These days, more and more software products are being delivered over the internet as services, and the charging practices are evolving with this trend. Let’s have a look at how and why these services are charged the way they are.

Case Study: DropBox

There’s a great product around called DropBox, which offers you storage ‘in the cloud’. It’s very easy to use – once you load the software on a computer, and create an account, it synchronises everything in the designated folder on your computer with ‘the cloud’ (that means it sits somewhere on a server connected to the internet). Firstly, it benefits you in that the files are backed up in case your computer breaks. But far more than that, you can load DropBox on another computer (or on your smartphone) and have those same files synchronised to that computer as well. Modify the files on one, and they are automatically updated on any other computer connected to that account.

In short, it’s like having a network drive, except that you don’t have to have your own server, you don’t have to worry about maintaining that server, and (here’s the really good bit), you can pay according to how much space you have. They will give you a free account with 2Gb, and more if you refer friends. They are currently selling a 50Gb account for $9.99 per month, and a 100Gb account for $19.99 per month

This is quite a revolutionary approach to network storage. From a financial perspective, instead of an upfront investment in a server (cap ex), and costs to licence and maintain that server (op ex), and upgrade it if you need more space (more cap ex), you pay a monthly or annual charge which varies according to how much space you need.

The way DropBox chooses to charge for their service is very simple: just a flat rate per month, stepped for the amount of storage you need.

However, there are actually two components of DropBox’s cost: the virtual storage system, and its connectivity to the internet (contrast this with a server in an office, where the cost is only for the storage, and the cost to move the information between the server and the other computers is effectively zero). To illustrate how this can affect DropBox, let’s compare two of their customers who are both using the 50Gb account.

Fred uses it to back up his personal files. Every week he archives a bunch of very large files to his DropBox folder, and leaves them there. It helps him sleep much better knowing that if his computer explodes, he can always retrieve those files. He uses lots of storage, but barely any bandwidth.

Mary runs a virtual business and has 3 people based in the Philippines working for her. Their entire business is on DropBox. Everyone in the company are accessing it 16 hours per day, constantly using files and updating files.  The service is an essential enabling technology for her business, and if she had to put something together herself, it would cost thousands of dollars. She doesn’t use much storage (relatively), but uses a huge amount of bandwidth.

Both of these customers pay $19.99 per month for the service, yet they gain vastly different value from it, and incur a very different cost to DropBox. Customers like Fred are probably very profitable for DropBox, but customers like Mary may actually lose money for DropBox, if you work out what the marginal provision of the service actually costs them.

Here’s the thing. No-one at DropBox actually knows Fred or Mary. No human who works there has ever had any direct interaction with them, and never will. They are just two in a sea of thousands of customers, and it’s doubtful that DropBox even have a costing analyst who reports on which of their customers have usage profiles that could be unprofitable. It’s just $19.99 each per month.

So why do DropBox have such a simple charging system? Because simple is easy: easy for them to bill their customers each month, and easy for their customers (and prospective customers) to understand.

But if DropBox charged the Freds of this world less for the service they provide, do you think there would be more customers like Fred? [of course] And if they charged the Marys of this world more, do you think the Marys would balk at paying more, given the huge value she gets from the service? [not likely] And if they did all of this, do you think they would be more profitable? [absolutely]

So again, why do DropBox have such a simple charging system? Again, because simple is easy. After all, DropBox isn’t rocket science. It’s a stack of servers in a data centre with a relatively simple application deployed to the desktop, and some relatively simple software at the back end to manage it all. And the marketing people at DropBox said: let’s keep it simple: simple for us and simple for our customers. And the billing people said: OK, that works for us. And the boffin in the accounting department pored over the numbers month by month and started analysing trends in storage usage and bandwidth usage, and was able to segment the customers into different usage profiles, and different margins. He spoke to his boss about it, and together they spoke to the CFO about it, and they may even have brought it before the board. And the board said: Naaaahhhh. Let’s just keep it simple, OK? We are making a reasonable margin across the board, and that’s good enough. Simple is best. Marketing 1, Accounting 0.

Did DropBox make the right decision, or are they leaving money on the table? Will a competitor come along with a pricing model that better reflects the value provided and strip DropBox of their profitable customers, leaving them with unprofitable ones? Is simple always best?

Subscription billing started simple, because that was the easy way. But subscription billing is changing as vendors get more sophisticated, and are better able to understand and segment their customers and implement a “user pays” model. This is being supported by more sophisticated subscription billing engines that are capable of extracting usage data and striking a better balance between simplicity and profitability. It no longer has to be one or the other. At the end of the day, like many aspects of a business, it becomes a trade-off. Companies are definitely leaving money on the table as a result of overly simplistic billing practices. It’s only a matter of time before their smarter competitors start to take advantage of this on a larger scale.

Disclaimer: I don’t work for DropBox, and I have no idea what discussions actually went on about pricing inside that company. I have insights into how marketing people think, and how billing people think, because I am bit of each rolled into one.

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