Amazon (NASDAQ:AMZN) bought Twitch, a live-streaming app focused on gaming, in 2014 for nearly $1 billion. Just a year and a half ago, that investment looked like it would pay investors back handsomely with Twitch setting a goal to reach $1 billion in ad revenue in just a few years.

However, those expectations were out of line with reality. Twitch generated around $230 million in ad revenue in 2018, and it was on pace to reach just $300 million by the middle of last year, according to a report by The Information. The company was expecting between $500 million and $600 million in annual ad revenue going into the year.

Twitch faces increased competition from several tech giants: Microsoft (NASDAQ:MSFT), Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) YouTube, and Facebook (NASDAQ:FB). Streaming hours continue to grow, but only slightly, as competitors eat into Twitch's market share. Still, the relatively slow growth in ad revenue is concerning considering Amazon's overall push into video ads last year.

The twitch logo on a purple background

Image source: Twitch.

The competition is taking a bite out of Twitch

Twitch is still the dominant force in live-streaming video games, but the competition is starting to affect its growth. Data from StreamElements and Arsenal show streaming hours on Twitch grew less than 2% year over year in December. Meanwhile, the overall market grew streaming hours about 12%, so Twitch's market share fell from 67.1% to 61.0%.

Meanwhile, unique visitors on Twitch's website are declining. Just 18 million people visited in November, down from 22 million in the same month a year prior, according to data from Comscore.

While Microsoft's Mixer has made headlines by signing contracts with big names in game streaming like Ninja and Shroud, they haven't made a huge impact on its streaming hours. Microsoft's market share expanded just 60 basis points to 2.6%.

The biggest share gainer by far has been Facebook, which is a relative newcomer to live game streaming as it slowly entered the market in 2017. Over the last several years, it developed an ecosystem to reward streamers and viewers, and the efforts have paid off. Streaming hours more than tripled year over year in December, and Facebook took 8.5% of the market.

Amazon's video ads have catching up to do

The growth in Amazon's ad business is mostly due to growing search ads. Video still plays a relatively small part of its overall mix despite grabbing a lot of inventory through its Fire TV platform last year. 

That shows Amazon is struggling to carry over its success from its marketplace ads to its display ad inventory, including Twitch. The company is trying to resolve that issue by offering more integrated ad-buying tools like Facebook. Facebook has been able to quickly grow ad revenue on new platforms by simply adding the inventory to its existing ad-buying framework.

Amazon's ability to grow its video ads business is challenged by the growth at Facebook, YouTube, and other connected-TV and streaming video companies. Facebook and YouTube offer best-in-class ad targeting and measurement for digital video ads, so the growth in streaming hours on those platforms ought to result in outsized growth in ad revenue.

Twitch's plan to reach $1 billion this year

Advertising isn't Twitch's only source of revenue. The company also offers viewers a chance to subscribe to channels for a monthly fee or tip streamers by buying "bits" -- animated emoticons that show up on broadcasters' chat messages. As of the end of 2019, revenue from these commerce activities surpassed ad revenue on Twitch, according to the report from The Information

The company expects the combination of advertising, subscriptions, and other commerce on Twitch to generate over $1 billion in revenue this year. That said, Twitch's profit margin on commerce is lower than its margin on advertising, so the overall profit number for the company will be lower than originally anticipated just a couple of years ago.

While Twitch is still the most popular source for live-gaming streams, the competition is giving marketers access to more valuable inventory. Twitch's ability to grow subscriptions and commerce indicates it has a strong core of dedicated viewers, which means it still has solid, long-term potential for growth. As Amazon improves its video advertising capabilities, it may be able to reaccelerate video ad growth. That'll remain a challenge in the near term, though, as competitors grab market share and offer marketers easy access to high-value ad inventory.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.