Virtualization Out, Expense Management In

With the expected adoption of 'virtualization' as a means to consolidate and also streamline hardware costs, the general perception was that corporates would swap a 'good' chunk of their hardware spend for such technologies, which help them leverage their existing hardware better. Obituaries were written for hardware vendors and 'virtualization' was touted as the next big paradigm shift.

Leading hardware vendors HP (NYSE: HPQ) and Dell Inc (NASDAQ:DELL) could have been the most affected by this phenomenon as corporates could just spend less on PC's/Servers and spend their IT dollars to virtualize.

Two companies, VMWare (NYSE: VMW) and Citrix Systems (NASDAQ:CTXS), have been at the forefront of virtualization and they were naturally expected to do better than such hardware vendors thanks to their products which had a compelling 'cost reduction and consolidation' value proposition.

Let's look at how these two have fared in recent times in terms of convincing customers to virtualize.

Exhibit I : License revenue for VMW and CTXS

Exhibit II : License revenue growth for VMW, CTXS

Source: Gridstone Research

It looks like in tough times it's even tougher to convince customers to virtualize, cost savings be damned!

Now let's take a look at how the hardware vendors have fared in terms of revenue and revenue growth, especially in corporate sales. We take the server revenue for HPQ and DELL as a proxy for corporate sales since their desktop and notebook segments could have a large consumer component.

Exhibit III: Server revenue for HPQ and DELL

Exhibit IV: Server revenue growth for HPQ and DELL

Source: Gridstone Research

What we need to keep in mind is that the top two vendors in hardware have a larger base and therefore their revenue declines being worse than the virtualization vendors is expected. However, virtualization license revenues has slowed dramatically despite growing on a smaller base and this is true not just for the October 2008 - March 2009 period (when IT spending was severely impacted across all segments) but even prior to that in January - June 2008.

Therefore, in my books, the virtualization vendors have fared as badly the hardware vendors - the very companies they posed a threat too! Their revenue growth declines are more pronounced that the hardware vendors itself!

My argument is not that such vendors with a 'cost reduction' value proposition are equally worse off; but that customer spend on 'cost reduction' solutions has not vanished but is more targeted and in fact has increased in specific areas. Companies which provide solutions which show a 'visible' impact on costs are doing great. One such is Concur Technologies Inc. (Nasdaq: CNQR), a expense management software vendor.

As exhibit V below shows, topline and bottom line performance of Concur has been impressive in the last six quarters despite the macro environment.

Exhibit V: Revenue and profitability trends for CNQR

Very often software like 'virtualization' represents savings on a total cost of ownership (TCO) basis and that largely tends to confuse customers rather than making life simple for them.

Software like Concur's travel and expense management are able to show a clear ROI thanks to their ability to show 'hard' dollar savings in terms of reduction in specific expense items. Further such cost reduction techniques will be appreciated by all senior executives with segment or geographic P&L responsibilities as they are able get specific data on savings through using such tools. On the other hand, many decision makers could view 'virtualization' as too broad in its approach with questionable results in terms of demonstrating visible cost saving.

So even when it comes to cost reduction, I would vote for simplicity as most customers have done. In the end what matters is real savings, not 'virtual' savings.

Disclosure: No positions

Comments

[User 424892:]

Agreed. Spend Management and increasing the level of smarter spending orgnaization wide has really become of growing and established organizations. A company on the forefront of this trend is coupa.com. This web based solution lowers the cost of ownership and delivers a significant return on investment.

Jun 03 10:18 AM

[honkytonker:]

Virtualization does not guarantee lower costs: the labor and additional software required to migrate to, and manage, the virtualized environment is not trivial. In addition, in an outsourced environment the fee to the customer for ongoing management is usually "per image" not "per hardware box", further diluting any "spreadsheet" savings.

Jun 03 10:22 AM

[Delaland:]

Mr. Selvaraj's data is way off base. First, he shows enourmous license revenue for Citrix since 2006, along with a recent declining growth of that license revenue. The fact is that Citrix only bought XEN, the hypervisor virtualization software Citix now sells, in 2008, and it did so for $500M. But XEN annual revenue to that point was only $5M!!! If his chart showed only the growth of Xen license adoption, instead of all of CItrix's software product sales, it would show enormous growth. Plus Citix Xen license model is the same as Linux; i.e. license is free, (for a few months this was not true, but it is now) you only pay for annual support, so there are no 'license' revenues to report. Finally, other comapnies have jumped in with their own hypervisor vitualization products, like Oracle and Microsft. Between Citrix (Xen), Oracle, MS, Virtual Iron (bought by Oracle), and others, their license growth more than makes up for the decline in VMware. The reason VMware growth has declined, is they are competing aginst more products, and competing against in some cases 'free products'. The assertion that overall hypervisor virtualization software user adoption (note I did not say license revenue), is slowing or on the same pace as declining server sales is rediculous.

Jun 03 11:04 AM

[Naveen Selv...:]

Thanks for your comments. However, I disagree that since there is more hypervisor adoption, the industry is doing well. If they are not able to monetize these 'adoptions' now, how can we be so sure that monetization of all these adoptions will surely happen. further please refer the data(sourced from company filings) which Citrix has reported the following as application virtualization revenue in their own filings:

FY04 - $696.8M
FY05-$776M
FY06-$871M
FY07-$998M
Fy08-$1081M

you will get the 06/07/08 'App virtualization' revenue from their 2008 10-K filings( Page F-30). So even in FY06, quarterly run rate was >$200M for App virtualization.


