New startup economics: Why Amazon (web services) and Dropbox need each other

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Earlier this week, I stopped by at the offices of Dropbox, the San Francisco-based online storage and syncing service. It was quite amazing to walk through the company’s sprawling offices — the company now employs about 470 people. Five years ago, they were two guys — Arash Ferdowsi and Drew Houston — both MIT dropouts working on the service out of their studio apartment.

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A few months later, they moved next door to me in a building in financial district and we would often catch up at our neighborhood Starbucks. Their relentless focus on making their service simple and invisible was a constant in pretty much any and every conversation.

That was then. The two-person startup today, according to sources close to the company, is rumored to be valued at more than $4 billion and is on its way to a billion dollars in revenue. It has about 200 million accounts and about 4 million of those are businesses.

Dropbox, like its peer Box.net, is a new breed of startups that live comfortably between consumer and corporate worlds. And a lot of their success can in part be attributed to Jeff Bezos and Amazon Web Services.

The Fast Startups

Almost a decade ago, I wrote a pair of stories in (the now defunct) Business 2.0 — The New Road to Riches and The Rise of the Insta-Company. The idea central to my thinking when writing those articles was that on-demand computing services, open source software and more standardized programing would make it easy to spin-up startups much more easily and at a much lower upfront spending. How it would happen and who would catalyze that change wasn’t clear.

What was a nebulous idea then is now a reality — a fact illustrated by the growth in the number of startups sprouting up around the world. Much of that startup mushrooming can be attributed to Amazon Web Services (AWS), which offers compute, storage and many other services on a pay-as-you-go basis.

Amazon, coincidentally hosted its annual developer conference re:Invent in Las Vegas this week, where more than 9,000 — the majority of them developers — were in attendance. A lot of folks don’t really comprehend the size and scope of AWS. This chart gives you a sense of how big Amazon web services has become.

  • AWS has over five times the compute capacity in use than the aggregate total of the other 14 providers.
  • AWS replaces an average of 400 servers per customer.
  • Amazon has lowered AWS prices 38 times since launching in 2006.

On Route to $10 Billion

Amazon Web Services as a business is growing much faster then most realize. Macquarie Securities estimates AWS revenues were around $2.044 billion in 2012. In 2013, they expect the revenues to jump to $3.47 billion and $5.9 billion in 2014. By 2015, less then 10 years after Amazon launched the S3 storage service, AWS will bring in about $9.02 billion in revenues according to their estimates.

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But money really doesn’t the full impact of AWS. About four years ago, I sat down for an interview with Werner Vogels, CTO of Amazon and talked about startups and AWS:

“With the cloud comes unconstrained thinking and willingness to tinker and experiment without worrying too much about cost. The cloud allows lot of businesses to scale aggressively. We are enabling a lot things in a way that will be long-term beneficial as it would help build more sustainable businesses using a lot less capital. The fact is that because of the cloud, today a young upstart can take market share without an incumbent having time to react.”

I had a ringside seat for the startup creation during the 1990s Internet boom and it was clear that in order for a web-based company to exist, the table stakes were about $2-to-$3 million. That money was spent on servers, storage systems, networking gear, database licenses and web server software. And that’s before taking into account the data center space rentals and bandwidth costs.

In short, if you didn’t have venture capitalists backing you, then getting going was a monumental task. A lot of that money went to line the pockets of Sun Microsystems, Oracle, Microsoft, IBM, EMC, Dell and Compaq/HP.

Today, all it takes to hang up a shingle is the proverbial dollar and a dream. It’s more like a credit card, Amazon account and an idea. In Silicon Valley, it is fashionable to laud and celebrate the accelerators and new funding tools such as AngelList, but to be fair, none of those would have much to do had it not been for AWS.

The Psychological Edge

AWS’s impact on startup ecosystem is psychological. Instead of buying hardware and paying for software licenses, a whole generation of companies are growing up with the idea of paying monthly fees for infrastructure, based on usage and demands put on the infrastructure. The idea of buying hardware is anathema to many startups who have grown up with AWS. It continues to have an impact up and down the entire food chain. As far as I am concerned, Amazon is the truest cloud computing company.

Amazon’s rivals in the cloud business have focused all their energies on older companies who will have shift to the cloud. Of course, those big companies might have big budgets, but they change slower. New comers like Dropbox don’t have the legacy needs holding them back.

Amazon’s decision to woo Startups as initial customers has turned out to be astute — it has been able to attain scale much like the startups themselves. Just look at the growth of Dropbox and see how it loosely mirrors the growth of objects on Amazon’s S3 storage service.

Amazon has been smart to focus on new markets, whether it is online storage providers such as Dropbox or HPC-in-the-cloud services such as Cycle Computing. They are the ones who are cloud-native and have created infrastructure demand that is many times the legacy companies.

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The other day I had coffee with an entrepreneur who said he is spending about $650 on Amazon to process about 100 million photos for his still in stealth-mode sentiment-gathering service. Many others are using it for genetic research. These new kind of cloud-intensive workloads are the reason why Amazon keeps growing faster than its rivals. Vogels calls these 21-century architectures.

More startups meant more usage, which drove down costs, which in turn has allowed the company to sell to others (including the government and large businesses) and at the same time lower the prices. The company says it has cut prices 38 times since launch. Lower prices means more customers, and more customers mean more economies of scale. Yes, this virtuous cycle is working for Amazon for now.

When I asked Dropbox CEO Drew Houston whether they will build their own data centers, he pointed out that they have a hybrid infrastructure which includes Amazon Web Services and there isn’t a need to change that. He is being pragmatic.  That has to be music to the ears of Werner and his crew. Now all they have to do is keep attracting the next crop of startups built in the image of Dropbox, Uber and Airbnb.

To that end, Vogels ended his keynote at re:Invent 2013 by introducing five cool startups — Koality, SportsXcast, CardFlight, Nitrous.IO and Runscope.

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