As Silicon Valley accelerator Y Combinator unveils its biggest-ever batch of 63 startups, it’s worth looking at the most successful of the hundreds of Y Combinator startups so far, Dropbox.
The Y Combinator startup that’s most often in the news is Airbnb, but Airbnb’s billion-dollar valuation is chump change compared to the reported $5 billion valuation Dropbox is getting.
Can Dropbox really be worth that much money?
In a word: yes.
Dropbox is a file storage service. It makes it easy as pie to store and backup your documents in the cloud, sync them between devices and retrieve them later. It’s completely free up to a certain level of storage, and if you want to backup more data you pay a fee.
So it’s going after a problem everyone has, and therefore a very big market.
It’s also very hard to copy. It’s very easy to create an online backup service, and there have been dozens of startups that have tried to do it. It’s extremely hard, however, to create one that’s reliable and drop-dead easy to use, and “just works”. Dropbox does that. People have been waiting for Google and Amazon to come along with a similar service and crush them, and that just hasn’t happened.
And even if they did, Dropbox probably has good customer lock-in: even if Google came out with a totally free, equally good backup service, would we go through the trouble of taking out all of our files out of Dropbox and upload them all again to Google’s cloud? Probably not.
Dropbox has also figured out distribution, because it gives additional free storage to people who get their friends to sign up. This is good old-fashioned viral marketing, and it works (that’s how we signed up). No need for traditional advertising, or SEO, or a big Facebook page.
But that’s not just why Dropbox is a blockbuster. Dropbox is a blockbuster because it has magic economics.
[credit provider=”Beth Beck” url=”http://twitpic.com/4yfqek”]
Let’s look at both sides of Dropbox’s profit and loss equation:
- On the cost side, Dropbox’s costs are always going to go down. Why? Because Dropbox’s biggest cost is cloud storage on Amazon servers, and the cost of that is always going down. It’s an iron law of technology akin to Moore’s Law, which predicts the drop in cost and rise in performance of computer processors. Cloud computing is always getting cheaper.
- On the revenue side, Dropbox’s revenues are always going to go up. Why? As we noted in our study of the freemium business model, freemium works best when the value of the service to the user goes up over time. That’s exactly what’s going on with Dropbox. Most people wouldn’t pay just to back up a few files. But after they’ve been using Dropbox for a while and gotten used to having all of their files synced and backed up in the cloud, when they hit the limit, they’re not going to yank out everything. They’re going to pay. And they’re going to pay in the form of recurring subscription revenue for Dropbox, which compounds.
This is brilliant. Dropbox’s economics work in such a way that it’s almost a law of nature that its costs are always going to go down and its revenues are always going to go up. It’s not voodoo economics, it’s magic economics.
Unless they screw up in a major way, by having a huge security breach or by failing to innovate or copy some crucial feature we can’t think of right now, there’s basically no limit to how big Dropbox can be. It’s almost irrelevant what Dropbox’s P&L looks like now. What matters is whether Dropbox’s management can execute to stay on this expressway to the stars, and so far everything in their track record suggests they can.
So it’s not surprising that investors are willing to pay $5 billion for the company. And it won’t be surprising if in the relatively near future, they’re willing to pay a lot more than that.