Facebook (NASDAQ:FB) and Twitter's (NYSE:TWTR) fortunes have clearly diverged over the past few years. Facebook experienced surging demand for its ads, which generated more mobile display ad revenue than Google (NASDAQ:GOOG) (NASDAQ:GOOGL) last year. Twitter, which recently announced a CEO transition, has been generating less revenue from fewer clicks. As a result, Facebook's stock climbed 27% over the past 12 months, while shares of Twitter tumbled 16%.
The key reason Facebook keeps beating Twitter is simple: Facebook is a network of friends, co-workers, and acquaintances, but Twitter is a chaotic soapbox with an identity crisis.
Twitter's fundamental problems
Twitter is a platform for self-promotion, a megaphone which gets louder with more followers. Therefore, many users see follower counts as "scores" of a user's credibility.
That's why Twitter users buy fake users from grey market websites, which sell thousands of algorithm-generated "followers" for a few dollars. Of Ashton Kutcher's 17 million Twitter followers, 57% are probably fake accounts, according to analytics site Twitter Audit. Sales of fake Twitter followers likely generate $40 million to $360 million in annual sales worldwide, according to Italian security researchers Andrea Stroppa and Carlo De Micheli.
Twitter admits that 8.5% of its active user base consists of bots or third-party apps which contact its servers without any "user-initiated action." Yet the company keeps including those users in its MAU figures, which have nonetheless slowed down every single quarter since Twitter went public in 2013. Twitter also partially relies on retweeting bots to send a "firehose" of data to various organizations. However, fake accounts, bots, or third-party apps can diminish the value of Twitter's own ads to marketers.
Facebook runs a tighter ship
Whereas Twitter is a soapbox where followers can be considered virtual currency, Facebook establishes closer connections with people you actually know. Twitter users might want 20,000 followers, but most Facebook users don't want 20,000 strangers poring through their personal photo albums and status updates.
Facebook carefully compartmentalizes its user base into different comfort zones -- "friends" for all posts, "followers" for public ones, and closed business networks for coworkers with Facebook at Work. It also tethers users back to its News Feed via single sign-ons for third-party apps and sites, and offers alternative platforms -- like Instagram and WhatsApp -- which appeal to different demographics.
Facebook's network gathers personal data from users to craft better targeted ads for the News Feed. That's a gold mine of information that Twitter could only dream of obtaining. Unlike Google, which spreads its ads all over the Internet, Facebook keeps them tightly focused in the News Feed, where they reach its 1.44 billion monthly active users. Facebook then throttles the number of ads that it displays each quarter, which caused Facebook's average price per ad to soar 285% annually last quarter, even though ad views dropped 62%.
Exposure and engagement
Marketers generally care about two things in social media ads: exposure and engagement. Twitter's Promoted Tweets, Accounts, and Videos get exposure, but they're light on engagement.
Last year, Twitter dumped its cost-per-engagement model, where marketers only paid for tweets when users interacted with a click, reply, retweet, or favorite. Instead, it let marketers only pay for ads that led to a "desired" interaction, such as gaining new followers, conversions on a website, or app-installs. Yet Twitter vastly overestimated the engagement rate of its ads, causing it to generate less revenue from fewer clicks. Facebook, by comparison, charges advertisers on cost-per-impression, then rewards ads with higher engagement rates by displaying them more frequently.
Last May, Forrester Research revealed that Twitter had a much poorer engagement rate with brands than Facebook or Instagram. On Twitter, only 0.3% of companies' posts were engaged with by their followers in any way, compared to engagement rates of 0.7% for Facebook and 4.2% for Instagram.
Marketers are likely more forgiving of Facebook's low engagement rate than Twitter's, since its active user base is nearly five times larger. However, Instagram, which has over 300 million active users, could soon become an advertising powerhouse. Analysts at Citigroup estimate that Instagram could potentially generate $2 billion in annual revenues for Facebook once fully monetized.
A final thought
Twitter has added a lot of new services -- like Periscope, mobile payments, hosted videos, and group chats -- to maximize average revenue per user. Unfortunately, none of those features address Twitter's fundamental problems of lackluster MAU growth and poor ad engagement rates.
Simply put, Twitter doesn't know what it is. It's a soapbox with an archaic 140-character limit for tweets, where clusters of strangers and bots follow other strangers and bots. Facebook, on the other hand, has a clear idea of what it is, and what it could eventually become -- a formidable rival to Google.
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.