Investopedia/Steven Richmond: How Snapchat Makes Money

How Snapchat Makes Money (FB, TWTR) By Steven Richmond | Updated November 16, 2016 — 3:18 PM EST
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As the final project for a product design class at Stanford in 2011, Evan Spiegel pitched the idea for a mobile app that permanently deletes photos and texts after opening them. His classmates balked and thought it was a terrible idea. Five years later, Snapchat – the company's official name is Snap Inc. – has become one of the hottest social media apps on Earth, the kind that feels comfortable turning down a $3 billion offer from Facebook Inc. (FB). Bloomberg reported in June that it draws 150 million daily users, compared to perhaps 140 million for Twitter Inc. (TWTR). On November 15 it emerged that the company may go public at a valuation of $20-$25 billion, significantly more than Twitter's market cap.

That price tag brings up the inevitable question: does Snapchat, a service that is entirely free to users, make money? And if so, how?
The "Black Hole"

Few believe that Snapchat is profitable at this stage, but outside a small circle of venture capital investors, the startup's financials are anyone's guess. Gawker published a leaked income statement for the 11 months to November 2014, which showed the company generating shockingly little revenue: just $3.1 million, while the bottom line stood at -$128.4 million. Its balance sheet as of the end of November 2014 was more promising: it showed the company with $320.6 million in cash and equivalents.

Things change quickly in Silicon Valley. Re/code reported in March that Snapchat was aiming for revenues of $300-$350 million in 2016, having hit a $100 million revenue run rate the previous October. Where exactly these revenues are coming from won't be clear until Snapchat goes public – assuming it does – but if the company is a black hole from potential investors' perspective, it is even more of one from its customers'. According to an unnamed executive quoted in Digiday, Snapchat is "a black hole of nothingness" when it comes to disclosing performance metrics that advertisers crave – and receive in generous measure from Alphabet Inc. (GOOG, GOOGL) and Facebook.
Cranking Up the Ad Engine

Because of Snapchat's demonstrated appeal to the coveted 18 to 34-year-old demographic – the company says it reaches 41% of this cohort in the U.S. every day – advertisers will probably continue to line up, metrics or no metrics. (See also, Snapchat Revenue to Reach $1 Billion in 2017.)

Snapchat offers brands different options for gaining exposure to young impulse-buyers. Geofilters are set to display branded images when the user is within the vicinity of a certain location; for example, fries pouring out over the user's head when they stray within range of a McDonald's Corp. (MCD) location. Sponsored Lenses allow users to play with an image a brand has created. You might raise your eyebrows to turn your head into a taco, for example, and then – if so moved – send the lens along to a friend.

In January 2015 Snapchat introduced its "Discover" feature, allowing media partners such as CNN and ESPN to publish in the form of a "story," a series of snaps that began as a purely user-generated feature (see below). Re/code reported the following March that Snapchat was charging these partners around $100 per thousand views (CPM). Snapchat took 30% of the ad revenue, if the media company sold the ad space, or 50%, if Snapchat sold it.

A year and a half later, Snapchat appears to want to change up the terms. Re/code reported in October that the company wants to pay content partners upfront license fees, sell all ads on its own and keep all the resulting revenue. Presumably the change in tack means advertisers are buying, though it's uncertain whether Snapchat will be able to renegotiate with publishers on exactly those terms. (For more, see How The Internet Web Ad Industry Works.)

Some have speculated that Snapchat will consider offering in-app purchases, which its sometimes-profitable Japanese rival Line Corp. (LN), has had success with.

According to CEO Evan Spiegel, Snapchat's ambitions go well beyond the features we've seen so far. The company revealed a hardware product called Spectacles in September, which it has begun selling through vending machines (possibly just as a marketing promotion). The 26-year-old co-founder once floated the idea of a buying record label. In other words, Snapchat's approach to making money is likely to change significantly as time goes on.
Core Features of Snapchat

Snapchat allows users to send and receive texts, photos and videos – collectively known as "snaps" – among fellow users of the app. A user can choose to add a series of snaps to a "story," which is publicly viewable by anyone following that user. Alternatively, users can choose to privately send snaps directly to other users. In both cases, photos and videos have a maximum duration of 10 seconds.

Unlike most other messaging apps, Snapchat deletes private snaps immediately after they're opened and public snaps 24 hours after they're posted. If your friend sends you a two-second snap, and for whatever reason you accidentally open it or miss the snap while it's being displayed, then it's gone – although as a Federal Trade Commission settlement from the end of 2014 shows, the snaps are not permanently deleted or entirely inaccessible to third parties.
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