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Advertising Spend on Instagram Is Blowing Up

When Instagram provided its most recent update on active users, noting it now has over 800 million monthly active users, it also quietly added that it has over 2 million active advertisers. That's double the number of advertisers Instagram had six months prior, and quadruple its count six months before that.

While it's one thing for the Facebook (NASDAQ: FB) subsidiary to throw out rapid growth in users and advertisers, it's another for that to translate into real advertising revenue growth. A recent note from SunTrust Robinson Humphrey's Youssef Squali says his talk with marketing software firm Kenshoo indicates ad spend on Instagram increased 2.5 times year over year in the third quarter. For a bit of context, that's exactly the kind of growth analysts were expecting from Snap (NYSE: SNAP) before it went public earlier this year.

Image source: Facebook.

The Facebook funnel

Instagram is a huge beneficiary of what I like to call the Facebook funnel. Facebook has over 5 million active advertisers on its platform. Facebook can gently nudge all of those advertisers toward Instagram ads. It even offers the option to use the same exact ad buying tools advertisers use to buy Facebook ads, and marketers can measure campaigns across both platforms through a single interface.

That's a huge competitive advantage for Instagram.

One of the biggest disappointments in Snap's second-quarter results was that its self-serve ad platform failed to produce any operating leverage. Snap had to spend heavily bringing marketers onto the platform and teaching them how to use it. Even so, it didn't attract enough advertisers to ensure stable ad prices as it shifts to auction-based pricing instead of fixed rates. Average ad prices declined as marketers were able to secure all the ad inventory they wanted with relatively low bids.

Snap's struggles seem to be directly correlated with Instagram's success. As advertisers are funneled into Instagram's ad platform, they have less need to look into Snap's advertising products.

That's especially true considering Instagram offers similar ad formats to Snapchat through Instagram Stories -- a copy of one of Snapchat's core features. The feature now has 250 million daily users compared to the 173 million Snap reported for Snapchat at the end of last quarter. Instagram Stories accounts for 10% of ad impressions on Instagram, according to Squali.

What this means for Facebook investors

Investors have been anticipating Facebook's upcoming third-quarter earnings report for about a year now, ever since CFO Dave Wehner warned advertising revenue growth will slow in the second half of 2017. But the rapid growth of Instagram may help make up for a good portion of that slowdown.

In fact, Instagram's ad inventory may ultimately provide better value to advertisers. Instagram ads are usually big beautiful images that take up nearly the entire screen, save a call-to-action button at the bottom. What's more, Instagram's younger audience is more appealing to brand advertisers. All else being equal, the average Instagram ad should sell for more than the average Facebook ad.

So, while Facebook runs into ad load saturation on its flagship platform, the rapid growth in users on Instagram is opening a ton of excellent ad inventory. Advertisers seem more than happy to spread their campaigns to Facebook's sister app, and Facebook makes it extremely easy to do so.

There's no shortage of ad dollars flowing into digital. Facebook is one of the companies best positioned to take advantage of that shift, and the only thing potentially standing in the way is whether it can serve all the advertisers that want to spend money on its platform. For now, Instagram provides an outlet for excess demand for Facebook ads, and marketers are going for it.

Still, it seems like only a matter of time before Instagram faces the same problem as Facebook. Of course, there are much worse problems to have than running out of inventory.

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Adam Levy has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Facebook. The Motley Fool has a disclosure policy.