Abbreviated Executive Summary

A new 100-page report from industry research firm TechAlpha illustrates how server virtualization will have ripple effects that extend much beyond the current market consensus. How much of that ripple effect will be a disruption of existing markets vs. creation of new markets will be of vital importance to customers, vendors and investors. The report discusses customer feedback and product strategy for the following vendors: VMWare, Citrix, Microsoft, Oracle, IBM, Symantec, CA, BMC, NetApp, EMC, DELL, HP.

Key highlights include:

• Private cloud management becomes the most significant source of new profits in the virtualized data center.
• Virtualization is cracking open storage industry.
  
• Virtualization creates unprecedented pressure on the database and middleware business.
• Virtualization enables business continuity to go mass-market.
• VMWare is repositioning itself away from Microsoft’s line of fire.
• VMWare, Citrix and Microsoft are well-positioned for larger than expected successive waves of virtualization adoption.

The private cloud management layer will be the most significant source of new profit pools in the virtualized data center.

Cloud computing starts in private: Cloud technologies in the enterprise, growing out of virtualization and service-oriented management, will enable centralized management of complex, multi-tier, composite application services running on cheap pools of commodity infrastructure.

IT becomes a variable cost: Data center automation will deliver at least an order of magnitude greater IT staff productivity while democratizing the most sophisticated online applications that only the biggest companies can afford today. From a business perspective, virtualization will transform IT investment from a fixed capital expenditure to a much more variable operating expense. From a technical perspective, applications and infrastructure get transformed into services that are delivered on-demand.

New customer requirements: Customers are looking to integrate a “downward looking” unified view of their assorted servers, storage, and networking with an “upward looking” application service management view. The winner in this market will deliver end-to-end application and infrastructure service management solutions, not best-of-breed standalone tools for managing servers, storage, networks, and applications separately.

And the winner is…: Network effects will drive self-reinforcing market share gains for whoever emerges as the leader over the next 3 years. VMWare will experience greater than expected competition from Microsoft, while the incumbent Big 4 systems management vendors (BMC, CA, HP, and IBM) are upgrading their service-oriented capabilities.

Detailed vendor SWOT: Includes strengths, weaknesses, opportunities and threats analysis for VMWare, Citrix, Microsoft, CA, and BMC.

Virtualization is cracking open the storage industry.

Noise hides disruption: The storage industry is at the cusp of the biggest structural change since networked storage began to eat into direct-attached storage a decade ago. Current enthusiasm over virtualization adoption obscures adverse secular trends which will lead to slimmer margins for all but the most innovative vendors.

Demand stimulus: Virtualization adds 10 points annually to secular data growth. 50% of storage capex is directly driven by virtualization, double the latest IDC forecast.

Demand destruction: Increasing adoption of de-duplication on primary and secondary storage will permanently halve the underlying rate of storage capacity growth. Thin provisioning in conjunction with the recession will lead to a 2-year lull in storage purchases. Efficiency gains will cut secular capacity growth to only 17% per year.

Loss of differentiation: Functionality emerging in the virtualization layer will make obsolete a good part of what is today differentiating functionality in storage. Applications will embed storage management at an accelerated pace, further reinforcing hardware commoditization and reducing the need for dedicated storage management products.

Increased commoditization: Storage hardware standardization will accelerate the erosion of gross margins that has set in at some storage vendors over the last 18 months.

Unprecedented levels of discounting: Some high-growth customers, particularly online service providers, are building their own clouds. Recent EMC deals illustrate the margin pressure that results.

New sales models: What is a systems sale today becomes a separate selling motion for the software and the hardware. This will force Sales to sell software based on business value rather than systems based on capacity.

VMWare friend or foe? VMWare can commoditize EMC’s core business or become its ultimate salvation.

Detailed vendor SWOT: Includes strengths, weaknesses, opportunities and threats analysis for VMWare, EMC, NetApp, DELL, and HP. Other companies mentioned include IBM, SUN, HDS, 3PAR and others.

Virtualization creates pressure on the database and middleware business.

"Just in case" not "just in time": Server virtualization upends enterprise software business models because database and middleware licensing in an on-demand virtualized world will enable customers to buy and deploy capacity "just in time" instead of "just in case." Rather than fusing server software to a physical box in perpetuity, customers will demand the ability to allocate additional capacity for their virtual machines on demand from their aggregate pool of license capacity.

Tremendous wastage prevalent today: Today, customers typically forward-purchase excess capacity of three to four years per server when sizing server hardware and software purchases. As a result, average database server utilization is 5-20% (EMC and IBM data).

Buying “minutes”: Customers are forcing vendor licensing to accommodate not just smaller increments of capacity, but also increments of time, thus loosening the ties to a specific physical server. Buying minutes of capacity that can float across different physical machines fits the current economic constraints a lot better than buying perpetual capacity tied to a specific physical box.