On Jun 03 11:04 AM Delaland wrote:

> Mr. Selvaraj's data is way off base. First, he shows enourmous license
> revenue for Citrix since 2006, along with a recent declining growth
> of that license revenue. The fact is that Citrix only bought XEN,
> the hypervisor virtualization software Citix now sells, in 2008,
> and it did so for $500M. But XEN annual revenue to that point was
> only $5M!!! If his chart showed only the growth of Xen license adoption,
> instead of all of CItrix's software product sales, it would show
> enormous growth. Plus Citix Xen license model is the same as Linux;
> i.e. license is free, (for a few months this was not true, but it
> is now) you only pay for annual support, so there are no 'license'
> revenues to report. Finally, other comapnies have jumped in with
> their own hypervisor vitualization products, like Oracle and Microsft.
> Between Citrix (Xen), Oracle, MS, Virtual Iron (bought by Oracle),
> and others, their license growth more than makes up for the decline
> in VMware. The reason VMware growth has declined, is they are competing
> aginst more products, and competing against in some cases 'free products'.
> The assertion that overall hypervisor virtualization software user
> adoption (note I did not say license revenue), is slowing or on the
> same pace as declining server sales is rediculous.

Jun 03 11:53 PM

[Delaland:]

Naveen:

I am virtually (no oun intended) certain, that the 'virtualization' license revnues that Cirix is providing/reporting during this period is NOT hypervisor license revenue. Its their core product which, in a nutshell, vitualizes applications, such that you don't incurr desktop licensing fees (short version explanation). XEN is the technology they acquired when they bought Xen Source ( only 1/1/2 years ago), and that is the competing hypervisor technology with VMware, hyper V (microsoft), et. al. If you go to their website, the first thing you see is they offer Xen for free, using the Linnux Open-souce model. Ask Citrix for those numbers (Xen license adoption) and I'll guarantee it is growing at a fast pace. VMware, on the otherhand, licenses ESX for between $4K and $5K per 2-socket server. Their revenue growth may be declining because there are simply many more hypervisors in the market to compete against (Oracle, Microsoft, Citrix), where they were the only player years back. Plus, they compete against 'free' in many instances, certainly with Citrix. Hypervisors will eventually be a commodity. But the adoption across the industry is anything but slowing.


On Jun 03 11:53 PM Naveen Selvaraj wrote:

> Thanks for your comments. However, I disagree that since there is
> more hypervisor adoption, the industry is doing well. If they are
> not able to monetize these 'adoptions' now, how can we be so sure
> that monetization of all these adoptions will surely happen. further
> please refer the data(sourced from company filings) which Citrix
> has reported the following as application virtualization revenue
> in their own filings:
>
> FY04 - $696.8M
> FY05-$776M
> FY06-$871M
> FY07-$998M
> Fy08-$1081M
>
> you will get the 06/07/08 'App virtualization' revenue from their
> 2008 10-K filings( Page F-30). So even in FY06, quarterly run rate
> was >$200M for App virtualization.

Jun 04 10:44 AM

[Naveen Selv...:]

Thank you for your comments, Delaland. I probably should have clarified that what I meant by 'Virtualization' is all 'forms' of virtualization(if I may so) i.e Server, Application, Desktop etc.

I know that in a jargon-filled industry like Tech, we tend to get carried away by such jargon and many companies also 'piggy-back' on the latest fad and classify their product under the same . Your comments have made me inquisitive enough to try and unravel this jargon. Let me attempt that!


On Jun 04 10:44 AM Delaland wrote:

> Naveen:
>
> I am virtually (no oun intended) certain, that the 'virtualization'
> license revnues that Cirix is providing/reporting during this period
> is NOT hypervisor license revenue. Its their core product which,
> in a nutshell, vitualizes applications, such that you don't incurr
> desktop licensing fees (short version explanation). XEN is the technology
> they acquired when they bought Xen Source ( only 1/1/2 years ago),
> and that is the competing hypervisor technology with VMware, hyper
> V (microsoft), et. al. If you go to their website, the first thing
> you see is they offer Xen for free, using the Linnux Open-souce model.
> Ask Citrix for those numbers (Xen license adoption) and I'll guarantee
> it is growing at a fast pace. VMware, on the otherhand, licenses
> ESX for between $4K and $5K per 2-socket server. Their revenue growth
> may be declining because there are simply many more hypervisors in
> the market to compete against (Oracle, Microsoft, Citrix), where
> they were the only player years back. Plus, they compete against
> 'free' in many instances, certainly with Citrix. Hypervisors will
> eventually be a commodity. But the adoption across the industry
> is anything but slowing.

Jun 04 11:22 PM

[BeachRider:]

Don't forget the virtualization also include disks. It is no mistake that VMWare is owned by a Disk-company. VMWare enables thin-provisioning of CPUs, memory, cable-infrastructure and disks. VMWare greatly improves the Windows capability to expand a filesystem on-demand and without service interruption.

Jun 05 07:35 AM