Instagram Is the New Engine Behind Facebook's Growth

It's only been a couple years since Instagram opened its advertising platform to everyone, and it's already big enough to make an impact on Facebook's (NASDAQ: FB) growth. That's no small feat considering Facebook generated almost $40 billion in advertising revenue last year. Instagram accounted for about 10% of that revenue in 2017, according to separate estimates from Wells Fargo and eMarketer analysts.

Despite its relatively small size compared to its parent company, Instagram is poised to account for the majority of Facebook's revenue growth over the next few years. That's a combination of two factors: Facebook's News Feed reaching ad load saturation and the plethora of advertising opportunities that still lay ahead for Instagram.

Facebook's slowdown

Facebook's management has warned investors about an expected slowdown in ad revenue growth for a year and a half now. That's the result of reaching ad load saturation in News Feed. Facebook can't show more ads in News Feed without ruining the user experience.

Compounding that issue is that Facebook is making changes to its News Feed that it expects to reduce engagement. While a lot of that reduction will come from showing fewer viral videos and news stories -- media where Facebook isn't actively monetizing time spent -- there's still a risk that ad impressions will fall due to the changes. In the fourth quarter, Facebook's total ad impressions (including Instagram) grew less than total users, implying the average user saw fewer ads than last year.

Facebook has thus far made up for its slowdown in ad impressions through increased prices. Demand remains extremely strong for Facebook advertising as it still produces one of the best returns on investment for marketers.

But the growth in ad price can only last so long before the return diminishes compared to Facebook's competitors like Snap. Furthermore, Facebook is currently facing risks from the fallout of the Cambridge Analytica controversy, which could put pressure on advertiser demand, marketers' ability to fully leverage Facebook's user data for targeting ads, and possibly user engagement.

Instagram's major growth opportunities

Instagram is still in relative infancy compared to Facebook's News Feed. Not only is there plenty of room for Facebook to show more ads in the Instagram feed, but Instagram Stories also has incredible monetization potential that Facebook is just starting to explore.

In the feed, Instagram is working on ad formats that are unique from News Feed and offer much more value to marketers. Shoppable posts, for example, allow users to see the prices of items in a photo and add them to a cart. That's something that capitalizes on organic behavior on Instagram already.

Stories presents an excellent opportunity because of the full-screen immersive nature of the format. Facebook CEO Mark Zuckerberg expects the stories format to overtake feed posts as the most popular way of sharing this year. COO Sheryl Sandberg is very optimistic about the potential of ads in stories.

It's worth noting that Instagram stories ads will go head-to-head with Snapchat's stories ads. Analysts are currently expecting Snap to grow its revenue from $825 million in 2017 to $2 billion in 2019. Considering Instagram has 300 million daily active stories users compared to Snapchat's 187 million, Instagram could earn quite a bit more from stories ads alone. Combine it with superior user data and ad targeting, and it's easy to see the format more than doubling Snap's results.

The new growth engine

With all the opportunities ahead for Instagram, analysts expect it to produce meaningful revenue growth over the next few years, accounting for a majority of Facebook's total growth.

Instagram's revenue could reach $10.9 billion by 2019, up from about $4.1 billion last year, according to eMarketer. Meanwhile, analysts expect Facebook's total revenue to reach $70.1 billion in 2019, up $29.5 billion from 2017.

Those numbers indicate Instagram will account for nearly one-quarter of Facebook's total growth over the next two years. But Wells Fargo analysts think Instagram is already contributing much more than that, accounting for 29% of revenue growth in the fourth quarter last year.

The impact of Instagram is clearer when looking at Facebook's operations in the U.S., where Facebook has saturated the market with its flagship product. Instagram will account for nearly three-quarters of Facebook's U.S. ad revenue growth through 2020, according to eMarketer.

Watch for Facebook to put a bigger focus on Instagram over the next few years as it becomes its most important source of revenue growth.

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Adam Levy owns shares of Facebook. The Motley Fool owns shares of and recommends Facebook. The Motley Fool has a disclosure policy.