Wtf is wrong with Twitter's financial model and what Musk might be doing to fix it
Exploring the economics of what Musk might be trying to do with Twitter through a rationale lens rather than an emotional one.
If you haven’t been paying attention to the news this week, Elon Musk bought Twitter. He did so to much consternation, complaint and general whinging from people. People either love Musk or despise him, and so it seems there are post rationalisations on both sides as to whether Musk is a genius or not.
I think the answer is somewhere in the middle. My genuine thought is Musk has little to no idea how to run an ads business, and he’s likely bought Twitter in order to make the model non-ad related. Remember Musk’s thinking on Twitter is likely highly influenced by Jack Dorsey, one of the early Twitter staffer. Dorsey for a long time felt that Twitter should not have been fuelled by an ads based model.
Some background… how does Twitter’s model work?
Twitter is an ads company primarily. In 2021 the company made around $4.5bn in ads revenue with around $6bn in costs. That’s a hugely bloated business model for something that isn’t making much money.
Broadly, social media companies get less profitable as they get bigger, mainly as the onerous obligations of content moderation bite into the business model and user growth plateaus. There’s a strong argument to say that social media businesses will never be as profitable as they were in the 2010s purely because the social licence required to operate now means huge operating costs in content moderation. Until this problem is solved, it’s hard to see them getting back to massive profitability.
Twitter has been losing $1.5bn as a mature, publicly listed stock. That means something is fundamentally broken in the business model.
There are some fundamental features as to why. Twitter lacks both the ad sophistication and the must have environment to make it mission critical for most advertisers. That means it’s relatively easy to pull spend from, and also lacks the strength in core Ad Product that most scaled social companies (e.g Google, Meta, Snap) tend to have.
Within WarChest, we often see uninterrupted video as being a high value ad asset. Twitter doesn’t maintain strong video advertising other than in-feed. Whereas Google has YouTube, Meta has Instagram Stories and Snap has a similar Stories-based product. All given uninterrupted views of the screen for advertiser.
You might ask how Twitter has survived. Functionally it’s used some debt, capital market raisings and upfront payments to basically cashflow itself. In essence it’s still a “startup” without yet proving profitability.
It’s worth noting as well Twitter had significantly reduced the losses in 2021. My general view is this was more to do with a hot, inflated advertising market than a sign of a fundamentally healthy business model.
Twitter’s also drives a fundamental different consumer behaviour to traditional social media and digital advertising metrics
Twitter’s pattern of consumption is different to Facebook, Instagram and others as well. Whereas Instagram is heavy on beautiful, almost magazine style content, and Facebook is heavy on links and similar, Twitter is heavy on simple, short text updates. This encourages users to stay within feed and not leave, whilst discouraging the two key things advertisers look for in digital advertising (video views and link clicks). That makes Twitter a bloody hard model to monetise in the digital ad market.
What might Twitter be good it?
If it’s clear that Twitter isn’t ‘match fit’ for advertising, how might it work then? Well, if you see Twitter as a collection of users, you start to get indicators. Twitter is far more valuable for an individual to broadcast their thoughts than Facebook or Instagram. And it’s far more the ‘public voice’ where you maintain your thoughts and purposes.
Where does higher value lie in that model?
Making your voice more valuable (verification)
Letting you make money off your voice (Substack style monetisation)
Giving you access to certain groups
What’s clear is it isn’t a conventional “buy space to present a product” model. Twitter has neither the click throughs, performance business or the visual inventory to really nail helping brands grow through products outside of launch periods.
Musk has already indicated that he may not see Twitter as primarily an advertising model
If you look at how Musk spoke in his email to staff he was candid about his thought process on trying to get away from advertising revenue:
“Frankly, the economic picture ahead is dire, especially for a company like ours that is so dependent on advertising in a challenging economic climate. Moreover, 70% of our advertising is brand, rather than specific performance, which makes us doubly vulnerable!
