Instagram, Instabillion

You probably saw the news this week that Facebook has purchased Instagram for $1 billion in cash and stock.  Instagram is a free photo sharing program that allows users to take a photo, apply a digital filter to the photo (for example, to make it look retro) and then share it to different social networking sites.  It was founded a mere 18 months ago and has a mere 13 employees.

The principal founder, Kevin Systrom, is a 2006 Stanford grad who is 28 years old.  He will net a reported $400 million on the sale.

I thought this was an interesting story as it underscores several points that I made in earlier posts at BeeLine.

I wrote about the sad case of Eastman Kodak on January 2 of this year.  Kodak lost 88% of its stock value last year.  It was priced at 65 cents per share on December 31, 2011.  In 1997, it was trading at $95 per share.  I predicted that it would soon declare bankruptcy.  That prognostication proved accurate a couple of weeks later.

What I find interesting is that nobody knew more about photography than Kodak.  In fact, a Kodak engineer invented the first digital still camera.  However, it did little to capitalize on this expertise in the marketplace while other companies successfully undermined their film business with digital cameras.  To add insult to injury, a 20-something kid and 12 others develop a photo sharing program and net $1 billion while Kodak was on the road to bankruptcy.  What were they and all of their engineers doing?  It should be a cautionary tale to all of us.

The other interesting point in the Instagram story is the fact than so much money and wealth was created by so few.  We keep hearing about the uneven distribution of income and wealth in the world today compared to 30 years ago.  The Instagram story shows why this is occurring in the information age and the marked contrast with the manufacturing age of the past.  I wrote about this in BeeLine in 1% + 99% Should Be Greater Than 100%.

We entered the information age from a manufacturing age.  Manufacturing spreads income in a much broader swath in an economy.  You need to pay a lot of workers to build an automobile.  You only need a couple of computer programmers to develop a video game that might sell millions.  For example, the Call of Duty: Modern Warfare 3 game that was released last year grossed $1 billion in the first 16 days it was for sale. 

The Instagram story underscores the point.  In the manufacturing age you would need millions of invested capital in plant and equipment and thousands of workers to build a business worth $1 billion.  It is unlikely that it could be done in 18 months no matter what the resources were.  There is little doubt the world has changed.

This raises another question. How much should the federal government share in Mr. Systrom's good fortune?  This is a perfect example of a situation where President Obama's "Buffett Rule" would come into play.  This gain would be taxed at 15% based on current law.  The size of the gain is so large that it would dwarf any other income.  Thus, his overall effective rate is undoubtedly going to be close to that 15% rate.  President Obama's Buffett Rule would double the tax on Systrom and other entrepreneurs in similar situations to 30%.  Is that fair? You also need to keep in mind what happens to $60 million differential.  Based on past performance is that money going to be put to better use over the long term in the hands of Kevin Systrom or the federal government.  I leave that answer to you.