1 Thing Twitter Inc.'s Management Doesn't Want Investors to Know

Source: Twitter.

The first quarter of 2015 didn't go well for Twitter . The social network saw its revenue come in well below its guidance after its direct-response advertising products failed to live up to expectations. The company will readily admit that its projections for direct-response advertisers was too high, and it's adjusted its revenue guidance going forward to account for that.

One thing Twitter won't tell investors is how it's doing with regard to retaining the ad spend of larger brand advertisers. When asked about it on the company conference call with analysts after the earnings report, CFO Anthony Noto dodged the question.

Strong growth in total advertisers, but where's the ad spend?Twitter was happy to report to investors that it saw continued growth in total advertisers. In his prepared remarks, Noto said, "Ad revenue growth was driven by strong year-over-year growth in the number of advertisers on Twitter across all channels."In the Q&A portion, he clarified that advertiser growth, year over year, was similar to the growth the company saw in the fourth quarter.

The problem is that Noto also said that ad load remained flat. Indeed, Twitter grew total users 18% year over year, and timeline views per user were starting to trend back up as of the end of 2014. Noto's comment indicates that the 32% increase in ad engagements is solely the result of additional timeline views, and no increase in ad load. Management works to balance ad load with advertiser demand to produce the best results for advertisers, its users, and its business.

And that's where Twitter's switch to action-based pricing has come up to bite it. Twitter made the switch to results-based ad pricing last summer, which is aimed largely at the small businesses with a presence on Twitter. While ad impressions may have increased, Twitter now gets paid only when an action is completed. Twitter says advertisers were reluctant to spend more on ads even though Twitter is delivering more value. This situation indicates that Twitter's ads aren't as effective as it originally thought.

Twitter should have had better insight into how much its advertisers are willing to spend, though. It's been running action-based advertisements for three quarters now, and app-install ads even longer. Surprisingly, management blamed app-install ads as a large reason direct-response ad spend fell below expectations. But app developers have a good idea of how much an install is worth to them, so of course they're not going to spend anything above a certain threshold.

Twitter knows that.

A better explanationWhile Twitter switched to action-based pricing for its self-service ads, it still has a direct-sales team to work with brands for ad units that are based on impressions. In fact, brand advertisers still make up the majority of its advertising revenue.

And while Noto explained that "direct sales was once again the largest contributor to year-over-year dollar growth on an absolute basis," he also said the company's small-business advertisers grew at a faster rate. The fact that a large percentage of Twitter's ad revenue comes from branded advertising seems a more likely culprit for Twitter's disappointing ad-revenue results.

Brand advertisers are interested in reaching large audiences, and while Twitter certainly has a large audience, it's facing increasing competition. Snapchat rolled out Discover last quarter, and it's reportedly attracting $600,000 to $1.2 million in branded advertising spend per day. In addition, Instagram continues to increase the number of advertisers on its platform. That ad spend has to come from somewhere.

With the slowing user growth on Twitter, brand advertisers may be looking to Snapchat and Instagram -- which surpassed Twitter's active user count last year -- and their younger audiences for advertising opportunities. That has the potential to have a lasting impact on Twitter's results unless it figures out how to make its ads more effective in converting. That's key to getting more ad spend from small businesses, which are worried more about getting users to take a certain action than to impart their branding.

The article 1 Thing Twitter Inc.'s Management Doesn't Want Investors to Know originally appeared on Fool.com.

Adam Levy owns shares of Apple. The Motley Fool recommends Apple and Twitter. The Motley Fool owns shares of Apple and Twitter. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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