Snapchat: How it Became a Real Business, and Why it's on the Cusp of Explosive Revenue Growth

Executive Summary

Snapchat, once written off as an irrelevant social media app for teenagers, is in the midst of implementing a shrewd, dynamic business model that will help them bridge the gap between being a highly-valued private company and executing a successful public markets exit.

Introduction

Started under the name ‘Picaboo’ in 2011, Snapchat (now Snap Inc.) has evolved from a childish selfie-sharing app to a powerful social media juggernaut valued at more than $20B. Over the years, led by co-founder Evan Spiegel, the company has built up a user base mainly consisting of one of the most valuable advertising commodities– millennials – and monetized them to the tune of up to ~$750,000 per day, per advertiser. As the company continues to grow, they have reached both a valuation and point in their life cycle at which an exit looms. Recently, rumors circulated about Snapchat considering an IPO towards the early part of 2017, and with that comes the need to satisfy public market investors by demonstrating a long-term business plan and a path to profitability. While Snapchat as a product is captivating to the people that use it, Snapchat as a business is equally fascinating for those who can look past the disappearing pictures to discover the longer-term vision that the company is striving toward.

Snapchat – The Product

In the crowded market that is social media applications, Snapchat has found a way to stand out as a differentiated, sought after alternative to market leaders Facebook and Twitter. In fact, their core product has been so successful that Instagram (owned by Facebook, who made an all-cash $3B buyout offer of Snapchat in 2013), launched a feature called “Stories” in which users upload photos and videos that expire in 24 hours and Apple, as part of their iOS 10 update, has a new disappearing feature that can be attached to certain messages. Just given the names of the companies trying to emulate Snapchat, it’s clear they’re onto something.

The concept of making a moment disappear was Snapchat’s unique differentiator as it came onto the market. People loved the idea that they could share an experience with friends without the fear of it remaining in the corners of the internet indefinitely. Though privacy concerns have arisen, along with questions of what really happens after the timer expires on a photo, users have continued to embrace the service. Beyond sending pictures to individuals, users can post to a story – seen by all their friends –and can view live stories that capture an event either nationwide (i.e. Super Bowl) or specific to a certain region (a Red Sox game in Boston). Other key features include lenses and filters, which allow a user to augment their pictures and videos with text or images, and the Discovery tab, which allows publishers like ESPN or Buzzfeed to publish their own unique content to a broad audience.

On top of the features, which can be copied in some form or another by competitors, a unique advantage for Snapchat is that it allows people to be “real.” Other social media platforms require users to put their best foot forward – a Facebook album of a recent trip highlights the top moments, an Instagram picture is usually taken and edited such that the person looks their best, or a tweet is read over multiple times before sending. Snapchat, in creating a platform that does not leave a lasting impression, allows someone to open up their daily lives to others in a way – and with a certain level of comfort – that they weren’t able to before.

Snapchat – The Business

In typical Silicon Valley startup fashion, the emphasis early was not on revenues and profits but rather on gaining users. The latest belief among many startups – especially those that benefit from the network effect – is that a company should build a core user base, and at a later undetermined date find a way to monetize those users. The trouble is, there are few examples of companies that have successfully pioneered this transition. One that comes to mind is Facebook (a company that I plan to cover in a later post), which has masterfully used targeted advertising to deliver eye-popping revenue growth for their mostly free services. However, the list is long for companies on the other side. Twitter has been plagued by investors that have been selling off the stock as user growth slows and revenue per user, or in other words their monetization tactics, stall. Music streaming companies Pandora and Spotify have struggled greatly with profitability as they can’t convert enough of their free users to paying ones, instead having to rely mostly on advertising revenues. With this in mind, Snapchat faced an uphill battle with the odds stacked against them using this approach. The big question is, how can a company with messages that disappear every 1-10 seconds produce revenue? It’s not just how can they generate revenue, but can they generate enough to one day become profitable?

Though it wasn’t clear at first as product features were added over the years, it turned out that each offered a specific way to cater to advertisements and user monetization. For example, remember the filters and geofilters (filters based on location) that were supposed to just give people an interesting image or text to put in their picture? Snapchat monetized that feature by selling advertisers the opportunity to create filters, for example to promote a movie nationwide by letting a user take the shape of a recognizable character, or geofilters that could be accessible only to certain users depending on their location, such as to someone within a certain distance of a company location. These were intended to offer a company a fun and interactive means of engaging with their potential customers beyond traditional forms of advertising, which are usually one-sided interactions. Likewise, the Discovery tab now offers a way to interlay advertisements among the provider’s content, or a company can pay to be promoted within the tab. Similarly, with Live Stories, an advertisement can be strategically placed among the rest of the content.

