Instagram is going to share some revenue with users. It's running tests with select content producers to run ads in their IGTV videos and offering the ability for influencers to sell digital "badges" during live videos.

The move could generate billions in revenue for the Facebook (NASDAQ:FB) subsidiary and put it in greater competition with Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) YouTube for both talent and ad sales. For reference, YouTube generated $15 billion in gross revenue last year.

Facebook will share at least 55% of ad revenue with creators, the same as YouTube. During a test period, creators will keep 100% of badge sales, but Facebook will eventually take a cut of that as well.

The potential for Instagram is absolutely massive, as the lack of an easy way to monetize content has held a lot of creators back from using IGTV and led them to use competing services for long-form video instead.

Instagram co-founder Kevin Systrom standing in front of the IGTV logo

Instagram co-founder Kevin Systrom introducing IGTV. Image source: Facebook.

Changes to make advertising work

Just seven million people downloaded the stand-alone IGTV app before Instagram pulled it from the app stores. Earlier this year, Instagram decided to remove the IGTV button from the homepage of the Instagram app (presumably because nobody was clicking it). The main way to find an IGTV video now is via clips creators post in their feeds or stories.

In hindsight, those moves to reduce direct access to IGTV may have been intentional to produce natural ad breaks. The new video ads will appear once a user clicks through to watch a video in the IGTV section. Facebook has long tried to avoid pre-roll video ads, preferring to give videos a chance to grab users' interest before showing them an ad.

The mechanism is still unproven. Users can still abandon videos after clicking to watch them in IGTV if they decide watching an ad isn't worth finding out what happens next. But it may be a better way of producing higher ad completion rates and stronger attention from viewers, which ultimately provides higher value to ad buyers. That will eventually translate into higher average ad prices as Instagram allows more ad buyers to access the channel.

Attracting the creators

The ability to easily monetize videos is a big reason creators flock to YouTube. While IGTV can be a good way to engage an audience or share information, it's not attracting the same level of entertainment or quality informational videos found on YouTube, because there's no incentive for most creators (some influencers have been able to strike private deals with businesses to promote products, but those deals are inaccessible for the vast majority of users).

Ads and the promise of revenue sharing in IGTV could convert millions of users on Instagram into IGTV video creators. YouTube highlights the revenue potential for creators in its "about" section. It points out that the number of creators generating over six figures from their channels grew 40% last year, and the number of creators earning at least five figures grew 50%. No wonder it sees over 500 hours of video uploaded every minute.

IGTV may provide some creators a better opportunity than YouTube. The ability to leverage existing audiences in Instagram could enable higher view counts versus trying to move that audience to YouTube. What's more, Facebook's data and decision to use the transition from the feed to the IGTV section as the ad break could produce higher average ad prices than YouTube for some creators.

Getting good content in IGTV will increase engagement among viewers in the section and create a virtuous cycle where the opportunity continues growing for creators to attract an audience and grow ad revenue.

The opportunity to grow IGTV into a legitimate YouTube competitor is massive for the FAANG stock and its investors. As mentioned, YouTube generated $15 billion in gross ad revenue last year. If Instagram can manage just a fraction of that, it'll net billions in additional ad sales, unlocking further growth for the app. The opportunity is just one of many for Instagram as it blazes a path to overtake its parent company's ad revenue in just a few years.