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INNOVATION ECONOMY

Backup firms take different paths in same market

By Scott Kirsner
Globe Correspondent / August 7, 2011

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On an August morning four years ago, an MIT alum and an MIT dropout presented their start-up idea to a group of investors gathered in a former candy factory just outside of Harvard Square. They were building a service called Dropbox, which would allow users to store copies of their files online, access them from any computer, and share them with others.

The audience at the event, organized by an entrepreneurship program called Y Combinator, was pretty unimpressed. The market for data backup service already seemed crowded in 2007: Boston-based Carbonite had raised $21 million, and another firm, Utah-based Mozy, was about to be acquired by EMC Corp. for $76 million. None of the investors who saw that first public presentation put money into Dropbox.

But what happened in the succeeding four years offers a fascinating case study in how young companies approach the problem of finding customers - especially when Dropbox is compared with Carbonite, which now has 206 employees and hopes to raise about $100 million in an initial public offering.

Dropbox founder Drew Houston got the idea for the service while waiting for a bus at South Station in 2006. He had work to do on the trip to New York, but he’d left crucial files on a USB drive back at his apartment. What if he could get access to his files from any Internet-connected computer?

Houston quit his job at an information security company in Waltham and started working on the idea with cofounder Arash Ferdowski. They won admission to the three-month-long Y Combinator program, which gave them access to mentors and $15,000, in exchange for a thin slice of Dropbox’s equity. At the end of the program, despite the lack of interest from Boston venture capitalists and angel investors, the pair raised $7.2 million from Sequoia Capital, the West Coast firm that has backed companies such as Apple, Google, and Oracle. (Dropbox is now in San Francisco.)

Houston and Ferdowski focused on making the Dropbox service simple to install and use. It creates a folder on your computer, and Dropbox stores a copy of anything that you put there on servers it rents from Amazon.com. Files inside the folder are automatically “synced’’ with other devices, and you can get access from any Web browser. You can also share them, granting people permission to view and edit certain files in your Dropbox folder.

Early on, Dropbox experimented with buying ads on Google, but found it cost more than $300 to acquire a customer for what was a $99-per-year service, according to a recent Harvard Business School case study. Instead, the company wound up focusing on a “freemium’’ strategy: It offered free use of Dropbox, up to 2 gigabytes worth of data. Once you require more space, you can pay either $99 a year for 50 gigabytes, or $199 for 100 gigabytes.

“Two gigabytes can keep people going for a long time,’’ says Tom Eisenmann, the Harvard Business School professor who wrote about Dropbox. “And people see after six or seven months that the thing just works so well.’’

Eisenmann cites two other clever ideas: Every time a Dropbox user shares a file with someone, that introduces a prospective customer to the service. And the company offers a referral bonus when you get a friend or colleague to use Dropbox, even a free account. (Both you and your friend receive an extra 250 megabytes of storage space: “It takes away some of the sleaze factor of promoting some product to your friends, since you both get rewarded,’’ says Eisenmann.)

Carbonite, by contrast, doesn’t allow you to share files, limiting its exposure to potential new customers. You do get three months of free service as a bounty for referring people - but only if they sign up as paid users. There is a free two-week trial period during which you can test Carbonite’s service, and no credit card is required to begin the trial.

Dropbox also has a word-of-mouth advantage, with 25 million people using the service (most for free), compared with the 1 million who pay to use Carbonite. But Carbonite’s paid plans are cheaper: The company will store an unlimited amount for $59 a year.

Dave Cahill, an Arlington strategy consultant, recently looked at the two companies’ approaches to finding new customers. Carbonite spends about $91 on advertising - often buying expensive on-air endorsements from radio hosts such as Howard Stern and Rush Limbaugh - for every new customer it gets.)

By contrast, Cahill estimates that Dropbox, which has stayed away from traditional advertising, shells out roughly $10 a year for every user that takes advantage of the 2-gigabyte free offering. Even if a Dropbox user enjoys the free service for a decade before deciding to upgrade, the company would just about recoup its marketing expense in the first year of paid service. Since Dropbox is a private company, it won’t reveal information about whether it is profitable. Carbonite lost $25 million last year, according to a Securities and Exchange Commission filing.

We may soon find out how well investors like Carbonite’s approach, provided the recent plunge in stock markets doesn’t postpone the firm’s IPO. Dropbox won’t comment on its fund-raising plans, but in June the blog TechCrunch reported that the company may raise as much as $300 million in new funding that could vault Dropbox’s valuation toward $10 billion.

In time, Carbonite could enhance its file-sharing and collaboration capabilities, becoming more like Dropbox. And Dropbox could introduce new plans that exceed its 100-gigabyte storage limit, becoming more like Carbonite.

Both companies could be toast, of course, if a company like Google decides to launch its own back-up or sharing service - something that has been rumored for years. The world of storing data, ordinarily deadly dull, is in for an action-packed few years.

Scott Kirsner can be reached at kirsner@pobox.com. Follow him on Twitter @ScottKirsner.

Correction: Because of a reporting error, an earlier version of this Innovation Economy column incorrectly stated that consumers must enter a credit card number to sign up for a free trial of the data back-up service Carbonite. No credit card is required to begin the trial. Additionally, Carbonite’s current employee count was misstated. It is 206.