There are several parts of these types of advertising that I find especially effective for advertisers. For the geofilters, the advertisements can be specifically targeted based on location such that a company is only paying for users to see the filter within, say, a two-mile radius of their location (for example, McDonalds used this method of advertising near their restaurants nationwide). In TV, print, or the like, a company is casting a wider net hoping that some of the people who see the advertisement might be a relevant consumer. It’s not as if radio stations can play certain ads to customers depending on where they’re driving at that moment in time. Snapchat, on the other hand, offers value similar to Facebook in that they can hone in on the exact area that an advertiser wants to reach. Second, the advertising is effective because consumers don’t always view it as advertising. Who among us hasn’t skipped over the commercials of a recorded TV show, scrolled past the web advertisement as fast as we could, or flipped past the page in the magazine that has the sponsor? In the case of Snapchat’s filters, people are actively being exposed to (and further promoting) the advertiser while simply feeling like they’re sending a funny photo or video to a friend. The effectiveness comes in that the advertiser is getting their message across, while simultaneously the user doesn’t feel like they’re having a message pushed on them.

This leads me into my third point, which is that engagement with Snapchat ads are among the highest in the business. The company has created a situation in which the ad is more likely to be viewed by the person on the other end of the screen by the nature of the way the content is provided – short bursts about a topic the user is interested in. I mentioned in the last paragraph the ease of skipping advertisements, which in effect means that the company has paid for something that has very little value. Even Facebook, who I lauded for their targeted advertising, suffers from the fact that someone can simply scroll right by an advertisement in their news feed without thinking twice about it. However, simply by clicking on the Discovery channel of a certain provider or the Live Story, a consumer has indicated that they are interested in the content. Given that they are interested in the content and that it comes in short, easily digestible periods of time, a user is more likely to be focused on the content rather than mindlessly scrolling. When an advertisement appears amid that content, the user is already so engaged that it’s unlikely they’ll take their attention away for the short time.

Herein lies the beauty of Snapchat: they have created a sense of urgency with their products. They have capitalized on our short attention spans and provided a product that caters to our modern living. As much criticism as there is about the lack of people’s ability to focus, it doesn’t change the situation. Companies that find ways to adapt to their user base – or the general population at large – find themselves in a better situation to succeed. When content disappears, it creates an artificial ticking time bomb that forces a user to pay attention. The ability to keep the user engaged is what allows Snapchat to charge well above market rates for their advertisements, and also what makes a company willing to pay those rates. Their money is better spent reaching a targeted, engaged audience rather than a semi-targeted audience that is only interested in seeing how fast they can skip the advertisement, or maybe taking that time to get off the couch to grab a snack or refill a drink.

The statistics regarding Snapchat, especially as it relates to advertisers, are pretty incredible in their own right. As of January of this year, over 9,000 snaps were being sent per second, a figure that has risen to ~11,500 according to a recent WSJ article that mentions the company now has over one billion snaps sent per day and 10 billion videos viewed. Furthermore, the same article informs readers that 60% of 13 to 34-year-old smartphone users are on the app, and on any given day the app reaches 41% of all 18 to 34 year olds in the US, whereas the average TV network in the top-15 reaches only 6% of the same demographic. These numbers are an advertiser’s dream. It targets – and successfully reaches – the most coveted age range, and has high engagement among that group.

All of this, while special, is only useful if it translates into actual revenue. In other words, Snapchat is only as successful as their ability to continue to attract advertisers and build out these offerings. So far, it appears that they are ramping up revenues quickly. In 2015, revenues were reported to be in the range of $59 million, which was a miniscule sum given their valuation at the end of that year was in the range of $15B. Like many thriving tech companies, though, that’s only the beginning of the story. Snapchat is expected to experience explosive growth in the years to come. By the end of this year, they are estimated to bring in $250-$350M, and next year between $500M-$1B. While these are wide ranges, even hitting the bottom of them each time represents revenue targets that experience 100%+ revenue growth year-over-year. In short, it appears that Snapchat’s business model is finally coming to fruition, and for those who had the patience to see it through, it’s a very exciting time indeed.

