Yesterday Twitter released very disappointing quarterly results, with misses on both user and revenue growth. From the Wall Street Journal:

Twitter Inc. delivered its weakest quarterly revenue growth as a publicly traded company, casting a shadow on its fledgling advertising business, which until now has been a consistent bright spot. Investors, who sent the company’s stock down nearly 20%, were hit with a double whammy Tuesday as Twitter’s first-quarter results were leaked on the social-media service itself an hour before their release was expected.

The symbolism of the leak was appropriate: Twitter the service is so clearly indispensable, at least for some, but Twitter the company can’t seem to get it right.¹ And so, after five years in charge, I believe it’s time for Twitter’s leadership, in particular CEO Dick Costolo, to make way for new leadership that has improved credibility with Wall Street, with developers, and within Twitter itself.

Note: At the bottom of the article I have included a number of links to previous articles and Daily Updates where I developed many of the individual pieces of this argument; in other words, this is not a knee-jerk reaction to one bad earnings report, but rather a culmination of years of concern

Twitter’s Fundamental Problem

Twitter’s fundamental problem is that their active user growth is simply too small given their current size. Twitter yesterday reported the service had 302 million Monthly Active Users (MAUs), an increase of only 18% year-over-year and 5% quarter-over-quarter (and the company said the current quarter would be worse!). This is a fraction of Facebook, half of Facebook Messenger, fewer than Instagram and not that much bigger than SnapChat; presuming the latter service passes Twitter later this year, Twitter will be only the 5th most popular U.S.-based social networking service looking to monetize through advertising. This distinction — which excludes WhatsApp, at least for now — is a critical one, because the issue with advertisers is most don’t have the time or ability to work with multiple services; it’s likely most digital advertising spending (which I believe is set to expand greatly) will be consolidated onto the biggest networks (along with Google’s properties), with Facebook taking the lion’s share. Were that to happen, it’s easy to see Twitter as the odd network out.²

Worrying Signs from Advertisers

Twitter’s recent results suggest this shakeout may already be happening. CFO Anthony Noto was asked repeatedly on the earning’s conference call about Twitter’s success in retaining advertisers, and Noto repeatedly refused to answer the question, instead stating that “year-over-year growth [in total advertisers] was very similar to what it was in the fourth quarter.” The problem, though, is that later in the call Noto noted that Twitter’s advertising load factor was flat: if Twitter was adding advertisers, but not ads, that strongly suggests that the company is in fact losing advertisers just as quickly as it is adding them.

Noto’s other justifications for Twitter’s revenue miss weren’t very compelling, either:

• The first was that “some advertisers limited spending at higher levels of scale because the bids required to win incremental auctions were higher than they were willing to pay, which limited additional spending.” In other words, larger advertisers had in mind a price they were willing to pay, and preferred to reach fewer users rather than pay a higher price, suggesting that advertisers saw limited value in Twitter’s ads

• The second was that Twitter “improved the quality of leads for direct response advertisers using our Website Cards by raising the bar on what constitutes an engagement or click”; Costolo later explained that some types of ads were moving from a cost-per-engagement model to a cost-per-action model, which was worth more to advertisers but more difficult to achieve, and that while the number of clicks decreased more than the price Twitter was able to charge increased, in the long-run this trend would reverse itself. The problem is that Twitter started this shift last summer when they rolled out app-install ads, which calls into question why the company failed to forecast the decline? Clearly the decrease was worse than they expected.

These two justifications are particularly interesting in light of one more factoid that emerged in the earnings call: the aforementioned app install ads were one of the key ad types that underperformed. What makes app install ads especially interesting is that the companies buying these ads are able to be very sophisticated in their measurements of just how much these ads are worth to them. Thus, for example, said companies would almost certainly have a price limit on how much they were willing to pay for an ad placement (justification one), and we know their particular ad type is measured on a cost-per-action basis (justification two). In other words, it seems likely that not only does Twitter suffer from a potentially fatally small user base, but that their direct response ads may in fact be less effective than hoped, as evidenced by the pullback by app install advertisers.

Indeed, Twitter’s direct sales team, which is focused on brand advertising from large advertisers, has long dominated Twitter’s revenue numbers, and that was again the case this past quarter (Noto noted that “direct sales was once again the largest contributor to year-over-year dollar growth”); this is a significant contrast to both Google and Facebook’s reliance on self-serve ad products. This isn’t necessarily a bad thing — I think branded advertising is set to explode past direct marketing — except that it is specifically brand advertisers who care the most about having an efficient way to reach a lot of people. In other words, Twitter’s limited user base is a particularly pressing problem in the ad category it excels at.

