Ever since Facebook announced plans to spend a billion dollars to acquire photo-sharing startup Instagram, critics have rightly wondered why even a Silicon Valley giant flush with cash would spend so much on a company with $0 in revenue and no business model. But it's far from the first zero-revenue startup acquired for millions recently. It's not even the first one acquired by Facebook.
The social network spent tens of millions grabbing startups such as FriendFeed, Hot Potato, and Beluga—companies with little or no revenue, and no established business models. Like Instagram, there were other, perhaps less tangible (non-monetary) benefits to the acquisitions, from talent to technology to users. Other companies have followed the same strategy.
Skype acquired GroupMe for a reported $85 million, even though the group messaging service had no revenue. But Skype didn't scoop up the service because it was a money generator. Rather, GroupMe provides Skype with a smart solution for group chats, excellent social data, and an awesome new feature for Windows Phone when Skype's integration with Microsoft is complete.
The same goes for Zite, the personalized-news service CNN acquired for between $20 million to $30 million—despite, again, having zero revenue and no business model. But CNN is gaining a strong foothold in mobile news, and a fantastic recommendation technology that could enable CNN to personalize its own news.
And the same also goes for Siri, the personal-assistant service that Apple reportedly acquired for $200 million. Apple didn't buy Siri because of its outstanding revenue potential. However, the service did give the latest iPhone a hit feature that's driving sales of the smartphone; it also gives Apple a position in mobile search, which could have a long-term impact on the company's bottom line.
The point is that a startup's revenue isn't necessarily the best indicator of the price it deserves to be acquired for. Sure, Facebook is spending roughly $33 per Instagram user (which isn't too bad considering New York City Mayor Michael Bloomberg once spent $174 per vote), but it's getting a long list of benefits for that price: one of the world's fastest-growing social networks; a talented team of designers and engineers; arguably the best mobile photo-sharing service; tens of millions of users and countless hours of additional mobile engagement; and a product that ties together well with Timeline.
Admittedly, valuations do appear to be growing higher and more arbitrary. But before criticizing Instagram's $1 billion sales tag, do consider that social networks with actual business models and revenues have turned out badly for their acquirers. For example, years ago AOL purchased Bebo for $850 million, while News Corp. acquired MySpace for $580 million. Both established startups reportedly boasted annual revenue in the eight figures—Bebo reportedly saw $20 million in revenue in 2007. Yet we all know how that ended up: AOL later sold off Bebo for a pathetic $10 million, while News Corp. rid itself of MySpace for just $35 million.
And there is one more significant benefit to Facebook acquiring Instagram: nixing off one its chief competitors before it grows too far out of reach. Remember, Facebook is said to have bid around $500 million a few years ago for a fast-growing startup that barely had revenue, let alone an established business model.
That startup was Twitter, a startup now valued at nearly $8 billion.