Protect the nerds

Twitter's sky-high R&D hits the right spot

Twitter's research and development spending might be sky-high, but it hits the right spot. At 44 per cent of revenue in the first half of the year, the microblogging site is spending far more as a proportion of its top line than Facebook. But with a lower number of users than its rival, Twitter needs to grow to make new investors happy.

Technology tends to be a winner-takes-all - or almost all- market. If a company can establish a useful standard or platform, network effects usually mean users will flock to it. Twitter is a good example, with monthly active users growing more than fivefold over the past three years to 218 million. That's a big reason revenue is growing at an even faster pace. It should hit around $700 million this year, well over 20 times larger than in 2010.

Twitter is also growing into its spending. Granted, R&D expenses more than quadrupled over the past two years. But the amount it spends as a percentage of revenue has dropped as advertising income has grown. In fact, as recently as three years ago, R&D costs outstripped sales. Since advertising is seasonal, this metric should fall further in the second half of this year.

Twitter's biggest risk is a dramatic fall in the rate of people joining the service. The number of new users appears to slowing already - and the company has less than a fifth of Facebook's monthly users. The larger social network is steadily rolling out features, such as hashtags, that it has cribbed from its smaller rival.

Facebook has aggressively ramped up R&D spending, too, boosting it from seven per cent of revenue in 2010 to 27 per cent last year. Its far larger size means its budget dwarfs Twitter's - it spent more than 10 times as much last year. Sure, the two companies don't entirely overlap. Facebook is largely built around semi-private interactions while Twitter is more open to strangers.

Twitter's strategy of hiring engineers at a fast clip to build new features and services is the best way to ensure growth. Curtailing that hefty investment too soon would be a big mistake.