An impressive amount for a technology startup with no clear means of generating revenue, so I thought I would do some calculations of my own:

Twitter has about 18-20 million users in the US, according to Mashable

Earnings, earnings, earnings

There are 300m people in the US and 750m in Europe. Let’s assume that the ratios are the same for Twitter users. Therefore, the total number of Western Twitter users (ie. people who would potentially pay for anything) in 2010 is:

(20m / 300 ) * (750 + 300) = 70m users

To justify a $1bn (£625m) valuation they need to be able to realistically generate at least 5% of that as profit (20x earnings multiple, which is basically unheard of outside blue chip corporates) ie. at least $50m/year.

Therefore, in round numbers, they need to be able to realistically expect (in future) to generate earnings (profits) of $0.70/year from each user.

So far, perhaps not unreasonable; once micro-payment systems start working properly one could imagine users paying a notional $0.10/month to use Twitter, or advertisers paying that per user, at least so long as Twitter is the only one of its kind.

Twitter ain’t so special

That is where we realise the valuation’s big flaw: Twitter is not doing anything special. To build another system that replicates their functionality would, in my opinion, take 2 good coders, 2 good system administrators and one good web designer 6 months, tops. Add in some management and marketing capability for operational running and if you are a generous employer your wage bill might be £500k/year ($800k).

What about hosting costs? Well what it boils down to is a large and very active database:

Assuming 100m users
100 reads & 10 writes per user per day
= 10 billion reads & 1 billion writes per day

Squeeze into 16 active hours (just looking at the West)
= 120,000 read & 12,000 write transactions per second

To host a system which is capable of those transaction levels you would need at most 100 1U quad-core machines loaded with RAM (eg 24GB), costing £200/month each, or £240k/year ($385k).

So, I reckon that Twitter’s operational costs should be under $1m/year. But what do I know, right? I’ve only been designing, building and hosting massively automated online business systems for a decade, not to mention being one of the UK’s leading tech entrepreneurs.

A more rational valuation

So why are Twitter’s investors valuing such an easily-and-cheaply replicable business so highly? I suppose that they are banking on a land-grab effect and user stickiness, but we have seen what is happening to MySpace’s diluted popularity faced by new competitors.

When faced with such valuations I fall back on common sense and base the valuation on a cost-plus revenue model, ie. “what would it cost to provide the service, plus a modest profit margin”? All businesses and markets eventually commoditise down to that price point after all, and such commoditisation can happen very rapidly in the online world.

Viewed from that perspective I estimate that Twitter’s services are probably worth about 1.4 cents per user per year at present (estimated $1m/y running costs divided by 70m users). Lets be really generous and assume that they are able to generate 50% profits on that (first-mover advantage etc), so we get $500k/year profit, which at our mentalistic 20x valuation ration would give a valuation of a whopping $10m (£6.25). Hmm.

But that can’t be right?

I admit, I am taking an extremist point of view, and commoditisation of this very new and innovative sort of service is almost certainly several years away. However, defaulting to a cost-plus business model does demonstrate the likely value of such services when the competition have all caught up, and in Twitter’s case it is not a terribly exciting outlook.

Further, the valuation is being extrapolated from a $50 million purchase for a minority share holding. That investment was possibly more about getting a seat on the board than about a real valuation of the company.

Finally, and call me a cynic, but most investors are in the business of making a large return on a high-risk investment with a short time-horizon. One of the ways that happens all-too-often in the technology sector is less about yields and more about a business’s price getting hyped as high as possible before the savvy investors get out. Some some poor sap is then left holding the baby when commoditisation or better-competition comes to bite, exposing the lack of substance behind the valuation and causing the valuation to tumble.

Eye of Google

That is Twitter’s fundamental problem, to repeat myself: It is nothing special. Google (for example) deserves its outrageous share capitalisations because they have a unique technology which gives them an indomitable lead in the market place. Twitter is little more than a non-realtime Web-based chat room, and its technology would be trivial to replicate. Expectedly, the behemoth that is Google has indeed turned its lidless eye on chat-like status-updates in the form of Buzz.

To my eyes, their strangle-hold on the consumer Web-services market remains unchallenged by the likes of Twitter. The only interesting thing I’ve seen, however, is that their master-plan to crush Microsoft by making the browser the new platform was perhaps hiccoughed by Twitter in the form of software like TweetDeck – an example of Web services reverting to local software clients. Perhaps the browser is not quite ready for everything we want to do just yet after all, but I doubt that will save Twitter from eventual relegation to the Web-stars twilight world along with the likes of friends reunited.

They announced it as a “Small Settings Update” – pasted below:

Small Settings Update

We’ve updated the Notices section of Settings to better reflect how folks are using Twitter regarding replies. Based on usage patterns and feedback, we’ve learned most people want to see when someone they follow replies to another person they follow—it’s a good way to stay in the loop. However, receiving one-sided fragments via replies sent to folks you don’t follow in your timeline is undesirable. Today’s update removes this undesirable and confusing option.

The Importance of Discovery

Spotting new folks in tweets is an interesting way to check out new profiles and find new people to follow. Despite this update, you’ll still see mentions or references linking to people you don’t follow. For example, you’ll continue to see, “Ev meeting with @biz about work stuff” even if you don’t follow @biz. We’ll be introducing better ways to discover and follow interesting accounts as we release more features in this space.

The beauty of Twitter has always been that it is like a chat room where you are not necessarily listening to the same people who you are talking to. That may seem a bit odd at first, but when you think about it it can be rather cool. Take me for instance; without sounding too egotistical, I have time to follow about 100 people, but more than that are interested in what I have to say. Some of those people might mainly use Twitter to talk about personal issues that are not relevant to me, so I don’t follow them.

Equally, I like hearing replies from people I do follow to people that I do not. That way I can “listen in” to conversations of the people I follow and if it sounds interesting I can link through and look at the other side of the convo, but I don;t have to have the other person in my feed / timeline.

@monkchips is a good example; he is a great Twitterer and a strong voice in the IT community. He follows about 800 people, and is followed by >5,000. I like hearing his side of conversations directed at people I do not follow, since then I can cherry-pick interesting sounding ones. I follow him because he is interesting, not because he is a personal friend or we share friends.

In effect, this change is turning Twitter into a ‘normal’ chat room just like the ones I was using 13 years ago at University. We used a system called Internet Relay Chat.. or IRC as it is commonly known. Such a shame to see a great innovation in online comms take a massive leap backwards.