Warren Buffett said, "In business, I look for economic castles protected by unbreachable moats." The castle is a metaphor for a company and the moat refers to its competitive advantage and ability to secure long-term profits. Solely investing in companies with wide moats has been a key Buffett investing strategy.
Tech companies like Twitter (NYSE: TWTR) prove not all big castles have wide moats.
Despite the company's hashtag revolution and hundreds of millions of monthly tweets, Twitter is failing to secure its future and make money. This has been especially difficult for the company in light of Facebook's (NASDAQ: FB) much larger market share.
What is Twitter's real value?
Twitter is lagging behind its competitor Facebook in monthly active users and GAAP basis profits. In 2014's first quarter, Twitter's revenue increased 119%, yet showed a net loss of $132 million. Its competitor Facebook had a good quarter with a 72% increase in revenue with $642 million in earnings. Facebook also has over a billion monthly active users on mobile devices alone while Twitter has secured 255 million monthly active mobile and desktop users.
Even with such an active user base, Twitter's moat is narrow. Twitter lags behind its social media rivals in reach and competitive advantage. Competitors have tapped into a growing mobile advertising market while growing a steady mobile user base. Companies such as Google, Yahoo and Facebook have a much greater reach for mobile and desktop users. Rick Summer, an analyst at Morningstar, believes Twitter would have to provide massive competitive advantages and greater reach to be sustainable.
Although Twitter's IPO was more successful than Facebook's debacle, the company's value is suspect considering its stiff and profitable competition.
Twitter should look at giants like Apple and IBM for support. Consider that only 13 years ago Apple was on the verge of bankruptcy. Now, the company is ranked on Forbes' World's Biggest Public Companies list.
How did these once-dying companies make Cinderella stories? Apple and IBM survived by learning two valuable lessons.
Lesson 1: innovate
In the late 1990s Steve Jobs left Apple and joined Pixar in a time many thought Apple was a failure story. On PBS an interviewer asked Jobs, "What went wrong with Apple?"
Jobs' answer: Apple stood still, and only innovation could return its former glory.
Twitter is not innovating its product. As FastCompany editor David Lidsky pointed out, Twitter has chosen a clunky desktop look for its mobile app because it is convenient for advertisers. While ad revenue may please shareholders, Twitter should focus on pleasing users in its beginning stages. To simultaneously please shareholders and users, change is inevitable.
Lesson 2: know your true competitive advantage
In the early 1990s, IBM lost some of its core business to smaller, more nimble competitors. Its CEO decided the answer was to split IBM into autonomous business units to mimic its PC rivals.
That mistake resulted in $8.10 billion in losses. The only way IBM could survive against its competitors was to listen to what consumers really wanted. IBM discovered its losses were due to a lack of integration of separate computing technologies. In other words, IBM had mistaken its real competitive advantage of integration. The company quickly adapted and provided more integrated solutions.
The lesson is clear: know what makes you unique. Tech companies thrive by building off a well-defined identity.
Twitter believes one of its greatest competitive advantages is real-time news. However, Facebook also integrated strategies to deliver real-time updates to its users, while succeeding at building a solid mobile platform.
In order to thrive, Twitter needs to grow its mobile user base and give users exclusive benefits they can't find elsewhere.
Where to go from here
Twitter does not have a wide moat, but it is not a lost cause yet. In this stage, the company would be wise to listen to its users and focus on building a competitive advantage that will secure future cash flows. Twitter's real-time competitive advantage can easily be destroyed by Facebook's efforts, and the company needs to provide innovative solutions to attract advertisers and users. Through persistence and innovation, Twitter may gain back investor confidence.
Ashley Carmichael has no position in any stocks mentioned. The Motley Fool recommends Apple, Facebook, Google (A shares), Google (C shares), and Twitter. The Motley Fool owns shares of Apple, Facebook, Google (A shares), Google (C shares), and International Business Machines. 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.