The Strategy and Economics Behind Google’s “Race to Zero”

If you paid attention to Google I/O 2015 last week, you might have noticed that the tech giant made a relatively extreme move in a bid to win what some are calling the “Race to Zero” — a term that encapsulates the rapidly declining prices of cloud storage until those prices ultimately become totally free. In Google’s case, the company announced that its impressive photo service (Google Photos) would now come with free unlimited storage of high-quality photos and videos.

For consumers, Google’s announcement was an enormous win. If you haven’t checked Google Photos out yet, the service features some serious technology (face and object recognition, advanced geo-targeting, and more) while still delivering a smooth, easy-to-use experience. Of course, services offering photo storage have been around for a while. But the fact that Google’s offering unlimited storage for free is an enormous differentiator.

For competing cloud services, that’s not good news.

In fact, Google’s move will likely usher in an era that, as Julie Bort writes in this post for Business Insider, many in the cloud services sector have dreaded for years. The reason: in this race to zero, the businesses best-suited for competition will be well-resourced thoroughbreds like Google, Microsoft, Amazon, and others. And among that group, Google is particularly well-equipped to win because it doesn’t necessarily need to generate revenue from cloud storage in order to monetize the value of providing it.

For Google, user data is the real value point because that data means greater insight into consumer behavior. That insight can then be used to help Google amplify its value proposition to advertisers by delivering more targeted, relevant ads. For a business like Microsoft, that model doesn’t work quite as well. Free unlimited storage is a nice add-on for users, but accessing it requires users to purchase and pay for Micorosoft’s other services. The same might be said for Amazon’s AWS, which generates revenue based on tiered storage volumes. If, ultimately, cloud storage is commoditized and prices are pushed to zero, then Amazon’s cloud storage economics will make very little sense.

Has Google Nailed the Economic Singularity?

I first observed this trend 10 years ago in studying how several large tech companies — namely, Google, Microsoft, Intuit, and Salesforce — began skewing toward strategies that allowed them to:

• Build better, simpler products that users loved
• Drive down costs, which allowed them to charge less for their products
• Optimize sales and marketing processes at scale

Over the last decade, those strategies enabled those businesses to manipulate funnel economics (revenue / sales and marketing expenses) in ways that drove them toward what’s called an “economic singularity” — the point at which a denominator (expenses) shrinks faster than the numerator (revenue).

Some of you may be familiar with singularity as a mathematical term (definition here), but from a business standpoint if a company can aim for a singularity in a very large market, then it could be a formula for a very big, successful business. After all, if costs in various areas of the business decrease exponentially as profit margin and customer value grows, then you’ve got one heck of an appealing business model on your hands.

From my seat, this appears to be the direction Google is aiming.

Using Google Photos as an example, free cloud storage is just another lever Google can pull to lure in more users and more data (a big draw for a business like Google, which derives a big chunk of its revenue from monetizing data insight in the form of more relevant advertising). Layer in the rapidly decreasing costs of providing that value to users, and this lever will become an even more appealing one to pull over time — particularly for a big, strong company like Google that can simply offer cloud storage as a value-add on top of its broader platform.

Can businesses like Microsoft, Apple, and Amazon make the same offer? Of course. But, as I wrote above, the economics don’t make as much sense given their cloud storage monetization strategies.

Do These Economic Dynamics Apply to B2B SaaS Companies?

Of course, the factors impacting the consumer cloud storage industry’s “race to zero” don’t exactly mimic those of the B2B SaaS market. Enterprise buyers have bigger needs, products tend to be more complex, and price isn’t always the most important differentiator. As such, this race to zero in the consumer cloud storage market won’t mirror what happens in the enterprise cloud storage market.

That said, there are some lessons to be gleaned from Google’s aim to create economic singularity by increasing overall user value. Specifically, this strategy has some really basic, but powerful elements:

1. Make something useful that’s really easy to purchase, use, configure, and update. Like Google Photos, many B2B SaaS companies can increase value for users by making their products absurdly easy to use. This “really easy” principle almost always encourages increased product use and decreased churn, which can improve the economic equation over time.
2. Continuously improve the product with rapid development cycles. Economically, this serves several purposes. First, it increases the value to the user base by better meeting their needs. Second, it gives the users something to “sing” about. And third, it reduces the cost of customer service (if the product works and is easy to figure out — see previous point — then customer service becomes more about proactive customer success).
3. Design a few features that compel users and influencers to talk about the product. From a PR perspective, photo storage was a great feature for Google to highlight because it’s the primary file storage need for most everyday consumers (and one that many people are willing to pay for). In B2B SaaS, the PR opportunities aren’t often as obvious or sexy, but they do exist and tapping into them can unlock serious network effects.
4. Consider the price points at which customer and company value are maximized. For Google Photos, that answer was free. And for some versions of a B2B SaaS product, free versions might make sense, too (see: Box, Dropbox, Slack, and many other B2B SaaS startups). For others, it won’t. Ultimately, your goal should be to hit the price point that maximizes profit margin and converts more prospects into customers.
5. Invest in high-value activities that grow revenue and decrease expenses. Mathematically, bringing the denominator (expenses) closer to zero creates the singularity, but this principle isn’t exactly realistic in business (costs will never reach zero). Instead, the key here is to orient toward the singularity in a way that pushes for efficiency and keeps costs as low as possible relative to the gross profit generated by a specific activity.

Now, it’s time for the caveats.

While I’m a strong believer in the elements above, there are a few major things every company needs to consider in order to perfect its execution of them:

1. What’s your optimal “operating point”? Try to think about each of the elements above as knobs on a stove that you can rotate to set at a specific temperature. Ultimately, the ideal temperature — or optimal operating point — will depend greatly on the sensitivity of customers to that element. For example, if your customers are less sensitive to price and more sensitive to product usability, then those factors will obviously make your operating point very different from companies like Google, Microsoft, and Amazon.
2. Before you set your initial operating point, remember that it’s easier to move away from the singularity than toward it. That is, it’s easier to move from a simple product to a complex product, than vice versa. This is where deploying a free product initially can be hugely beneficial (see: Google). With few barriers to entry, you’ll acquire more customers early on and those customers will help shape how you tune your operating points going forward. Competitors can copy that strategy, but laggards very rarely win the race.
3. The larger the market, the better this strategy works. Google is perfectly suited for its particular economic singularity because it has the power of massive scale. B2B companies targeting a market with only a few hundred (or fewer) customers may not extract as much value from this approach.
4. You can use this strategy against your competitors (and they can use it against you). By dropping its price to zero for unlimited storage, Google has set that operating point as close to the singularity as possible. This will make it very difficult for competitors like Microsoft, Apple, and Amazon to respond because it’s always more difficult to move closer to the singularity than away from it. A company like Microsoft’s only hope is to match Google’s price and features, and hope it’s not too late to capture market value.

Finally, it’s important not to confuse this approach as a pure cost or price cutting strategy. Ultimately, if your company sets the right operating points in the right market situation, then the company should still grow — possibly explosively. But to do that, you need to identify your economic singularity and make sure that you start closer to it than your competitors do.

As for Google, it would be interesting to know if the company already knows that its economic math is viable, or if the company is projecting forward lower costs and better monetization in the future. Or, maybe the company’s leadership simply views cloud storage as a winner-take-all data grab and they’re making an aggressive move to achieve strategic dominance.

Regardless of the rationale, one thing is clear: Google Photos appears to be a great product at a price no other service can beat. Long term, that’s a very good thing for Google and its users, but a potentially devastating move for competitors like Microsoft and Amazon.

Photo by: Carlos Luna