Podcast Startups Look Doomed from the Start –

The recent funding of two podcast companies is eerily reminiscent of the Internet Bubble, when dot-coms were able to pull down huge amounts of venture capital without a clear idea of how they would make money.

It was big news in August when Podshow Inc. of San Francisco snared an $8.85 million Series A investment from the financial team that brought the world Google: Kleiner Perkins Caufield & Byers, Sequoia Capital and Sherpalo Ventures, run by esteemed angel investor Ram Shriram.

It was almost as attention grabbing when, a few days later, San Francisco-based podcasting startup Odeo Inc. announced that it, too, had landed funding. Its backers are Charles River Ventures; Amicus, a small VC firm in San Francisco; and a long list of angel investors that includes Lotus Development Corp. founder Mitch Kapor and Ron Conway, another Google backer. Says Conway, “I have opened my mind to the fact that podcasting can be huge since the use of media on the Web is one of its fastest-growing segments.”

Odeo didn’t announce how much money it had raised, but if it assembled anywhere near the overly rich round for Podshow, its investors may regret it. Podcast companies, it is becoming evident, face an uphill battle to make money.

Consider the facts. First, it isn’t hard to understand why enthusiasm for podcasts is becoming widespread. By signing up for a podcast, a user gets automatic updates of website audio content-like a portion of a radio or TV news program-and can listen to it on an iPod or other mp3 player at his or her convenience.

It’s an undeniably cool technological development. In fact, as the numbers of both people creating interesting new podcasts and radio and TV shows offering podcast versions of their programming grow, radio listening-which is often repetitive and jammed with advertisements-will start to seem increasingly boring.

Adding to the gee-whiz factor of podcasts is their near-zero barrier to entry. Virtually anyone can have his own radio show, and some people are already attracting many thousands of listeners. It’s exciting stuff.

Unfortunately for the startups and their backers, trouble lies ahead, starting with Apple Computer, which announced around the time of the fundings for Podshow and Odeo that its newest version of iTunes lets customers easily find, subscribe and transfer podcasts to their iPods. For free.

Apple’s involvement is great news for podcast listeners. Before Apple got into mainstream podcasting, management of podcast files was time consuming and aggravating. Listeners had to struggle to find a quality podcast, then download it and sometimes pay for a podcast-management program. No longer. “Before, downloading a podcast was a clumsy process,” says Ray Lane, a Kleiner Perkins general partner who sits on Podshow’s board. “It was very difficult to get through all the steps; iTunes has changed all that.”

Apple’s news is less encouraging to startups that were hoping to attract visitors to podcast directories and services. It means that the growing millions of people who use iTunes to manage their music are staying right where they are.

Lane notes that he got into talks with Podshow “well before Apple became involved. But I was approached through two referrals for two different podcasting companies, and when I get two [referrals] within the same time frame, I look and say, Something is going on.'”

The second problem for podcast startups is that the ad dollars anticipated to transform podcasting into a profitable industry will likely never materialize in a meaningful way.

Take Podshow, which came together in January 2004 and provides podcasters with tools to create, distribute and market their programs.

The company proudly boasts that it manages a podcast directory that features more than 100 categories of podcasts, mostly from individuals. Yet as it evolves, it has traditional media in its sights. “We’re getting inquiries from almost every conceivable outlet: radio, cable, public radio, international [media outlets],” says Podshow CEO Ron Bloom. “We want to be the lightening rod for those providers to explore how to make their content unique in podcasting.”

The plan sounds fine in theory. Apple has given Podshow a platform within iTunes to promote some of its podcasts, and Podshow’s first big client-Sirius Satellite Radio-already repurposes four hours of its programming into podcasts available through Podshow.

But to make money Podshow needs to sandwich in advertisements. Toward that end, the company plans to work with its partners to complement listener experiences rather than compete with them. For example, Podshow is working with Warner Bros. on a podcast ad for “The Inside Man,” director Spike Lee’s newest film, which is set to hit theaters this fall. To create the ad, a Podshow producer shadowed Lee around the film set, describing what he saw, and offered the microphone to Lee whenever he felt like communicating something, all of which is being edited into a preview.

