As more and more startups launch on an advertising-only revenue model (i.e. offer products/services for free to generate traffic and make money from ads), an idea occurs to me of how competition might evolve in the wonderful world of the Internet over the next few years.

Given that many of these ad-supported web apps operate in the same spaces - social networking and user generated video, music, photos etc, I wonder if competition will get so hot that the model will shift from offering products for free to paying users to sign-up for them.

If this were to happen on any sort of mass scale then what would the effect be? Well for one thing I think we would begin to see a clearer distinction between companies that make genuinely useful products that users are willing to pay for and these ad-supported web apps. The latter will operate in what Read/Write Web calls the attention marketplace, for the sole purpose of getting your attention in order to make you aware of their advertising customers’ products.

The net effect would be higher advertising rates, which will inevitably be passed on to the user in the form of higher prices for the really useful products. So the user loses out at the end of the day.

More importantly than ever, every startup would need to ask itself what sort of business it wants to be - one that makes a useful product that users are willing to pay for, or a feeder business for others who do make such products. I suppose the answer will continue to be that if you solve a real pain then you will be able to sell your pain-killing product or service. If on the other hand you provide nice-to-have products and services, e.g. in entertainment then it would be more difficult than ever to sell it to users and you would be better off focusing on ad revenue.

There is of course also the bigger question of whether the continued proliferation of ad-supported businesses is sustainable in the long run or if it will ultimately lead to another burst - but let’s not get into that in this post.

PS: It seems to have started already. I just learnt of Yuwie - a new social network that claims to offer everything we are used to getting from other social networks, but one that shares its ad-revenue with its users. So the more you use the website and refer people the more you get. The company argues that since we the users generate all the content, why shouldn’t we get a piece of the action. Can’t say I disagree with them on that score.