Over dinner tonight with a good friend, I discussed the somewhat misguided approach of a lot of young startups to rely on advertising as their primary (and often single) revenue stream. Which made me think about the underlying economics and how blatantly obvious the flaws in this business model are:

Assume that your effective CPM (eCPM) is $1 (which is high - believe me, pretty much regardless how great you think your content and how good your targeting is, for a startup it’s nearly impossible to achieve a higher eCPM) — which means that for every 1,000 page impressions you get $1. Now assume that you have a tiny little office, a half-way decent server (you might be clever and run your stuff in the cloud, which unfortunately doesn’t change the argument), some infrastructure (phone, computers, electricity, a hot coffee from time to time) and pay yourself and your two buddies, who work with you on your startup, a little salary to pay for your personal expenses (again you need to sleep somewhere and eat something) and your monthly costs run rather easily in the range of $5,000 to (more likely) $10,000. Which means you need to generate and sell 5 to 10 million page impressions. Not an easy feast to start with…

Now imagine your eCPM is not $1 but more in the range of $.25 (which is the grim reality for most young companies) and you already need to generate and again sell between 20 and 40 million page impressions to pay for your little company. This assumes that you can sell all your PIs which again is highly unlikely - oh yeah, and your costs will go up because your servers suddenly need to serve not 5 but 40 million page impressions. It’s getting more complicated already…

And now the final stage - you want a VC to invest into your company. These guys don’t want to see revenues along the lines of $5,000. They want to see $50,000 and more. Much more. Let’s assume you need to generate a mere $100,000 per month. And your targeting and content is so great that you manage to sell your inventory for a whopping $1 eCPM; you also manage to sell 50% of your inventory (which again compared to industry standard is high). That all means that you need a mere 200 million page impressions (!) to generate this level of income. Not exactly a piece of cake - and exactly the reason why I don’t believe in ad supported business models.

So please, please, please - if you have a startup (or think about starting a company), please sit down with our good, old friend Excel and run some realistic numbers. Don’t cheat on yourself - it doesn’t help you and will only come back to you once you need to either pay the bills or justify your business model in a discussion with an angel/seed investor/VC.

Have a different point of view? Send me an email or comment here - I would love to hear your thoughts.

Posted in Analysis, Entrepreneurship