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Why Facebook paid $1-billion for Instagram

Screen cap of Instagram's web site, run through an Instagram filter.

Shane Dingman

Facebook Inc. has a smartphone problem, and it's paying a billion dollars to solve it.

The world's biggest social network is on the verge of buying a far smaller, photo-based Web service called Instagram. Founded less than two years ago, San Francisco-based Instagram allows users to quickly edit and share the photos they take on their mobile devices.

Facebook chief executive officer Mark Zuckerberg announced Monday that his company will buy the service, which boasts some 30 million users and fewer than 20 employees, for $1-billion (U.S.) in cash and shares. The deal is expected to close by the end of June.

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While news of the lofty valuation – which comes just days after a round of financing pegged Instagram's value at half the Facebook purchase price – quickly led many observers to wonder if the technology sector is in the midst of another bubble, Facebook appears to have a real need for an Instagram-like service.

"Facebook has to believe that this could be a core part of their mobile product," said Michael Scissons, founder and CEO of social marketing firm Syncapse Corp. in Toronto. "They must have believed in the power of the [Instagram]brand – they've never paid anywhere close to this amount before."

Primarily, Instagram exists as a smartphone application. Last week, it launched a version of its app that runs on smartphones powered by Google's Android operating system; before that, Instagram was available only on Apple's mobile devices.

The app is sort of a social network for photos: Users can apply various filters to their pictures, such as one that makes the pictures look as though they were taken with a Polaroid camera, and then share them with their friends.

Many other apps have copied Instagram's filters, however, making it unlikely that Facebook was interested in the technology itself. And although Instagram's user base has grown quickly in the past two years, it is still relatively tiny compared with Facebook's 850 million accounts. (Facebook is already the world's biggest social photo-sharing site.)

But Instagram's popularity with smartphone users – particularly iPhone users – gives Facebook a much stronger presence in the mobile market, where it has acknowledged that it has trouble generating revenue.

"Growth in use of Facebook through our mobile products, where we do not currently display ads, as a substitute for use on personal computers may negatively affect our revenue and financial results," the company said in a February regulatory filing.

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As Facebook's initial public offering is set to happen next month. As it draws nearer, the Palo Alto, Calif.-based company will likely find itself under more pressure to monetize its mobile products. So Instagram's user loyalty may prove especially useful if Facebook starts displaying advertisements on its smartphone-based apps.

Facebook's acquisition history has usually involved buying companies solely to integrate their services and talent into Facebook.

But Mr. Zuckerberg indicated that his company will allow Instagram to operate somewhat independently, and that it will not discontinue the app's ability to be used on other social networks, such as Twitter.

"We think the fact that Instagram is connected to other services beyond Facebook is an important part of the experience," he said in a Facebook posting. "We plan on keeping features like the ability to post to other social networks, the ability to not share your Instagrams on Facebook if you want, and the ability to have followers and follow people separately from your friends on Facebook."

Despite such assurances, however, it is uncertain whether users of Google's social network, for example, can expect a Facebook-owned Instagram app any time soon.


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The startup

Instagram is a social network built around cellphone photos. It lets people add quirky filters and effects to their snapshots and share them with friends, who can "like" and comment on them. The service has been something of a rising star in the startup world.

The audience

Barely two years old, Instagram has attracted close to 30 million users, even though it worked only on iPhones until last week, when it released an Android version of its app.

The plan

Facebook plans to keep Instagram running independently. That's a departure from its tendency to buy small startups and integrate the technology – or shut them down altogether just so it can hire talented engineers and developers.

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