As Twitter tries to get its financial house in order prior to going public at a multibillion-dollar valuation, one of the aspects of its business that will be under an intense spotlight — as it was with Facebook (s fb) — is the company’s ability to generate advertising income, since that makes up the vast majority of its revenue. Among other things, Twitter will have to show that in-stream ads not only work but are growing rapidly enough to justify a market value as high as $20 billion.
As Quartz has pointed out with a helpful math lesson, Twitter’s revenue per user is much lower than Facebook’s, currently running at about $0.55 vs. $1.41. To some extent the two are apples and oranges, since Facebook has a lot more variety when it comes to ad formats and can therefore charge more — but even so, investors are still going to want to see higher numbers. Many of them are going to be looking at how Twitter compares to Google (s goog) and Facebook and even LinkedIn (s lnkd), and they may not like what they see.
Twitter ad revenues were $269.4m in 2012. Compares to $32.7bn at Google; $4.3bn at Facebook and $3.5bn at Yahoo.
— Emily Steel (@emilysteel) October 3, 2013
But the biggest challenge in satisfying the requirement to boost ad revenue arguably isn’t financial at all, but behavioral, and it boils down to one question: Can Twitter introduce enough revenue-generating ad formats into the stream without ruining the experience for users and torpedoing its growth and engagement numbers? It specifically outlines this risk in its S-1 filing, saying:
“If we fail to grow our user base, or if user engagement or the number of paid engagements with our pay-for-performance Promoted Products, which we refer to as ad engagements, on our platform declines, our revenue, business and operating results may be harmed.”
Confronting the Facebook/MySpace problem
In a nutshell, this can be thought of as the Facebook problem — or even better, the MySpace problem. Social networks by definition are designed to encourage interaction between users, and in almost every case successful monetization rests on somehow convincing those users to interact with advertisers and their sponsored content at the same time. But not everyone wants to interact with ads while they are looking at photos of their loved ones: In fact, Sir Martin Sorrell of ad giant WPP Group argued last year that to some extent advertising and social networks may actually be fundamentally incompatible:
“The point is that Facebook is a social medium, not an advertising one, like search or display. It certainly is one of the most powerful, if not the most powerful branding medium. It is, however, a word of mouth or PR medium. You interrupt social conversations with commercial messages at your peril.”
For many users — at least the ones that I know — Facebook has grown less and less useful as the content stream has become more and more devoted to advertising, whether it’s sponsored pages or sponsored stories or some other intrusive content. On top of that, the size of images and video clips have been repeatedly enlarged, in part to encourage sharing of personal media, but also because images and videos theoretically drive more engagement with advertising, and because video is where the money is.
For now at least, Twitter ads are much less intrusive than Facebook’s. Sponsored tweets and trends blend in with existing tweets and trends — but they also don’t generate enough ad revenue to justify a $20-billion-plus market valuation. That means Twitter either has to add tens of millions more users at low cost, or it needs to goose its revenue-per-user, or both. And how is it going to do that? Among other things, with video, and tight relationships with TV networks.
Do you like TV clips in your stream? Good
Twitter’s new Amplify product targets advertising to users who have watched specific TV programs, and a related program lets networks like CBS push short video clips to specific users. Vine, the video-sharing app Twitter acquired, is also becoming a much larger part of its advertising efforts. And much like Facebook, the service has also redesigned a number of times to make images and video much more prominent, both on the web and in its mobile apps.
— NBA (@NBA) May 19, 2013
So while Twitter ads may be less intrusive now, over the medium to longer term the company almost inevitably has to become more Facebook-like, with more video, bigger video, larger ads, more calls to action (share, click, etc.) The hard part for Twitter is that Facebook has an entire page it can use and sell, so ads don’t take up as much relative real estate. Twitter is famous for its brevity — or at least it was, before it added expanded tweets and Twitter “Cards” and auto-play video clips.
And that’s the double-edged sword: in order to justify the market value it hopes to grow into, Twitter has to boost its revenue, and advertising is one of the biggest tools it has for doing that. But the more it pushes ad content, no matter how well it might be targeted by algorithms, the more irritated some users will become — and slow user growth is already a red flag even prior to the IPO. How Twitter manages that tension could be the single most important indicator of its future success.
Post and thumbnail images courtesy of Shutterstock / auremar and AP Images