By Juergen Urbanski
Two trends shape big picture industry strategy
We think the storage industry is at an inflection point and may be about to face serious business model disruption from a combination of factors, including virtualization, flash solid state disk, increased storage efficiency and the advent of cloud computing. Against that context, it seems to us that the sweet spot currently is in one of two camps:
1. Fully integrated infrastructure solutions, notably for small- and medium-sized enterprises, from HP, IBM, Cisco + EMC, Sun + Oracle, or Dell + TBD. HP, IBM and Cisco in particular are driving a major vendor and technology re-alignment in the data center. That re-alignment, let’s call it data center tectonics, aims to bring unprecedented levels of integration across virtualized resource pools of storage, servers and networking. The general idea behind this strategy is that, while many of the point products in each silo are commoditizing, customer total cost of ownership has not come down as a result because operational complexity has not come down. In other words, IT labor does not ride on Moore’s law, particularly as the data center gets more complex not more simple. Hence, these mega-vendors are hoping to justify high margins on an integrated solution - unified computing for example - if they can bring customers’ operational costs down. This is particularly relevant for small- and medium-sized enterprises, since those tend to lack the human and financial resources to stitch together best-of-breed point solutions from various vendors. Moreover, since the mega-vendors rarely have the focus to create best-of-breed solutions across all their product lines, they are most successful at selling storage as part of a larger deal, notably with servers. Finally, those mega-vendors also leverage their commercial clout with suppliers (e.g., large volumes beget low input costs) and customers (e.g., one-stop-shop solution and account control). So that can be a very sustainable, profitable position.
2. Next generation best-of-breed solutions targeting the large enterprise and service provider space. A host of challengers are attacking the legacy storage OEMs with innovative point solutions optimized for specific workloads or environments. Not surprisingly, a lot of that innovation falls into four areas: virtualization, flash solid state disk, storage efficiency and cloud computing. Most of these challengers are small ankle-biters. Data Domain is the largest of the challengers in revenue terms, and has carved out a leading position in just one area – de-duplication to achieve higher storage efficiency. In general, the only long-term future we see for these ankle-biters is in the arms of the mega-vendors. Given the data center tectonics trend and the commercial rationale for further consolidation described above, it makes a lot of sense for the mega-vendors to resell, OEM or buy the ankle-biters. (It remains to be seen whether the other large challenger, 3PAR, can carve out a large enough position at the high-end next to IBM, HDS and EMC to remain independent long term.)
NetApp is stuck in the middle
The basic strategic challenge for NetApp is that the company is ’stuck in the middle’ between these two trends / sweet spots. Fundamentally, NetApp suffers from the fact that it is, for the most part, still a single product line with limited growth opportunity in its core market. Its attempt to penetrate the data center with its “unified storage” message has met only moderate success and its WAFL (wide area file layout) is actually limiting its growth in different segments. While goodwill / sentiment towards NetApp is still very positive among the customers and channel partners we spoke with, the company’s revenue from large enterprise accounts seems down about a quarter year over year. At the same time, the company may feel exposed to the downside from cloud computing, given that Facebook and Yahoo seem to have turned away from NetApp. Meanwhile, arch rival EMC has relied on more than a dozen acquisitions for access to innovation and a broader portfolio, and has aligned itself closely with Cisco. In essence, NetApp seems very exposed and needs to increase its relevance to customers for continued growth.
Acquiring Data Domain provides some growth for NetApp but does not solve strategic challenges
Data Domain not only provides NetApp with industry-leading storage efficiency technology but also, and this is often overlooked, provides a back door into EMC accounts.
- NetApp management estimates that NetApp, which has a leading position in de-duplication for primary storage, will have only 6 percent customer overlap with Data Domain, which dominates de-duplication in backup settings.
- On the offensive, NetApp can leverage Data Domain as a way to penetrate new accounts where EMC or HDS may be entrenched in primary storage, with the eventual goal of cross-selling NetApp primary storage into those accounts.
- On the defensive, Data Domain products can be cross-sold into NetApp’s large enterprise customer base (60-70 percent of NetApp revenue) and to international markets (45 percent of NetApp revenue, but only 22 percent of Data Domain revenue). In particular, this should prop up NetApp sales into top enterprise accounts, which have been underperforming of late.
With a cash pile of only a fraction the size of EMC’s, and lacking a track record of successful M&A, it remains to be seen though how NetApp will fare longer term as a stand-alone entity in a consolidating industry. Perhaps it might be driven closer into the arms of its partner IBM who already OEMs NetApp solutions.
EMC’s bid for Data Domain seems primarily a defensive move
EMC’s bid prevents EMC competitors and its partners (e.g., Dell) from accessing a technology that is reasonably strategic to the industry. It also precludes arch-rival NetApp from getting inside EMC accounts via a “Trojan horse.” Moreover, it provides EMC with more of a proven solution compared to selling its owns Avamar product or products from partner Quantum. And finally, it may reduce pricing pressure, since Data Domain reported running into EMC on 50-60 percent of deals. EMC’s reported tactic was to bundle de-duplication functionality into these deals at no extra cost.