Why Facebook, Inc. Needs to Tread Lightly With Instagram

It was like clockwork: One of the first questions CEO Mark Zuckerberg fields virtually every quarterly conference call since Facebook acquired Instagram for $1 billion in 2012 is "When will Instagram be fully monetized?" At the time of the deal, Instagram was growing by leaps and bounds and had just been rolled out to Android device users, prompting expectations of as many as 50 million monthly average users. While Facebook watched from the sidelines, Instagram co-founder and CEO Kevin Systrom has since grown its MAU base to over 300 million and counting.

Now that Zuckerberg has finally taken the wrapping off Instagram and will fully monetize the site, the possibilities seem endless. Some conservative estimates suggest Instagram could generate nearly $600 million in ancillary revenue this year and nearly $3 billion in just two years. Why are so many industry pundits so bullish on Instagram? It has what advertisers want: user engagement stats that are through the roof, blowing the doors off Twitter and even Facebook itself.

Its Instagram's strength user engagement that presents the biggest challenge to Facebook: getting a return on its $1 billion investment, without ruining what makes the site so popular.

How good is good?In addition to the staggering revenue estimates of nearly $3 billion in just a couple of years, Instagram-specific mobile ad revenue will make up 14% of Facebook's worldwide sales by 2017 and a whopping 28% of Facebook's U.S. mobile ad revenue. The tools are in place to meet Instagram's sky-high expectations, including direct buy alternatives, an ad-buying tool or application programming interface, not to mention video spots and Facebook's world-class ability to utilize data to target its ads to the right people, at the right time.

A study was conducted comparing user engagement levels as measured by "likes," "shares," and "re-posts" in Q1 2015 vs the year-ago period. Year-over-year engagement levels on Instagram more than doubled, jumping 108%. In contrast, Twitter's user engagement improvement -- an on-going concern along with its meager MAU growth -- grew by 32%.

Facebook users were an estimated 27% more engaged in Q1 of 2015, but given its 1.49 billion MAUs, it takes quite a bit to "move the needle" relative to Instagram with its 300 million users or Twitter's meager 304 million full-time MAUs, up just 2 million sequentially. Naturally, Instagram's sky-rocketing engagement for both its organic marketing efforts -- users sharing or liking a business post for example -- and paid ads has marketing departments salivating.

As one digital ad exec put it, "Organic engagement on a given Instagram post is leaps and bounds above its counterpart on Facebook, on Twitter, on Pinterest, on any of them." Another key metric advertiser's love is "ad recall," how long and how many spots are remembered post-viewing. Instagram user's ad recall is about three times the industry average.

Proceed with cautionWith the advent of more spots, the question, of course, is whether Instagram can both continue to grow MAUs while maintaining its incredibly high user engagement levels. So far, Facebook's slow but steady introduction of ads appears to be a hit among both users and Instagram's marketing partners. But caution still reigns supreme considering Instagram is nowhere close to reaching its full revenue-generating potential.

According to Facebook COO Sheryl Sandberg, investors should "be patient" as the monetization of Instagram ramps up. To be sure, Facebook execs will be asked about Instagram's progress with each successive quarterly conference call, and the response is likely to be the same: "Be patient." Good advice, both for investors and Facebook.

Zuckerberg recognizes both the potential of Instagram and the possibility of alienating 300 million of Instagram's highly engaged users by saturating the site with ads. Longtime Facebook fans will recall many of the same concerns were raised when discussing monetizing Facebook itself. Clearly, that's worked out all right, and there's no reason to think the monetization of Instagram will turn out any different. Assuming, that is, Zuckerberg takes the same cautionary approach with Instagram as he's done with Facebook.

The article Why Facebook, Inc. Needs to Tread Lightly With Instagram originally appeared on Fool.com.

Tim Brugger has no position in any stocks mentioned. The Motley Fool recommends and owns shares of Facebook 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.

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