Twitter’s success shouldn’t surprise anyone

Twitter’s stock price is surging on news that the social media company is earning more revenue and attracting more users than the market had expected. This is interesting, because in the past, the market — and pundits — consistently underestimated Twitter. When the company began selling its shares at $26 last year, many observers speculated that the stock was overpriced. After today’s announcement, the stock is worth about twice that.

Twitter’s not the only company that the market has consistently underestimated. I recently came across this 2007 Kara Swisher column scoffing at the notion that Facebook could possibly be worth $15 billion (it’s now worth more than 10 times that figure). People have expressed similar concerns about other fast-growing startups.

A big reason people make this mistake is that they confuse current advertising revenue with the potential to generate ad revenue in the future. The reality is that if you have millions of loyal users, it’s not difficult to generate millions of dollars in ad revenue. But for a variety of sound business reasons, technology companies tend to focus on growing their user base first, and pivoting to generating ad revenue only after they’ve reached a significant size.

As a result, people are constantly writing columns about how crazy it is that some new startup has been valued at millions (or billions) of dollars despite having little if any revenue. And then once the company starts putting serious effort into generating revenue — as Twitter has been doing over the last couple of years — the same pundits keep getting surprised when revenue grows faster than they expected.

They shouldn’t be surprised. Lots of startups have failed because they’ve failed to gain traction with users. But it’s hard to think of examples of startups that have succeeded in attracting millions of users, only to fail because they couldn’t figure out how to turn all those eyeballs into cash.