How Snapchat Will Make Money Even Though It Deletes The Most Important Asset It Has - Its Data

This is the central mystery at the heart of Snapchat: How can it make money when it deletes the most important asset any tech startup has - the data created by its users?

Other tech companies - Facebook and Twitter - have become hugely valuable because they allowed advertisers to target the content created by their users. That's why you see ads on Facebook relevant to things you've liked, and promoted tweets on Twitter relevant to the tweets you've written.

But Snapchat, obviously, deletes all the content its users create, as soon as they create it.

Snapchat's terms of service indicate the app keeps only a tiny fraction of the user-data available to Facebook or Twitter. In terms of selling advertising, this appears to leave Snapchat rather vulnerable. It can only persuade advertisers to target its users based on the same data offered by the most basic of mobile apps: usernames, passwords, email addresses, phone numbers, and age.

Snapchat, as a revenue driver, is currently less sophisticated than Bejeweled, in other words.

One potential solution to Snapchat's revenue situation is so simple it's brilliant - and it ought to silence critics who say Snapchat isn't worth the $3 billion valuation it has been given.

First the context.

The Snapchat backlash

There has been a fierce backlash in the tech world against people who scoffed at Snapchat for rejecting Facebook's $3 billion offer to acquire the company.

The logic of the backlash is this: You're an idiot to think that Snapchat - which makes no money, and is run by a couple of 20-somethings with no prior business experience, neither of whom yet control the central patent of their own technology because it's tangled in litigation with the "other" founder of Snapchat - isn't worth $3 billion.

Of course it's worth $3 billion, these people argue, because startups which have lots of users always find a way to make money, eventually. And, also, they can run advertising on Snapchat!

That's what Facebook and Twitter did: Problem solved!

This logic is frustrating. It's simply not good enough to say, "We don't know how Snapchat will make money, but because other companies have made money in the past we should assume Snapchat will too. Snapchat is therefore worth $3 billion."

Snapchat bulls ignore the fact that three out of four tech startups fail. And there is a long history of companies with very large user bases, strong network effects, and equally impressive valuations turning out to be worth only a tiny fraction of that, or even nothing at all: TheGlobe.com. GeoCities. MySpace. LiveJournal. Second Life. Friendster. Tribester. Napster.

The odds are against Snapchat

The fact is the odds are against Snapchat - which is why it is completely reasonable to question the wisdom of investors who have put $73 million into the company (by July 2013) turning down an all-cash offer that is 41 times that stake.

Not being able to offer advertisers any user-generated content to target - even though as a social media app, user-generated content is its reason for being - is a serious issue. If Snapchat is "worth" $3 billion the assumption is that it must generate profits after revenues that will someday equal more than $3 billion. There are very few standalone mobile businesses that generate that kind of cash. They are Google, Facebook, Twitter and maybe Pandora, eventually. The largest pure-play mobile ad business on the planet, Velti, just went bankrupt trying to do the same thing.

I recently asked one of Snapchat's investors to address this conundrum - how do you sell data that you've deleted - and the person declined comment on the basis that, with potential acquisition offers and a new funding round in the background, the issue was too sensitive to talk about.

Hmm.

How do you sell data you've deleted?

So I turned to Jan Rezab, CEO of Social Bakers, one of the larger social media marketing agencies that does business with Facebook and Twitter. His company has 2,000 ad clients globally, pouring millions of dollars into Facebook and Twitter. Those advertisers include Samsung, Nestle and Diageo.

Rezab pointed out something so obvious, it's brilliant. All Snapchat needs to do is sync its application programming interface with Facebook or Twitter and advertisers can use that data to target users inside Snapchat. (An "API" is the thing that allows one app to talk to, or build on top of, another.)

For instance, if an advertiser wanted to reach Snapchat users who are also fans of Manchester United who live in Oregon, it would identify those people on Facebook who were also users of Snapchat. (Facebook has 1 billion users, and therefore a huge portion of Snapchat users also have Facebook accounts.) The advertiser could then send ads into Snapchat targeted only at Snapchatters who said on Facebook they were United fans in Oregon.

Thus Snapchat doesn't actually need its own data in order to slice and dice its audience the way advertisers really want.

Once you know that, Snapchat's fast-growing user base suddenly looks very valuable indeed.