Friday, May 04, 2018

Dropbox, the ultimate Mouse Hunter

I’m late to the party here, I know. Dropbox went public a bit more than a month ago and I’ve finally had a chance to take a close look at the company’s S1. I’ll be sharing a few specific observations from the S1 review, but let’s start with some more general thoughts about the company.

The mighty king of Freemium

Like Zendesk, Yammer, and a few other SaaS companies that were all founded around 2007-2008, Dropbox was one of the early champions of the "consumerization of the enterprise" movement. In contrast to Zendesk (and I think, Yammer), which eventually moved upmarket and now generates an ever-increasing percentage of revenues from larger customers, Dropbox is still getting most of its revenues from individual users and small teams. The company hasn't disclosed how much revenue it is generating from larger companies, but according to its S1 filing, a staggering 70% of its 11 million paying users are on an individual plan as opposed to a "Dropbox Business" team plans. More than 90% of its users are acquired via self-service channels, presumably driven in large part by the inherent virality of the product. These characteristics make Dropbox the "King of Freemium", as Tomasz put, or the ultimate “Mouse Hunter”.

And what an almighty King it is! Dropbox was the fastest SaaS company ever to hit $1B in ARR. As every aspiring SaaS entrepreneur knows, getting a hundred million dollars in ARR within around eight years is incredibly hard and extremely rare. Getting to more than one billion within the same timeframe is completely nuts. If the improbability of reaching a $1B valuation is epitomized by a unicorn, getting to $1B in SaaS revenues within eight years is as unlikely as seeing a unicorn with three heads.

Dropbox is one of the very, very few companies in the top left corner of the LTV/CAC chart.

A three-headed unicorn

So what is it that made Dropbox beat all odds? I believe that no single factor alone can explain a success of this magnitude. Instead, I think that the right team has to hit the right opportunity at the right time. Call it the positive equivalent of a perfect storm.
More specifically, here are some factors that I think contributed to Dropbox's success, in no particular order:

1. Timing
As consumers tend towards using more devices over time, they’ll experience a  bigger need for a solution that synchronizes files across all of their devices. Until 2005 or so, most people used only one or maybe two devices to work with their files: a desktop PC and/or a laptop. Dropbox was founded in 2007, the year the iPhone was launched and just when the move to a multi-device world started to become inevitable. Dropbox also benefited from an ever-increasing number of remote workers who need easy access to their company's files. According to a 2016 study by Deloitte that is mentioned in the S1, 30% of full-time employees primarily work remotely.

2. Product
Dropbox managed to beautifully solve a very difficult problem. It might look like a simple product on the surface, but from handling versioning conflicts to building deep integrations with different operating systems to ensuring secure and fast access to files, it required solving a number of hard technology problems. I remember that before switching to Dropbox, I used another piece of software to sync files across two computers. It was pretty messy. With Dropbox it just works.

3. Virality
While it's possible to use Dropbox just by yourself, my guess is that at some point, most users use Dropbox to share files with one or more other users. It's this built-in virality that allowed Dropbox to grow at a pace that no other B2B SaaS company has seen before. As if this wasn't enough, Dropbox also had a famous two-sided referral program that augmented the inherent virality with additional referral incentives.

4. Team
I don't know the founders of Dropbox, but looking at the quality of the early product and their referral program, it's clear that the founding team combined excellent product and tech skills with a strong growth mindset. In any case, the results speak for themselves – there's no question that a remarkable team must have been at work here.

Dark clouds on the horizon?

As much as I love Dropbox – the product and the company – I'm not entirely sure about the company's long-term prospects. Dropbox's one big weak spot, in my opinion, is that the product is almost UI-less. While you can access your files using Dropbox's (simple) Web app, there's very little need for it. We use Dropbox for all of our files at Point Nine and I have it running on four devices, but Dropbox does its magic almost entirely in the background. That makes me think that Dropbox is much less sticky than other SaaS products, e.g. workflow tools that require training. I could imagine that if a company's IT department decides to switch the file storage and sharing provider for its entire workforce overnight, most people wouldn't even notice it. In contrast, imagine the outcry that would ensue if you took away Zendesk from a support team or if you tried to get your development team off Slack.

Would I switch to another provider to save $20 a year? No, not worth the hassle. Would I consider moving all files to Google Drive if it's significantly cheaper and if a tighter integration with GMail, Google Calendar and Google Docs offers more and more benefits? Yes. (Interestingly Google Drive’s “Quick Access” feature is already using e.g. information from your calendar to predict which file you are likely to need at which point in time.)

I think the company has recognized this issue. Two and a half years ago they launched "Paper", a collaborative document-editing app, presumably to get more "face time" with its customers and to own a bigger part of the value creation chain. However, I know almost nobody who uses Paper and the company doesn't disclose any usage numbers, so my guess is that it's not a big success so far.

Don't get me wrong, more than $1B in ARR and 500 million registered users are an incredible asset. The King of Freemium won't be dethroned any time soon. But for what it’s worth I didn't buy the stock yet :-)

Update: Here is part 2 of this post.

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