The Billion-Dollar App: How Apple Propelled Instagram to Fame and Fortune

Yesterday’s news that Facebook is buying Instagram and its photo-sharing app was eye-popping for about five reasons at once. But the most interesting reason, to me, has also been the most overlooked so far.

Here are the points that jumped out in yesterday’s news, starting with the least important (and most discussed) and building up to the most important (but least discussed).

Reason Number One: The Price Tag. A billion dollars! Yes, an impressive exit for a company that was only 551 days old and had never bothered to figure out how to make money. It will certainly skew the valuations of mobile startups elsewhere in the Valley, and make other entrepreneurs even more starry-eyed. But Facebook is probably paying mostly in stock. And even so, a billion is an immaterial amount for the company, which will soon be awash in IPO cash. This isn’t the real story.

Reason Number Two: The Gamesmanship. Just last week, Instagram closed a $50 million funding round led by Sequoia Capital on a $500 million valuation. The ink wasn’t dry on those checks before the Facebook deal happened, in effect doubling the investors’ money in one weekend. “A nice play if you can make it,” as Intel Capital’s Christine Heron commented. Whether the Facebook offer came unexpectedly, after the venture round had closed, or whether Instagram was really just courting venture investors as a way to fatten an acquisition bid, we may never know. But who cares? It’s all back-room horse-trading that has little to do with innovation or the future of social media.

Reason Number Three: The Users. Facebook just got about 30 million more of them, with a lot more on the way thanks to Instagram’s recent arrival on Android smartphones. Again, impressive but immaterial. Facebook doesn’t need more users—it’s got close to a billion of them already. And I’m betting that nearly 100 percent of Instagram’s users already have Facebook accounts anyway. If anything, this deal is about the amount of time people spend using Facebook and its services and the number of ads they see, now and in the future.

Reason Number Four: The Mobile Factor. Facebook is a Web-first company that still doesn’t get mobile, as the mediocre quality of its smartphone and tablet apps demonstrates. Mark Zuckerberg, this argument goes, realized that the first startup to come along with a compelling social networking offering on mobile platforms was likely to steal away a big chunk of Facebook’s mindshare. Instagram was looking like it might become that company. So in a single stroke, Facebook has taken down its no. 1 threat (Dan Frommer’s words). Which is all true enough—but this isn’t just about mobile. Smartphones wouldn’t be very interesting unless there was also a powerful marketplace driving the creation and distribution of great apps. This brings us to the most important takeaway from the Instagram news.

Reason Number Five: The Rise of iOS and the App Economy. This is the meaning of the deal that really matters, to my eyes. It took almost four years, but the revolution Apple sparked by opening the iTunes App Store in 2008 has produced its first big success story: an app with such a fast-growing network of users that it began to make a dent in the plans of an established pre-iPhone Web behemoth. Facebook looked at the ad revenue it earns from photo browsing, it looked at Instagram’s insane growth curve (the startup added a million users in a single day after rolling out its Android app), and it knew it had to do something.

In other words, a company that came out of nowhere less than two years ago was able to identify an untapped market, foster a new type of behavior among consumers, and give Facebook a migraine so bad it was willing to pay a billion dollars to make it go away. All thanks to the platform Apple created.

But let’s take this story apart a little. How did Instagram achieve such massive growth, and what does it mean for other innovators and entrepreneurs? Instagram is a great app, no doubt. It deftly combines social networking chatter, the ability to capture and share moments that have personal meaning, and a dash of creativity (with the instant filters that make your photos look like vintage 1970s Polaroids). But let’s be honest—Instagram is not 10 times better than Picplz, Hipstamatic, Path, Klip, Best Camera, or the dozens of other photo- and video-sharing apps.

Rather, it was the first mobile photo-sharing startup to get network effects working massively in its favor. Media-sharing communities are only as interesting as the people in them, and Instagram managed to sign up 300,00 users within the first eight weeks after its launch in October 2010, which gave it momentum that none of its competitors were ever able to overcome.

And how did it sign up those users? Partly through word of mouth, but mostly because it cracked the “top 20” charts in the iTunes App Store early on, and stayed there as users begat more users. And didn’t just win popular acclaim: In December 2011, Apple anointed Instagram as its “iPhone App of the Year,” which boosted downloads even more.

Perhaps you thought Facebook itself grew pretty fast back in 2004 and 2005, when it was spreading like wildfire across college campuses? Well, it turns out that favored placement in the app stores is an even better way to achieve rapid growth.

