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Tuesday, 28 June 2016

Protect the nerds

Twitter's sky-high R&D hits the right spot

Twitter’s research and development spending may be sky-high, but it hits the right spot. At 44 percent of revenue in the first half of the year, the microblogging site is spending far more as a proportion of its top line than Facebook. But with a lower number of users than its rival, Twitter needs to grow to make new investors happy.

Technology tends to be a winner-takes-all – or almost all - market. If a company can establish a useful standard or platform, network effects usually mean users will flock to it. Twitter’s a good example, with monthly active users growing more than fivefold over the past three years to 218 million. That’s a big reason revenue is growing at an even faster pace. It should hit around $700 million this year, well over 20 times larger than in 2010.

Twitter is also growing into its spending. Granted, R&D expenses more than quadrupled over the past two years. But the amount it spends as a percentage of revenue has dropped as advertising income has grown. In fact, as recently as three years ago, R&D costs outstripped sales. Since advertising is seasonal, this metric should fall further in the second half of this year.

Twitter’s biggest risk is a dramatic fall in the rate of people joining the service. The number of new users appears to slowing already - and the company has less than a fifth of Facebook’s monthly users. The larger social network is steadily rolling out features, such as hashtags, that it has cribbed from its smaller rival.

Facebook has aggressively ramped up R&D spending, too, boosting it from 7 percent of revenue in 2010 to 27 percent last year. Its far larger size means its budget dwarfs Twitter’s – it spent more than 10 times as much last year. Sure, the two companies don’t entirely overlap. Facebook is largely built around semi-private interactions while Twitter is more open to strangers.

Twitter’s strategy of hiring engineers at a fast clip to build new features and services is the best way to ensure growth. Curtailing that hefty investment too soon would be a big mistake.

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Context News

On Oct. 3, Twitter filed public documents with the Securities and Exchange Commission to sell $1 billion of stock in an initial public offering. The social messaging service did not disclose the number of shares it proposes to sell or their price.

The company had $254 million of revenue in the first half of the year, compared to $122 million in the first half of 2012. Twitter had an operating loss of $63 million in the first six months of this year. It has never made a profit.

The company spent $112 million on research and development in the first half of 2013. That is equal to 44 percent of the company’s revenue during that period. The company spent $119 million on R&D during all of 2013.

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