What’s the Business Model and Outlook for Dropbox?

With just about everyone in agreement that the future of computing is “in the cloud,” the personal cloud storage market, encompassing such services as Apple’s iCloud, Google Drive and Windows SkyDrive, will only continue to heat up in the next couple of years.

Although there are some distinctions, such as file clouds, device clouds and app clouds, cloud storage as a whole refers to a model in which users store their personal files on remote servers and can access them anywhere they have an internet connection.

One of the major players in this market is Dropbox, a company whose software gives users a special folder on their computer that automatically syncs with the Dropbox “cloud.”

You can open and modify your files on your computer just as though they were stored locally, but you can also access them through the Dropbox web interface by signing in with your username and password. You can also sync your files to your smartphone or tablet and invite others to view and change particular files.

A Look at Dropbox’s Pricing Structure

The pricing model of Dropbox is an interesting one, as they offer a fully-featured free account with 2GB of storage.

Users are encouraged to upgrade to the Pro service, where they can choose from a 100GB plan for $9.99/month or $99/year; 200GB for $19.99/m or $199/y; and 500GB for $49.99/m or $499/y. There is also an upsell for a $39.99/y “Pack Rat” feature that provides unlimited old versions of files in case you want to undelete something or refer to earlier versions.

Is Free a Legitimate Business Model?

2GB is a lot of space, enough for storing just about all of the personal documents most people need with a little left over some photos or songs. Because of this, a staggering 96% of Dropbox users simply stick with the free service and never pay Dropbox a dime.

All of the server space used by the overwhelming percentage of free users costs the company money, so how can they afford to offer this free account?

Dropbox’s is a classic example of the “freemium” business model, one in which a product or service, usually digital, is given to users free of charge, with a fee for additional features or in this case, storage space.

Freemium is a risky business model in which a certain percentage of free users must convert to paid users and join the usually tiny percentage who pay from the start. Dropbox and other freemium services must provide an excellent user experience and an appeal that will grow on users over time. In this respect, Dropbox is well-positioned.

First, the convenience of accessing all of your personal documents, photos, videos, movies and more on any device is a strong draw. Dropbox isn’t the only company that can offer this, but once you sign up and spend time getting used to the service, it’s likely you will want to continue once you hit your 2GB cap. It is at this point that Dropbox is particularly effective. In addition to purchasing the Pro options, free users are also encouraged to refer friends in exchange for an extra 500 MB of storage (up to 16GB).

Dropbox Marketing and The Viral Social Effect

A major strategy of many freemium online services is to spend little, if anything, on marketing.

Instead, in this case, Dropbox would consider the storage space offered to free users as a marketing expense. This marketing, however, is much more effective than banner ads or a TV commercial because it gets people using the product and makes them much more likely to start paying once they see how much they like it.

In addition, the referral system is an ingenious way to use word-of-mouth social marketing to get new user signups, and Forbes reported that this system still drives one-quarter of all new customers.

Other points that help explain Dropbox’s success include the fact that shared Dropbox folders  are extremely convenient for group projects, and all parties must obviously be Dropbox users in order to participate.

Also, not many users convert to paid customers quickly, but it is important to remember that many free users use much less than their whole 2GB of space. For those who do stay on for longer and store more of their files using Dropbox, the conversion rate is much higher. In other words, the perceived value increases the longer they use it.

Dropbox’s Prospects in the Cloud Storage Market

Personal cloud storage is a crowded market, and Dropbox faces plenty of competition including huge players such as Apple, Google and Microsoft. Security is perhaps the biggest concern in cloud storage, and Dropbox needs to establish itself as a safe place to store files and a brand name users can trust. Last year a security breach exposed a small number of Dropbox account passwords, and CEO Houston apologized swiftly:  “’I cannot express how deeply sorry I am,’ he e-mailed the exposed users, appending his personal cellphone number. ‘Dropbox is my life.’”

Finally, Dropbox is negotiating deals with phone companies in order to make Dropbox the default cloud storage service for their phones, including HTC. And a growing enterprise service is attempting to sway companies into using Dropbox for business as well as personal needs.

Although profit numbers are closely guarded, it is clear that Dropbox is doing well, as they were reported to hit around $100 million in revenue for 2011, and a recent venture round gave a valuation of $4 billion.

How do you think Dropbox measures up to other personal cloud storage providers?