Snapchat – The Future

In many ways, Snapchat and its growth evolution mirrors that of fellow social media giant Facebook. A young, enthusiastic entrepreneur dropped out of a prestigious school (Spiegel left Stanford shortly before graduating) to start their business. Both quickly grew and scaled their fledgling companies, and were faced with lawsuits over the role of fellow co-founders in the early years of the companies. At times both were ridiculed for their hubris in spurring large buyout offers from reputable companies (Yahoo offered FB ~$1B early on). From a product standpoint, Facebook started as a social media site but has extended their reach into all things technology – Artificial Intelligence, Virtual Reality, Messaging, Live Broadcasts, and more. FB repositioned themselves from a social media company to a technology juggernaut, while others like Twitter have never been able to grow out of their initial product set and reputation.

Snapchat, too, is now consciously branching out beyond their core product. So far, everything has revolved around their app – adding the filters, Discovery, live stories, etc. This past week, though, news broke that Snapchat is going to introduce a consumer product reminiscent of Google Glasses. “Spectacles,” a product that resembles a pair of glasses and will launch with a price tag of $129.99, allows users to capture videos of up to 10 seconds – the same amount of time as a regular snap – from a complete first-person perspective. The video syncs wirelessly to a user’s phone, at which point it can easily be distributed at their discretion. To hear Spiegel talk about it, the glasses create an incredibly unique situation in which the product connects you with a moment like no picture, video, or memory can. It’s not about looking through a camera screen, but rather looking through your own eyes to experience that moment in time once again.

The new product represents a shift from application development to hardware, which is ironic given that so many other companies are trying to go from hardware to the cloud, or some version thereof. Part of this shift is a rebranding of the company from Snapchat to Snap Inc. The new name is a way to break with old perceptions of the company and signify that there’s more to come as the company continues to build itself out. In a way, it’s similar to the renaming of Google to Alphabet. Google was thought of as just a search company, but Alphabet is a tech behemoth where search is the breadwinner, but really only a small piece of what they do. Between YouTube, Nest, Fiber, and Google Ventures, among others, Alphabet is so much more than the search engine. In the same way, Spectacles is likely only the beginning of what we will see from the newly formed Snap Inc.

As Snapchat moves forward, I see them positioning themselves more and more as an ‘Experiences’ company. Each social media staple tends to have their own word or short phrase that represents their core mission and positioning in the market. For example, Twitter has largely branded themselves as ‘Live.’ When an event happens, Twitter enhances the experience by offering a user the chance to share their thoughts –and read those of millions of others – together in one space. A community is born for the duration of the event, whether it be an awards show, sports game, or social movement. Facebook, on the other hand, tends to represent the past, or someone’s history. An album is created after a vacation, or thoughts are shared in a status update after a situation happens, not in the moment.

Given that these two companies own those areas, Snapchat needed to find the whitespace where they could carve out their own niche. This is where the idea of ‘Experiences’ comes in. If you’re at a concert, a tweet saying how much you love the performer or a Facebook album after the fact doesn’t really convey what you felt and saw in that moment. A 10 second snap – showing the music blaring, the lights flashing, and the crowd going wild – does. This is where Snapchat can, and does, shine. It’s the ability to capture experiences as you see and feel them without the fear of long-term repercussions that separates Snapchat from its competition and positions it in a social media league of its own.

Conclusion

I admit that I’m incredibly skeptical of the current Private Equity environment, specifically in the tech sector, which is a topic that I intend to cover in a later post. Having said that, the more reading I did on Snapchat, the more of a bright spot it became to me. While what I’ve written is by no means an indication that the company will have success in the future, it’s at the very least a sign that some companies are separating themselves by maturing in a way that allows them to see the bigger picture. Unlimited subsidies, price wars, and free products are not sustainable business models. Given the recent high private valuations, investors are demanding companies to earn those valuations by demonstrating paths to profitability and successful exits. Snapchat is at a promising phase in which it looks like they’re about to turn this crucial corner, and as a company on the early end of Silicon Valley unicorns looking at an exit, I hope others will look to them as an example of how to grow, mature, and most importantly – make money.