Snapchat is such an odd business.
It’s losing money. It’s losing increasing amounts of money. It’s losing increasing amounts of money per user. And it doesn’t have a good plan to make money.
But yet it floated on the stock market earlier this year at a $25.6bn valuation. Someone out there clearly saw a way to make it work.
I had my doubts at the time. Here’s what I had to say:
Snapchat has two problems.
The first is the number of users. Snapchat exploded in popularity around the start of 2016. In less than a year it went from 180m to 300m monthly users. And that was great – like the level of growth we saw in successful social networks like Facebook, Whatsapp and Instagram.
The problem is that at the end of 2016, the growth in users came to a sudden stop. It’s hard to know why. But you could speculate that Snapchat has saturated the millennial market, and that older demographics have less use for it than, say, Facebook.
The same thing happened to Twitter at roughly the same number of users. Twitter has turned into a useful social network for a particular type of person – not a universal social network with something for everyone, like Facebook Instagram or WhatsApp.
The second problem is related to the first problem. As the excellent Ben Thompson points out, it’s related to Snapchat’s marginal costs – the extra costs Snapchat has to pay to serve an extra user. In the ideal scenario – lets call it the Facebook scenario – marginal costs per user go up at first, then hit a peak, and then start to fall. And in Facebook’s case, marginal revenue was higher than marginal costs. This meant that as long as Facebook was adding extra users, it was making more money, and the amount of money it was making per user was going up.
Snapchat’s numbers don’t look so good. The first problem is that marginal costs per user keep on going up. This means a) Snapchat is losing money on each extra user, and b) Snapchat is losing an increasing amount of money on each extra user. This might not be a big deal if Snapchat were still adding hundreds of millions of new users, because economies of scale could get marginal costs “over the hump”. But if user growth is stalling (see point one) it’ll be much harder to lower marginal costs.
Seven months and two earnings reports later, Snap has completely tanked. It’s now worth $11.3bn — down 57% in eight months.
Today I want to take a closer look at Snap with the help of my US colleagues Louis Basenese, Jonathan Rodriguez and Martin Hutchinson.
No Moat Equals Certain Death
By Jonathan Rodriguez
For thousands of years, the world’s most crucial castles were protected by moats.
In today’s technology business climate, lack of an economic moat will likely doom a firm.
If you’re unfamiliar, an economic moat is simply a business’s ability to maintain a competitive advantage over its rivals.
Take America’s infamous FAANG (Facebook, Apple, Amazon, Netflix, Google) companies, for instance.
All of these technology firms have a substantial protective ring around their businesses.
An upstart online retailer is going to have a whale of a time building out a platform to combat Amazon. That is, if it isn’t scooped up by the online shopping behemoth first.
Rival Samsung has been eating away at Apple’s smartphone market share for years.
But Apple’s ability to maintain premium pricing power over cheaper Android phones lets shareholders sleep soundly at night.
And after Yahoo was acquired by Verizon, only Microsoft’s Bing offers any kind of challenge to Google’s search engine supremacy. If you could call Bing a real rival to Google. (SPOILER: It’s not.)
So what about Snap’s moat?
Well, the app is quite popular among millennials and the Gen Z population. But all of its most popular features — disappearing messages and stories — have been successfully cloned by Facebook and Instagram.
Worse still, the business has never been — and may never be — profitable.
In other words, there’s nothing really stopping competitors from storming Snap’s “castle.”
And in the game of tech thrones, you build a moat (and win) or you die.
Advertising Death Spiral
By Martin Hutchinson
Companies that are dependent on advertising require massive economies of scale in order to be particularly profitable.
Not only does Snap need a large number of users who actively click on ads, but it also needs a large number of repeat advertisers who provide them.
If the advertisers see diminishing returns — in terms of clicks and potential sales — they will spend less. And the quality and profitability of the ads will remain low.
Once advertisers decrease spending, their returns from Snap will never increase. Which makes them unwilling to spend more in the future.
It’s a devastating cycle that’s common among midtier advertising platforms. And Snap is struggling to break through it.
The company had promised the ability to place ads between consumer-provided content, making them appear more personal.
But advertising completion rates (how often users watch ads all the way through) are running well below projections.
Advertisers are also seeing a lower return on their investments than on rival platforms, according to Morgan Stanley. And sure enough, they’re not increasing ad budgets.
Snap had also promised advertisers an automated bidding platform to place ads, but this is rolling out more slowly than expected. This feature will likely be pushed into 2018.
Making matters worse, as Jonathan mentioned above, Instagram and Facebook have been replicating new features of Snap more quickly than expected. So the increased competition in the space is making Snap’s outlook even more dire.
Now, taken individually, these problems wouldn’t be fatal. But their combination appears to be developing into an advertising death spiral that Snap may find impossible to halt.
Hardware Is (Really) Hard
By Louis Basenese
Back in 2013, famed venture capitalist Marc Andreessen told conference attendees, “Hardware is hard. It’s called hardware for a reason.”
Snap’s CEO, Evan Spiegel, is learning this lesson, well… the hard way.
Months before the company’s IPO, Spiegel tried to diversify into wearables with the launch of Spectacles. These were 1980s retro-looking sunglasses equipped with a camera. This allowed you to snap pictures and short videos that could be instantly uploaded to the company’s social media network.
The early results looked promising, too. So much so that Spiegel completely rebranded the company from Snapchat to Snap and declared it “a camera company.”
That metamorphosis proved to be a bit premature and overly optimistic.
As The Information reports, “Snap badly overestimated demand for its Spectacles and now has hundreds of thousands of unsold units sitting in warehouses, either fully assembled or in parts, according to two people close to the company.”
Instead of catalyzing a new revenue stream to bolster the company’s advertising sales success, Spiegel’s foray into hardware proved to be nothing but a novelty.
In fact, Snap’s internal data reveal that less than 50% of Spectacles owners use the sunglasses after just four weeks. Many users quit using them after just one week.
Such a shockingly low retention rate apparently forced Spiegel to reconsider other hardware launches. Snap was reportedly working on a drone, but those plans have now been scrapped.
At the end of the day, Snap’s hardware problems have become shareholders’ problems. The stock is down 50% from the highs hit right after its IPO.
Expect more downside ahead. As Ben Thompson of Stratechery put it, “Spiegel is incredible at product, but not so good at business.”
And that, my friends, is anything but the ideal combination for above-average stock performance.
For Risk and Reward
[Ed: It’s easy to pile onto Snapchat, with its silly product and non-existent business model. But it still has 175m daily active users. At $10 per share, is there value there? Let me know what you think — email@example.com]