That is why the priority over the past ten days has been to develop and launch Twitter Blue Verified subscriptions (huge props to the team!). Without significant subscription revenue, there is a good chance Twitter will not survive the upcoming economic downturn. We need roughly half of our revenue to be subscription.”
That gives us some indication as to the thinking. If you fundamentally believe that Twitter’s primary value isn’t advertising, you turn to subscriptions. And aligned to the above, there’s likely a bunch of value in subscriptions for large(r) accounts:
Verify your voice (subscription)
Pay to have your posts go to prioritised to go to all of your followers (subscription)
Pay to promote your voice to non-followers (per post)
You could even name these products for users… “Verify”, “Voice” and something else. It rewards core power users for what they want to do - reach their followers and audience base quickly with their own message on Twitter. There’s no platform that is better at this.
Some back of the hand maths
Okay, so if we make the previous assumptions, how might Twitter work if you funded it this way?
Firstly, you’d make dramatic headcount reductions (which is happening). You likely strip out a lot of the sales function, ad product function and those other non-core areas. Then you’d build user based revenue products that move and align revenue to users, instead of conventional advertisers.
I don’t think you can be as bullish and say 50% of Twitter’s revenue will come from subscription, or even user based revenue. But I do think you can make a case for moving away from the constraints of more traditional advertising models currently now in place for most major technology companies.
This only works if a) Twitter doesn’t collapse and b) it’s able to get users paying
Twitter users have a long history of a free product and they’re stripping Engineering headcount at a rapid and alarming rate. Both elements open you up to big challenges. This is an existential change for Twitter and it’s definitely one that puts the company at risk. But, if you do the analysis, you can see a case for how to make a sustainable Twitter even if you lose 50% of your ad revenue.
IMHO, you're overlooking a few things.
Debt servicing: Prior to Elon, Twitter's debt servicing was $50m. That is now $1.2B/year. That is a new cost.
1% of MAU converted. This seems generous. The most likely market for twitter subscriptions are those that post regularly. Twitter has 450m MAU, but only 250m daily users. Furthermore, 95% of twitter content comes from just 25% of its user base. Giving you a far smaller acquisition pool. Thus, 1% of MAU seem unlikely. YouTube Red has been around for 7 years, and has barely cracked 2.5%. It's worth noting that Twitter Blue users will also see 50% less advertising, further eroding your advertising revenue. Let's get to that.
Your assumption that ad revenue would drop 50% is worth examining. Last week NPR reported 50% of twitter's 100 biggest advertisers have already left. Maybe you think that's rock bottom. I doubt that (lest we forget that the prank tweet about Elli Lilly cut $15B off their market cap - we are not talking brand safety, we are talking serious business damage), but let's leave that there.
Employee layoffs. While Elon has fired 3700 employees in the last month, he has stated he eventually intends to hire over 11k. While this target sits alongside other gaudy ambitions, his vision is not for a low head count operation. There is currently a class action lawsuit for wrongful dismissal, and certainly more brewing. Now, that'll take a while to shake out, but with stricter employment laws in Europe, Twitter will be dragged through the courts for years before it fully enjoys the full savings from hiring less people.
Speaking of Europe, Germany's NetzDG laws allow for fines of up to €50 million for failures to comply with reports to takedown illegal hate speech. Again, lax moderation is far bigger than a brand safety issue. The incoming and ongoing fines from broader GDPR legislation Twitter faces due to their haphazard moderation will be a significant cost over the next decade, particularly if Elon continues with his obsession with "Free Speech", and the restoration of previously banned accounts.
Finally, Twitter can no longer be considered in isolation. Tesla's stock is down 58% since Elon announced his twitter purchase. That personally cost him $100B. That's not entirely due to Twitter, but it's related. Which puts the quibbling over a few $100m into perspective. In summary, how much money can Elon handle losing, before he cuts a losing bet?
But like, fun thought experiment.