Why you should not build an Instagram

by Chandoo on April 18, 2012 · 11 comments

in Money Matters, Startup Mistakes

By now, anyone and their grand-mother in Startup circles has heard it,

Facebook acquires Instagram for $1 Billion (on TechCrunch)

Instawhat?!?

Instagram is an iPhone (and Andriod) application and is primarily used to apply cool, retro style filters to your photos and share it with your followers everywhere. Here is a recent pic my daughter after instagramming it.

Nakshatra - instagram

Isn’t $1 Bn cool, why should we not build an Instagram?

There have been some very good articles on why instagram is worth it. But to me the purchase seemed like a rare exception than a rule for start-up founders. It is almost as if Facebook wanted to find someway to spend $1 Bn of cash & equity.

Let me explain 2 reasons why I think so.

  1. Instagram does not make any money. Nor we know of any plans to do so.
  2. No 2nd reason.

Further inspection – why you should not build an Instagram?

No matter what business you do, the basic rules do not change.

  • Cash is king.
  • If you are earning $100, you should spend less than that.
  • A paying customer is better than 100 free users.
  • Chase value, not valuation

Let us examine each of these.

1. Cash is king

Well, nobody would dispute this. If a business is like a person, cash is like blood. If blood does not circulate, the person is dead. Scary, but true. I am not sure about Instagram finances, but as far as I know they relied on venture capital funding (with latest valuation at $500 Mn) to get cash flowing in to their business.

As mentioned earlier, they had no visible plans to make revenues. If that sounds normal (because many services like Twitter, Groupon etc. bleed), it is because we are seeing one too many such services. But imagine running a physical shop where you sell socks. And all day long customers would walk in and pick up their favorite pair of socks and simply walk away. No paying, no chit-chat or no worries. Would you run such a business? If not, why build a service where your plan is to offer everything for free?

2. If you earn $100, you should spend less than that

In case of Instagram they had no revenues. But in your case, are you building a business where revenues < expenses? It is ok to have expenses > revenues for a while, especially when you are starting out. This is normal in businesses with lot of capital expenditure like a factory, hotel, shop. In such cases, even before you make a single sale, you must construct the factory, set up the restaurant, purchase inventory. But what is your excuse to spend more for a web based business? The start-up costs for website are very low. So any half-decent web business can recoup the costs and move in to green zone with in an year.

3. A paying customer is better than 100 free users

I think Hotmail started it all. They gave away a free web based email account to all. The model worked well for them and Microsoft acquired the company for lots of $s ($400 Mn I think). Very soon, everybody was building a hotmail. I am sure further examples of YouTube (free service, sold for more than a Billion), Twitter and now Instagram add fuel to this fire.

Remember, all these services had companies (or VCs) with really deep pockets and extra-ordinary vision behind them. They have ways to monetize the attention of millions of users.

But, you & I – small business folks, have no chance in hell to make money by giving away everything for free. This is because,

  • To make free model viable, you need to have billions of page views, lots of user attention (then probably someone would advertise on your site and give you $s)
    • Example – Facebook, Twitter
  • To make free model viable, you need to collect user data, profiles & offer it to people who pay for it. This works only if you billions of people using you every month
    • Example – Gmail, Google
  • To make free model viable, you need to ask your users for money
    • Example – Wikipedia collects donations from its users every year to fund the company

I am sure you are not ready or geared for any of these options. So why give away everything for free? Go ahead and serve a dozen paying customers than chasing a million free users.

4. Chase value, not valuation

Value: Something desirable and of worth, created through exchange or effort.

By chasing value and by creating it, you become worthy.

By chasing valuation, you are trying to find someone to believe that you are worth certain $s.

Take the case of Instagram again. As fellow entrepreneur & inspiration Alok Kejriwal points out in this article,

$1 Bn is roughly 5,200 crores of rupees. If you have $1Bn, you could buy Oberoi hotel group or Taj hotels.

If you are in USA, you could pick up roughly 10% stake in Hasbro, Mattel, XEROX or Garmin. Assuming you pick up 10% stake in Garmin for $1 Bn, which made $2.7 Bn revenues & $ 590Mn in profits last year, you would get $59 as your share of profit. (source: Google Finance)

Compare this with purchasing a company for $1bn that has no revenues and increasing costs (hosting, salaries, development etc.)

So when you are building a business, chase value. Create value instead of chasing valuation. Once you accumulate value (cash, assets, good people) someone will always give you fair valuation.

Are you building an Instagram?

So go ahead and tell me. Are you building an instagram like company or are you providing something of value & finding customers for it.

Please share using comments.

Note: I have no dis-respect for Instagram or their founders. I think they are wonderful individuals who put in a lot of hardwork & got fortunate. I wish them more success in future.

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