-to-B or enterprise, or…" But this is the point of Web 2.0. The boundaries between consumer, business, enterprise, enduser, vendor and channel become increasingly situational.
Case in point, as a blogger, am I writing this post as a consumer, an entrepreneur, a consultant, an investor, or what? Is Google a consumer company when so many of the activities it facilitates are business oriented? Finally, is there any question that unlike the past where innovation began in the enterprise and proliferated to the consumer, the exact opposite scenario is playing out in the present?
Netting it out: I haven't been this excited about my industry since the first time I played with Lynx, a text based precursor to the graphical web, and had the same "AHA" moment that I am having right now. Lots of questions to be answered, and increasingly the road ahead is more like chess than checkers, but exciting times indeed for entrepreneurs, investors and consumers alike.