But does it? What exactly is so bad about making a few hundred million a year? Is that anything to scoff at? A strange delusion overtakes the tech industry in good times. When entrepreneurs see a few startups selling for billions—in 2006, Google snapped up money-losing YouTube for $1.6 billion—they believe that they, too, can realize billion-dollar dreams, and in the process they overlook million-dollar opportunities. "People tend not to look closely at the odds," Hansson told me. "There will always be people winning the lottery, but that doesn't mean a good financial strategy is to go out and buy lots of lottery tickets."
Instead of taking a heap of venture capital money—lottery tickets—in the hope of one day getting a huge payout, Hansson says that Web entrepreneurs would be better off starting their businesses in the way most offline entrepreneurs do: Use a small amount of seed capital to make a good product that appeals to a client base that is willing to pay you for it. Then, over time, use the money you make from your customers to improve the product or to create more products—allowing you to attract more paying customers, which then lets you invest more into the business, and so on. It's a cycle that has proved quite successful over the millenniums that humans have engaged in economic activity.
Hansson calls this the neighborhood Italian restaurant model of Web commerce: It's a lot easier to start a nice neighborhood restaurant than it is to start the best Italian restaurant in the world (the Google of restaurants). But just like their bigger brothers, neighborhood Italian restaurants make money. Sure, they don't make as much as the best restaurants in the world, but they do well enough—and it's not nearly as much of a headache to run a neighborhood restaurant as it is to run a place where investors, critics, and the world's press are breathing down your neck.
Indeed, launching a small business online is much easier than starting one offline. Startup costs have plummeted over the last few years; using application-hosting services from Google or Amazon, one or two smart developers can cobble together a Web app with just a few thousand dollars. And the Web offers numerous ways to charge for your wares. Like 37signals, you can levy a subscription fee. But Hansson points to other firms that have seen success with different strategies. Freshview, a software company based in Australia, runs a service called Campaign Monitor that manages e-mail newsletters. There's no subscription fee; you just pay per use—a flat fee of $5 plus $.01 for every recipient. (E.g., sending a newsletter to 4,500 subscribers would cost you $50.) The Web also lets businesses offer tiered pricing. FaxIt Nice, a clever startup that lets you send faxes from your computer, charges $4.99 to send a single fax or $.18 per page if you buy in bulk.
The beauty of such small Web businesses is that they are well-positioned to survive downturns. Software from 37signals replaces collaboration tools that cost thousands of dollars; as IT departments around the country shrink, Hansson predicts that his software will increase its market share. Contrast that to the fate of Web firms that rely on advertising to make money: When the economy turns sour, large clients will stop buying ads, and suddenly the Web firms are sunk.
Hansson told me that many aspiring Web entrepreneurs thanked him for the presentation he gave last spring. "Many felt that being in San Francisco, they were being pushed to start the next billion-dollar social-viral-whatever thing, and if they were not doing that—if they were just trying to think about a business that makes money—they got the feeling that they were doing it wrong," he says.
Since then, however, Hansson has seen some evidence that rationality is coming back to the startup world. Consider the nascent microblogging sector. The much-ballyhooed startup Twitter now has more than a million users, but it still has no way to earn a single penny from them. But in September, a new microblogging service hit the Web. Yammer is pretty much identical to Twitter except in one major way—it charges businesses a fee to manage employees' Yammering. It's unclear whether this is the right model, but at least it's a model—something Twitter might have thought of, Hansson notes, if it hadn't been given a free ride by investors. Incidentally, Twitter seems to have heeded the message; the company says it'll reveal its business model next year. Hopefully that won't be too late.