Virtualization Rivals May Vex VMware

"In our forecast, we assume that VMware's market share will decline modestly, that their pricing will be relatively stable and that operating margins will expand significantly from current depressed levels," Sacconaghi wrote in a research note on Tuesday.

But that view could be incorporating an unrealistically rosy scenario for the company.

Given the competitive landscape, it would be extremely difficult for VMware to hang on to its 85% market share and hold the line on its top-dollar prices. That's especially true given how early it is for storage virtualization, which helps companies save money on hardware by allowing multiple operating systems and application programs on a single machine.

Bernstein estimates that penetration levels are still only at about 5%, meaning that the vast majority of the market is still up for grabs.

And while VMware investors may be aware of the threat from Microsoft -- which is launching a new product into the market in 2008 -- what may be less acknowledged is the pressure to lower prices that some top venture-backed start-ups will exert.

These fledgling companies are building on top of a virtually free, open-source platform, which allows them to keep their own costs very low.

Take start-up XenSource, which announced Wednesday that it was being acquired by Citrix(CTXS Quote), a move that will only make it more competitive by allowing it to tap into resources like the parent company's sales force.