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There seems to be an increasing number of large funding rounds taking place in the consumer internet space.

From Slide's $50m to MOLI’s $30m, big money is in play.

I've watched recent funding announcements for a couple of reasons:

  • I've argued that, despite claims to the contrary, consumer internet startups today are not "frugal" in comparison to their Bubble 1.0 counterparts.

    While Slide's $50m raise might seem small compared to all the Bubble 1.0 ecommerce companies that raised well over $100m, when one compares the true capital needs of these different breeds of companies, I think the level of overfunding is quite proportional.

  • While startups often like to claim that they're recession-proof (or can even thrive in a recession) when the economic situation gets gloomy and startups begin to take huge chunks of capital, it is often a signal that entrepreneurs are worried about their near and mid-term prospects and want to make sure they can survive.

    While this can be a wise move, that should not distract us from recognising that this is a bearish indicator.

So I was interested when I learned that a startup I actually like, Etsy, just closed a $27m round of investment from Union Square Ventures, Hubert Burda Media and Accel Partners.

Etsy, which describes itself as "an online marketplace for buying & selling all things handmade" has a simple mission:

"To enable people to make a living making things, and to reconnect makers with buyers."

It's a simple business that probably isn't going to become the next eBay, but that I expected could carve out a decent little niche.

That said, the amount of money raised by the company seems disproportionate to the size of the opportunity. As such, I think Etsy makes for an interesting case study, especially because the company's CEO, Rob Kalin, posted an explanation about the funding on the company blog.

"We do not want Etsy itself to be a big tuna fish. Those tuna are the big companies that all us small businesses are teaming up against...Those big companies are holdovers from the days before the web existed. And any company that is being run the same way now as it was before the web came about is due for some massive restructuring or deflation."

He added:

"This means that we now have the resources to extend Etsy's reach in this world, to enable so many more people to make a living making things. We want Etsy to exist for hundreds of years. Our goal is for Etsy to be an independent, publicly traded company, focused on all things handmade."

I like Etsy but it's clear that the founders are idealistic and quite possibly out of touch with reality and the economics of mass-production. Many individuals produce hand-crafted items.

Unfortunately, it's tough to make a living this way and mass-production is required to produce enough essential goods for a world with more than six billion people.

Furthermore, the average consumer, who himself or herself may be feeling financial pains, makes a considerable number of purchases based primarily on price.

The Cynical Drama 2.0 would note that the people who are most likely to buy "handmade" items are holier-than-thou, bourgeois liberals.

Rob goes on to note that Etsy is "almost break-even." But here comes the catch: "it's not enough."

Etsy needs to invest in infrastructure to keep up with the service's usage growth, it needs to develop new features, wants to improve customer service and feels obligated to keep its employees well-fed.

Perhaps most interestingly, he also mentions that "we need to be able to make it through any hard times that hit the economy," giving credence to my belief that large funding rounds often signal bearish economic sentiments.

All this might sound fine and dandy, but I see two major problems:

  1. Etsy has a simple business model - it charges 20 cents for a listing and takes a 3.5% cut of each sale.

    Unless it starts charging for other services and/or increases its fees, the economics of the business are fairly predictable.

    If the current pricing, metrics and projected growth figures don't align to enable the company pay for the $5m it anticipates it will need to spend on hardware and hosting over the next two years just to keep the service running, it would appear that the company has a problem scaling the business that isn't going to be solved long-term with a capital injection.

    Unlike advertising-dependent companies, which often scale rapidly to support volatile and hard-to-project perceived revenue ceilings, Etsy has a business model that should enable it to scale in a more sensible fashion.

    Since it apparently needs a considerable amount of capital, however, it's clear expenses have grown more rapidly than revenues (for instance, why does the company need close to 50 employees?). This is not a good sign, especially for this type of business.

  2. In hard economic times, the odds that hordes of mainstream consumers are going to be paying a premium to buy "handmade" goods over the internet are not good.

    To the contrary; consumers are likely to turn to the Wal-Marts of the world because they can get more bang for their buck.

    Again, even in prosperous economic times, buying certain "handmade" products is typically the domain of those who have higher-than-average disposable incomes (or those searching for a piece of "art" or a "gift").

In short, Etsy is a perfect demonstration that:
  • The claims that successful internet startups can be built a lot less expensively today than they could in Bubble 1.0 are often false. Entrepreneurs continue to build internet companies in a fashion that requires hefty capital investment and the same common problems (an inability to scale up in accordance with revenues, investments that are disproportionate to the size of the market, etc.) are just as present today as they were in the late 90s.
  • At least some of the current justification for raising large rounds of funding is based on concerns about the economy.
I certainly won't fault any startup for taking big money based on economic concerns, as this is a survival move, but unfortunately I think a lot of these big money investments are going to end the same way the big money investments in Bubble 1.0 did.
Drama 2.0

Published 31 January, 2008 by Drama 2.0

237 more posts from this author

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zephyr

a recent book that i read on easy ways of internet marketing was quite interesting. the author, Jeff Paul is supposed to be a professional in guiding people on web
businesses and how to make easy money through the web while sitting at home! Was quite a captivating book! i advise you all to read it.

over 8 years ago

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Daniel

This is an excellent article, which I stumbled across and I agree with many of the statements made especially in terms of the cost of creating websites. Many people believe that this has decreased but Web 2.0 has in fact increased the cost as entreprenuers seek to satisfy consumer demands for media rich content and services.