Twitter’s Abandoned Users

The trouble for Twitter is that awareness of the service has long outstripped its usability. And yet, despite the fact that Twitter has struggled with new user growth for years, almost nothing was done to improve the product or on-boarding experience until just the last few months, when the company finally rolled out a new logged-out page meant to entice people with Twitter’s content, as well as an instant timeline that helped people get started. Unfortunately, both efforts seem to be too little too late: Twitter admitted on the earnings call that neither improvement had increased retention.

This isn’t a surprise: Business Insider reported last year that Twitter likely had 697 million abandoned accounts (and that number, presuming it was correct, has certainly grown). The problem is that those 697 million users, having already decided that Twitter isn’t a useful service for them, are much less likely to even experience things like the new logged-out page or instant timeline, even though Twitter @-handles and hashtags continue to be plastered all over TV and the web.

The Problem with Twitter’s New Strategy

This suggests, then, that Twitter needs a new strategy: the timeline has taken the company as far as it can, so how else can the company grow?

To that end Twitter has taken to increasingly focusing on logged-out users, both on twitter.com, and also those who see Twitter’s content around the web. Ad Age reported from last fall’s analyst day:

The company’s central focus was on the “largest daily audience” notion, driving the point that Twitter content flows and appears across the web and beyond. The company told investors to consider Twitter’s reach in four concentric circles: logged-in users, logged-out ones, eyeballs from Twitter posts’ syndication around the web; and, finally, the expanse of Fabric, its new mobile software platform. With this reach, Mr. Noto said the platform is en route to becoming “better than anybody else in digital advertising.”

The problem is in the last line: “better” when it comes to digital advertising is only partially about reach: targeting, effectiveness, and measurement matter just as much. To that point, such an approach abandons Twitter’s biggest differentiation when it comes to its ads: the knowledge it has about logged-in users’ interests. Jay Yarow of Business Insider pressed Costolo on this point in February:

Q: How do you think about [logged-out users]? When you look at a company like Yahoo, the display business is down. It seems like all the ad growth online is mobile, or social, or native advertising. What you’re essentially creating is a display ad unit for logged out users. When you have people who come in through search you don’t get the rich targeting like you do in your app. Are these logged-out users going to be less valuable than people in the app?

Costolo: We still are going to be using the same native ad units, the Promoted Tweets. The content that’s also an ad is going to be the same unit. We like our ad unit a lot, we know that others in the market have replicated it, so were going to stick with that.

As regards targeting, look we have this whole internal scrap about people who are logged in, it’s also the case that we’ll know a lot about people who are coming as logged-out users and why they’ve come there. A lot of those users come direct via searches, directly from a search engine, so we’ll know about them. We’ll know of course around events and specific topics, and in the moment what’s happening in the world, we’ll know the kinds of things that are happening and be able to direct our targeted ads into those experiences. So there’s a lot of the existing targeting capabilities that we’ll still be able to bring to these experiences.

You’ll note that Costolo didn’t answer Yarow’s question, because the answer is obvious: logged-out users are significantly less valuable, and all those signals Costolo is counting on are no better than Yahoo’s. It is difficult to interpret this new focus on significantly less valuable users as anything other than giving up on acquiring new users, and I believe it is absolutely the wrong strategy.

A Different Strategy

Instead, Twitter should redouble its efforts to acquire new users even as it redefines what Twitter the company is all about. I wrote about this in What Twitter Might Have Been:

What makes Twitter the company valuable is not Twitter the app or 140 characters or @names or anything else having to do with the product: rather, it’s the interest graph that is nearly priceless. More specifically, it is Twitter identities and the understanding that can be gleaned from how those identities are used and how they interact that matters. If one starts with that sort of understanding — that Twitter the company is about the graph, not the app — one would make very different decisions.

