Sweet Tweets for Selling Online

Twitter is a rising new potential tool on the horizon for small business. With Twitter, a small business owner can send short messages, or “tweets”, concerning product specials, important links, information, discounts, events, news, polls, etc., to the mobile phones of consenting customers, through RSS feeds, and to its own website or blog with one short post. According to (http://www.toprankblog.com/2008/05/top-10-twitter-uses/), the top three uses of Twitter are sharing links to items of interest to a user’s network (34%), networking for new contacts (18%), reinforcing current network contacts (16%) – all relevant activities for small business.

Twitter was launched in 2006 by Jack Dorsey, Evan Williams, and Biz Stone as part of a podcasting company called Odeo. Twitter is a free service where originally users were to post the answer to the question “What are you doing?” in 140 characters or less – a number just shy of that allowed by most mobile phone carriers for texting services. Designed for users to report the day to day fuss of everyday life to family and friends, Twitter has evolved into a communication tool with a variety of uses. For example, Democratic Presidential candidate Barak Obama announced his vice presidential running mate, Joe Biden, using Twitter’s free text messaging capability to over 60,000 Twitter followers on August 23 at 2:22 a.m. (http://twitter.com/BarackObama). Seconds after the July 22 earthquake that hit southern California, the first tweet by “thevixy” that simply stated “earthquake” beat the news media reports by four minutes. The search term “Earthquake” already had thousands of updates on Twitter Search before the AP came out with a report 9 minutes after that first tweet. (http://blog.twitter.com/2008/07/twitter-as-news-wire.html). Businesses like Dell (http://twitter.com/DellOutlet), JetBlue (http://twitter.com/JetBlue), Zappos (http://twitter.com/zappos) and Whole Foods (http://twitter.com/WholeFoodsLA) use Twitter to make announcements to interested customers who have signed up to receive their updates.

What is Twitter?

Twitter is a social online network that is part of today’s Web 2.0. It is a mixture of blogging and texting – known as micro blogging. Twitter is a system that sends messages (tweets) from members to followers (tweeple) who subscribe to receive them. Interested individuals who do not wish to receive messages via text messages to their mobile phones can follow tweets via feeds, instant messages, and the member’s twitter page. They can also conduct searches (http://search.twitter.com/) on various Twitter keywords and even subscribe to the feed of the query.

Currently, the service is offered for free to its users and produces no revenue stream for its investors. So how does a company operate with no revenue stream or known business plan? Twitter is funded (to the tune of about $22 million) by venture capitalists Bijan Sabet with Spark Capital, Jeff Bezos of Bezos Expeditions, Union Square Ventures and Tokyo-based Digital Garage who believe that once Twitter reaches an undetermined critical mass it can be monetized (i.e., some sort of revenue stream can be created). The investors are relying on the power of network effects. Other Web 2.0 companies that began without a business model that also rely on network effects are Google, Facebook, and YouTube.

What are network effects?

In economics, these are also known as “demand side economies of scale” popularized by Carl Shapiro and Hal Varian in their book Information Rules. The idea is that demand for products with potential network effects does not have the traditional downward slope. In fact, it initially slopes upward and then downward. This is because the value of connecting to a network depends on the number of other people already connected to it. In other words, willingness to pay increases as more users join the network, but it then decreases as the network gets very large.

As an example, a few years ago we bought our first phone with caller ID. I told my son that he would be able to see who was calling. He was so excited about caller ID that I began to suspect his excitement. I asked why it was so interesting to him. He said, “I can’t wait to see Jerry the next time he calls, but that screen sure is small!” He had confused caller ID with a video phone. While video phones would have been cool, why haven’t they taken off? I would not purchase a video phone unless I knew that a majority of people that I call also had video phones. Otherwise, that feature of the phone is useless. Therefore, the more people I know that have video phones, the more I am willing to pay – TO A POINT. There is some point where its value to me does not exceed the value of the next best alternative. And would that value be enough to cover the costs? The videophone (or picturephone) has been around as far back as 1964 (http://archives.cnn.com/2000/TECH/computing/09/05/picture.phones.ap/); however, the demand has never been such that willingness to pay by users covered the cost to allow the market to reach a critical mass for success.

