Internet Gambling

Facebook Makes Big Bet by Acquiring Instagram

By buying up tiny Instagram for a whopping $1 billion, Facebook acquires a dominant player in mobile apps, and neutralizes a potential rival.

04.10.12 8:45 AM ET

One billion dollars might seem like a high price to pay for a company with 13 employees and not much, if anything, in the way of revenues. But that’s what Facebook will pay to acquire Instagram, maker of a popular photo-sharing app for mobile phones. And though at first glance the deal might seem nutty, it may turn out to be a brilliant strategic maneuver—and a bargain to boot.

Look at it this way. Facebook has built a booming business on the Web, with 850 million members and $4 billion in revenues last year. But the world has moved beyond the Web. Mobile is the next big market. And in mobile, Facebook has not been very successful.

But Instagram has. The tiny company has 30 million users who are addicted to its simple application, which lets you apply color filters to photographs so they look kind of blurry and old-fashioned. Last week, when Instagram finally made its app available on Google’s Android platform, the software was downloaded 1 million times the first day. (For what it’s worth, I find Instagram, or rather the artsy people who just lurve Instagram, to be kind of annoying, as I pointed out in a rant last week.)

You can use Instagram to share your photos with others on social networks like Twitter, Tumblr, and Facebook. In fact, a lot of people use Instagram to upload photos to Facebook, because Instagram is easier to use than Facebook’s own mobile app. Instagram also is a place to discover photographs taken by others. You can follow people on Instagram and see their photos in a stream. Thus, Instagram has become a kind of social network; one that some people viewed as a threat (albeit a minor one) to Facebook.

By snapping up Instagram, Facebook stakes out a top spot in the mobile space, and locks down an app that has become a “front end” to Facebook for a lot of people. Also, Facebook has neutralized the only company that could have even remotely represented a threat to its core business. And while $1 billion seems like a lofty price, remember that Facebook is about to go public with a valuation of about $100 billion, which means they’ve spent only 1 percent of their valuation to patch up a hole in their armor.

In a way, Facebook just bought an insurance policy. There aren’t many companies that can compete with Facebook in the social space, though a lot are trying. One way for a rival to go after Facebook would have been to acquire Instagram. But now Facebook has taken Instagram off the table.

Sure, some might quibble about the price, considering that Instagram launched only 18 months ago, and that only a few days before the acquisition, Instagram had closed a round of venture funding that valued the company at $500 million, half what Facebook paid. But in these frothy, frenetic days, what difference does a few hundred million dollars make?

Joking aside, what’s really going on is that people are starting to realize just how huge the mobile Internet wave is going to be. As big as this price tag seems today, it might look cheap in five or 10 years.

Consider that there are about 7 billion people on the planet, and about 5.6 billion mobile phones. Today most of those phones are feature phones. (The smartphone installed base is approaching 1 billion.)

But at some point, maybe in a decade, virtually every phone will be a smartphone, if only because the parts required to make one will become so cheap and commoditized. Today’s smartphones are already as powerful as a mainframe computer from 1990. In 10 years they will have doubled in power five times.

What are the implications of a world where virtually everyone on the planet carries a mainframe-class computer and has a constant connection to the Internet, and where people have easy access to all of the world’s information, and to each other?

Spending $1 billion to lock down a chunk of prime real estate in that market probably makes sense. And in the coming decade, Facebook may turn out to be more dominant than Microsoft, Google, or Apple ever dreamed of being.