An advertising-based business model, however, doesn’t jibe with the reason that podcasts have become popular. The beauty of time-shifted content-and what has driven Tivo’s success-is that people can watch or listen at their convenience and can avoid ads. That’s why podcasts of syndicated radio programs are becoming so popular with their longtime listeners.

Even if podcasters can attract advertisers, it’s unclear if the podcast companies will hold the keys to those ad dollars or whether they’ll be managed by the online ad companies that arrived to the scene first. “Podcasting is just another channel for online advertising,” says a Silicon Valley VC who asked not to be named. “Existing third-party ad networks already hold strong relationships with both online and traditional advertisers. If Podshow thinks that it will control relationships with major advertisers, it’s crazy.”

Not even podcasting entrepreneurs are sure if advertising will support the medium. Ali Partovi, a successful entrepreneur who launched music podcasting site Gcast.com in September, says he isn’t sure how it will fare. (Partovi co-founded the Internet advertising startup LinkExchange in 1996 and later sold it Microsoft for $265 million in stock.) He says he expects to make money through advertising within the podcast stream, but he’s still wrestling with the mechanics.

“I don’t think listeners will tolerate a 60-second block of advertising,” Partovi says. “Because there’s so much consumer choice, ads might have to be friendlier-like 10 or 15 seconds long.” What if even 15 seconds is too long for a podcast listener? “You have to be ready for change,” he says. “Maybe the content creator pays to eliminate the ad. I wouldn’t rule that out. We’ll be developing these things over time.”

Either way, it is clear to Partovi and others watching the podcasting market that there are plenty of kinks to be worked out. That’s partly the reason that the $8.85 million raised by Podshow appears to be too much. There are several other reasons which the financing appears too rich. One, a podcast company probably can’t deploy that kind of capital in a productive way. Two, while Podshow’s backers presumably checked with their older portfolio companies like Google and Yahoo to ensure that Podshow was interesting, Podshow’s financing has now created a situation in which its valuation is probably too heady for either. (Google, in particular, prides itself on being frugal when acquiring smaller companies.)

Further, while CEO Bloom says Podshow’s primary goal today is to build up its base of listeners, that probably won’t require much cash because the companies that it might acquire should be cheap. Podshow has already has made one acquisition. It bought podcast directory PodCast Alley, which was run by one person, for an undisclosed amount.

It is hard to imagine, too, that Podshow requires the remarkable number of people already on its payroll. Bloom says his company has “20 to 25 people working on core technology, another 100 in editorial and directory management, and then gobs of independent podcasters that integrate with us and who aren’t full time. Sometimes we pay them, too.” (Assuming the company spends $40,000 per employee on salary and benefits, that comes to $5 million per year.)

If Podshow, Odeo and other podcast startups really want to cash in, they may have to do something that would cause any podcast listener to cringe: They may have to sell listener information to marketing companies. Podshow already hinted at that strategy in its funding announcement, stating that the company “provides a gateway for marketers to gain access to the elusive and highly desirable podcast listener demographic.”

Asked about it, Bloom says, “We’re providing an increasing level of knowledge about who listens to what and why by constantly asking our listeners and watching what flows through our directory.” The point, he says, is to “help us make higher-quality podcasts” and to “bring advertising into the medium in a way that isn’t considered by the podcasters to be invasive.” But Lane acknowledges that Podshow may one day consider selling such demographic data directly.

Lane notes that Kleiner Perkins has “six consumer Internet kinds of plays right now,” and that “we’ll try to use our network and help Podshow along the way in finding new podcasters and finding connections with people who work with Apple or iTunes.” He underscores Podshow’s ostensible first-mover advantage: “It is an attractive partner because it has been in this business longer than anyone else.”

Whether that’s enough for a solid venture return someday remains to be seen. Says Reid Hoffman, an angel investor and founder of social networking service LinkedIn: “I’ve been thinking a lot about podcasting. I’ve passed on any investment opportunities thus far. Frankly, I’m unsure about the business model.”

Email: Constance.Loizos@Thomson.com