“If you think about Facebook’s growth, it grew virally, largely through e-mail-based invitations,” says venture capitalist Kevin Spain, who follows the mobile business as a general partner at Emergence Capital Partners in San Mateo. “But when you look at Instagram’s growth, a lot of it came through placement in the App Store. The reality is that if you don’t have great placement in the App Store—if you’re not a featured app—your ability to acquire users is severely hampered. But if you become one of the top 20 apps, your growth just continues to accelerate.”

Apple isn’t the only kingmaker in the mobile app world: Instagram is also benefiting from top billing in the “social” category in Google Play (formerly known as the Android Market), where it’s even ahead of Facebook’s Android app. Amazon, obviously, offers similar lists of top-selling apps and other products, and through its best-seller lists, the New York Times has been telling us what books to buy for decades.

But what’s unprecedented about the mobile app store experience is that so far, the app store owners are in control of both distribution and discovery. With the possible exception of app review sites on the Web, there’s no viable alternative to the app stores themselves for finding and buying new apps. (The first startup that came along to challenge Apple’s role in iOS app discovery—Chomp—promptly got acquired by Apple.) The bottom line: without the dual system of promotion and instant distribution that Apple created and Google copied, it’s very hard to imagine that Instagram could have grown as fast as it did.

Of course, there’s a major downside to the reward system Apple invented. The “discovery barrier”—the difficulty of making it into the top-app lists or getting picked as a “new & noteworthy” app—means thousands of very good apps never get noticed. Which may be contributing to what activist Eli Pariser has called a filter bubble culture, where people only learn about content or products that are already deemed popular.

But for those who pierce the bubble, the rewards are lavish. Whether or not it really meant to—remember, Steve Jobs was initially opposed to allowing third-party apps on the iPhone—Apple has pioneered a distribution system so effective that it makes the last 15 years of the Web’s evolution look tame by comparison.

This may be the biggest lesson of the Instagram deal: in the Web/mobile arena, the pace of innovation continues to accelerate, which means no one is really safe. Today’s entrepreneurs benefit from cloud computing platforms that allow them to get up and running with almost zero capital expense. They have open-source tools and other off-the-shelf building blocks that allow them to assemble a basic app quickly, which means they can focus on refining the user experience. And thanks to Apple and now Google, they’ve got built-in marketplaces so powerful that huge windfalls await those who can crack through the discovery barrier.

“If Facebook—which was seen as one of the companies with incredibly strong network effects—is potentially made vulnerable by a two-year-old company with no revenue and a fairly simple photo-sharing app, then anyone is theoretically vulnerable,” sums up Emergence Capital’s Spain. “It doesn’t matter if you are 30 years old or three years old, there is always someone younger and smarter coming up underneath you. And if you are not embracing mobile and cloud and open-source tools to iterate rapidly, you are going to be lapped very quickly.”

Wade Roush is a freelance science and technology journalist and the producer and host of the podcast Soonish. Follow @soonishpodcast

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9 responses to “The Billion-Dollar App: How Apple Propelled Instagram to Success”

  1. Sasha says:

    Excellent article.

  2. Nate says:

    An astute article. Two responses/points:

    1. The big story really is the purchase price. It’s easy to explain why Facebook would want to acquire Instagram. It’s much, much harder to explain why they would pay so much for it.

    2. Regarding the App Store, Instagram’s meteoric rise reveals how deficiencies in the “discovery barrier” are distorting the marketplace. Apple has evidently decided not to invest a lot of resources in reviewing apps and finding the diamonds in the rough. That’s their choice, but what’s really surprising is that no third party has taken up the slack. Sure, there are lots of app review sites out there, but the vast majority are pretty mediocre and to my knowledge no one has risen out of the pack. As a result, consumers are left floundering around and relying on the App Store, which is very weak.

  3. Wade RoushWade Roush says:

    Nate: Thanks for your comment. To respond to your responses…

    1. I agree that there’s probably an interesting story behind Facebook’s willingness to pay what, to the rest of the world, seems like an insane price. But I guess I see it mainly as one of those bizarre, bubbly things that happen when people invent cash machines.

    2. You’re absolutely right that the iTunes App Store is horribly broken from the standpoint of anyone trying to discover good apps. I was trying to make the point that Instagram was one of the lucky and/or skillful companies that figured out how to exploit the parts of the ecosystem that do work well for the anointed few — the top app lists, the “new & noteworthy” lists, etc. For companies like Instagram, the deficiencies and distortions in the marketplace turn out to be great competitive “moats.”