You can't blame the VCs as long as companies like Google, Yahoo, etc. can make money offering free services.
Which is exactly the author's point. He says that small companies are forced to swing for the fences in terms of user-base because a) that is all advertisers are interested in and b) the competitors (such as Yahoo! and Google) offer free alternatives.
I dont think it reasonable to set Yahoo or Google as the measuring stick of success as those companies are clearly way out ahead of anyone
Suppose you start a company to compete in an industry (any industry) where your rivals are profitable despite offering free services.
The fact they're able to do that is going to force your hand in that direction, too.
So it's the market which dictates those conditions, not your investors.
You're right. And this will lead to a massive market correction at some point. Companies that had the balls to listen to reason (a la 37signals), will be the ones that weather the storm. They'll end up being the Berkshire-Hathaway of the internet industry because they a)focus on the long-term, b) concentrate on what they know and do best, and c) fiercely execute on value, and not trends.
There's a reason Warren Buffet came through the dot-com crash unscathed. And it's the exact same reason why companies like 37signals will as well.
Either way, though, it's not the fault of the VCs.
Another example: PC operating systems (where the cost of the OS license is subsumed into the price of the PC).