The Instagram Buyout: What the Numbers Reveal About the Future of Tech Value

The $1 billion acquisition of non-revenue producing internet photo sharing app Instagram is being cited as further evidence of a tech bubble. Or worse, of too many tech companies with way more cash than ideas they can commercialize.

But is that fair? Or accurate?

OK, we get that life's not fair so let's focus on accurate. Any start-up acquisition involves intangibles for the simple reason that such companies are not usually in a position to generate much in the way of tangible results, especially of the balance sheet or income statement variety. Which is not to say there isn't any data. Far from it. But in the realm of intangible value, determining the measures that matter - to borrow a phrase from a study we created in another life - is crucial. And by that standard, Facebook may actually have not overpaid, but gotten something of a deal.

Andy Baio has done some interesting comparative work on this and you can download his spreadsheet on Google docs. But the key data point may well be acquisition cost per user in the chart above, by which standard the deal looks pretty good, particularly when one contemplates the growth rate Instagram may reasonably expect to generate based on comparable historical measures.

Even the cost per employee numbers, which many have cited as proof of the current insanity, may tell another tale. Which is that app development, by dint of its employee productivity, could be an extremely efficient means for creating value. How sustainable that value is remains to be seen (cue the foreboding music...)but the proposition seems worthy of further study.

The broader implication is that twenty years on, advances in tech development and entrepreneurial knowledge may be contributing to a change in the economics of tech value creation. When my colleagues and I did the original IPO Transformation Process study in 2000, the surprise was that most of the companies that had successfully gone public up to that time had been larger and more established than previously believed. The opposite may now be coming true. JL

Andy Baio reports in his blog Waxy.com (hat tip Big Picture):

Instagram's billion-dollar sale to Facebook raised eyebrows, renewing cries of a new bubble. But relative to other major acquisitions of the past, how does it measure up?

I crunched the numbers, pulling together data from a selection of 30 notable internet acquisitions over the last ten years, from Broadcast.com to OMGPop, to see if the Facebook/Instagram acquisition was as crazy as everyone thinks. (I left out companies without public purchase prices or user stats.)
The spreadsheet captures the acquisition date, dollar amounts, and ballpark counts of the users and employees at the time of acquisition. These numbers are very rough, cobbled together from Internet Archive searches, old news articles, Quora answers, and tech blogs. If you have more accurate information, please leave a comment and I'll fix it. Download the spreadsheet or view it on Google Docs.

Cost Per User

When a startup's acquired, they're purchased for any combination of the technology, talent, or the user base.

If we look strictly at the acquisition cost per user, Facebook got a relative deal with the Instagram purchase, paying roughly $37 for each of Instagram's 27 million users. (The median cost across all the acquisitions is about $92 per user.)

Compare that to acquisitions like Aardvark ($555/user) or Jaiku ($240/user), and you can systematically see which were likely technology or talent hires. The glaring exception is Yahoo's famous purchase of Mark Cuban's Broadcast.com in 1999, which paid nearly $10,000 for each of their 520,000 monthly active users, ten times any other startup. (Broadcast.com skewed the chart so much, I had to leave it off.)

Cost Per Employee

But if you look at the payout per employee, Instagram is completely off the charts. If split equally, each of Instagram's 13 employees would make nearly $77 million. The nearest runner-up is YouTube, with a paltry $24M for its 2006-era staff of 67. Skype, Broadcast.com, and Myspace all top the charts. The median? About $3 million.

Some would point to this as a sign of a bubble, but I think it's more likely it just reflects the incredible scalability of modern app architectures. Using cloud services, failover, and solid monitoring, Instagram can quickly scale up to support a million new users overnight with very little additional engineering effort.

The User-to-Employee Ratio

Instagram's numbers are exactly what you'd want to see in a social network -- high user counts with the lowest number of employees. This ratio is a measure of your efficiency, and it's no surprise that Instagram comes out on top here, with a ratio of one employee for every 2.07 million users.

The second highest user-to-employee ratio is OMGPOP, famous for developing Draw Something, the fastest-growing mobile app in history. With only one employee for every 875,000 users, they were able to scale to 50 million users within 50 days.

On the other end of the scale are the short-lived Q&A service Aardvark, with one employee for every 1,800 users, and customer-service giant Zappos with one employee for every 3,400 users.

More than anything, the app ecosystem rewards efficiency; your ability to massively scale with very little engineering effort. I'm guessing these ridiculously lean startups with huge exits aren't a freak occurrence. We'll see more of them as the rest of the world catches up, and learns how to do more with less.

Methodology

All figures are at the time of acquisition, and I favored active user counts over total registered users for calculating acquisition cost per year.

Thanks to Tristan Louis for providing some of the rumored numbers.

Update

I originally published this yesterday on Wired, under a different headline and revised lede from my editor. To be clear, I don't know if we're in a bubble or not. My only point is that, relative to other acquisitions, the per-user cost for Instagram isn't insane. Union Square Ventures' Albert Wenger added some additional thoughts, noting that the per-user costs should be discounted as the userbase grows.

Many Wired commenters complained I was wrong because Instagram has no revenue. In 2006, YouTube had 34M users, zero revenue, and were bleeding $1M/month for bandwidth alone. Was Google was crazy to buy them, too?

Anyway, it was a good excuse to collect all of this data in a spreadsheet for the first time. I went looking, and couldn't find the numbers available in one place anywhere. Hope you liked it.