One of Costolo's worst decisions was the introduction of a new pricing model. In the past, marketers were offered a cost-per-engagement model in which they only paid for Promoted Tweets when users interacted with a click, reply, retweet, or favorite. Under the new model, which it introduced over the past two quarters, a marketer only pays for ads that lead to a desired interaction. These interactions include adding new followers, conversions to a website, app installs, or collecting user email addresses.
Twitter believed that offering more marketing choices would bring more advertisers to the social network. Unfortunately, the company ended up charging advertisers for fewer clicks and generating less revenue. Last quarter, Twitter's revenue rose 74% year over year to $436 million, but that missed its own forecast of $440 million to $450 million.
Even Costolo didn't seem confident that plan would work. Since unveiling the new pricing model last year, the CEO sold over $34 million in Twitter stock, according to SEC filings. Unlike Twitter's new pricing model, Costolo's stock sales were fairly well timed -- the stock has fallen over 17% since last August.
Twitter isn't Facebook
Unlike Twitter, Facebook (NASDAQ:FB) doesn't let marketers pick and choose. Instead, it charges advertisers auction-based costs-per-impression or cost-per-click prices, and rewards ads with higher engagement rates by displaying them more often. Facebook also throttles the number of displayed ads per quarter to inflate demand and prevent ads from overrunning the News Feed. As a result, Facebook's average price per ad soared 285% annually last quarter even as ad views dropped 62%.
The key difference between Facebook and Twitter is that there is no pent-up demand for Twitter's ads. During last quarter's conference call, CFO Anthony Noto claimed Twitter was still adding advertisers, yet growth in ads remained flat. That contradiction indicates Twitter is either losing advertisers as quickly as it adds them, or existing advertisers are reducing the quantity of purchased ads.
Noto also admitted that advertisers "limited spending" because some prices were "higher than they were willing to pay" -- meaning advertisers saw limited value in Twitter's ads. Twitter's "pick and choose" pricing model further exacerbated the problem.
Ignoring its biggest problems
Twitter keeps testing and adding more services -- including mobile payments, Buy buttons, videos, Periscope, and group chats -- to evolve beyond a simple news feed of 140-character blurbs. The hope is that these new features will boost its average revenue per user, or ARPU, to offset its core problem -- sluggish growth in monthly active users, or MAUs.
Twitter's MAUs rose 18% annually to 302 million last quarter. By comparison, MAUs rose 20% in the previous quarter and 25% annually in the prior-year quarter. In 2013, Costolo asserted Twitter would have 400 million MAUs by the end of the year. To spur growth, Twitter signed a lopsided deal with Google (NASDAQ:GOOG) (NASDAQ:GOOGL) to draw new users to the network.
On the bright side, Twitter's quarterly ARPU rose 47% annually to $1.44 last quarter, indicating that new marketing products were maximizing revenue per user. But when companies compare Twitter's MAU base to Facebook's 1.44 billion MAUs and Google 69% share of global searches, it isn't clear if advertising on Twitter should be a top priority for most businesses.
As long as Twitter is overshadowed by those two giants, it won't have enough clout to convince advertisers to buy more ads, even with its new "pick and choose" model.
Twitter's business model can be tough for investors to understand. The company is imitating some of Facebook's strategies, yet failing to execute them properly. In the end, there simply isn't enough demand for Twitter ads to let marketers simply pay for the ad interactions that they want. As a result, Twitter will likely continue generating less revenue from fewer clicks for the foreseeable future.
Leo Sun owns shares of Facebook. The Motley Fool recommends Facebook, Google (A shares), Google (C shares), and Twitter. The Motley Fool owns shares of Facebook, Google (A shares), Google (C shares), and Twitter. 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.