Facebook and Instagram

On April 12th, Facebook acquired the well-known app company Instagram for approximately $1 billion. The pricing may be bewildering to some; after all, how could a company with just one free smartphone app and 13 employees of negligible value sell for the same price as a small island nation? The app’s functions, while clever, are nothing that Facebook couldn’t recreate for a small fraction of the acquisition cost — Instagram simply allows users to take photos from their smartphones and applies various digital filters in order to give them a vintage feel, modifying them in the style of old Polaroid cameras. The result is photos with a distinct vintage feel to them that can then be shared to various social networks. The app was a breath of fresh air for users (read: hipsters) who wanted that old- school feel to their pictures without having to lug around a bulky analog camera. From a functionality standpoint, that’s all the company offers. Any decent programming team could produce (and have produced) almost identical apps.

However, this train of thought misses the point. The lack of proprietary value in the app belies the true value of this deal to Facebook: the network of people that Instagram can bring to the social networking giant.

Instagram has over 30 million registered accounts, representing a vast network of mobile users that represents huge potential for a social network like Facebook. This number should continue to soar as Instagram only recently began expanding beyond iOS devices (the Apple lineup of mobile electronics including the iPhone, iPad, and iPod Touch) to the most popular smartphone operating system in the world, Android. The app was downloaded over one million times in the first 12 hours it appeared on the iOS alternative, representing the eager user base for the app. Despite the staggering number of users, Instagram has made no revenue to date, leading many to say that is has no business model at all. In other words, with nothing proprietary, no real future hope for revenue, and only popularity and polish to its name, Instagram is worth $1 billion for its loyal mobile users alone.

In Facebook’s eyes, what users actually do with the app is irrelevant, so long as it gives them access to users they could not reach before. Facebook’s own business model is dependent on getting as many users as possible using the site as much as possible, and one place it has not been able to do so is in the mobile app area. Facebook not only gets revenue through users clicking on ads of relevance to them, but by analyzing the preferences of its users, it can give each user the ad they are most likely to click on–thereby maximizing ad revenue.

Instagram not only adds another way to profile users, but it also adds a brand new network to Facebook’s massive web. Facebook has a mobile app for its social network, but amidst poor reviews has not found a great increase in traffic from it. Instagram’s users are exclusively mobile, and the social network simply wants to change that network of Instagram users into new mobile Facebook users. In a statement regarding the purchase, the company emphasized the importance of mobile usage, calling it “critical to maintaining growth and engagement over the long term”. Ultimately, this is not a purchase of an app, or some employees, but an acquisition of users, which is well worth it to a modern internet company like Facebook.

The Instagram acquisition represents an industry-wide trend of buying companies to capture their network despite their apparent lack of a business plan. Companies like Groupon, Pandora, LinkedIn, and Yelp all attract investments valuing them at hundreds of millions, largely for the users they bring to their investor. Each of these companies stakes its future on all its users having intrinsic monetary value, and assumes that they will inevitably make money off of them through advertising. With the power of advertising that tracks users’ preferences, capturing networks may end up being the key to capturing the riches on the Internet…or it could end up being fool’s gold. That user base may represent incredible potential profit, but it seems increasingly dubious that the valuation of these companies is reflected in their sky-high stock prices.

Such was the problem of the Web 1.0 bubble, where popular companies with no real earnings potential were gobbled up by investors and failed spectacularly. Could we be seeing the new Web 2.0 bubble, a severe overvaluation of the networks of companies doomed to failure? Or is Facebook slowly consolidating users to the point where they will be a financial success until the end of time?

Either way, we are entering an era where the people that follow a company are far more valuable than the company itself.