Facebook (NASDAQ:FB), LinkedIn (NYSE:LNKD) and Twitter (NYSE:TWTR). All sites which started with a simple goal of connecting people. They have now become the darlings of portfolio management firms around the world. The reach, size and visibility of these companies has drawn the attention of investors and skeptics alike who regularly ask:
- What is the main source of revenue of these companies?
- Can these companies continue to grow their profitability, purely on the strength of advertising revenue?
- And the question discussed the most: In what areas can these companies expand?
[I] Sources of Revenue
Before thinking about how and where these companies can expand in the future, it is important to analyze and compare the financial statements of these companies as they are now. We want to understand their current sources of revenue before looking to their next possible areas of expansion.
Facebook makes money from two sources:
- Advertising. The company's advertising revenue is generated by displaying ad banners (including text ads) on their website and mobile applications.
- Payments and other fees. Non-advertising revenue come from payments for online games like CityVille, FarmVille, Empires & Allies and ZyngaPoker. The company receives fees from developers of these games when users make purchases using Facebook's payment infrastructure.
While advertisements remain the key source of revenue for Facebook, contributions from payments and other fees is also increasing. Ad revenues contributed 91% to Facebook's total revenues for the financial year ending December 2013.
Source: Facebook Inc., 10K - December 2013
LinkedIn generates revenue across three distinct product lines:
- Talent Solutions. Recruiters and corporations looking for potential employees pay LinkedIn to connect with other members on the network.
- Marketing Solutions. The company's next biggest revenue stream comes from displaying of advertisements (graphic and text links). This accounts for 24% of LinkedIn's total revenue.
- Premium Subscriptions. The final 20% of LinkedIn's revenue is from premium subscriptions where the company sells various monthly or annual subscriptions with advanced features - like the ability to initiate direct contact with other members on the network and the ability to view profiles of members who visit your page.
Source: LinkedIn Corporation, 10K - December 2013
Twitter generates its revenue from two sources:
- Advertising. The company generates 89% of its revenue from advertising. There are three distinct ways for a company or an individual to advertise on Twitter: by promoting a tweet that will appear on people's timelines, by promoting a whole account so that other users can see the promoted account in its entirety, or by promoting a specific trend.
- Data Licensing. The company generates its balance revenue by licensing their data to third parties like advertisers and market researchers and by providing mobile advertising exchange services.
Source: Twitter Inc., 10K - December 2013
[II] A Word on Advertising Revenues
I strongly believe that display advertising can never sustain "big business" for digital companies if they are not actively engaged in optimizing their advertising per their users. Why? For the very same reasons working against traditional forms of advertising.
Before we had the internet, everybody saw the same adverts. People relied on TV and traditional print media to find out about the best offers and products. Naturally, these adverts were not optimized based on the recipients' interest. With the advent of the internet, came the ability to optimize content, to give people what they were looking for. Search engines have allowed users to find and compare exactly what they are looking for. This makes unsolicited ads on the web even more annoying. Even when something catches a user's attention, the user will go back to a search engine and compare every possible option before making a decision. This has greatly weakened the strength of unsolicited digital advertising.
Companies like Facebook and Twitter are likely going to see a reduced interest from marketers from this point forward. Soon, they will have to find newer ways to stay profitable. In fact, LinkedIn's niche as a networking portal gives it a much higher chance of succeeding with marketing. LinkedIn can potentially emerge as a global recruitment firm by providing a platform for advertisements in the recruitment space.
[III] Where can these companies expand?
Facebook: Facebook has a massive worldwide reach with ~ 750 million daily active users (Source: Facebook Inc., 10K - December 2013) while Twitter has only ~240.9 million monthly active users and is yet to become profitable (Source: Twitter Inc., 10K - December 2013).
Given the current user base of Facebook and its ability to scale up, it is highly likely that in the future it will supersede Twitter for trends and news. Further, Facebook's reach and the scalability of its platform give it a huge advantage if it ever moves to enter the telecommunication and/or e-commerce space.
LinkedIn: The biggest advantage for LinkedIn is its specificity. It has the most targeted audience and has carved a niche for itself in as much as its visitors are sincerely interested in career advancement and networking.
To do well however, LinkedIn must either become one of the largest and the most trustworthy recruitment firms in the world or find another way to capitalize on its reach. While companies will continue increasing their budgets for hiring high quality talent, I don't see an online platform scaling up to the point where it can outperform local recruitment firms.
Twitter: Twitter has largely become news services syndicate. Like LinkedIn, it must become an increasingly reliable source, in its case of news, to ensure that more people start relying on Twitter for news updates.
Twitter's business model of short text messages faces a structural challenge. Unless a user visits a page, there is very little chance he will click a text or banner ad. Tweets, as opposed to the content on Facebook (mainly pictures and videos), give no reason for a user to visit the site or the actual page where the tweet is hosted. This is bad not only for advertising revenues but also for the prospects of the company entering into another web based service.
At the same time, Twitter's data licensing business, while still not a major source of revenue, is one of the most promising verticals for future growth. The company sells its tweet data (i.e. tweets from all its users) to social listening companies who arrange these tweets on the basis of interests, age, location etc. This data is then supplied to news desks, political parties, advertising firms, etc., to help them gain insight into the latest trends and enable them to design more effective advertising campaigns.
To that extent, Twitter analytics can create a greater synergy with search engines like Google because they allow the latter to tweak its algorithms based on what people are talking about or looking for at a given point in time.
Each of these companies has a well-defined market segment. I foresee that the platform most likely to succeed is the one possessing maximum reach. So far, Facebook has the clear advantage in this area. Furthermore, Facebook's platform is strongly placed not only to generate substantial revenue from advertising, but also to potentially eat into the market share of Twitter.
As things stand today, and believing that each company has the same likelihood of coming up with something revolutionary in the future, Facebook makes the best long term investment stock, given that it has the potential to generate the highest advertising revenue amongst these three social media giants.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.