Commentary

Whither Profitability, Twitter?

FailWhale-DropMoney

Venture capitalists continue to throw money at social media, with the vague hope hope that some of it will stick. Most recently, Twitter announced today that it has raised another $200 million from venture capital firm Kleiner Perkins Caufield & Byers and a number of other investors. That brings total capitalization to $360 million, and gives Twitter an overall value of $3.7 billion -- but the $64,000 question is, when can investors expect a return on their money from the microblogging service, founded in July 2006?

I've already written about my belief that social media is showing signs of a bubble economy, and the events of the last six months have only served to reinforce my suspicion. I won't deny the self-evident power and popularity of social media, of course, but stupendous growth in user numbers and engagement doesn't necessarily translate into a durable business model and long-term profitability. As one of the most visible and well-capitalized of the new social media services, Twitter is a good case study for the industry in general.

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According to leaked financial documents cited by the trade press, Twitter is projecting total ad revenues of $50 million in 2010, mostly from sponsored tweets through its Promoted Products Platform. Meanwhile the site has boasted massive growth in traffic, with 175 million users posting 25 billion tweets over the last 12 months. All these are nice-sounding numbers, until you realize that they actually cancel each other out because of server costs and other overhead.

At the end of 2009, when 75 million registered Twitter users were posting at a rate of two billion tweets per quarter, the company's total server costs probably came to about $25 million. Crunching the numbers, at the end of 2010 it seems likely the total server costs have trebled to at least $75 million (if not more, because of new data-rich features), absorbing all the ad revenue plus some more besides. Server space and its associated costs are clearly some of the main obstacles faced by the company: in September Twitter CEO Dick Costolo admitted that server space was a major constraint on Twitter's "scalability," and the service continues to suffer interruptions due to overloaded servers ("fail whales"). Meanwhile personnel costs are also multiplying, as the number of employees almost trebled from 130 to 350.

Even allowing that the Promoted Products Platform is still in its experimental phase, it's worth noting that there are also serious constraints on the scalability of Twitter's advertising business. One recent survey by Sysomos determined that 71% of tweets are ignored, while just 23% get a reply, and a mere 6% are retweeted; in terms of actual numbers, that would imply 7.25 billion tweets actually reached an audience in 2010, 5.75 billion got a reply, and 1.5 billion were retweeted. Averaging the total audience out over the year, this works out to about 600 million tweets viewed per month in 2010, or four tweets per registered user per month. Long story short, this means the vast majority of tweets can't be monetized through ad impressions -- but they're still out there, somewhere, running up server costs.

Twitter is projecting total revenues of $1.53 billion by 2013, somehow, but the question remains whether it will be profitable even after growing ten-fold in three years. One cautionary example is YouTube, bought by Google for $1.65 billion in 2006, which has sense ballooned in terms of user traffic, videos hosted and viewed, and advertising volume. But earlier this year co-founder John Hurley dodged questions about its profitability in an interview with USA Today, suggesting (to me, at least) that it is still operating at a loss.

2 comments about "Whither Profitability, Twitter?".
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  1. Eric Schmidt from Winfield & Associates Marketing & Advertising, December 16, 2010 at 3:54 p.m.

    I've had sneaking suspicions for some time now that social media might have a difficult time generating the revenue necessary for long term survival. Your numbers tell the story. How in the world can Twitter be valued at 3.7 BILLION dollars?

    My best guess is that social media will continue to be a major player in personal communications, but the value for marketing purposes will be limited and probably complimentary to other media.

  2. Susan Breidenbach from Broadbrook Associates, December 16, 2010 at 9:05 p.m.

    I think social media (Web 2.0) is about where Web 1.0 was during the height of the dot.com bubble. Social media will become huge, just as the original web became huge. It will be just as disruptive--maybe more so. It is invading all aspects of business processes, not just marketing.
    These bubbles may be an inevitable result of the lack of barriers to entry when you are creating something that is essentially software. You don't have to build a big physical plant or physical logistics infrastructure or physical reseller/distribution channel. Hence the bubbles while the new market finds its footing and figures out how to monetize things. I expect that with each iteration (Web 3.0, Web 4.0, etc.), the VCs will get a little smarter about things, but they will never completely eliminate the bubble phase. And remember--even before the Internet era, the vast majority of venture-backed startups failed, and the invested money was lost. The VCs keep trucking along, because the one-in-ten (at best) successes more than makes up for the nine (or more) losses.

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