With network markets like Twitter, there is a critical mass to be reached, as well, which is the smallest size of the market that can be sustained at a particular price. For those who like a graphical image, this is illustrated below. The graph plots willingness to pay with the size of the market. The market will continue to grow after the critical mass point as more people who value a larger network more than price join the network, but there will be some point when willingness to pay by additional users to enter the large network begins to fall and may even fall to zero. The question for Twitter is to determine at which point, as the price is raised from zero to some positive amount, will the willingness to pay at least remain high enough to cover the marginal (additional) costs of providing the service. They want to find the network size such that most of those who highly value the service have already joined, n*. If Twitter begins to charge users, membership will decline. Thus it is in Twitter’s interest to have reached a market size greater than n* before it begins charging. Then the question becomes to choose the P where the associated n* generates a revenue sufficient to cover costs and maximize profit.

Graphical Illustration of a Market with Network Effects

Graphical Illustration of a Market with Network Effects

What will Twitter’s profits look like?

Twitter currently covers the SMS charges on its end for the services provided by Twitter (however, it does not cover the costs of members to update their accounts from their mobile devices or the costs of receiving messages on their mobile devices.) On August 13, Twitter stopped sending “tweets” via SMS to countries other than the U.S., Canada, and India (http://blog.twitter.com/search?q=sms+costs) due to the “disproportionate” operational costs of using foreign billing services. Twitter has also limited the number of people that a member could follow to 2000. While a good portion of Twitter’s costs are due to charges for SMS messaging (a.k.a., texting), there are also the costs of server space, bandwidth, programming, database management, employees, etc.

It is not believed that Twitter will begin charging personal users. In their own blog, Mr. Stone reports that Twitter will not pursue a revenue supported business model until it can provide a “reliable and robust” service, thereby acknowledging the many troubles of a network growing faster than its infrastructure can currently support. (http://blog.twitter.com/2008/06/welcoming-bijan-and-jeff.html) If Twitter does not begin charging users directly, its other potential revenue streams can come from advertising revenue on individual web pages or in search results, advertising in text messages, charging corporations and businesses that use Twitter to communicate to a large commercial audience. Advertising on individual pages is not likely to generate sufficient revenue since many consumers don’t go to the Twitter homepages. They receive and post from cell phones via text messaging. This has been test marketed in Japanese markets (http://www.technewsworld.com/rsstory/64258.html?wlc=1220381088). This same article speculates that Twitter may be gearing up to put advertising in search results since the recent acquisition of Summize.com. Customers who search are looking for information on a specific topic and may be more responsive to targeted advertising. Advertising in text messages on cell phones would not be permitted and sending an advertisement as a text message might alienate consumers – especially those that pay per text message. Then there is the “freemium” model which includes continuing the free service for the smaller users, but charging a premium to users with large followings. “Dell says that it made well over $500,000 in sales from sending special offers from its Dell Outlet store to its Twitter group, which began in June 2007.” (http://www.wired.com/techbiz/people/news/2008/08/portfolio_0804) Yet Bob Pearson, Dell’s VP for Communities and Conversations, says that it would “probably not” be willing to pay for use of Twitters services. Dell has about 1500 followers.

Conclusion

The final message of using Twitter for businesses selling online is that eventually Twitter WILL need a profitable business model. The investment of $22 million is based on the bet that a large market will ultimately be a huge money maker. Expect that businesses with large followings will ultimately pay something and therefore subsidize personal use; however, if its use in business becomes popular, this will become just the cost of a marketing alternative.

Additional Reading:
http://www.attentionmax.com/blog/2008/05/psychographics_of_the_twitterati.php, Psychographics of Twitterati, AttentionMax
The True Meaning of Twitter, Lashinsky, Adam; Burke, Doris. Fortune, 8/18/2008, Vol. 158 Issue 3, p39-42, 3p
Top 10 Uses of Twitter, Lee Odden, May 15, 2008, http://www.toprankblog.com/2008/05/top-10-twitter-uses/, online Marketing Blog
Information Rules, Carl Shapiro and Hal Varian, Harvard Business School Press, 1999

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