EMC Becomes 'Virtual' Target

The company's hold on a fast-growing niche market could be in danger of losing its grip.
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Updated from 10:37 a.m. EDT

EMC

(EMC)

has had a lock on the complex but rapidly growing market for software that allows businesses to save money by "virtualizing" their servers and desktop computers.

But now, improvements built into chips by

Intel

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-- and soon by

Advanced Micro Devices

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-- will make virtualization easier and could open the gates to a wave of competitors, including

Microsoft

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.

How the virtualization battle will play out is unclear. EMC, and some of the analysts who follow the company, say the new chips may help expand the market. Moreover, they argue that EMC's software virtualization offers far more advanced capabilities than anything enabled by the new chips.

The bear case, from EMC's point of view, is this: Technically difficult as it is, virtualization is already becoming commoditized, and the new chips will speed that up. Indeed, prices have already begun to drop as Microsoft and other competitors enter the fray, says Gartner analyst Tom Bittman. "This is huge," he says.

Although virtualization is not the core of EMC's business -- storage is -- it's a lucrative sideline. VMware, which the company acquired in late 2003, contributed $157 million in revenue in the second quarter, a growth rate of 73% year over year.

Run as a semi-autonomous entity within EMC, VMware boasts a team of some 800 engineers, has its own sales force and is on an annualized run rate of $630 million, says the company. And because the technology is sought by a wide variety of large businesses, it opens doors for EMC that might otherwise stay shut.

This would not be a good time for VMware to take a hit from the competition. Parent EMC had an

unexpectedly weak second quarter, and shares have dropped 29% since the beginning of the year.

At the most basic level, virtualization allows a group of servers to be treated like one large computer. If one server is overworked, its load can easily be shifted to another running below capacity. Since servers tend to be underutilized, this allows IT staffers to manage their networks more efficiently, and even buy fewer expensive servers and related hardware.

There are other plusses as well. A particular application can be walled off, or partitioned, from the rest of the system. So a security application, for example, could run and not be affected by a virus infecting the rest of the server. And a virtualized server can run multiple operating systems at the same time.

More recently, desktop, and even notebook computers, are being virtualized to allow them to run more efficiently as part of a business network.

A recent survey of more than 700 IT managers by the Yankee Group found that "for the overwhelming majority of corporations, the major question is when -- not if -- they will implement virtualization in their data centers." More than three quarters of the managers said they will deploy virtualization, while only 4% said they would not.

Virtualization wasn't invented by VMware; that credit goes to

IBM

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, which used it on mainframes as long ago as the late 1960s. But VMware brought virtualization to the x86 chip architecture -- the standard developed by Intel and later adopted by AMD and other chipmakers.

Meanwhile, as chips became more dense and powerful, designers were able to add new features. Intel began adding virtualization to some of its chips as far back as 2005 and is adding more as it rolls out new processors. AMD is behind, but it's an open secret in the industry that the company's "Project Pacifica" will add similar capabilities to its chips in the near future.

The chips' new function doesn't actually perform virtualization, but it does make it easier. For one thing, it improves performance, although there's no agreement on how significant that boost is. Gartner's Bittman says the boost is just a few percentage points, not in itself enough to drive many new customers to adopt virtualization, he said in an interview.

However, virtualization capabilities in the hardware do lower barriers that have either kept out competitors or confined their efforts to low-end or niche markets, Bittman argues. "This will put VMware's business model on its head," he says.

Rather than making money selling the virtualization software, or hypervisor, VMware will have to sell tools and services as the basic capabilities become a commodity, he says. That's already started.

When Microsoft introduced its Virtual Server product in 2004, VMware cut the price of its lower-end product by 44%, and then dropped it to zero, says Bittman. VMware's high-end ESX software is not free -- it costs about $3,750 per CPU, plus another $1,300 or so for additional management tools.

Microsoft's Virtual Server is now free, and the company plans to release its own hypervisor by 2008. And in May, Microsoft acquired Softricity, a venture-backed startup that developed application virtualization and management software.

Also waiting in the wings is

XenSource

, an open-source company that provides virtualization software for Linux users. Hardware-enabled virtualization, says Bittman, will make it much easier for XenSource to support Windows.

There's another way to look at the changes wrought by the new hardware. IDC analyst Stephen Elliot says "the big money depends on how broadly virtualization is adopted." He figures that the gains in performance and ease of use will encourage companies to virtualize more applications and more servers, which means VMware will be able to sell them more licenses.

Elliot agrees that there will be at least some commoditization of the market, but he says VMware has a major edge because it's platform neutral, i.e., it runs with any (or almost any) operating system. And the additional features found in VMware products, plus the company's array of related management tools, make it a much more compelling buy than products from competing vendors.

Meanwhile, the performance of VMware is another important metric for savvy EMC investors to track.

As originally published, this story contained errors. Please see

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