Have you written anything similar on websites such as elance, ifreelance, and more notably domystuff.com which is an excellent new-ish concept but has no obvious signs of generating income?

over 8 years ago

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BetterRetail

Excellent article. Your points are very valid. There is most definitely a consolidation happening in the online marketplace.

over 8 years ago

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Jane

Overall this is a good article with some very good insights, but I do think it's a little misguided in places.

Primarily I do think there is a bigger market for handmade goods than you'd expect. People are keen to find items for themselves and as gifts which nobody else has - or at least very few other people. While those items are primarily non-essentials, there is still a big market for them. Those who cannot afford non-essentials of course aren't part of that market, but an awful lot of people are. It's never going to be an Ebay sized market where anything and everything can be bought and sold (including handmade items of course), but it's pretty decent.

Also prices on Etsy are hardly excessive. In fact, the issue of under-pricing is something which is frequently discussed within the Etsy community. In addition there are a large number of lower priced items for sale (US$15 or less). So I don't see that as a huge issue at this point either.

Another point to make is that while Etsy charges a mere 20 cents to list an item, the way the site is set up means that for sellers to be visible, they must list and/or renew very regularly to remain near the top of the categories and search results. So this is, in fact, a type of advertising revenue. Listing at least once a day is the general advice given to sellers, but many will list four or five times a day, so that's up to a dollar a day they're spending purely on being visible. There are also paid advertising spots available on the site, although most people feel they are primarily not a good investment and would prefer to spend the same money on listing.

Finally, your article is written as if the only market available to Etsy is in the US. This is absolutely untrue. There is a figure of 40% bandied around of the number of non-US visitors to the site. Given that Etsy itself seems mostly ignorant of the non-US market and gives it very little attention, with a change of thinking this market could make up a huge piece of Etsy's customer base - especially buyers of items.

This will potentially make a great difference as most western economies are faring far better than the US currently is, their currencies are also strong and they are used to paying far higher prices for pretty much everything. Particularly in Europe - but even in places like Australia and New Zealand - the prices in USD on Etsy generally seem inexpensive, even factoring shipping costs.

However, Etsy itself is the biggest risk when it comes to the success of Etsy. For instance, you've picked up on the astounding number of staff they have for a relatively business. Those associated with Etsy know that a fair number of those people are involved in work which is of little or no value to users of the site. We're also aware that many of them have minimal experience in the areas in which they're employed and at least a few of them are extremely unprofessional in dealing with their customer base.

This is a symptom of the broader problems with Etsy - a great lack of general business experience and knowledge, too much arrogance to realise this is the case, a lack of skills in vital areas (take a look at their HTML, for instance) and sometimes a grave lack of professionalism which is doing a lot of harm to the reputation of the business amongst its customers.

Most of us who have a stake in the success or failure of Etsy are hoping that the injection of $27 million comes with big strings attached and particularly a big say from people who have a lot more business sense and skill than has been seen to date. That could be enough to make something of this business, to help it weather the US recession and really see it become profitable both for the owners and investors, along with the thousands of small businesses selling via the site.

over 8 years ago

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gurlfaa

Definitely a consolidation happening in the online marketplace.itself is the biggest risk when it comes to the success of Etsy. For instance, you've picked up on the astounding number of staff they have for a relatively business.

over 8 years ago

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Rebecca Pokela

This article is rather interesting. I am a buyer on Etsy and through reading your highly unresearched article I realised how uneducated and narrow minded some of you actually are. If you actually did your research you would have noticed that Etsy is not just about hand made goods but it's about supplies. In just the past few weeks I personally have spent a couple hundred dollars on buying fabric and craft supplies that are not available at the magnificent and sucker fueled WalMart, let alone the other craft stores out there. They have name brands that yes they are available at the convenience of your finger tips but they are not always available in the ideal increments, cuts or price. Some of these craft items are also retired, rare or just plain hard to find.  Walmart along with other stores have cut down on their crafting supplies. The Walmarts in Wisconsin have removed all their fabric and sewing notions from their stores, making it harder for us stay at home moms to find what we are looking for. Not to mention Walmart had one of the saddest fabric selections to begin with. Maybe they are the misguided ones.  Shame on some of you for basking in someone elses failure. I'm sure that along with me others would agree that Etsy is a genius idea, they make it possible for us stay at home mom's who don't sit on are asses and expect to make money. In fact we bust are asses taking care of our children and our homes and still we are making our craft/art items in hopes we'll make a few bucks. In fact we are so busy and exhausted that at the end of our crazy day we can't even fathom peeling of our baby spit-up encrusted clothing to make ouselves presentable to the outside world so we turn to ETSY to buy the supplies we need.

One more thing I would rather a handmade item over a crappy cheap factory made walmart gift anytime. At least I know that it's original quality and this gift was made with love and hope and I would apreciate a gift more if I can look at it and be inspired and I can imagine the story behind it.

As for your prediction well I think you can find a place to stick it. Or prehaps you can post it on etsy I'm sure it will sell as a wonderful dartboard item. Or some of us will turn it into pulp and recycle it into something more useful.

over 7 years ago

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