Sorry, Box, but free is not a business model

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Credit: Flickr / frankh

Free is not a sustainable business model. Everyone knows this, especially those who lived through the dot-com bubble 15 years ago. Everyone, it seems, except for cloud storage investors. Billions of dollars have been poured into cloud storage companies that are giving away their product, with just a tiny sliver of their customer base actually paying for anything.

Offering a free version of your product is nothing new for technology companies, but those who are successful at using this model either give the customer a strong incentive to upgrade to a paid version, or they do as [company]Google[/company] has done and create a massive audience that can then be sold to advertisers. The most popular and heavily-financed cloud storage companies do neither.

Venture capitalists have invested more than $400 million in [company]Box[/company], a cloud storage file sync and share company, and assessed its value at $1.2 billion. Its much delayed IPO ultimately did better than anticipated, pricing above the expected range — even though only about 10 percent of its customers pay anything at all. Unlike Box, Dropbox is not a public company and has never filed for an IPO, so its financials remain private, but it has raised $1.1 billion in financing, $500 million of which is debt, and is valued at around $10 billion. It too has said that most of its customers use the free product.

Mission: Converting users to customers

With Box, a free personal account provides 10 GB of space, plus the ability to sync and share files with other Box users. Similarly, Dropbox offers 2 GB of free space, with the potential to earn up to 16 GB by referring new customers. Just 1 GB of storage will hold more than 15,000 Word documents, on average, and more than 300 images.

Ideally, the free product offers not only enough value to spread virally, but also offers a strong incentive to upgrade so that it sells itself. Unfortunately for Box and Dropbox, the free services more than cover the needs of customers, which is why it should come as no surprise that about 9 in 10 of Box’s customers don’t pay, according to its SEC filings.

What’s more, Box is paying about as much money as it makes to win those paying customers. For the nine month period that ended Oct. 31, 2014, Box brought in $153.8 million in revenues, while spending $152.3 million on sales and marketing alone. Its total net loss for the nine month period was $129 million. If Box has to spend almost everything it makes from current customers to win new ones, what is the use of giving its product away for free, aside from boosting the size of their user base to impress investors? After all, the entire purpose of giving the product away is to introduce people to the product and then entice them to buy. Simply put, Box went public because it had no other choice. It needed another big cash infusion to pay for its losses.

Dropbox’s financial results are not public, but given how similar its model is to Box’s and how much more money Dropbox has raised, there’s little reason to believe that they are significantly different. After all, the more money a company raises, the more of the company the founders have to sell, and no founder enjoys parting ways with equity. The only reason for Dropbox to raise that much money is because the company needs it.

Why pay if you don’t have to?

The marketing value of “free” is minimal in terms of real dollars if very few of those users convert to paying customers. And, more importantly, Dropbox and Box still have to support all those non-paying customers. There is simply no palatable way for them to eliminate free users, and the costs associated with them will continue to rise as the need for storage increases. As more free customers are added into the system, those costs continue to grow, creating a death spiral. Last year, in an effort to increase the number of paid customers, Dropbox reduced the price of a gigabyte of storage by 90 percent. That is a clear indicator that, over time, the price of cloud storage will continue to reduce to zero.

Eventually, these competitive pressures will likely force Dropbox and Box to invest heavily in building their own storage clouds, but that’s a losing game as well, as Nirvanix discovered much to its chagrin last year. Nirvanix had raised $70 million to build a storage cloud to compete with Amazon, Azure and Google. It sealed big partnerships with IBM and Dell, and had won customers like NASA, Fox Sports and National Geographic. But in the end, Nirvanix couldn’t keep up in the ruthless price war between the bigger, commodity cloud storage giants. When Nirvanix abruptly announced it would shut down, customers had mere weeks to move terabytes of data out of their system.

Eventually, investors will cut off the spigot, and, unless they change course, companies like Box and Dropbox will die like Nirvanix.

So, how can these free sync-and-share companies avoid disaster? The most likely scenario is acquisition by a large software or systems vendor who would ultimately integrate this sync and share functionality into their own products as a major feature. To thrive as independents, however, sync and share companies will need to do two things: move beyond a business model built on free and create a more robust and valuable product offering.

It’s not that sync-and-share isn’t valuable — it is! I personally use Dropbox almost every day. But sync-and-share is quickly shrinking from a stand-alone product into just one feature of a much larger integrated workspace. If these companies can create a compelling service that integrates communications, collaboration and project management into a single, intuitive environment, they may have a future. Box is clearly already moving in that direction, but both companies will need to do much, much more if they’re going to win against companies like Slack and their numerous competitors and outpace their own prodigious burn rates.

