A few months ago, Microsoft (MSFT -0.71%) announced a significant increase in the amount of cloud storage available to its business customers. This dramatically undercut the prices offered by upstart Box, which is rapidly burning through cash and has since delayed its IPO, and it made clear that cloud storage is quickly becoming a commodity service. Microsoft has now made a similar move on the consumer side, ramping up the amount of free storage it offers while bundling a massive terabyte of cloud storage with its Office 365 subscriptions. OneDrive now matches the price structure offered by Google (GOOG -1.86%) (GOOGL -1.84%), and it makes the prices that Dropbox charges seem outrageous in comparison.

Is this the end of Dropbox?
The goal for Microsoft is to make Office 365 look more attractive to consumers, and the company can afford to offer vast amounts of free storage because Office is a lucrative business. Dropbox, which raised funding at a $10 billion valuation earlier this year, now has over 300 million users, adding 100 million users over the past six months alone. This was despite a price cut by Google during that time. But because most of these users use the free version, that number doesn't really mean anything. Dropbox hasn't filed an S-1 with the SEC yet, so we don't know how the company is really doing. But if Box's results are any indication, things are likely not as rosy as they seem.

It's unclear what percentage of these 300 million Dropbox users are paying customers, but it's likely very small. Dropbox reportedly recorded about $200 million in revenue in 2013, so we can come up with a rough estimate based on that figure. At the end of 2012 Dropbox had about 100 million members, so the average for during 2013 was about 150 million. Dropbox's annual plan costs $100, and if all paying members paid that amount, it suggests that there are only a couple million paying customers. This number is likely higher now, given the user growth and the launch of Dropbox for Business, but the conversion rate is extremely low.

Converting free customers to paid customers is even more difficult now that both Google and Microsoft have slashed prices. Both companies offer more free storage than Dropbox, and while Dropbox charges $10 per month for 100 GB of storage, both Microsoft and Google undercut that price by a factor of five.

Dropbox is not worth $10 billion. That would value each paying customer in the thousands of dollars, which is ridiculous. The growth in total users is meaningless when so few are becoming paid customers, and I suspect that once Dropbox files with the SEC for its IPO, it will become clear that its business model is not working.

Pushing Office 365
It's unlikely that either Microsoft or Google plan to make money directly from cloud storage. The only real differentiator is price, especially since OneDrive and Google Drive work on basically every platform, so turning much of a profit on storage would be difficult. The strategy of both companies is to bundle cloud storage with higher-value services, and this puts Dropbox, which offers little more than basic storage, in a difficult position.

Office 365 now appears to be the least expensive way to get 1 TB of cloud storage. 1 TB of storage on Google Drive costs $9.99 per month, the same price as Office 365 Home. Not only will this version of Office 365 include 1 TB of storage, but it also allows for Microsoft Office applications to be installed on 5 PCs and 5 tablets. In other words, if you need 1 TB of cloud storage, you can basically get Microsoft Office for free. The increase in storage won't take effect immediately, and Microsoft's Office 365 website has yet to be updated with the new quantity of storage, but the changes will roll out over the next month.

An even cheaper plan, Office 365 Personal, costs just $6.99 per month, and that also includes the full 1 TB of cloud storage. Students can get an even better deal, paying $80 for four years, or $1.67 per month, for a plan that also includes 1TB of storage.

This is an extremely aggressive move by Microsoft, and it makes Office 365 subscriptions quite a bit more attractive. Office 365 is a tougher sell for consumers compared to businesses, considering that free, albeit limited, options like Google's web productivity apps exist. But bundling a massive amount of free cloud storage with Office 365 is a good way to get people to pay for Office, and it has the potential to accelerate an already fast growing product for Microsoft.

The bottom line
Stand-alone cloud storage companies like Dropbox are in a world of trouble. Microsoft is basically giving cloud storage away at this point, using it to sell Office 365, and converting free users to paying users will only become more difficult for Dropbox going forward. Microsoft is being extremely aggressive as it protects its dominance in productivity software, and trying to turn a profit from cloud storage alone simply isn't going to work.