Wow! What else can you say? Facebook pays $1 billion for a company with 12 employees and no revenue. I'd love to see the discounted cash flow model that my students could come up with to determine that valuation!
What's going on with this acquisition? First and foremost, we have to remember that photo-sharing is a crucial element of the Facebook experience. As my former colleague Mikolaj Jan Piskorski likes to say, Facebook made it socially acceptable for all of us to become exhibitionists and voyeurs to some degree! In that sense, Instagram has emerged as a major threat to Facebook. As people spend more time sharing their photos via Instagram's mobile app, they are likely to spend less time on Facebook. That reduced time on Facebook will cost the social media heavyweight a significant amount of advertising revenue. Moreover, rumors of a possible link-up between Twitter and Instagram (or perhaps even Google and Instagram) surely made Mark Zuckerberg more than a bit nervous.
What challenges will Facebook face with this acquisition? Zuckerberg has announced that he intends to continue operating Instagram as an independent company with relationships to other social media platforms such as Twitter. Users will still be able to post photos on other social media services, follower users outside of Facebook, and can choose not to share photos on the Facebook platform. In some sense, this move is a type of vertical integration. When that happens, firms also face the challenge of competing with their customers. Instagram will now be competing with its customers - i.e. Twitter and Google Plus compete with Facebook. Will that cause friction? Will it cause Instagram competitors such as Hipstagram and PicYou to steal away users? Facebook will have to be quite careful as it manages those relationships.
Some experts have wondered why Facebook could not have achieved some of the same benefits without having to acquire Instagram. Could they have formed an alliance or partnership with Instagram? Perhaps they could have. However, such an arrangement may have made it more difficult to engage in the type of close coordination required to integrate Instagram more deeply into the Facebook platform moving forward. If Instagram simply were to remain an independent company, then an alliance might have made more sense. However, I think more intense coordination and integration is coming... and a merger probably makes more sense in that instance.