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A while back I set a client up with a backup solution that used the native Windows 7 backup utility to copy local files to a Raid 1 mirrored array.

And actually, I remapped all his documents and libraries to this raid 1 array and kept program data like his .pst and quickbooks files on the system drive so I only needed the backup utility to copy his outlook .pst (2 gigs) and quickbooks company files (1 gig) over to the mirrored array.

Flash forward 3 months later and this client calls and tells me his 500 gig backup drives are completely full and Windows is complaining about no disk space.

Thus, I crack open the backup utility and take a look at how this thing is making backups. To my surprise, it was duplicating the data every single day. So everyday, it was making completely new backups of his 2 gig .pst and 1 gig QB company files.

Further research suggests Windows 7 uses a block based backup system and even deeper research yields people who say this is a "differential" backup method and others who suggest something like "it makes duplicates"

How does this backup system work and is it a viable solution for data files that are quite large and change everyday?

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I'm sorry you had to learn that lesson the hard way. Windows backup utility is pretty much the worst backup utility I have found. I'm not certain exactly how it works but I know it's slow, and uses a ton of storage.

I would argue that it is not a viable solution for data files that change every day. My highly recommended solution is Crashplan. It can be used to backup to the cloud (which is what it's most known for), but it can also be used for local, or network backups. It has a very smart algorithm that reduces data duplication, and adds compression. It is free (with ads), and easy to use. I use it to back up my users directory to another hard drive and it's my favourite backup program by far.

I would not use Windows Backup utility unless I had no other choice.

Crashplan Website

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