Snap’s revenue growth looks like it will come from more ads, not more users

Snapchat co-founders Bobby Murphy (l) and Evan Spiegel (c) ring the opening bell on March 2, 2017, as NYSE President Thomas Farley looks on.
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Snapchat co-founders Bobby Murphy (l) and Evan Spiegel (c) ring the opening bell on March 2, 2017, as NYSE President Thomas Farley looks on.

Snapchat saw a slowdown in user growth in the back half of 2016, a legitimate concern for those who hope Snap becomes the next Facebook (1.8 billion users) and not the next Twitter (319 million users).

Snap chalked up the slowdown to a technical issue, and those close to Snap don't seem concerned about user growth — in part because they don't want you to be concerned about user growth, but also because Snap's revenue growth isn't necessarily reliant on driving new users. At least that's the claim.

Instead, Snap thinks it can grow its business significantly by simply making more money from the users it already has, the majority of whom live in the world's largest advertising markets, according to people close to the company.

Snap's plan is to hammer away in areas where it already has a foothold, like the U.S. and the U.K. The company isn't worried about spreading Snapchat to emerging markets like India or Singapore — the way Facebook is currently doing with its app.

That doesn't mean Snap isn't interested in adding new users altogether. It just wants to add users in markets where it can make money from them right away. So Snap is focusing its growth on the world's top 10 advertising markets, which it listed in its S-1. The company already has 50 million daily users in North America and 10 million in the U.K. In total, Snap claims 60 percent of its user base lives in the world's top 10 ad markets.

A lot of this strategy is actually outlined in the company's S-1 document, which it filed last month ahead of its recent IPO. In the document, Snap mentions multiple times that it's focused on ARPU, or average revenue per user, and plans to prioritize the world's top advertising markets as a result.

Here's a section that explains the thinking:

"Our products often require intensive processing and generate high bandwidth consumption by our users. As a result, our users tend to come from developed countries with high-end mobile devices and high-speed cellular internet...Global advertising spend—especially mobile advertising spend—is extremely concentrated, with over 70% of overall advertising spend and nearly 85% of mobile advertising spend coming from the top ten advertising markets...We benefit greatly from the fact that many of our users are in markets where we have the highest capital efficiency and monetization potential, allowing us to generate revenue and cash flow that we can then invest into future product innovation."

In other words, Snap wants to be where it can make money now. Emerging markets — where advertising budgets are small and data charges and wireless connectivity are still major barriers to the internet — aren't a top priority.

Right now, Snapchat makes about $2.15 per user in North America. Outside of Europe and North America, that ARPU number is just 15 cents, which explains why the company isn't rushing into India any time soon.

If you're looking for a blueprint for what Snap's revenue in these markets could look like, take a look at Facebook. The social giant made $19.81 per user in North America last quarter, or roughly 10 times the money Snap made from users in the same region.

Despite Facebook's efforts to grow in emerging markets, 75 percent of its Q4 revenue came from the U.S., Canada and Europe, which accounts for just 31 percent of its monthly active users. So if you believe Snap can someday make money as well as Facebook does, it's easy to see why people believe there is a lot of money still out there, even if Snapchat's user base doesn't explode.

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The simplest way to grow ARPU is to show users more ads. It's a fine line to walk, as most users don't actually want to see ads to begin with, but Snap clearly thinks it has room to work with.

Snap's strategy does have one obvious hiccup: There is a limit to how many ads you can show people before they start to revolt. Eventually, Snapchat will simply need more users in order to sustain revenue growth, and there are a lot more people in India and Africa than there are in the U.S., even if those people are less valuable to the company's bottom line.

Facebook knows that — it's currently dealing with that same ad load problem — which is why it's working to plant seeds in emerging markets early. In fact, Facebook's plan to combat Snap is actually focused on these emerging markets (the ones Snap says it doesn't care about).

Facebook built a Snapchat clone it's testing in Brazil and has copied Snapchat's Stories feature in WhatsApp, Messenger and Instagram. American teens probably aren't going to desert Snapchat because Facebook's apps have similar features. But teens in India who have never tried Snapchat, but already use WhatsApp and Facebook, may never see the need to give Snapchat at chance.

For now, though, Snap doesn't see the value of fighting for teens in those emerging markets. Maybe it never will.

By Kurt Wagner, Re/code.net.

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