One of the issues I wrestle with when surveying the Web 2.0 investing landscape, is whether a new company has the ability to challenge incumbent established companies. The term Web 2.0 is not fully defined, but for me it refers to technical (AJAX, RSS) changes and consumer behavior (broadband adoption, user generated content) changes that have allowed successful companies to be built for much less capital. For example, Ofoto is Web 1.0, Flickr is Web 2.0.
However, while I believe that most of the economic trends are all moving in the right direction to build and launch a Web 2.0 business (decreasing bandwidth, processing and storage costs) I do worry about Googlearchy. This is the concept of Google's PageRank algorithm reinforcing traffic patterns whereby the "rich get richer" and imposing a structural disadvantage for new websites. Given PageRank is driven by the number of incoming links and the importance of those links, this concern seems to be confirmed both intuitively and mathematically, but until recently this has not been empirically tested. The first test of this "common wisdom" has been made by Santo Fortunato and his colleagues from Indiana University in a paper called "The egalitarian effect of search engines" published in arXiv.
Fortunato and his colleagues built two theoretical models - one where all searches are done through search engines, one where all searching is done through surfing - and compared the results against empirical data based on 28,164 randomly chosen websites. The surprising result was that the empirical data did not lie between the two theoretical extremes. Fortunato's conclusion from this observation is that search engines, rather than giving structural advantage to incumbent popular sites, actually level the playing the field. The paper has since come under criticism for both the robustness of the data set (ie "different data sets will not produce the same result") and the causality ("even if the new data sets produce the same results, the result is not due to search engines"). The criticism is understandable given the paper questions "common wisdom" so I look forward to watching how the debate progresses given my vested interest as a VC looking to invest in Web 2.0 companies and overcome the "Googlearchy".