Twitter’s go-it-alone app strategy boosts costs before IPO

SAN FRANCISCO -- Twitter’s operating costs are growing faster than its revenue. To understand why, consider how the microblogging service deals with would-be partners.

More than four years after Twitter touted the importance of opening its doors for programmers to build businesses to complement its short-messaging site, startups are finding themselves shut out. The San Francisco-based company has restricted outside applications in its drive to shore up control of advertising sales on the site.

On the eve of the biggest U.S. technology initial public offering since Facebook, Twitter must instead rely on its own talent for a continuous stream of innovative products, contributing to surging expenses. Even as its business booms with brands seeking to reach its 230 million users, Twitter has to spend faster than its revenue growth to keep up.

“They will probably never let a business become huge on their platform,” said Nihal Mehta, a venture capitalist and co- founder of LocalResponse Inc., a New York-based online-ad company that buys Twitter data. “If someone is generating a ton of revenue on their platform, they’re going to want to do it themselves.”

Twitter plunged $87.3 million -- more than half its revenue -- into research and development in the third quarter, mostly tied to hiring. R&D costs soared 170 percent from a year earlier, while sales jumped 105 percent.

Similar to how developers build programs that run on Windows or Mac computers, an app would tap into Twitter’s data and network of users to provide complementary services -- say, a compilation of messages from a selected group. The app provider could make money off of Twitter’s platform by selling ads that accompany its services.

Unlike Facebook, Google and Apple before it, Twitter faces a trickier conundrum in its relationship with developers. All profess to be platforms. The word shows up 260 times in Twitter’s IPO prospectus. Even so, the other companies have success stories, be it Facebook spawning Zynga or the thousands of games and apps on Apple’s iOS and Google’s Android, from “Angry Birds” and “Candy Crush Saga” to Flipboard.

Attracting outside developers is one way Facebook, Google and Apple have kept R&D costs down. Facebook spent 19 percent of sales on R&D in the latest quarter and 14 percent in the last period before its May 2012 IPO. Google spends about 14 percent and Apple 3.3 percent.

Jim Prosser, a spokesman for Twitter, declined to comment.

Twitter hasn’t always had a platform that is more or less shut. In July 2009, Twitter co-founder Biz Stone posted, “We very much believe in nourishing and supporting” an ecosystem. And New York startups hosted an event in January 2009 called “Built on Twitter” for companies aspiring to create businesses on the service.

Joe Fernandez, chief executive officer of Klout Inc., was one of the presenters. In front of about 700 techies, Fernandez tried to stoke excitement for his product, which was designed to measure influence on the social Web by analyzing a person’s Twitter network.

Sharing the stage that night were founders of TwiTerra, CoTweet, StockTwits and Botanicalls, an application that lets plants publish tweets when they need water.

“There was this hyper-intense interest in Twitter as a platform,” said Fernandez, who the next year moved Klout into the same building as Twitter in San Francisco. “I was obsessed with it.”

Klout, which went on to raise $40 million from well-known investors like Kleiner Perkins Caufield & Byers and Institutional Venture Partners, has had some success because Twitter decided not to build a competing service. Klout makes money by helping advertisers find influential people who can promote their brands across social networks.

Of the other presenters, CoTweet was acquired a year later, and TwiTerra was an art project that wasn’t intended to be a business. StockTwits is still independent with about 10 employees, and Botanicalls has a small team and a plant-feeding kit still on the market.

Companies like Klout and LocalResponse pay for Twitter’s data by going through Gnip Inc. and DataSift Inc., which are among the few companies with access to the site’s so-called firehose, or the entire bulk of postings. DataSift and Gnip pay Twitter for licenses, a business that accounted for 9 percent of the short-messaging service’s third-quarter revenue.

That’s one area where outsiders can make money on Twitter. The company is also investing in a feature called Twitter cards, designed to let publishers and developers customize how their content shows up on the site.

As far as ad dollars flowing through its system, Twitter isn’t sharing. In mid-2010, it turned off the ability for other companies to put ads within tweet streams on their sites. Startups that had emerged to broker paid tweets like Adly and 140 Proof have had to find new ways to make money, while others like Magpie got acquired.

In 2011, Twitter also cracked down on services that allowed users to access Twitter in different ways, like an online dashboard or a separate mobile site. The move helped shut down a popular service called UberTwitter. TweetDeck, one of the biggest Twitter client programs, which lets people use the microblogging service via another program, was bought by Twitter in May 2011 for about $20 million.

Twitter CEO Dick Costolo told the Wall Street Journal last year that the platform wants to go from from a place where companies “build off of Twitter to a world where people build into Twitter.” Co-founder Stone left the company in 2011.

HootSuite Media Inc., which competed with UberTwitter and TweetDeck, survived the changes and has grown by expanding into all of the major social networks and developing software for businesses to create and monitor ad campaigns across them. In August, Vancouver-based HootSuite raised $165 million from venture capital firms including Accel Partners and Insight Venture Partners.

HootSuite’s customers include PepsiCo Inc. and Sony Music, and the company is helping Twitter by getting more brands to spend ad dollars there, said Gregory Gunn, vice president of business development.

“You have to make sure you’re putting money in their pocket and understand what’s of value to them,” Gunn said.

Twitter isn’t the only platform to decide who can stay and who must go. Facebook irked developers over the years by altering its terms of service, changing how payments were made and clamping down on the ability for apps to spam users.

Yet Facebook has allowed some partners to flourish by taking 30 percent of in-app sales in games and giving the rest to the developers and has let others take advantage of the billion-plus Facebook users for job-recruiting and online dating services. Apple and Google similarly act as portals, where developers can sell their products and share the revenue.

Twitter doesn’t have that attribute. And unlike Facebook, Twitter’s ability to help brands target customers is limited because users aren’t providing extensive profiles on their likes and preferences, said Charlene Li, an analyst at Altimeter Group in San Mateo, Calif.

“Twitter doesn’t know that much about its users,” said Li, whose firm focuses on social media. “They need to keep everything flowing through their system because of that lack of information.”

Some features Twitter has decided to do itself include mini videos, through the purchase last year of Vine, and shortening lengthy tweets with a product rolled out in 2010.

Bitly Inc. had been the Web-address shortener of choice until Twitter came out with its own product. Hilary Mason spent over three years at Bitly as chief scientist before joining Accel Partners in July. She said the hurdles companies like Bitly have faced come with the territory of building on another application that’s still trying to figure out its business.

“When Twitter began it was incredibly open,” Mason said “Any company that built on Twitter over the last few years has the same story to tell.”