Dropbox Q2 fails to impress, but it's all about the app

It's been a big summer for online file sharing and business teamwork vendor Dropbox. In June it launched its new app, which aims to put Dropbox at the heart of people's work routines. It also raised the price of its most popular paid plan by 20%, while adding extra features. Yesterday's Q2 results were the first opportunity to gauge the impact of these and other initiatives, but there was not enough substance to show a clear direction. Today, Dropbox's stock tanked in response.

The earnings call gave some useful insight into where Drobox is heading — of which more below — but analyst reactions were mixed. Good news from the quarter, which ended June 30th, included a rise of 400k paid users for the quarter, and revenue up 18% year over year at $401.5 million. But average revenue per user (ARPU) disappointed expectations, falling back slightly to $120.48 from $121.04 in Q1. Dropbox shares shed about an eighth of their value this morning, and have dropped 25% since their July high just four weeks ago.

CFO Ajay Vashee ascribed the ARPU shortfall to currency movements, which shaved off about 1.5%, together with the impact of some larger deals, such as Massachusetts behemoth Partners Healthcare, which extended an existing 20,000-seat contract first taken out 2016, and City University of New York (CUNY). He expects the metric to bounce back later in the year:

We are very confident in our ability to continue to expand ARPU over the course of the year, [with a] tailwind from strong adoption of our premium Professional and Advanced SKUs by new end users, and early success from our Plus SKU re-pricing and repackaging initiative.

Focus on the Dropbox app

But much of the focus during the earnings call was on the newly launched Dropbox app, which CEO Drew Houston said will become a crucial foundation for monetization, even though the app itself isn't a paid add-on:

We think the new Dropbox is essential to drive monetization even though, as we're rolling it out, it's not something you're going to have to explicitly pay for. Our Basics users will be able to use the new Dropbox as well.

First though, Dropbox has to get users onto the app — something the company is carefully managing, says Houston:

We certainly want to roll it out to as many people as possible, but we have to be thoughtful about how we do that. It's a major change to the experience, and when you make major change to a product, you need to communicate that well and do that respectfully.

In the meantime, the existing mechanism for using Dropbox from a desktop file folder remains fully supported. It's important that users make the shift successfully, he explains:

For continuity, we're not taking anything away ... it's not a gamble on that dimension. But we just want to make sure that we do some one-time work to educate people as to what we're offering, and then it's a bit of a mindset shift. We're thinking about Dropbox, again, not just for a place for files, but a place for all your cloud content, and a living workspace that we hope is one of the first apps you open in the morning and [one of] the last ones you close at night.

Monetization potential

Once there, Dropbox will be able to drive adoption and ARPU expansion in new ways, Houston adds:

We have this foreground surface that we entirely control, as opposed to being limited by the operating system. So it's a lot easier for us to drive adoption of things like Paper or HelloSign, when we can have a button that says send out for signature within Dropbox natively, as it were ...

We think there are much more powerful levers there to drive distribution of apps like ours and our partners' apps. There's a much a better surface to drive conversion. So when you're actually sharing something, we'll be able to highlight, inline, the benefits of having a paid plan ...

All of what I described will take place over time, but it's a new foundation we're really excited about.

Getting the transition absolutely right is crucial for Dropbox not only because of the monetization potential, but also because it cements its place in the business market. That's why the Dropbox app is focused on use cases for people at work and collaborating in teams, he explains.

That's certainly our sweet spot. 48% of our subs are using Dropbox at work, and we think the best experience is when you are using Dropbox in the team, when you're using it at work — and we made good progress in terms of that strategic focus over last few years, which reflects in all the numbers.

So the new Dropbox is kind of the product we would've built, if we had been focused on these use cases in the beginning. Historically, Dropbox has operated behind the scenes, in the file system — you're just navigating folders on your desktop — whereas with the new Dropbox, you have a dedicated app. It's much more of a workspace instead of just a static list of files. You see people and you see comments, and you see activity and all the things you'd expect in a real-time collaborative app. We think it is a generationally different experience from what other folks have.

Pain points of digital collaboration

Houston believes the offering is unique in how it addresses the pain points of working with modern digital tools:

A lot of the ideas we had for the new Dropbox came from observing how our customers work and the pain points they experience in this new environment. On the one hand, there are all these new tools so the experience is a lot better on some dimensions. But there's also this new problem, which are things that are a lot more cluttered and fragmented, and there's this information overload and distraction that people are dealing with.

We see our role as organizing your working life across all these different tools, and ecosystems, and we think that's something that every information worker needs ...

The value prop to the end user might really be about collaboration and personal productivity. For a team manager, it might be more alignment and how do you get your team on the same page and executing well.

For an executive, the value prop might be more like how do I get a better return on my cognitive capital? How do I free up my employees from having to do all this busywork or toggle between those different apps and help them focus? We've done a whole bunch of stuff on the IT side as well, how people wrangle all the complexity that's happening on the back end too.

We think all of this is the beginning of really addressing some much bigger problems in collaboration — and new problems in collaboration that we didn't see our industry focused on.

My take

Wall Street is often criticized for focusing on quarterly performance at the expense of taking a longer term view. Reading between the lines of the earnings call, it's clear that Dropbox is playing a long game. The new Dropbox app barely got started in Q2 but it's pivotal to the company's future strategy.

In the short term, that may imply a few more headwinds for the company before that new strategy starts to bear fruit. Houston is absolutely right to emphasize the importance of ensuring users and customers get their heads round what they can do with the new app. That may require more investment in onboarding and coaching than the company has yet made.

A more sophisticated product also implies a more complex sales cycle, especially as Dropbox signs more of those large-scale deals. Chief Customer Officer Yamini Rangan emphasizes its investment in data science analysis to help identify where to focus its 'land-and-expand' sales strategy to broaden its footprint in those larger accounts. But you can't automate away all the costs of selling into larger accounts — just ask Google Cloud.

Any new product introduction involves an element of risk, and scaling up to handle larger enterprise accounts typically front-loads costs that are recouped over timescales of years not months. Both these factors mean that Wall Street was probably not wrong to price in those risks — but if they come right, the upside for Dropbox looks strong.