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 that 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, increasing 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.
Robert Cyran is a columnist for Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com.