Specifically, Twitter should dramatically increase the number of applications — and thus the number of potential reasons — a potential user might create and maintain an active user account. For example, Twitter could follow the Facebook strategy and build out a family of apps — one for messaging, another for news, others for specific events — and enhance the ways one could interact with Twitter content, whether that be through comments, private communities, etc. It’s ok that this is aping Facebook; what differentiates social networks is not their feature set but rather their organizing principle. Facebook is about people you know, and Twitter about those that share your interests. Everything else — including all the quixotic features that Twitter holds dear — are implementation details.³

Alternatively, Twitter could empower third-party developers to build these sorts of applications that feed back information into the Twitter interest graph. An application like Nuzzel, for example, which uses your Twitter graph to create a news app, has much more of a one-way relationship with the social network: Nuzzel is getting all the benefit, and not sending much information back to Twitter. Twitter would be better off retooling their API and developer agreements to ensure they are learning from every application they interact with, and in return sharing their graph along with advertising in the form of their MoPub or Namo Media-derived offerings. The advantage of this approach is that the imagination and ingenuity of a massive developer ecosystem will always be far faster and more innovative than anything any one company can do on its own — just ask Apple.

As an aside, something that has hurt Twitter on the public markets has been the expectation/hope that the social network would follow Facebook’s path with regards to user numbers and monetization. Clearly the company as presently constructed isn’t anything close to that; however, the open approach that I’m advocating could in fact become something exponentially larger. Last week I wrote about Facebook’s AOL-like dominance and concluded, “What might be the broadband to Facebook’s dial-up?” The answer, I think, is this open Twitter: an identity system for the rest of the web that connects people and apps according to interests, not just superficial relationships, and monetizes accordingly.

Obstacles

Unfortunately, it’s difficult to see Twitter under its current leadership getting even close to this ideal:

• A Facebook-type strategy would require a level of execution and speed that is pretty much the exact opposite of what Twitter has demonstrated throughout its existence. Facebook seems to be updating or testing new designs for its various products on a nearly weekly basis, while it feels like Twitter’s product hasn’t really evolved in years (in stark contrast, I might add, to the composition of its executive suite).

  Given that Twitter seems afraid to make even obvious changes to its core product for fear of messing up what they don’t seem to understand, I’m not particularly confident the current leadership team has either the vision or the internal credibility to lead such an effort⁴

• The open strategy I endorse has an additional x-factor outside of Twitter’s control: the cooperation of 3rd-party developers. And, given that Costolo was the CEO when Twitter burned its bridges with developers in 2012 (and, two weeks ago, with its data providers), the company under its current leadership has no credibility with the folks who might make such an effort a success

• Most importantly, now that Twitter is a (struggling) public company, it is exceptionally difficult to see Wall Street having the patience for the amount of time such a strategy realignment would take. After all, it took the company nearly nine months to come up with its current strategy of being Yahoo-lite; how much longer to map out much less execute the sort of ambitious plan proposed here? Unfortunately, any credibility the company may have had with Wall Street is, after yesterday’s huge miss, surely gone

New Leadership is Needed

To summarize:

• Twitter has a user growth problem that, as of this quarter, is showing significant signs of manifesting into an advertising growth problem
• Twitter’s current strategy of expanding to serve an audience they don’t know with undifferentiated ads is barely sustainable and a considerable waste of Twitter’s potential as the owner of the interest graph
• There are different strategies available, but the current leadership team doesn’t have the credibility internally, with developers, or with Wall Street to consider or execute them

That is why I believe it is time for a change. Twitter needs a better strategy, and more importantly, it needs fewer obstacles in its path to executing that strategy. There’s no question Costolo in particular has done excellent work at Twitter, taking over a dysfunctional company with a brilliant product and building it up into an actual business, and I wouldn’t begrudge him a particularly large golden parachute. But I firmly believe the time to act is short.

In fact, it may already be too late. It seems ridiculous to, as I did earlier, put Twitter in the same conversation as Facebook, given that the former owns 70% of social referrals and Twitter a pitiful 3%. Moreover, Facebook’s developer offerings are considerably more advanced, and its monetization opportunities significantly greater. Instead, as I hinted at in my previous article, there is a lot about a Google-Twitter merger that makes sense: the former pays the bills, and the latter provides a road into the brand advertising future. That, though, would likely require an even greater run-down in the stock.

I don’t want that for Twitter. I want one last shot for my favorite and most essential social network to truly take over the world, not just the headlines; I just want someone else taking that shot.

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Background

I am not the first person to discuss this issue. Last November, the Wall Street Journal quoted Walter Price, an Allianz Global senior portfolio manager as saying “People are losing confidence in [Costolo]”, and in December Robert Peck, an analyst at Sun Trust told CNBC “We think there’s a good chance he’s not there in a year”, which may have caused a mini-rally in the stock.

