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Twitter Inc. Needs to Change Its Focus

By Adam Levy – Feb 20, 2016 at 5:00PM

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User growth declined last quarter, and it's not clear it's coming back.


Source: Twitter.

Hundreds of millions of users have already abandoned Twitter (TWTR -1.35%) according to third-party sources, and in the fourth quarter of last year Twitter acknowledged that more people left than signed up or came back. It was the company's first-ever sequential decline in users. U.S.-based users fell from 66 million to 65 million, and global users (excluding SMS Fast Followers) fell from 307 million to 305 million.

The active user decline is especially notable because Twitter launched Moments and a branded ad campaign last quarter designed to drive users to sign up or come back. So far, that hasn't been the case. Management did its best to provide an optimistic outlook for the business going forward, but the drop-off in users is a huge concern for investors.

The big flop
Twitter launched Moments in October, and a few weeks later it ran its first television commercial promoting the feature. The commercial was widely criticized as confusing, only adding to the notion that Twitter has a steep learning curve when, in fact, Moments is designed to remove the curve. As a result, Moments' U.S. launch didn't spur user growth as expected; in fact, users declined in its wake by about 1.5%.

That doesn't bode well for future product changes such as the algorithmic timeline change the company introduced the morning of its fourth-quarter earnings report. Twitter will now place "recommended" tweets at the top of users' timelines instead of displaying tweets in strict reverse chronological order.

CEO Jack Dorsey has several other product changes in mind for 2016, from simplifying replies to improving the ease of creating a tweet. None of these is as big of an endeavor as Moments, but Dorsey believes incremental changes could keep users engaged.

Time to face the facts
Twitter management seems to have come to terms with the fact that user growth has peaked. It's made a lot of product improvements over the last year or so, but user growth rates continued to decline. As a result, what the company should be focusing on now is generating the most value per user for advertisers.

In the letter to shareholders, management noted that ad load increased last quarter both sequentially and year over year. Twitter made clear that the ad load increase was driven by demand, not because Twitter was desperate to squeeze more revenue per user. Total advertisers increased 90% in 2015 to 130,000.

Throughout 2015, CFO Anthony Noto told analysts that ad load was still only about one-third of what the company sees as its long-term potential. That rhetoric disappeared in the fourth-quarter earnings call, which may be a sign that Twitter is seriously increasing its ad load for the first time in over a year.

To its credit, Twitter managed to increase ad revenue 48% year over year in the fourth quarter, indicating there's still room to grow the metric despite a decline in users.

Twitter is also introducing new premium ad products, such as promoted moments and First View, which places a video ad at the top of users' timelines for maximum exposure. Continuing to introduce these high-end ad products while rolling out more self-serve functionality for smaller direct-response marketers will help drive growth in ad revenue.

But increasing ad load could only accelerate the negative engagement trend at Twitter. When asked how the increased ad load in the fourth quarter affected user engagement, Noto dodged the question.

While Twitter management says users have returned to third-quarter levels, the focus needs to shift to maximizing revenue per user. With the interest-graph Twitter has on its users, it should be able to produce much higher average revenues per user. It just needs to develop better targeting and tracking ad tech and attract more advertisers, and that's where management should focus.

Adam Levy has no position in any stocks mentioned. The Motley Fool owns shares of and recommends 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.

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