Twitter’s Long Hard Path To Profitability

Submitted by Samuel Rae as part of our contributors program.

Twitter’s Long Hard Path To Profitability

Since its inception, Twitter (TWTR) has been the go-to place for celebrities looking to interact with their fans. It is the removal of the communication barrier between fans and their followers that has driven Twitter’s growth. Now however, Facebook (FB) is mounting a challenge to Twitter’s apparent dominance in the fan to celebrity communication space, which could serve to hinder Twitter’s chances of generating retainable earnings. This, and a number of other factors, could make Twitter’s expansion difficult.

Microblogging

Twitter is so popular with celebrities because its flagship microblogging feature enables them to communicate quickly and easily with fans. While a whole range of individuals, companies and organizations regularly post to Twitter, the vast majority of those followed are celebrities. These celebrity posts attract the most user attention, and in turn, hold the most potential for attracting advertising revenue for Twitter.

User interaction

Up until now, the difference between the two companies has been the user interaction use case. Facebook attracts users looking to interact with friends and family, Twitter attracts users looking to interact with celebrities. One of the primary goals Twitter outlined in its IPO prospectus was user growth. The site currently has around one-fifth the user base of Facebook. To do this however, its offerings must differ from that of Facebook. Analysts expect the aforementioned difference in use case will be the primary driver in this user base expansion, but Facebook recently revealed it would be implementing a new feature into its platform that would make it easier for celebrities to communicate with their fans.

Redundancy

While the implementation of this tool alone is unlikely to attract more Facebook users, it could reduce the number of Twitter users. The top three celebrities on Twitter have 47 million, 46 million and 40 million followers, respectively. The same celebrities on Facebook have 54 million, 55 million and 57 million likes, respectively. It is reasonable to assume that a high percentage of those following the top three on Twitter also like the same individuals on Facebook. In turn, it is reasonable to assume that if Facebook offers these three individuals the functionality that Twitter offers them, then they will redirect the content they publish on Twitter to Facebook. In short, if Facebook can successfully replicate Twitters main offering, it could make Twitter redundant.

Advertising revenues

During the three months ended September 30, 2013, Twitter generated $168.6 million in revenues. $153.4 million, or 91%, of revenues was advertising revenues. During the same quarter, Facebook generated $2.02 billion in revenues, of which $1.91 billion, or 94%, was advertising revenues. The financial success of both companies is rooted in their ability to attract advertiser spend, and if a celebrity microblogging tool redirects users’ attention from Twitter to Facebook, advertiser spend will likely follow.

What is in it for celebrities?

The aforementioned figures relating to the top three followed individuals on Twitter revealed that Facebook attracts, numerically at least, more user attention. Furthermore, this is not apparent in the top three individuals. A comparison between the fan bases of almost any celebrity will reveal the same trend. Interaction with a larger fan base holds advantage of a smaller fan base for a number of reasons. The first is rooted in branding. Modern celebrities are brands, and social media allows for instant, free self-promotion. The second is third party promotion. One of the fastest growing sectors of online advertising is social media sponsorship. Social media sponsorship involves advertisers paying individuals with a social media following to promote goods or services through the content they publish. To illustrate the growth, consider IZEA (IZEA). IZEA operates a number of platforms that facilitate social media sponsorship. The company takes a transaction fee from each promotion. IZEA recently reported record Q3 2013 revenues, revealing the extent of the industry growth.

The future of social media advertising

Social media advertising is currently undergoing a fundamental shift in its nature. For a long time, banner ads were the dominant form of online advertising. Their effectiveness has long been questioned, but up until recently advertisers overlooked this and directed revenues towards them. In recent years, the growing mobile user base across social media platforms has forced companies to find alternatives. The reduction in screen size has meant that banner ads are no longer viable, and this has led to a rapid rise in the use of native advertising. Native advertising is the incorporation of ads into the main content of a website, Facebook’s in-feed ads for example. The only form of advertising Twitter offers is native, and Facebook is increasingly shifting its focus towards this type. They are not the only companies that stand to benefit from it however. Again looking at IZEA, the company plans to release its Native Ad Exchange during Q1 2014. Native Ad Exchange will facilitate the aforementioned social media sponsorship, across a variety of social media platforms including Facebook and Twitter. Celebrities can register on the platform, and advertisers can approach them with promotional campaign proposals.

Revenue redirection

A reduced user base is not the only problem that Twitter faces. Currently companies promote goods and services through promoted tweets. Promoted tweets, for a cost, appear and reappear in user timelines. One of the major complaints Twitter users have is rooted in the number of times these promoted tweets appear in displayed content. Users direct this negative attention towards Twitter, but also towards the companies the ads are promoting. Platforms like Native Ad Exchange offer advertisers a method of promotion akin to celebrity endorsement on television ads. Endorsement increases effectiveness, which in turn reduces the need for repeat promotion that could lead to negative commercial perception. It is reasonable to assume therefore, that in the coming year’s advertisers will increasingly turn to social media sponsorship to promote goods and services. This will redirect revenues from Twitter towards companies such as IZEA. The same apples to Facebook, with its sponsored posts and sponsored stories.

An uphill struggle

Investors that took part in the Twitter IPO last week did so on the assumption that the company will be able to expand its user base in the coming years. This is not an unreasonable assumption.  But it is far from guaranteed. Twitter faces competition not just from its social media counterparts, but also from companies that focus solely on the advertising element of social media, such as IZEA.