Naveen Selvaraj's  Instablog

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 harware 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 forefornt 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 Oct08-Mar09 period(when IT spending was severly impacted across all segments) but even prior to that in Jan-Jun08. 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 targetted and in fact has increased in specfic 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 enviroment.

Exhibit V: Revenue and profitability trends for CNQR

Very often software like 'Virtualization' represent 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 responsibilties 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