Finally, these new products will need to provide ample incentives for customers to pay. Having a lot of “customers” that don’t pay you anything is the surest way to repeat a lesson we were all supposed to have learned after the dot-com bubble burst. That lesson was painful enough the first time, and there should be no need to repeat it.

Andres Rodriguez is CEO of Nasuni, a Natick, Massachusetts-based cloud storage-as-a-service company.

11 Comments

ferrellparker

why do little people users need CLOUD STORAGE,and besides whoe would buy storage when theirs all kinds iof storage that anyone can buy also they had to use the word CLOUD instead of warehouse,so they make people belive their buying half way to mars.their thieves,plain and simple.

navigator

Well, of course Mr. Rodriguez has his own cloud storage business, but that is not an argument against his point of view on box and Dropbox with their large investments and continued loses. Box and Dropbox started as consumer-grade, freemium-based, data storage services. Conversion of free-to-pay customers by going upscale to meets the needs of businesses needs to happen at a rate that eventually makes their business model viable. There are only so many funding rounds investors will subscribe to if there is no exit for them either through an IPO or buyout. Box has gone public so their financial performance will be subject to public scrutiny and reflected in the value of their stock. Dropbox is still private so their financial performance is opaque, although the investors know what is happening. Long term greedy may be their position, but something eventually has to happen in terms of an acquisition or buyout as there is no such thing as an unlimited burn rate when it comes to investor funding. There is also more to the failure of Nirvanix than the cost of storage but that’s another conversation. In the past several years file sync and share has moved from public to private deployments thanks to software from ownCloud, SME, aeroFS and others. The major public providers of file sync and share services like AWS, box, Dropbox, Citrix, Google and Microsoft have a share of the paying business-class market but now there are private alternatives to provision file sync and share on premises or in a colocation facility. Many business-class users initially ignored or waited for public file sync and share providers to improve their service in terms of management and security. Yet there are still many business-class customers who will never turn this type of data over to a public provider for governance or legal reasons. The avaiability of private file sync and share services may put an upper limit on the number of business-class customer who will choose public file sync and share providers like box and Dropbox. Box and Dropbox should take a hint and figure out how to play with business-class customers who want private file sync and share services. They have the brand and the resources to address this market but will they move into it bigtime or will they stick to their fremium model no matter what happens.

Louis Edward Sbardella

I have about 35 gigs of photos. I am not a photographer

Anthony

This is the most contrived, stupid article I have ever read on GigaOM, and the author completely misunderstands the freemium business model or fundamentally how Box operates. And as I read he is the CEO of a cloud storage SaaS company I’m sure will be out of business very soon too – good luck to him.

Francisco Samour

Google seems to be doing awesome. This article is bullshit.

David Mytton

This article completely misunderstands the SaaS business model. If you look at a single year then of course Box is spending far more money than it’s bringing in revenue, but that’s not how large scale SaaS works. The SaaS business model looks further than a year to the Lifetime Value (LTV) of each customer so they spend once to acquire the customer, and the returns come back over the lifetime to bring in significantly more money than was originally spent.

Box is executing very well on this strategy and has raised the money required to implement this strategy. They have raised a lot with significant dilution but based on analysis of the latest few year cohorts (which is provided in their publicly available S1 filing), they are going to be making some very nice margins. See also the analysis in http://stratechery.com/2014/daily-update-box-updates-s-1-look-great-instagram-passes-300-million-microsoft-acquires-hockeyapp/

Adam Saverian

With all respect, and in all seriousness, this article is full of downright stupid arguments.

monirom

This seems to be a lot of “thats not fair” and sour grapes written by a CEO of a cloud SaaS company who may be having problems getting customers to pay for their cloud storage product. (I’m speculating here)

The truth is the average consumer has no time to do the extra research required to make discernable decisions on Cloud Storage for themselves. They rely on word of mouth and advice from more knowledgeable friends.

Its also true that casual users aren’t very loyal to their free cloud storage companies/services and will switch on a whim based on cost, capacity, ease of use/tools. The free users Box and Dropbox attract to their services based on price alone will never convert to paid subscribers.

You need to reach out to the people who need large amounts of storage (and no upload limits) to make money. These are people with large music, movie, photo archives. People who need storage for portfolios and operational data and system back-ups. These people need reliability, uptime, performance and security. These are the people who are willing to pay for pro accounts on Dropbox.

Of course you can always differentiate yourself from the pack by offering a service – vs just storage. This is the key to Evernote’s success. Its a layer of functionality on top of storage.

luv96discovery

As long as there is the term “free” the average consumer will always keep the mindset of searching for what they can get for nothing in return.

Free Willy

With 25GB free on OneDrive and 1TB free on flickr my 2GB on dropbox will last forever

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