3 Ways Twitter Is Driving Ad Revenue Growth

MarketsMotley Fool

Twitter's (NYSE: TWTR) ad revenue growth has accelerated through each of the first three quarters of 2018, rising from 21% in the first quarter to 29% in the third quarter. This year's growth came after the company's operations overhaul over the last couple years, which eventually resulted in negative revenue growth last year. The question investors have is whether the growth is sustainable into the next year or the next decade.

In order to answer that question, it's important to understand the underlying drivers of Twitter's revenue growth. During a recent investors conference, CFO Ned Segal provided some insight into three of Twitter's biggest ad revenue drivers.

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Ad load

Segal has used the term "demand constrained" for several years now. That's a fancy way of saying Twitter has room to increase the number of ads it serves to its users, but it doesn't have enough advertisers on the platform to make it worth showing more ads.

"We definitely continue to feel demand constrained more than supply constrained when we look across geographies, when we look across times of year, when we look across different surface areas," Segal said.

Not only does Twitter have room to increase the number of ads users see in their timelines, it can also put ads on relatively unmonetized parts of the app. Areas like search or the entertainment tab have much lower monetization levels than the core timeline. At the same time, they can present an opportunity for more timely and relevant ads for users.

In order to increase ad load, however, Twitter first needs to increase demand for its advertising products.

Ad relevance

Getting the right ad in front of the right user at the right time is essential to creating value for advertisers. Twitter is getting better at using its data to find the right ad for users and it's developed the necessary technology to find the right ad quickly enough to serve it to the user in a timely manner. (Otherwise, a user would scroll past an ad unit before it loads.)

Despite its improved technology, Twitter's ad relevance is also limited by its advertising demand. The more ads Twitter has to choose from when deciding which ad to show a user, the more likely it will find a relevant ad.

Twitter has never broken out specifically how many active advertisers are on its platform, but its last update came about three years ago when the company reported 130,000 advertisers. Even if the company doubled its active advertisers every year, it would still have only about 1 million advertisers on the platform. That's well short of the 6 million active advertisers Facebook reported a year ago, or even the 2 million active advertisers on Instagram.

User growth

The biggest growth factor for Twitter is user growth and engagement.

"When we look ahead, we feel like we know that ultimately, we need to continue to grow audience and engagement in order to realize our purpose and in order to deliver great outcomes for all of our stakeholders," Segal said.

Having more users is more attractive to advertisers. One reason Facebook has become popular with smaller advertisers is that it's able to reach practically everyone and anyone in a business's target audience. It's a one-stop shop. The bigger Twitter gets, the more attractive it becomes to smaller advertisers.

Additionally, more users can improve the experience for existing users by increasing engagement and contributing more content. A more engaged user base means more advertising opportunities, and more opportunities for Twitter to show an advertiser's message in a context that maximizes its value.

Twitter has grown daily active users in every quarter since the start of 2016, but its growth still lags Facebook despite its much larger base. The quality of Twitter's growth is arguably better, as it's actively worked to deactivate and stop spam accounts that detract from its ecosystem.

However, growth has begun to slow. If Twitter can't maintain its user growth, it may not be able to sustain its revenue growth either. Both ad load and ad relevance are constrained by ad demand, and ad demand is constrained by Twitter's user base.

Twitter may have managed to operate the company profitably, but user growth continues to be a key metric to watch.

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Adam Levy owns shares of Facebook. The Motley Fool owns shares of and recommends Facebook and Twitter. The Motley Fool has a disclosure policy.