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Instagram: Stocking Against the Odds

Instagram is heavily invested into Direct Response Advertising and needs to explore less cyclical sources of revenue

When Google’s advertising revenues became severely depressed in the last economic downturn, it served as a cautionary tale for Facebook to diversify its revenue streams. The two most popular forms of online advertising are Direct Response Advertising and Brand Advertising. In Direct Response Advertising, marketers look to spend on ads that bring quantifiable results such as increases in sales or spikes in website traffic. Facebook, the world’s largest social media network, generates 70% of their revenues from Direct Response compared to an industry average of 59%. Tools like Ads Manager for Facebook and AdWords for Google help achieve this, as they enable marketers to accurately target their audience and collect analytics on specific metrics that they value. Conversely, Brand Advertising focuses on building awareness with consumer markets over a longer period of time. As a result, marketers are quick to reduce investment in Direct Response Advertising in times of company cutbacks and adverse economic conditions.

Google is highly dependent on Direct Response Advertising and had its advertising revenues from Google Sites and Google Network Sites sharply declining. In 2006, revenues from these two streams were growing at 80% and 50% year over year, respectively. In 2008 however, growth fell to 22% and 4% year-over-year. After the Great Recession passed in 2010, growth only moderately recovered to 28% and 22%, respectively. Given these adverse effects on advertisement revenues during the most recent economic downturn, Facebook should diversify its revenue streams given the cyclical nature of Direct Response Advertising.

Monetizing Instagram

Instagram - 1-2Facebook made headlines when it decided to acquire Instagram for $1B in 2011. Since then, Instagram has grown into one of the world’s most popular social media platforms; however, it has not generated significant revenues. To improve this, Facebook recently integrated Ads Manager with Instagram to enable marketers to create ads to be featured in Instagram user feeds.

Instagram, now revamped and complete with insta_1advertising capabilities, charges companies varying rates based on the number of users on the platform and the quality of interactions users have with the posts, as indicated by likes and shares. With 400M monthly active users, Instagram constituted just under 20% of Facebook’s user base. However, Evercore analysts estimate that Instagram only generated 2.7% of Facebook’s total revenue. Given that Instagram is fundamentally different from Facebook, an opportunity currently exists for the photo sharing platform to add a substantial stream of income. Monetizing Instagram in a way that complements advertisements can reduce Facebook’s risk exposure by introducing an additional revenue stream.

Inspiration from Google

Companies in the past have successfully insta_2monetized acquisitions, with a notable example being Google’s acquisition of YouTube. Similar to Facebook, Google shook the tech world when they acquired YouTube for $1.65B in 2006. Both Facebook and Google have invested in platforms where users share their content online, and neither platform made substantial amounts of money prior to the aforementioned acquisitions. The main differentiator between the two investments is that Google implemented a partnership program in which YouTube users allowed advertisements to appear before their videos, and subsequently shared revenues with YouTube. What resulted was an increase of professional, creative, and quality content from the YouTube Partner network that further engaged existing users, drove new users to the platform, and increased usage rates and profitability.

To draw inspiration from this success story, platforms can create a positive feedback loop by incentivising users to do what they love. These incentives result in increased content volume and content quality, which draw more users to the platform. The newly acquired users then become partners themselves and post more content. The loop then continues, resulting in overall platform growth.

The Instagram Partnership Program

Instagram photos are known to be both artistic and of high quality, and the platform holds one of the world’s largest archives of diverse user-generated content. As such, Instagram has the ability to establish a partnership program with its users to use its library of photos and sublicense them to various businesses and organizations as stock photography. The profits they make would be shared with the original creator. Legally, Instagram is in a position to do so, as their user policy states that all pictures posted on their platform are sublicensable.

To browse through potential pictures to license, it is recommended for Facebook to develop a marketplace that companies can access on Instagram’s mobile and web platform. There, the company should be able to filter through Instagram’s pictures by shape, camera quality, theme, and hashtag. Furthermore, all future pictures posted by subscribing partners should be required to include a minimum of three descriptive tags, and the submission of a short description before pictures are uploaded to help potential customers easily identify and discover pictures. If properly executed, Instagram should be able to utilize its brand and size to compete with major stock photography companies.

