How Does Snapchat Make Money? By Kyle Anderson

One of the most popular mobile apps, Snapchat, is rumored to be joining the flood of Internet and social media companies considering IPOs.

So investors need to know: How does Snapchat make money?

Snapchat was first released in 2011. Snapchat allows users to send pictures, messages, videos, and drawings to a controlled list of friends. It is part of a wave of messaging apps like WhatsApp, Tango, HeyTell, and countless others that provide users alternate ways to send and receive messages.

What makes Snapchat special is its delivery method. Messages sent over Snapchat completely disappear once they have been viewed for between one and 10 seconds. When it was first introduced, Snapchat was the only app that offered the vanishing message feature.

Since then, numerous imitators have popped up like Slingshot, Frankly, and Sobrr that all include the disappearing message feature.

But Snapchat remains the biggest name. According to Snapchat's 24-year-old CEO Evan Spiegel, the app handles more than 500 million messages per day. The company doesn't disclose user totals, but the research firm comScoreestimated that SnapChat had 27 million users in June. That total was up from 11 million in June 2013.  

That user base has helped Snapchat complete several major rounds of funding, including this week's investment by Kleiner Perkins Caufield & Byers, which values the company at $10 billion, according to The Wall Street Journal.

For investors, the value in Snapchat is found in its user base, not in the company's revenue. Because at the moment, Snapchat doesn't make any money at all.

But that's about to change...

While no money is being made from that audience now, Snapchat's users consist of a demographic that's highly coveted by marketers.

More than 50% of the Snapchat's users are between the ages of 13 and 17. The average user accesses the app 14 times per day, according to research by Digiday.

Recent reports indicate that Snapchat will soon be expanding its services, allowing users to see news articles, television and movie clips, and advertisements through the app. Like Snapchat's other content, these clips and news stories will vanish once they've been viewed.

According to The Wall Street Journal, the new feature will be called "Snapchat Discovery," and the company has already discussed the new venture with at least 12 media companies including magazines, newspapers, and television networks. Snapchat Discovery will reportedly launch in November.

This week's funding round was the third for the company. Snapchat received separate investments of $60 million and $50 million in 2013 and reached a valuation of more than $2 billion at the time.

For the time being, Snapchat has received enough funding that it hasn't had to worry about generating revenue. It's focused on growing its user base, especially the teenage demographic.

While massive rounds of funding have gotten Snapchat this far, the company now needs to prove it can generate a strong revenue stream. Especially if a Snapchat IPO is in the works.

Snapchat Discovery will fix the fact that companies using the app don't buy advertising. Numerous companies like Taco Bell, Acura, and Grubhub Inc. (NYSE: GRUB) use Snapchat to engage with customers by sending discounts, promotions, or simply entertaining pictures.

By providing more engaging content from newspapers and television companies, Snapchat believes it will be an appealing option for advertisers looking to reach a young, growing audience. Eventually, disappearing commercials or quick advertisements could greet users opening up messages on the Snapchat app.

Many mobile apps charge users to download their application, or for premier add-ons once the app is downloaded. Snapchat does neither - implying that advertising will bring in the lion's share of revenue, at least initially.

If Snapchat wants to bring its stock public soon, revenue generation must start as soon as possible. User growth will only get the company so far. It's the same challenge that social media companies like Facebook and Twitter Inc. (NYSE: TWTR) needed to prove before going public.

Company officials have not announced any plans for an IPO, but the fact that it's rejected a $3 billion takeover bid and is working diligently to prove its revenue potential suggests one may be possible in 2015.

Join the conversation on Twitter @moneymorning and @KyleAndersonMM using #Snapchat

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