Has he gone mad? Mark Zuckerberg, Facebook’s CEO announced this week that his social networking company is buying Instagram. Facebook is paying $1 billion—a 100% premium to the company’s valuation only one week ago. Instagram is the creator of the identically named photo sharing / editing app for Apple and Android mobile devices..
Instagram was founded by two twenty-something Stanford grads about 18 months ago. The company only has about a dozen employees and by all accounts it generates almost no revenue. I am no Instagram expert. I didn’t even know the company existed until this week. But as best I can tell, Instagram is a basic social networking application built around photo sharing.
Users can snap a photo on their iPhone, edit it, and upload it to their Instagram account where it can be shared and commented on by friends and family. The app functions a lot like the photo sharing features in Facebook.
So why would Zuckerberg pay $1 billion for an app that a few of his engineers could have created over a long weekend? The exponential growth in Instagram’s registered users is likely part of the motivation. In only four months, Instagram’s registered users doubled to more than 30 million. But user growth isn’t the whole story.
One of the most commonly used features on Facebook is photo sharing. Many users log on to Facebook simply to view and comment on photos of their friends and family. If Facebook users migrate to Instagram for their photo sharing needs, user activity on Facebook would likely tumble.
Zuckerberg views Instagram as a threat to Facebook’s position as the preeminent social network. Taking Instagram out while it is still in its infancy is the correct strategic move for Facebook, but it exposes the company’s fatal flaw. Just in time for the IPO no less. There are almost no barriers to entry in Facebook’s business.
Facebook bulls may say, “What about the network effect? Facebook has over 800 million users.” Indeed it does, but that didn’t prevent two recent college grads from creating a competing service in only 18 months that posed a serious threat to Facebook’s dominance.
Like most technology companies, Facebook is only one college drop-out away from being the next—dare I say—Myspace.
Jeremy Jones, CFA
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