What is the Potential of Twitter’s Business Model?

Twitter is profitable. Twitter-haters, deal with it. And while you’re at it, write this down: you ain’t seen nothing yet.

Twitter still gets a bad wrap from many pundits and non-users because they don’t understand the service. The common objections (e.g. What can you write in 140 characters? Who needs another service telling you what a friend is eating for lunch?) reveal a misunderstanding of Twitter’s functionality and how people actually use a real-time streaming platform to share information.

In reality, Twitter is a hugely valuable network of 93 million users that’s capable of generating a lot of money. Back in September I wrote that there was no reason to rush the monetization of Twitter, which had just received a $100 million investment at an implied $1 billion valuation. I made the case that Twitter was probably the third most important company for online content distribution (after Google and Facebook), which is hugely valuable because content sharing is the activity people spend the most time doing on the Web. I pointed out that there were so many ways to monetize the service, so Twitter’s management team was wise to focus on growth initially.

That wasn’t exactly revolutionary advice—many experiences entrepreneurs argue the same general point. Sean Ellis, from 12in6, writes on his blog that non-enterprise startups should wait until after they’ve achieved market fit to begin charging for their product. This was the same game plan we employed at PayPal; as I detailed in The PayPal Wars, we grew out our payments network before attempting to move business users to fee-bearing accounts.

That’s exactly what Twitter did. The search deals they inked with Mircosoft and Google this fall will give them a small profit for the year. And BusinessWeek reports that the company has additional plans after the New Year: “Twitter plans an advertising program for early next year. The company also will charge for commercial Twitter accounts that would let businesses analyze tweet traffic.”

I view those as cautious first steps toward monetizing a truly valuable and vast network. There are a lot of other ways to monetize the system that we could see down the road:

  • Featured users. A number of Twitter-based companies (e.g. FeaturedUsers) already sell sponsorships to help users add followers. While Twitter has a suggested user list, it’s mostly public figures and Twitter doesn’t sell placement on it. Why not let users pay to get more followers? This wouldn’t be spam, and Twitter could target recommendations so they’re relevant to the viewer’s interests.
  • Corporate accounts. Companies have different needs than individuals, so let them pay for additional functionality. In addition to the metrics listed above, let companies allow multiple users to tweet under their brand umbrella (e.g. customer service, marketing, etc.), which would give consumers more ways to dialogue with them. Twitter is the Cluetrain Manifesto put into practice.
  • In-stream sponsored tweets. This would probably be controversial at first, just like it was when Google began to feature ads alongside its search results. But if it’s done in the right way, sponsored tweets need not be obtrusive or diminish the usefulness of the network.

I could go on and on. This is just a cursory glance to illustrate my point—Twitter can potentially generate a lot of money. How much? To guesstimate this, I’ll use Facebook as a benchmark, since it has a little more public data and is further along on the road to monetization.

Facebook’s annual revenue run-rate soared from $500 million in July to $1 billion this month. With 350 million users, this means Facebook is currently generating around $3 in revenue per user per year. And Facebook is not even focusing on monetizing; board member Mark Andreessen noted earlier this year that growth remains that company’s primary goal.

I don’t think Twitter will monetize its user base as highly as Facebook because the latter has much more personal data, content, and user touch points. But since Facebook isn’t even trying that hard yet, the $3 per user metric is really just a floor. Over time, surely Twitter could monetize its own users to at least one-half of that amount. 93 million users times $1.50 in revenue per user implies about $140 million in annual revenue, which assumes no growth. This seems like a pretty conservative back-of-the-envelope goal.

But I think Twitter will do better. If its user base grows 30% each of the next two years, and Twitter is able to match Facebook’s current $3 in revenue per user, then in 2011 the company would be at a $471 million revenue run-rate (i.e. 157 million users * $3 each). Or, if you’re really bullish on the service, let’s assume that users grow at 50% each of the next two years, and the company can stretch revenue per user to $5, then it would hit $1 billion in revenue (i.e. 209 million users * $5 each) by the end of 2011.

That final estimate might be a stretch since Twitter’s growth has slowed down the second half of this year, but regardless this benchmarking exercise illustrates that Twitter has a lot of revenue upside.

Of course, revenue is only part of the equation. Let’s talk bottom line. The BusinessWeek article I linked to above says Twitter’s annual expenses are in the range of $20-25 million. Obviously this will have to increase as the company scales up over the next couple of years, as Evan Williams and Biz Stone staff up their company and incur additional expenses for sending out more SMS text messages. Let’s assume expenses quadruple and approach $100 million. That still leaves them with a net operating profit of $371 million under my second revenue scenario, and margins around 80%. Not bad.

Hopefully the recent profitability announcements by Twitter and Facebook will serve as a reminder that some business models—especially those that display a network effect—are best served by focusing on growth first, and monetizing later.

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