Why Snapchat Posted Disappointing Earnings: The Answer Is AI

Snapchat (SNAP) is a social networking service (SNS) built around a messaging app.

It is a messenger app used heavily by Gen Z in the United States. In its early days, its popularity surged among teenagers as they used the feature that lets photos disappear after a set period of time for sexting.

For reference, sexting refers to sharing photos of one’s private parts and engaging in sexually explicit chats. In Korea, Hyperconnect (Azar: random video chat) achieved huge success in the Middle East by tapping into a similar need.

In the fourth quarter of 2022, Snapchat recorded 375 million DAUs (Daily Active Users), an increase of about 17% year-on-year.

Judging by Snapchat’s DAU alone, the company does not appear to be suffering from the demand issues that are weighing on the broader IT sector. But the growing user base has actually become a drag on its earnings (ironically, a negative).

On the surface, this is because digital ad spending has not recovered to previous levels.

The economic downturn, thinner consumer wallets, higher interest rates, and uncertainty about the future have also shut advertisers’ wallets. For Snapchat, the increase in users did not translate into any revenue growth over the same period, and the company projected that first-quarter revenue this year would actually decline by about 2–10%.

This kind of revenue contraction is the first in the company’s history.

Bloomberg notes that Snapchat has become a bellwether for the earnings of other digital advertising companies. It was the first in the communication services (digital advertising) sector last year to flag concerns about declining online marketing spend, and it responded by laying off roughly 20% of its workforce.

This week, earnings will be released for Alphabet (GOOG), the parent company of Google and YouTube, and Meta (META), the parent of Facebook and Instagram, which operate in the same digital advertising space. I expect their results to look better than Snapchat’s.

According to internal Meta documents and interviews compiled by The Wall Street Journal, “heavy investment in AI tools has enabled the company to build more efficient ad-targeting systems even with less data,” and “although CEO Mark Zuckerberg changed the company’s name and declared that investment in the metaverse ecosystem would be the top priority, most of the effort has actually gone into optimizing its social media platforms, including Facebook.”

In fact, Alphabet and Meta are considered among the leaders in AI technology even within Silicon Valley. Meta’s internal documents indicate that, after Apple introduced its App Tracking Transparency (ATT) policy and ad-targeting accuracy declined, the company has already managed to recover most of the roughly 8.5% of revenue it lost.

Especially since 2023, more sophisticated AI algorithms and an increase in interactive ad formats within the Facebook and Instagram apps—ads that users can respond to directly—have boosted ad efficiency even as it becomes harder and harder to collect personal data, making these platforms increasingly attractive to advertisers.

Despite its growing user base (which should mean more ad inventory), Snapchat is missing out on opportunities to attract advertisers because its AI capabilities lag behind. The digital advertising market going forward is likely to make the gap between AI leaders and followers even more apparent.

Let’s pay close attention to the earnings that Alphabet (GOOG) and Meta (META) report this week.