Facebook's (NASDAQ:FB) Instagram recently opened up its advertising API (application programming interface) to marketing partners, which will automate all purchases of Instagram ads.
The API will enable advertisers to plan and cross-promote Instagram ads alongside other digital ad platforms like Facebook and Twitter (NYSE:TWTR), and let them monitor all Instagram marketing activity via third-party platforms. In the past, companies had to pay a minimum of $200,000 to place an ad on Instagram. Those orders were taken by Instagram sales representatives, then planned and approved individually.
With the minimum requirement lifted and the process automated, Instagram's worldwide annual ad revenue could soar from $595 million this year to $2.8 billion by 2017, according to research firm eMarketer. That would account for about 10% of Facebook's estimated worldwide ad revenue.
The evolution of Instagram
Many people mocked Facebook's $1 billion purchase of Instagram in the past. Computerworld's Steven J. Vaughan-Nichols called it a "complete waste of a billion dollars," claiming that many of Instagram's 35 million monthly active users probably wouldn't stick around.
Yet last December, Instagram announced that it had surpassed Twitter with 300 million monthly active users. In response, Twitter co-founder Evan Williams told Fortune that he didn't care if Instagram had "more people looking at pretty pictures" and that "Twitter makes a hell of a lot more money than Instagram."
That was certainly true in 2014. However, if eMarketer's forecast is accurate, Instagram could eventually make more money than Twitter, which expects to generate about $2.2 billion in revenue this year.
With a massive user base in place, Instagram has started beefing up its advertising features. Last year, it introduced video ads, which proved popular with both advertisers and users. In March, Instagram added carousel ads, which let advertisers fit more images into a single ad. In June, it offered Facebook's ad targeting tools to advertisers, which accessed user data from Facebook profiles. That same month, Instagram launched "Shop Now" buttons and support for external links.
Why Instagram matters
Instagram is a lucrative platform for advertisers for three reasons. First, it was the fastest growing major social network among American adults last year. According to Pew Research, the portion of U.S. adults using Instagram rose nine percentage points from 2013 to 26% in 2014. By comparison, Twitter's usage grew five percentage points to 23% of American adults while Facebook's remained flat at 71%.
Second, Instagram's user base is dominated by teens. According to Pew, 52% of American teens use Instagram, compared to 71% for Facebook and 33% for Twitter. The 35.6 million teens in the U.S. command over $200 billion in annual spending power and Edudemic estimates they log in to social networks over 10 times daily. According to Piper Jaffray, teens spend most of their money on food and clothing -- both of which can be easily enhanced with Instagram's vintage filters.
Lastly, Instagram claims that users recall ads on its app 2.8 times more than other forms of online advertising. That's probably because it crafts targeted ads with data gathered from users' Facebook profiles. The large photo and video ads, which appear while scrolling through the app, are also probably easier to remember than simple search or display ads by Google (NASDAQ:GOOG) (NASDAQ:GOOGL).
Bigger than Twitter and Google
Instagram could also generate more mobile display ad revenue than either Google or Twitter in the U.S. by 2017, according to eMarketer. The firm expects Instagram to generate $2.39 billion in U.S. mobile display ad revenue that year, compared to Google's $2.38 billion and Twitter's $2.29 billion.
That could be bad news for Google, which already generated less than a third of Facebook's mobile display ad revenue in the U.S. last year. If Facebook turns Instagram into a second pillar of ad revenue growth across mobile devices, Google could fall behind even further. Meanwhile, Evan Williams will be forced to backtrack on his claim that Twitter makes "more money than Instagram."
The bottom line
The monetization of Instagram demonstrates Facebook's strategy of growing its ecosystem by offering users an illusion of choice. Facebook, Messenger, WhatsApp, and Instagram might have lots of overlapping users, but all those services keep them tethered to the social network's system.
None of Facebook's other services generates as much revenue as the main site yet, but the company is simply corralling together millions of users for future monetization. Many people doubted that Instagram would ever make money, but it could soon become a major contributor to Facebook's top line. If that happens, Google and Twitter might have to rethink their mobile advertising strategies.
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Leo Sun owns shares of Facebook. The Motley Fool recommends Facebook, Google (A shares), Google (C shares), and Twitter. The Motley Fool owns shares of Facebook, Google (A shares), Google (C shares), and Twitter. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.