Oracle has the most to lose: The coming transition is highly disruptive to current vendor business models. Microsoft's September 2008 server software licensing changes began to accommodate these new realities, offering Windows Server on Amazon Web Services for as little as 12.5 cents per instance per hour. Oracle is most inflexible but will eventually bow to the pressure.

Vendors discussed include Microsoft, Oracle, and IBM.

Virtualization enables business continuity to go mass-market.

More servers too critical to fail: Server consolidation has led to many less critical workloads being all packed onto one highly utilized server, making that server too critical to fail.

New platform at radically lower cost and complexity: Virtualization creates a new platform for delivering high availability (HA) and disaster recovery (DR) at much lower cost and complexity than that delivered by legacy solutions such as server operating systems (e.g., Windows, Linux, Unix) or applications (e.g., Oracle, Exchange). Penetration of high availability and disaster recovery will increase dramatically from 10-20% of servers today to 50% by 2010.

Traditional HA and DR vendors under pressure: Specialized, premium-priced products by Symantec, Microsoft, and Oracle may see limited upside despite high market growth as they are confronted by lower cost, good enough alternatives. VMWare, Citrix, and the systems management vendors will try to deliver HA/DR as a feature of a much broader data center automation offering that guarantees the end-to-end performance of multi-tier applications.

Detailed vendor SWOT: Includes strengths, weaknesses, opportunities and threats analysis for VMWare, Citrix, Microsoft, and Symantec.

VMWare is repositioning itself away from Microsoft’s line of fire.

Stalled in mid-flight: VMWare forward-sold a lot of advanced functionality during 2008 using ELAs (enterprise license agreements) in the hope of accelerating customer adoption ahead of Microsoft’s release of entry-level server consolidation functionality in Summer 2008. One of the biggest near-term challenges for VMWare is the pace at which customers can absorb and deploy this next wave of business continuity functionality. The ROI for customers is softer than for consolidation and the sales cycle is longer.

Microsoft competing on price, for now: Evidence of uptake for Microsoft’s Hyper-V in Q4 2008 is encouraging, forcing VMWare into intense discounting. Competition will intensify as enterprise-class features migrate to a new “cheap SKU” which we expect Microsoft to introduce in CYH2 2009.

Repositioning itself away from Microsoft’s comfort zone: VMWare is allocating resources to desktop virtualization at an accelerated pace. The vision VMWare and Citrix have of desktop virtualization is a “user-centric” one, where an operating system-independent environment or desktop follows the user around across all her devices. Previously, users lived in a device-centric world, where data and applications were tied to individual machines. VMware is also likely to build on this “user-centric” interaction style and leverage “information-centric” technology that EMC acquired from Pi Corp. VMWare’s multi-year lead on Microsoft in its core market gives it time to prepare for the battle with Citrix over the desktop. Microsoft is likely to be conflicted to drive innovation in desktop virtualization.

In the pressure cooker: VMWare’s challenge with the “virtual datacenter operating system” is several-fold, possibly contributing to their recent shift in emphasis towards the desktop.

• First, most of its management tools assume its hypervisor is the only platform on which they run. That deployment scenario is unlikely, even if Microsoft remains a distant second in hypervisor market share.
• Second, much of the critical technology for managing applications comes from service-oriented management platforms, which Microsoft, BMC, CA, HP, and IBM have been working on for years.
• Third, Microsoft’s presence as a dominant deployment platform, a leading tools vendor, and a dominant server applications vendor can help tilt the management platform battle in their favor.
• Fourth, VMWare has to build credibility with, and a sales channel to, CIOs and application owners within the enterprise, not just IT infrastructure buyers.

VMWare, Citrix and Microsoft are well-positioned for larger than expected successive waves of virtualization adoption.

Higher than expected adoption: Server virtualization will reach at least 10 percentage points greater penetration than the 60-70% consensus forecast, positively impacting VMWare despite increased competition from Microsoft.

Business case remains compelling: Server consolidation is merely an entry point to a steadily richer follow-on set of capabilities from VMWare, Citrix, Microsoft. It creates the platform for radically lower capex cost and 10x higher labor productivity in data center automation and business continuity (e.g., high availability, disaster recovery). This fuels new waves of adoption, even though growth rates for consolidating newer applications will be materially slower because a new type of customer is involved. More than half of new x86 servers deployed by year-end 2009 will be virtualized.

Hardware disconnect also fuels momentum: Virtualization allows software to catch up with hardware performance improvements. Rapidly increasing mainstream server capacity in terms of cores per socket will force customers to virtualize more applications than anticipated or risk dramatically underutilizing servers again.

VMWare dominance to continue: We expect VMWare to maintain its leadership position among enterprise customers with a 66% share in 2010. This buys the company time to take the lead in desktop virtualization.

Detailed vendor SWOT: Includes strengths, weaknesses, opportunities and threats analysis for VMWare, Citrix, and Microsoft.

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