Snap's (SNAP 0.19%) average revenue per user, or ARPU, climbed to $2.58 in the fourth quarter. That's up 23% year over year.

However, management insists there's still a long way to go for it to improve its user monetization. "Looking at our current ad products and applying comparative industry [cost per ad impression] to our own inventory, we are in a position to meaningfully close the ARPU gap relative to our peers," Chief Business Officer Jeremi Gorman said during Snap's fourth-quarter earnings call

CFO Derek Anderson and CEO Evan Spiegel later said Twitter's (TWTR) ARPU is a near-term benchmark that Snap is driving toward. For reference, Twitter's ARPU was about $6.28 in the fourth quarter of 2018, but it may have declined last year as it grows its user base faster outside of the United States. Still, it shows Snap's ambitions to more than double its ARPU over the next few years.

The biggest factor influencing whether or not Snap can succeed is increasing advertiser demand, specifically whether it can add more active advertisers.

The Snapchat logo

Image source: Snap.

Snap's weak advertiser demand showed up in its results

Revenue growth at digital advertising giants Facebook (META -0.28%) and Alphabet (GOOG 1.06%) (GOOGL 1.08%) showed marked deceleration in the fourth quarter, indicating a generally weaker-than-expected demand for digital advertising. 

The impact on Snap compared to the bigger ad platforms was much more noticeable, as RBC Capital Markets analyst Mark Mahaney points out. In a note to investors, he wrote:

As a smaller platform with few supply constraints (much more inventory than advertisers), a reduction in advertiser demand has a bigger impact on Snap's head/premium inventory versus Alphabet and Facebook, where demand changes are more impactful at the tail end.

In other words, by nature of having more bidders in the ecosystem, Facebook and Alphabet saw resilient ad pricing, especially for more premium ad inventory. Facebook announced it ended the year with 8 million active advertisers. When asked for an update on the range of advertisers on Snap, Gorman merely replied, "We do have fewer than 8 million advertisers, but a lot of headroom to grow."

That said, Twitter also has far fewer active advertisers than Facebook or Google. CFO Ned Segal reiterated during Twitter's third-quarter earnings call in October that the advertising platform remains "demand constrained." He also neglected to provide an update on how many active advertisers use Twitter. Still, it shows there's room to improve ARPU without saturating demand or ad load.

How Snap plans to increase advertiser demand

Gorman outlined three key priorities in Snap's efforts to increase advertiser demand and close the ARPU gap between itself and the competition.

First, improving our measurement, ranking, and optimization to drive relevance and deliver ROI.

Gorman says the company's investments in products like the Snap Pixel (which enables marketers to track ad viewers from impression to checkout and retarget users) are paying off. Ads targeted at consumers lower in the sales funnel are growing, and those ads generally provide greater return on investment than campaigns with a broader focus. The ability to expand its ads to those higher-value ad impressions may attract more small and medium-sized businesses to Snap's ad platform.

Second, building out our sales and marketing functions to support the needs of our advertising partners globally.

Snap will invest more in ad sales teams across different verticals and geographies in 2020. Additionally, Snap started investing in a business-to-business marketing campaign in order to attract the attention of media planners. Investing in sales personnel will have a negative impact on operating margin in the short term, but it may be essential to attracting the breadth of advertiser demand that will allow it to catch up to the ARPU levels of Twitter and others.

Third, creating innovative ad experiences around video and augmented reality that deliver real business value.

Snap's strengths in augmented reality and visual communication have resulted in several interesting advertising products. The challenge with innovative ad products, though, is that they can be difficult to create for. Snap's most successful ad product is its 6-second commercial video ad displayed within its Discover content, which is notably easier to create than an AR lens.

Taking on the big competitors

Snap's plans to attract new advertisers are well thought-out. While the investments may curb margin expansion, the opportunity to scale revenue is too big to remain conservative. 

However, trying to win over advertisers to split their budgets from other tech companies in order to experiment with new innovative ad products on Snap could be a tough sell. The return on investment must be there. And while management pointed out strong returns at scale, smaller businesses may need to invest a lot more upfront in their ad creatives for Snap, making the returns less appetizing. 

That weakness could prevent Snap from attracting the long-tail of smaller advertisers that support ad prices when the digital ad market shows lower-than-expected demand, like it did last quarter. 

Still, with every quarter of climbing user growth and increased engagement -- particularly on its Discover platform, which offers easier advertising opportunities -- Snap become more attractive. Smaller advertisers could generate more views from a single ad creative.