More importantly, I have been building up the substance of my argument for over two years here on Stratechery; the following are a selection of articles and Daily Updates that contain many of my concerns (please note the Daily Updates are members-only)

• September 16, 2013 — There are Two Twitters; Only One is Worth Investing In — This article written when Twitter filed for its IPO, and predicted that Twitter would monetize relatively well but that it would struggle with user growth
• April 30, 2014 — Daily Update: Twitter’s Earnings — This Daily Update discussed, in the context of Twitter’s earnings, why I was increasingly concerned that the company’s new user problem was intractable given the fact that many people had already tried the service
• May 1, 2014 — Twitter’s Marketing Problem — This article posited that Twitter’s new user problem was exacerbated by the fact the company had never had to figure out product-market fit; the core product was so good it appealed to a very large number of users without any effort on Twitter’s part, but now the company did not know how to grow marginal users
• July 30, 2014 — Daily Update: The Twitter Enigma — This Daily Update expressed my concern that Costolo did not seem to have a clear vision for the company
• October 23, 2014 — Daily Update: Twitter Fabric — This Daily Update discussed the fact Twitter seemed to be giving up on Twitter the service and turning its attention to developer-based services and monetization options, and the difficulties they would have with such a strategy
• October 28, 2014 — Daily Update: The Twitter Mismatch — This Daily Update discussed the disappointing number of advertisers on Twitter, both in terms of direct-sale brand advertisers as well as self-service direct marketing focused advertisers, and posited that Twitter was in danger of losing out on advertiser attention completely because it was simply too small
• October 31, 2014 — Daily Update: Twitter Changes, Again — This Daily Update discussed yet-another Twitter executive reshuffle, this time around product
• November 13, 2014 — Daily Update: Twitter’s Analyst Day — This Daily Update discussed Twitter’s analyst day announcements and my concerns that the company was increasingly focused on pandering to Wall Street at the expense of making need product improvements
• February 6, 2015 — Daily Update: Twitter’s Results, Algorithm, and Value — This Daily Update discussed Twitter’s new plan to focus on non-logged in users and the financial ramifications of doing so
• March 13, 2015 — Daily Update: Nuzzel and the Unbundling of Twitter — This Daily Update explored the possibility that the 140-character timeline was a minimum viable product that is being unbundled in favor of speciality services, and that Twitter should embrace that
• April 15, 2015 — Twitter and What Might Have Been — This article, just two weeks ago, explained how Twitter was cutting off access to its interest graph due to its increasingly desperate need to monetize, and explored how much brighter the company’s future may have been had the company been more open with developers in particular

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1. To be fair, the specific mistake in this instance was Nasdaq’s reponsibility. But, as we’ll discuss, there seem to be excuses for everything that is, at the end of the day, Twitter’s responsibility ↩

2. Moreover, Twitter’s MAU numbers are not necessarily what they seem, particularly from an advertising perspective. The company disclosed last year that 14% of its MAUs never visit Twitter’s website or apps; rather, these users have connected 3rd-party applications and websites that don’t display Twitter ads; for example, you can log into Twitter from Instagram in order to post a link to a photo. Moreover, that number doubled over the previous year, a stark contrast to Facebook’s <5% figure. Worse, a sizable portion of those users may be lapsed completely; according to Twitter approximately 8.5% of MAUs are due to applications that automatically ping Twitter without any user involvement.

   One example of such an application was iOS 7 Safari: in Twitter’s 2014 4Q results the company blamed its slowing user growth numbers on iOS 8, which ended Safari’s practice of pinging Twitter for its Shared Links whether or not the logged-in user ever read that section. The proper interpretation, though, was not that Twitter’s user growth numbers were accidentally and temporarily slowed, but rather that the company had been over-counting MAUs for at least a year. Add in the fact that, according to Twitter, up to 5% of MAUs are likely spam accounts, and it’s fair to wonder just how many people are actually being served ads from Twitter’s advertisers ↩

3. Arguably Twitter is on this path with Vine and Periscope, but progress is painfully slow; the company needs to be moving 10x faster ↩

4. And, I might add, I remain disappointed and disillusioned by Twitter’s hire of a head or product who, at the time, only had 72 tweets to his name; to Costolo’s credit he fixed this mistake quickly ↩