Pull up a random press release from a major enterprise server and/or storage provider such as IBM (IBM) - Get Report, HP Enterprise (HPE) - Get Report, Dell EMC, Lenovo or NetApp (NTAP) - Get Report, and chances are the word "cloud" will be shown at least several times. These companies are far from oblivious to the fact that IT dollars are steadily migrating to public cloud infrastructures, apps and services, and have unveiled numerous products, partnerships and acquisitions meant to improve their cloud exposure.
But these moves can't change the fact that cloud giants such as Amazon (AMZN) - Get Report, Alphabet's (GOOGL) - Get Report Google, Facebook (FB) - Get Report and Microsoft (MSFT) - Get Report haven't relied much on the servers and storage systems of traditional IT giants while building out their infrastructures. And as public cloud adoption keeps growing, the hardware sales of the traditional leaders are declining markedly. Third-quarter sales estimates from major research firms bear this out.
IDC believes global server revenue fell 7% in Q3 to $12.5 billion, and that storage revenue fell 3.2% to $8.8 billion. Gartner estimates server revenue fell 5.8% to $12.7 billion. IDC and Gartner had respectively estimated just 0.4% and 0.8% server declines for Q2; the former pegged the storage market as being flat in Q2.
To make matters worse for the IT giants, the companies collectively lost both server and storage share to smaller players, thanks partly to the fact cloud giants rely heavily on low-cost hardware made by Asian contract manufacturers in accordance with specs set forth by the cloud firms. Such sales, referred by IDC as "ODM Direct," respectively made up 10.3% and 15% of server and storage revenue, up from 9% and 13.7% a year ago.
In addition to the low cost of the hardware they often use, the scale and efficiency of cloud infrastructures is part of the reason industry sales are dropping. As JPMorgan analyst Rod Hall observed in a recent note, major cloud providers tend to be much more efficient than the average enterprise when it comes to using server and storage resources.
Hall believes cloud infrastructures already account for about 15% of data center computing capacity and about 7% of storage capacity, even though they (in spite of 60% spending growth) are only forecast to account for 8% of 2016 data center IT spending. Thus, a dollar of cloud-related hardware spending could eat $1.50 or $2.00 worth of on-premise IT spending.
In addition to servers and storage, Hall thinks data center switch sales will be stung by cloud adoption, something he naturally sees as a negative for Cisco Systems (CSCO) - Get Report. Cisco reported a 7% annual switching revenue drop for its October quarter, but largely blamed soft demand for "campus" switches used to wire offices rather than data center switches.
HPE, in the process of taking on a stronger hardware focus by spinning off its IT Services unit and a large chunk of its software business, is estimated by IDC to have a 25.9% server share (#1 overall) and a 15.5% storage share (#2). Dell Technologies, the product of the recent Dell-EMC merger, is assigned a 17.8% server share (#2) and a 25.5% storage share (#1).
IBM's server and storage shares are respectively pegged at 6.9% (#5) and 5.9% (#4). In addition to cloud adoption, Big Blue's server business has been hurt this year by share losses for its Power servers relative to servers running Intel (INTC) - Get Report Xeon CPUs, as well as a downcycle for its mainframe business. Cisco is assigned a 7.4% server share (#4), and NetApp a 6.6% storage share (#3).
Recent earnings reports from IT giants generally mesh with the estimates provided by research firms. HPE's Enterprise Group, which provides hardware and related services, saw an 8% annual revenue drop in the October quarter, with server, storage and networking sales all declining. IBM's Systems division (hardware + operating system software) posted a 21% revenue drop in Q3. Cisco's Data Center (server) unit saw revenue fall 3% in the October quarter.
Intel's Data Center Group (DCG), which sells server CPUs and various other chips going into data centers, fared better in Q3, with revenue rising 10% to $4.5 billion. The fact that Intel's CPUs power the vast majority of cloud servers -- some of which are powering new consumer and business workloads rather than taking over old ones -- makes enterprise weakness easier to manage. As do growing sales to the telecom infrastructure market and adoption of non-CPU offerings such as network processors and the company's Omni-Path server interconnect fabric.
Nonetheless, Intel used its Q3 earnings call to cut its full-year DCG guidance to high-single digit growth from low-double digit growth, which itself was below a 2014 to 2018 compound annual growth target of 15%. The opportunities provided by the cloud and other markets should allow Intel's DCG revenue to keep growing, but with enterprise headwinds intensifying, the growth might not be as strong as once hoped.
As for the IT hardware giants, a look at the many enterprise-focused service announcements recently made at Amazon Web Services' annual AWS re:Invent conference shows why the situation is unlikely to get any better in 2017. AWS, on a $12 billion-plus revenue run rate and climbing, is doing everything it can to convince Global 2000 CIOs their companies are better off shuttering some or all of their data centers and putting their contents in the cloud. And some of them are clearly buying into the sales pitch.
Big IT has certainly made plenty of moves to diversify and/or grow its cloud exposure. See IBM's cloud services and healthcare software acquisitions, Cisco's many purchases of software and services firms and HPE's attempts to unload weaker businesses and develop hardware that lets it win deals with cloud providers such as Dropbox. All of that certainly helps soften the blow.
Nonetheless, we're looking at billions in annual revenue that will need to be replaced. And the latest industry figures give fresh reasons to think traditional server and storage revenue streams are set to decline at an uncomfortable pace.