Facebook’s $1 billion acquisition of Instagram gives it 30 million avid smartphone app users. How the Palo Alto-based company eventually manages to profit from them could determine how the nascent mobile app industry makes money—and what tomorrow’s hot buyout targets will be.
“Instagram could be a lab to experiment with different monetization models,” says Tom Taulli, a tech consultant and author of a forthcoming book on the tech IPO market, to be published by Wiley. “Keep it as a separate brand, try some new ideas, and if they work, apply it to the mother ship.”
The purchase of Instagram, a service that enables users to add special-effects filters to photos and then share the enhanced images with friends, brings to mind another big-money acquisition of an overnight success with no revenue: Google’s $1.65 billion takeover of year-old video streaming site Youtube, in 2006. Six months later, Google bought ad network Doubleclick for $3.1 billion. After the Doubleclick acquisition, the Youtube deal suddenly made more sense. With Doubleclick, Google had acquired the software and publisher relationships that would let it sell and place display advertising on Youtube and elsewhere.
Instagram is growing fast, and has a passionate user base of early adopters—just the sort of folks whose habits could show Facebook how its broader user base might want to use their phones to engage with the site. “If you’re Facebook, you’re trying to be the operating system of our life—all our interactions,” says Jason Mendelson, managing director of Foundry Group, a Boulder, Colorado-based venture capital firm. Sharing photos is one small piece of that.
Users, But No Revenues
When it comes to hot companies with little or no revenues, smartphone apps are the new frontier. Instagram, like so many others, generates next to no revenue. Facebook, which has 425 million monthly active mobile users, doesn’t have meaningful mobile revenue either, according to its S1 filing. “If we are unable to successfully implement monetization strategies for our mobile users,” the S1 reads, “our revenue and financial results may be negatively affected.”
To be sure, a few app companies have figured out to make money. Zynga, which makes and markets casual games used on smartphones, saw revenue of $1.1 billion in 2011 by selling both advertising and virtual goods. Mobile ad networks, which sell space in bulk to advertisers and then push them out to various apps, are also growing fast. Today, two of the largest, Quattro and Admob, are owned by Apple and Google, respectively. Another, Millennial Media, which went public on March 29, is currently valued at $1.42 billion on the New York Stock Exchange. Last year Millennial's sales more than doubled, to $100 million.
Still, App-makers often struggle. Music-streaming site Pandora blamed its recent soft quarter on the fact that right now it only makes $20 per 1,000 hours users listen to its mobile phone service, compared to between $60 and $70 when they tune in on desktops. “It’s pretty nascent right now,” says Srini Dharmaji, founder of Goldspot Media, a mobile advertising startup. “There is no cost-efficient and streamlined way for an advertiser to create and present a rich ad experience across all devices.”
Following the acquisition, Zuckerberg wrote in a Facebook post, “This is an important milestone for Facebook because it's the first time we've ever acquired a product and company with so many users… We don't plan on doing many more of these, if any at all.”
The number of mobile users is growing faster than the number of users who log on from desktops. Zuckerberg hasn’t explained how he plans to make money from mobile—only that Facebook must. A startup that solves that conundrum could become the next billion-dollar deal.