Rushil Surapaneni March 28th, 2017

UGBA 106 Assignment #3

2. A key advantage to the freemium strategy begins with the fact that free features are a potent
marketing tool, as the model allows a start-up, such as Dropbox at the time, to scale up and attract a
user base without expending resources on costly ad campaigns or a traditional sales force. Houston
notes that with a freemium strategy, optimization of marketing messages and pricing would be critical
to Dropboxs success. Dropbox initially pursued a paid search advertising strategy, but due to the high
customer acquisition cost (CAC) associated with this strategy, the company eventually abandoned it in
pursuit of organic customer acquisition efforts. An organic customer acquisition engine, fueled
through word-of-mouth referrals by users and viral marketing, resonated well with the low-cost
advantage associated with the freemium model, allowing Dropbox to cut marketing costs and focus
more so on product development.
Another advantage of the freemium model goes back to the referral program utilized by
Dropbox. An existing user who referred a new user to Dropbox received 250 MB of additional free
storage. The new user, upon sign-up, received 250 MB of space on top of the 2 GB allocated to a free
account. The freemium model works especially well with a program such as Dropbox as it leverages
the power of social networks in acquiring potential free and paying customers and the appeal of the
product is enhanced to potential users through the free features the service offers. From this, an
inherent level of value is derived, as users begin to realize they can only share a Dropbox folder with
other Dropbox users, intensifying the referral program. The primary advantage of the freemium model
in this instance is having customers realize the value of having other customers using the product,
generating increasing demand and usage of Dropbox.
A third advantage of the freemium model for Dropbox is that there exists a clear path for
customers to upgrade as the company innovates. Dropbox begins charging users once they exhaust the
free storage space quota of 2 GB. The free version is adequate for basic documents, but anyone who
wants to back up photos or other media quickly hits the limit, giving free users a compelling reason to
upgrade into a paid customer for the additional value in paying more. In addition to serving as a
revenue model, the freemium strategy serves as a commitment to innovation. Dropbox evolved from
simply backing up files to offering shared folders, automatic syncing of smartphones, and the
improvement of the user interface. With each new feature, the value of the premium offering has
increased, further incentivizing the conversion of free users.
There do exist fundamental risks associated with the freemium strategy that Dropbox faces.
The central question behind pursuing the freemium strategy for Dropbox is answering how much is too
much? The chief purpose of freemium is to attract new users, but if Dropbox is generating lots of
traffic but few customers are paying to upgrade, then the free offerings are too rich. The challenge that
exists with this is finding the optimal balance between traffic and paying customers without facing
user revolt when asked to pay for things they are accustomed to getting free. As a result of the
freemium business model, Dropbox consistently faces the pricing challenge of balancing internal
profitability marks with that of the willingness of consumers to pay for the product without alienating
potential and existing consumers who seek the free version.
Another risk of the freemium strategy is failing to communicate to customers the purpose of
the premium product. The freemium strategy communicates two sets of benefits to customers, which
already further complicates the marketing efforts of a young company such as Dropbox. If Dropbox
fails to demonstrate to customers what they would gain by upgrading, the conversion cycle from free-
to-paying consumers would shorten, damaging the monetization capabilities of Dropboxs product.
The primary risk found here is failing to make the distinction between the free and premium product to
consumers. Consumers need to see clear advantages in regards to why they should upgrade to the
premium product and if they dont see those benefits, it becomes clear that the freemium model limits
Dropboxs ability to monetize more users.
A third risk the freemium model presents is the cost of serving free users. If Dropbox does not
consistently find the proper balance between the number of paying users to the number of free users, it

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Rushil Surapaneni March 28th, 2017
UGBA 106 Assignment #3
can hemorrhage the companys profitability in regards to lost money and time spent on servicing free
users. Dropboxs sole source of revenue is driven through subscriptions and if the company fails to hit
its target conversion rate, it signals that the freemium strategy is either providing too much for free or
consumers dont understand or value the premium product. In addition, if the conversion rate is too
high, then it signals to Dropbox that the free product is not compelling to consumers, limiting the
growth of potential users of the product. Failing to find the proper balance of free-to-paying customers
and not developing a favorable, target conversion rate can cause the freemium strategy to limit
Dropboxs financial growth.

To calculate how many free users a paying user can support, the following steps are taken:
Step 1:Calculate Gross Profit of 1 Paying User/Year (Assume 50% of paying users use 50 GB
plan for $100/year, 30% use 50 GB plan for $10/month, 15% use 100 GB plan for
$200/year, and 5% of paying users use 100 GB plan for $20/month, $3.18 monthly spending
per paid user, and $0.11 monthly spending per free user)
(0.5*$100) + (0.3*$10*12) + (0.15*$200) + (0.05*$20*12) ($3.18*12) = $89.84
Step 2: Divide Gross Profit of 1 Paying User per Year by Cost of Free User per Year
$89.84 / $1.32 = ~ 68 (1 Paying User can support around 68 Free Users per Year)
To calculate the profit or loss Dropbox is making per year, the following steps are taken:
Step 1: Annual Revenue Run Rate COGS = Gross Profit (Assume Annual Revenue Run Rate
is average of $10mm and $15mm, 4 million existing users plus 2.8 million users generated
through direct referral invites, 2.5% of users are paying users)
$12.5mm ((170,000*$38.16) + (6,630,000*$1.32)) = ($0.62mm)
Step 2: Estimated total operating expenses modeled off of Carbonites 2010 financials
2,326,000 (R&D1) + 3,750,000 (G&A2) + 5,000,000 (Sales & Marketing3) = $11.08mm
1. R&D = R&D is 21% of Carbonites total expenses so same % applied to Dropbox
2. G&A = # of employees as of June 2010 (25) * Fixed cost/employee (150k) = $3.75mm
3. Sales & Marketing = Estimated as significantly less than Carbonite as Dropbox no
longer uses pricier paid ad words campaign
Step 3: Gross Profit Total Operating Expenses = Operating (Loss) / Profit
($0.62mm) - $11.08mm = $(11.7mm)

