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.

{ 11 comments… read them below or add one }

Lukas April 18, 2012 at 11:20 am

My thoughts exactly! I first read about instagramm on the news. Once I actually went to look at what they do I just couldn’t believe that someone would pay 1b$ for a “company” that doesn’t earn any money. It doesn’t make any sense that a company would be worth that much just 18months after starting just because they have a lot of users.

Lukas

Reply

Matt April 19, 2012 at 3:13 pm

I don’t see anything wrong with trying to build an Instagram. If you have the vision and drive to create a free, mainstream app and have VC backing to pay your bills, then go for it.

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Chandoo April 22, 2012 at 1:04 am

If you answer YES for both of these then you should go for it:

1. Would you build such a company if you had to do it with your own money?
2. Would you build such a company if the VC gives money as Debt (instead of Equity stake)? Debt means you have to pay interest frequently.

If not, then why build such a thing in first place?

Reply

Saimi December 25, 2012 at 12:13 am

I just love that Cookie Monster cake, though the Elmo cueakcps are great too. And the picture of her all covered in blue is priceless. happy birthday to your little one.Twitter:

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Krishna April 20, 2012 at 12:39 pm

I agree you, it takes discipline and skill to build a business that makes money within a reasonable amount of time. Also, I feel its the best way to succeed in business by any measure. While success stories like instagram are glamorous, its a 1:1000000 shot. Not a very sustainable way to earn a living through business as many of us want to.

Cheers,
Krishna

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Foxorion April 24, 2012 at 3:19 pm

Instagram being bought for so much has to do with the patents it holds. Facebooks aquisition of these patents helps fb elude some large lawsuits as well as open up possibilities of applicable intagram actions such as hashtagging and utilizing a 10 million user base. Facebook is free to you know. Even if ads stay clear of ig, its clear brands have there own ig pages. Anyways. Look at the patenting and you’ll realize why this patent is worthy of it’s $1B pricetag alone. Not to mention it’s not $1B cash, it’s fb stock and other crap. Check out my ig@
FOXORION

Thanks.

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Phanivijay Pamarthi May 21, 2012 at 3:43 pm

Very True.With limited access to path breaking technologies and deep pocket VC’s its a good idea to build a start up which creates value to the clients.Valuation follows it obediently

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Noel June 18, 2012 at 2:56 am

User number is strength, that can be converted into money later. Facebook’s main opponent, google + has picnik-creativekit. Facebook hasn’t an alternative to that.
So, in my opinion, facebook did the right job, and I’ll definitely suggest to make a company like instagram.

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Momekh June 19, 2012 at 2:46 pm

Interesting thoughts.

Twitter anyone?

It’s a tough call to make, I think. Instagram had a lot of users, and they could be ‘monetized’ with adverts. But they chose not to. If there is a choice, and you are holding off for one reason or the other, then that’s make sense, no?

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Roshan P Vani September 8, 2012 at 6:44 am

I have been involved with the development and launch of a website that would find into this category (www.olimdives.com) and also have a friend that is involved with a similar site (www.buildingconnected.com).

While from a bottom line, “let me see the numbers” perspective I do not disagree with you. The only point I think worth talking about is “passion” – which is critical to all new ventures. I am sure when you launched chandoo.org the last thing on your mind was how much money you could make doing an excel blog?

I currently working in Saudi Arabia in the middle of no-where. My current assignment has drained me of all passion until I started my project controls blog. Recently we launched Olim Dives. I have a new sense of passion in what I do and drives me to keep going.

As entrepreneurs I think its the passion that drives us more so than the bottom line. Money will follow later if we love what we do, and I think that is what happened with instagram.

Just my 2cents. Love chandoo.org & startupdesi. Keep up the good work.

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Roberto October 15, 2012 at 10:12 am

Awesome article! That’s what I always thought and that’s why Facebook completely bombed since it got in the stock market

Reply

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