Snap (SNAP -2.72%) recently posted its second consecutive quarter with a sequential daily active user decline. CFO Tim Stone noted the company's fourth-quarter outlook assumes a further decline in DAUs during the company's third-quarter earnings call.
A declining user base is bad news for Snap for several reasons. Not only will a lack of user growth hamper its ability to generate revenue, it's hefty cloud computing commitments could weigh on gross margin.
Stone mentioned a stretch goal of accelerating revenue growth and positive free cash flow. It'll need user growth to get there. What could drive that user growth, and what could go wrong?
Image source: Snap.
Expanding beyond the core audience
Snap's user base is highly concentrated among 13- to 34-year-olds in the U.S. and Europe. Management thinks there's an opportunity to expand to older users by focusing the product back on speed of communication.
Snap released a redesigned version of Snapchat earlier this year, which separated communication features from more consumption features. But the redesign has actually reduced the amount of communication on the platform. CEO Evan Spiegel noted in his prepared remarks that users generated 3 billion Snaps per day on average last quarter. A year ago, that number was 3.5 billion.
If management is truly focused on improving communication, it seems it would be best served by rolling back some of the changes it made with the redesign. That could have deleterious consequences, especially considering users' reaction to the last major app overhaul. On top of that, Spiegel points out the redesign has resulted in more people watching premium content than ever before. That's where Snap makes its money, as the core communication features offer fewer opportunities to show ads.
But beyond the challenges of refocusing the product on communication, Snap has nothing to base the idea that older users will use Snap if it's marketed as a messaging tool. There are already more popular communication tools used by older people throughout the world, including the billion-plus-user Messenger and WhatsApp apps owned by Facebook (META -0.52%). Getting people to switch communication channels could be an even bigger challenge than simply reworking the app.
Getting Android up to par
Spiegel told analysts the decline in daily active users was "primarily among Android users." Eighty-eight percent of all smartphones sold around the world in the second quarter of 2018 were Android devices. Offering a subpar experience on Android has hampered the company's user growth, especially in markets outside of North America, where Android's market share is even higher.
Snap's focus on iOS over Android was understandable in the past. iOS is easier to develop for since there's only one device maker and most users quickly upgrade to the latest release of the operating system. Additionally, iOS users are generally more valuable to advertisers since iPhones are high-end smartphones.
But that focus was short-sighted. For Snap to grow into a global business, it needs to focus more resources on Android. The company is rebuilding the Android version of its app from the ground up in order to improve performance and bring it up to par with the iOS version of the app.
Again, however, Snap faces the challenge of overcoming the head start it gave Facebook. While Snap was ignoring Android users, Facebook grew Instagram Stories and WhatsApp Status into products each with more users than Snapchat. After ignoring Android and emerging markets for years, Snap could have a tough time convincing consumers it's worth taking the time to download and learn a new app, especially when their network is already on Instagram or WhatsApp.
Will users grow?
Five percent year-over-year user growth isn't going to cut it for Snapchat. With another sequential user decline next quarter, Snap will report its first year-over-year decline in users.
Management's plans to target older users and users outside of the U.S. and Europe face considerable challenges, not least of which is the existing competition from Facebook. After ignoring these users for years, Snap has fallen well behind the social network giant, and the gap may be insurmountable.