4. Non-discounted CLV = ((Avg. Revenue/User Variable Cost/Paid User) * 5) CAC/User

Non-discounted CLV (Dropbox) = (($128-$38.16) * 5) *$233.31= $215.89
Non-discounted CLV (Carbonite) = **(($21.34-$9.53) * 5) $21.05 = $30.00
* For Dropbox, assume Avg. Revenue/User minus Variable Cost/Paid User is same as Gross Profit of
1 Paying User/Year calculated in Step 1 of Question 4.2) and CAC/User is SYNC marketing campaign
cost per converted user that sticks ($233.31 per user)
** For Carbonite, assume Avg. Revenue/User is Carbonite revenue ($16.685mm) divided by # of
customers (782,000), Variable Cost/Paid User is cost of revenue ($7.449mm) divided by # of
customers (782,000), and CAC/User is sales & marketing expense ($16.464mm) divided by # of
customers (782,000)

For Dropbox to increase CLV, it could focus on 3 separate general strategies: increasing customer
loyalty, expanding margins, and increasing customer acquisitions.
Improving customer loyalty, or in other words reducing customer churn, would allow for
Dropbox to increase net new sales. To reduce customer churn, Dropbox must examine which of their
consumer segments is most likely to leave and after identifying this specific group of customers,
attempt to contact and communicate about their efforts to leave. In the case of Dropbox, even with its
easy-to-use services, the service ranked 6th in the consumer segment in a review of 25 online back-up

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UGBA 106 Assignment #3
companies and did not rank in either the SMB or enterprise segments. To increase customer loyalty,
Dropbox must focus on educating its customers in addition to saving those customers ready to abandon
the service and recognizing those customers committed to the product through a rewards system.
Customers tend to leave because of another product or service that has a feature that they believe their
original service does not provide. Even with it simple product, Dropbox must focus on continuing to
update customers about the features that make the Dropbox product unique and advantageous to their
users. Focusing on saving customers, or retaining their services, is also critical for Dropbox to
maintain customer loyalty. To do so, Dropbox should develop a specialized Save Team dedicated to
keeping customers and having access to better offers and incentives to help the process going. On the
other end, Dropbox should look to reward and recognize customers for ongoing business. However,
the company should pursue this in a measured way to ensure that any potential loyalty program is
delivering a net customer value improvement. Through taking these measures to improve the overall
customer experience, Dropbox increases the overall appeal of its product, potentially improving
customer loyalty and conversely improving customer lifetime value.
In addition to customer loyalty, Dropbox should focus on expanding margins through
strategizing how to lower the cost to serve its customers while also seeking opportunities to upsell. In
regards to lowering the cost to serve, Dropbox ought to end marketing to low value customers.
Dropbox should take measures to ensure they are not continuing to market to customers who cannot or
will not buy more of their product and service. The ROI on its marketing campaigns is critical to
measure and Dropbox should ensure that its marketing efforts are generating increased conversions
and new customers. This cost-benefit analysis should be conducted coincidently with marked efforts
by the company to upsell its product. Dropbox should put forward a more concerted effort in regards
to understanding its customers buying behavior, preferences, and purchasing powers to seek
opportunities to upsell, or increase the value of its product, to its customers. For this strategy to be
successful, Dropbox must relay the benefits of its pricier versions to customers and provide honest,
targeted information to the customer. By pursuing this opportunity to upsell, Dropbox increases its
potential to increase average sales without having to expend more resources into marketing expenses.
The last suggested strategy for Dropbox to utilize to build CLV is to focus on increasing
customer acquisitions through continued engagement with customers and developing partnerships with
other brands to gain exposure. In regards to engagement with users, Dropbox has already initiated
steps towards better understanding the needs and demands of their customers through the utilization of
the Votebox feature on its site. This community engagement delivers transparency to Dropboxs
customers, critical to the overall customer experience as McKinsey notes that 70% of buying
experiences are based on how the customers feels they are being treated. Dropbox should continue
this program in addition to developing programs arranging informal conversations with existing
customers and identifying opportunities to connect the companys values with its consumers. Taking
these additional steps will allow for Dropbox to develop accurate buyer personas while also
connecting the brands unique values with the needs of its customers, providing a key element in
signing up more customers for the service. Simultaneously, Dropbox should reengage with its previous
strategy of pursuing partnerships with other brands. While Drew Houstons earlier partnership talks
came to naught, the situation had evolved for Dropbox as it now could offer millions of users and a
strong reputation to potential partners. Pursuing strategic alliances at this favorable time within
Dropboxs life cycle offers opportunity to gain exposure to new audiences, increase market share, and
develop additional financial and human resources to meet client demand. Engaging with and joining
forces with like-minded brands can drive customer acquisition for Dropbox through eliminating the
need for client installation as partners could bundle the Dropbox service into its offered product,
lowering the barrier to adoption for Dropbox. Pursuing these two strategies in building customer
acquisitions, in addition to the aforementioned strategies involving expanding both customer brand
loyalty and margins, can combine to increase the overall long-term CLV for the Dropbox service.