By Michael Woloszynowicz

By Michael Woloszynowicz

Wednesday, April 20, 2011

The Economics of Dropbox

Dropbox's recent 25 million user milestone got me thinking about the economics behind the company and what it would take for them to be profitable. Given that Dropbox uses Amazon Web Services as their hosting platform, along with S3 for document storage, some rough cost figures are fairly easy to come by. After all, we know the company has 25m users and each free user gets 2 GB worth of data. The trick however is S3's charges are based on used data, not committed data so the big question mark is how much space does the average free user consume. This can be quite a large spread as my free account actually has 4 GB (thanks to many referrals), with about 2.5 GB used, while others I know use only ~10% of their 2GB account. Similarly we know that Dropbox uses deduplication to prevent duplicate storage of files and of course its effectiveness depends on the uniqueness of the average file being uploaded. If a good number of free users use their account for storing torrent downloads e.g. movies, songs, etc, then the amount of storage used can be reduced drastically. A Quora post I found suggests that the savings for deduplication are in the 5%-20% range. Given the large number of users and high likelihood of duplication for media files, let's take 20% as our estimate. Finally, any shared data is stored only once despite being shared across 2 or more users, so we'll roll this into our deduplication estimate of 20%. Given that specific data is not published, all we can really do is speculate and formulate a cost range. For starters let's assume that every user is a free user with 1.6 GB committed (2 GB - 20% deduplication savings), this will serve as our high cost. A 2009 post from GigaOM indicates that at the time, Dropbox had 3M users and the company was storing 1.3M GB of data. If we assume this proportion has continued we get a per user storage of 433MB, we'll use this as our low number.

Tier (GB) S3 Cost/GB/Month S3 Cost/Month
1000 $0.14 $140.00
50,000 $0.125 $6,125.00
500,000 $0.11 $49,500.00
1,000,000 $0.095 $47,500.00
5,000,000 $0.08 $320,000.00
40,000,000 $0.055 $1,925,000.00


$2,348,265.00

Above we see the calculations for each Amazon S3 pricing tier for our high cost figure, yielding a storage cost of just under $2.4M/month which represents the largest cost to Dropbox. Performing a similar calculation with our low estimate, the number would reduce substantially to $640K per month. I expect that the true number will be somewhere in this range so we'll consider these our high and low values.

In addition to storage we have to factor in S3's per request cost. I assumed that the average user will make 10 put/copy/list requests and 10 get requests daily, and given amazon's flat fee of 1 cent/1000 put/copy/list requests, and 1 cent/10000 get requests, we get a cost of $82,500 per month.

Dropbox claims to handle nearly 200M uploads per day and I've estimated the average stored file at 1.6MB based on my own account as well as those of a few people I've asked. Once again deduplication becomes a factor so we'll take another 20% correction, resulting in a daily upload of 25.8 TB's. At a rate of 10 cents/GB we get a cost of $770,000/month. Since download numbers are unpublished, we can only guess that it's close to the upload number since some files are downloaded multiple times (on a few devices), while others are merely backed up. With Amazon's rate of 8 cents/GB we get around $620,000/month. The combined transfer cost is going to be around $1.4M/month.

Of course Dropbox also needs a good amount of servers to handle all the heavy lifting. With a a mix of SimpleDB, RDS, and web servers, and given their volume of requests and number of users, it's easy to imagine that at least 200 instances are needed. We'll treat each server as a middle of the road on-demand server at a cost of 30 cents/per hour which yields a cost of $43,000 per month.

Finally, a number that's quite easy to estimate is their payroll. Dropbox's LinkedIn page lists 44 employees, and with an average Valley salary of $100k/year we come up with a monthly cost of $367,000.

Adding all this up gives us a cost in the range of $2.5M - $4.4M per month. So what can we infer from these numbers? First off, working with these same assumptions (less payroll costs) we can determine that a single full 2GB free account costs the company around 16 cents/month, while our low case account (with 433MB used) costs about 9 cents/month (see note 1). The most important thing to consider is how many paid Pro 50 accounts they would need to cover their costs. To get this number we need to figure out how profitable a paid user is. This once again depends on the amount of data the paid user has stored, but we can certainly expect that it's over 2GB, otherwise they'd use a free account. Since we've calculated the cost of a 2GB account to be around 16 cents/month, let's start by assuming that paid users are using only 2GB and therefore each one results in a $9.86/month profit (see note 2). At this level of profitability we see that Dropbox would need between 254,000 and 450,000 paid users to cover costs, or a conversion rate of 1% and 1.8% respectively. We could imagine a worst case profitability scenario being a paid user that consumes the same amount of resources as 25 users (50GB is 25 times as much storage as a free user). The cost of such a heavy user is $4.15 (see note 3) leaving $5.85 as profit. At this much lower profitability level, Dropbox will need between 427,000 and 750,000 paid users, or a conversion rate of 1.7% and 3% respectively. Running this calculation at a paid usage somewhere in the middle results in a required conversion rate of 1.3% to 2.2% (see note 4).

My guess is that the low usage numbers for free users, and average usage number for paid users are the closest to reality. With that in mind it looks like Dropbox needs a conversion rate somewhere in the 1% to 1.5% range. Since freemium conversion rates run anywhere from 0.5% to 5% this is neither a low nor high hurdle, and is certainly attainable. Dropbox's challenge is that these numbers will constantly shift as they depend heavily on the speed at which free users convert vs. how quickly new free users sign up and consume their space. If the rate of new sign-ups drastically outpaces conversions, then Dropbox will need to seek further venture financing. The final thing to consider is that Dropbox's total funding is in the $7.2M - $10M range. Given the high burn rate of $2.5M-$4.4M per month, Dropbox must have a good base of paid users already as they wouldn't be able to survive on outside financing alone.

Part 2 of this article is now available and offers a complete Excel model of Dropbox that you can download.

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Please note that the above numbers are "back of the envelope" style calculations and are not meant to be perfectly accurate. The intention is to gain some insight on how Dropbox's costs might break down and the profitability potential the company has.

Note 1 - These numbers are primarily driven by the marginal cost of the S3 storage as listed in the grid above. Transfer costs are expected to be similar in both cases as most users will fill up their account over time so more storage use doesn't necessarily imply more daily transfer use. For the full 2GB's of usage we get 18 cents as the storage cost plus 7 cents for data transfers. I've ignored the EC2 cost as it becomes nothing more than a rounding error at a per user level. 
Note 2 - We get this profit by taking the $9.99 price minus the 16 cent cost for 2GB plus we add back the 3 cents of storage cost for our average 433MB user. 
Note 3 - Since we've assumed the data transfer cost of a normal user to be around 7 cents per month (as used in Note 2), the data cost for our heavy paid user is 25*0.07 or $1.75. The cost of 50GB of S3 storage is $2.40 so the total cost is $4.15. 
Note 4 - The user will have used 25GB of data at a cost of $1.20 and used 12.5 times more data transfer than the average user at a cost of 87.50 cents yielding a total cost of $2.07. 

2 comments:

  1. A great analysis, gives a good insight of startup economy. Thanks for posting.

    ReplyDelete
  2. Don't think you understand how s3 redundancy works. There is no separate charge over the standard fee. They have a reduced redundancy option that is lower priced but that wouldn't be used here.

    ReplyDelete