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Twitter Inc's Solution to Slowing Ad Revenue Growth Is Counterintuitive -- but It Just Might Work

By Adam Levy – May 28, 2015 at 8:01AM

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Expanding the struggling objective-based campaigns globally is key to attracting new advertisers.

Source: Twitter.

The early results of Twitter's (TWTR) direct-response cost-per-action advertisements haven't been spectacular. The company's first-quarter earnings fell well below its own guidance, and it had to lower guidance for the rest of 2015 because of its weakness in direct-response ads.

So, how does Twitter intend to ease the impact of its struggling ad units? By expanding them to everyone in the world. And while that might seem like it would only amplify the negative impact of charging advertisers per specific action (like website visit) instead of per impression, it actually makes a lot of sense. Expanding the ad units also known as "objective-based" to everyone increases the likelihood that the advertisers that benefit from action-based advertisements most will get a chance to use them.

I'm talking about small businesses. Those advertisers have grown to become a huge piece of Facebook's (META 1.98%) advertising business, making up most of its 2 million-plus advertisers. Twitter's expansion of objective-based campaigns could help it tap that growing market and increase ad prices.

Following Facebook's lead
Facebook introduced objective-based advertising in October 2013, and it's done an excellent job of attracting new advertisers to the platform. It reported passing the 1 million active advertiser mark in the second quarter of that year, and it surpassed 2 million in February of this year.

Meanwhile, Twitter had just 60,000 active advertisers in November, shortly after introducing its cost-per-action advertisements. Twitter doesn't provide regular updates on its total advertiser numbers, but during the company's first-quarter conference call, it said, "Ad revenue growth was driven by strong year-over-year growth in the number of advertisers on Twitter."

As Facebook grew its total advertisers, it saw a rapid increase in its price per advertisement. Over the last two years, Facebook increased its average ad price more than eight-fold, but saw a decrease in ad engagements of nearly two-thirds (due mostly to changes in its right-hand column ads). The increase in ad prices is directly linked to its cost-per-action pricing and, more importantly, the increase in advertisers as ad inventory shrinks.

To its credit, Twitter has also seen an increase in average ad prices in each of the last two quarters. In the fourth quarter, average price per engagement increased 10%, and it increased 30% last quarter. And Twitter has effectively expanded its total ad engagements compared to Facebook's shrinking ad inventory. However, ad engagement growth slowed significantly last quarter to 32% from the 694% growth rate it posted a year ago.

Twitter's potential advertisers
Twitter already has a good amount of small businesses on its platform. At the beginning of 2013, about 4.5 million small businesses had a presence on the social network. Assuming the small business presence has grown in line with user growth (a conservative method), there are now over 7 million small businesses with a presence on Twitter. And Twitter has done a pretty terrible job converting those businesses into advertisers, especially compared to Facebook.

Facebook now has over 40 million small businesses with a presence on its platform, and about 5% of them (2 million) actively advertise. That 5% conversion rate has been consistent for years now as Facebook grows the number of businesses on its site.

If Twitter could convert 5% of the estimated 7 million small businesses on its platform into advertisers, it would have more than 350,000 advertisers. That's nearly six times the number it reported at its analyst day in November. Getting there requires offering ad pricing that's easy to understand (cost-per-conversion) and producing results for those advertisers to reduce wasted inventory. Twitter is now doing the former, and it's always working on the latter.

Increasing the total number of advertisers is key to increasing Twitter's average ad prices. Changing the way an engagement is counted naturally increases the price per engagement, but it comes at the cost of fewer engagements. Increasing the total number of advertisers bidding on inventory naturally increases ad prices with no sacrifices elsewhere, leading to real revenue growth.

Adam Levy owns shares of Apple. The Motley Fool recommends Apple, Facebook, and Twitter. The Motley Fool owns shares of Apple, Facebook, and Twitter. 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.

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