There are currently four main competitors in the stock image industry: Getty Images, Shutterstock, Corbis and Fotolia, with 2014 revenues of $878M, $377M, $133M, and $110M respectively. Their business models are similar in that they have freelancers take posed pictures, which are then uploaded and licensed through their website. The entire process is done manually, and has resulted in cost inefficiencies as well as inauthentic photos. Instagram’s differentiated advantage from these companies is its ability to offer the largest selection of authentic photos with a high degree of filterability. Unlike their competition, Instagram would not need to employ editors to screen and edit its image library, resulting in lower labour costs, and wider selections of pictures for customers.

Despite striving to build a large library, the recommended requirements before posting will ensure that a level of quality is still upheld in the marketplace. In contrast, pictures posted on competitor platforms have to go through a more rigorous inspection processes resulting in a smaller selection for customers. Instagram can instead take advantage of the ‘long-tail’ phenomenon which is inherent with social media content. The long-tail refers to the massive quantities of less popular content that may satisfy a niche desire that mainstream markets leave underserviced. The long-tail phenomenon is exemplified by the strategy championed by Netflix, a company whose online platform engaged many niche market viewers by offering niche content.

While each individual market may be small, the long- tail markets combined are projected to be worth $1.45B, derived from a proxy of freelance photographers who are not currently employed by a stock photography business in North America. This proxy was chosen because the demand of the customers in the long-tail niche markets can be seen as being less-than-satisfied by stock image companies. As a result, unemployed freelance photographers must create their content to fulfill these specific needs. Instagram is projected to capture a market share proportional to the freelance photography industry’s revenue size compared to that of the entire stock image industry. The resulting 27.4% of market share would translate to $400M of additional revenue for Instagram from solely the long-tail market.

Profitability from Partnership

Instagram - 2-2Income through sublicensing will be split between Instagram and its user partners to create a mutually beneficial situation for Instagram, its user partners, and sublicensees. By incentivising its users, Instagram will create a similar positive feedback loop to that of YouTube, and increase the volume of quality postings by users on Instagram. This positive feedback loop will in turn increase advertising revenues for Instagram, which diverts Facebook’s reliance on Direct Response Advertising revenue.

Advertising revenue is driven by two key factors: increasing user exposure to advertisements and raising the value of each advertisement. The positive feedback loop will increase the number of users and the amount of time each user spends on the platform, thus boosting user exposure to advertisements.

Instagram has the potentinsta_3ial to diverge Facebook’s sole reliance on Direct Response Advertising revenue, thus hedging Facebook’s revenues against competitor innovations and economic downturns. In addition to advertising, Instagram must also become profitable through its sublicensing revenues.

Instagram - 4-3Instagram should start by implementing the partnership program with users willing to test out the program. Alternatively it can engage in a soft rollout to notable users who post high quality images with more than 100,000 followers, assuming that those with more than 100,000 followers have more desirable photos. In 2015, it is projected that the stock image industry will grow to $3.19B in sales, and Instagram’s four biggest competitors will generate $1.55B of that market modelled after the growth they experienced from 2012 to 2014. From this, Instagram is poised to capture an initial market share of 7.1% solely from the users with over 100,000 followers. This percentage was derived by comparing the total library size of the users with a followership of more than 100,000 to the library size of the big four. After distributing 55% of the revenues to partners, Instagram could earn $281M in additional revenues in 2015 from the stock image market, effectively doubling its revenue prior to implementing the partnership program.

This revenue model takes a conservative approach to valuing Instagram’s potential profits, as the model assumes similar conversion rates compared to the big four competitors. However, Instagram’s ability to price their photos lower than the competitors has the potential to drive sales even higher. Additionally, the model assumes that all stock photography prices will be the same, when in reality, the market is willing to pay hefty premiums for high quality photos, demonstrated by 500px’s ability to price stock images as high as $750.

Innovate with Instagram

While Facebook and Instagram should not insta_4expect the partnership program to stabilize its entire revenue model, it is certainly a way for the company to innovate. If the partnership program is started with only a select few quality users to test for market rollout, Instagram can experience a network effect from its users and increase the demand of the program, all while continuing to test and iterate. As the partnership program funnels more traffic onto Instagram’s platform while the risk of a shift to Brand Advertising by various industries subsists, Instagram will become an investment that diversifies Facebook’s Direct Response Advertising portfolio, and hedges Facebook from uncertain economic conditions.