Is Facebook Ready to Monetize Instagram?

Instagram turned 3 years old this week, which is like bar mitzvah age for start-ups. It's the age at which people expect a company to mature and perhaps start making a little money. Instagram is no different, and Facebook (NASDAQ: FB  ) plans to flip the revenue switch on for the photo-sharing app soon.

Show me the money
With over 150 million users, Instagram has significant scale, dwarfing similarly aged Pinterest (70 million) and older microblogging platform Tumblr (30 million to 50 million). In fact, the platform has three times as many users compared to Twitter when it started to sell ads in October of 2010.

There's no doubt in my mind that advertising on Instagram will be very profitable for Facebook, but some fear ads may alienate users. Many had the same fears when Facebook started advertising in users' newsfeeds. While there were some who detested Facebook's ad strategy and abandoned their accounts, the site continues to add users in every region from the United States to Asia.

I expect a similar reaction to Instagram ads. A few people will leave the network for ad-free experiences on Pinterest, Tumblr, or any one of the nascent social networks that seem to pop up monthly, but Facebook ought to be able to maintain a stellar user experience on Instagram, which will keep its users coming back.

By its nature, Instagram is a highly visual platform and lends itself well to advertising. The company intends on displaying "beautiful high-quality photos and videos from a handful of brands," which ought to fit nicely into a user's photo stream. This native advertising strategy is what brought Facebook's mobile revenue from practically $0 in the second quarter of 2012 to over $650 million last quarter. I believe it will perform similarly on Instagram.

The mobile ad landscape
While Facebook continues to make strides in mobile ad revenue, Google (NASDAQ: GOOGL  ) is struggling to correct its downward trend in the space. The company saw its average ad price fall 4% in the first quarter and 6% in the second quarter. Mobile search ads have brought down the average ad price, and Google, while attempting to make mobile ads more effective, is relying on coercion to sell mobile ads through its "Enhanced Campaigns" program. Ad buyers are now required to bundle mobile ads with desktop ads. So far, the strategy hasn't proven effective.

Meanwhile, LinkedIn (NYSE: LNKD  ) rolled out a new mobile app, which included native advertising, in April, and the response so far has been strong. In its second quarter earnings call, CEO Jeff Weiner pointed to a 40% lift in engagement and an accelerating growth in users reaching the network through their mobile devices. It seems clear that advertising has not driven users away from LinkedIn, but it's unclear how the mobile ads perform compared to desktop. That's something investors should be looking for in the company's upcoming earnings report.

Just as LinkedIn is the premier network for professionals, Instagram is the premier network for photo sharers. Each has a critical mass of users on the network, which has allowed LinkedIn to successfully introduce mobile ads without losing engagement and ought to allow Instagram to do the same.

Flip the switch!
I expect Instagram to continue growing its user base as it flips the revenue switch. Users might not love it, but they will certainly tolerate it. Brands, many of which already run viral Instagram campaigns, will receive valuable insight into their ad's efficacy. And Facebook will continue to grow its mobile ad revenue.

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