Why Is Instagram Worth $1 Billion?

Matt Reich

April 27, 2012 · 6 minutes read

Uncategorized

The purchase of Instagram by Facebook has been covered extensively by all sorts of media outlets. And for good reason. $1 billion is a lot of money to pay for a small company that isn’t generating any revenue. The conversations have ranged from: “this is completely crazy” to “it’s a justified purchase” and every conceivable tangent in between.

I’ve been giving this some thought myself and, I’ll admit, I was certainly more on the “this is completely crazy” side of the fence. But, I think there are some possible justifications for a purchase of this magnitude.

Why Facebook Purchased Instagram

Facebook is huge- and that might be the understatement of the year. Facebook just released new numbers in an amendment to its S–1 documents as an update to its SEC filing in connection with the suspected May IPO. It’s safe to say that the numbers are quite staggering. As of March 31, 2012, there are 901 million monthly active Facebook users- a 33% increase from last year. There are also 526 million daily active users, which is an increase of 41% from the year prior. The growth is impressive as is the total number of users.

While Facebook offers many services, the most prominently used, by far, is photo sharing. In fact, Facebook dwarfs all other photo storage services on the Internet. To put an actual number on this, 300 million photos are uploaded to Facebook every day. This isn’t something that immediately comes to mind (at least it didn’t for me), but stop and think about exactly how you spend your time browsing Facebook. That’s right, you’re looking at photos of your friend’s party or your cousin’s new baby or a long lost high school buddy’s wedding. The photo sharing aspect of Facebook is a huge reason the application is as popular as it is. That is clear.

Mobile is obviously becoming a larger and larger market everyday and it’s no secret that for Facebook, growth in that area is extremely important. With 488 million mobile users, Facebook is certainly making headway in that space, however, I think we can all agree that the Facebook apps are lacking on the photo sharing and viewing side of things. Yes, it is possible to snap and share a photo or browse photos of your friends, but the experience really isn’t that great. In fact, it kind of sucks. Instagram, on the other hand, is a much more enjoyable mobile photo viewing and sharing experience. I think just about everyone that has used both applications can agree with this.

Why Didn’t Facebook Create Its Own Instagram?

Here’s one place that tripped me up right away. It’s easy to see why Facebook would want the functionality of Instagram as part of the Facebook mobile app; Instagram has become as popular as it has for good reason. But, why wouldn’t Facebook just build its own Instagram clone? The company certainly has the talent and resources to pull it off. That would seem like a much more economical way to gain a substantial hold of the mobile photo sharing market, and as it turns out, Facebook may have been originally going in that direction. Last summer, a few documents and images were leaked to TechCrunch showing what something like Instagram for Facebook would have looked like, but nothing ever materialized.

What Facebook really wanted was the Instagram users. The company realized that organically growing that kind of usage and loyalty from a new feature as part of a less-than-perfect Facebook app would be extremely challenging, if not impossible. Instagram has a very large, passionate, active photo sharing community. Given Facebook’s core functionality as a photo sharing service, they most certainly felt threatened by what the little app was doing. It’s strange to think that a company worth upwards of $100 billion that employs thousands of some of the most talented folks in the tech community would feel threatened by what Instagram was doing, but the bottom line is that they were behind in the mobile photo sharing space. Instagram, a company of twelve people, built a really great, simple application that gained too much steam too quickly for Facebook to react. My guess is that Facebook realized this, shelved their new photo product and decided to explore acquisition.

What Will Facebook Do With Instagram Now?

So, now Facebook officially owns one of the most popular mobile photo sharing platforms. They want to use this purchase to increase their strength with photo sharing in general, but more specifically, via mobile devices. Now the question is, what do they do with it?

When trying to figure out whether the purchase price was actually legitimate for Facebook to pay, this becomes an important question. I don’t necessarily have the answer, but there are a few things we can consider.

There are essentially two different things that can be done with Instagram. The features and functionality can become part of the current Facebook mobile application. In this scenario, Instagram as we know it dies and it ends up becoming an acquisition of talent and software. Facebook acquired Gowalla in December of 2011 and this essentially turned into an “acqui-hire” type scenario; the Gowalla team ended up working on the Facebook Timeline feature. This is definitely a possibility for the Instagram team.

This is always a slippery slope. If an active user’s beloved service becomes part of a larger service, a lot of times users will just leave. Facebook has become so huge that they could have that impact. A lot of people (I’ll throw my hat in the ring on this one) like to see the little guy doing well and are more skeptical of the huge, dominant player.

The other option is to essentially leave things as they are. The Instagram team becomes a part of the larger Facebook team, but essentially works on a separate product. Some tighter integration with Facebook would be likely, but ultimately Instagram would appear as if it isn’t actually owned by Facebook. There is still a good chance that some Instagram users will jump ship (I know some already have even though nothing has changed yet), but with this option, Facebook has a better chance at maintaining the current community, which is really what I think Facebook found the most appealing about the app in the first place.

An interesting point to add to this second potential option is that another huge number of users will be exposed to Instagram. There are obviously a large number of very loyal Facebook users and likely some who were not all that interested in signing up for yet another service to share photos. But now, with the app being a part of Facebook, people may be more apt to try it out. I’d say it’s pretty likely, if the app in fact stays separate, that the number of new Instagram users will far outweigh the number of users who bail.

Mr. Zuckerberg released a statement in which he said that Instagram will remain separate and continue to operate as is. I think this is probably the best direction for Facebook to take and it’s one I’m sure they’ve thought long and hard about. But the thought of that huge conglomerate starts to cloud my perspective. There is definitely benefit to saying that Instagram will be kept completely separate while they figure out exactly how they will use it. Let’s just say I’m still a little skeptical.

A side-note with all of this: Instagram doesn’t actually make any money. They essentially have no business model. Were it not for outside investment, it wouldn’t exist in its current form. Whether Facebook will attempt to monetize the service or just hope that the added app will increase their overall user-base is yet to be seen. Ads in my Instagram stream do not sound very appealing, but it is a possibility.

There are still plenty of questions surrounding the whole Instagram deal, and the answers will unfold as time goes on. I think the real value Facebook sees with this acquisition lies in the current Instagram users, and as a result, they’ll be quite careful with how they handle the application.

The bottom line is that Facebook wants to find that balance between keeping as many of the current Instagram users as possible, while adding as many new users as possible- all the while doing whatever the company can to get its money’s worth out of the purchase. And let’s be honest- Facebook has got quite a bit of worth to prove.

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