New Data Shows EMC and Cisco Doubling Down on VCE

Last August, Chris Mellor wrote a short piece calling into question the merits of EMC’s investments in VCE. Essentially he was looking at VCE as a startup and asking if it was a failed effort. I responded with a piece of my own looking at the VCE deal from a different angle, making the argument that EMC is subsidizing VCE to create a long-term competitive advantage for itself and more importantly, VMware (which of course is owned by EMC).

In his piece Chris wrote:

Viewing VCE as a startup it has not been very successful thus far. If it doesn’t make a profit by the end of this year then perhaps EMC, Cisco and VMware might reconsider things.

People who know me, know I have a great deal of respect for Chris’ work. He’s one of the best journalists in the storage business and I read his stuff all the time.

I have to say Chris…if you thought that last August EMC was spending a lot on VCE, wait until you check out EMC’s most recent 10K. There are some really juicy tidbits in there that give us much more information about EMC and VCE. Evidently, VCE is a big enough piece of its business now that EMC legally has to start reporting more information.

Here’s the summary:

EMC’s annual 10K filing shows a huge increase in investment in VCE. It’s clear from the narrative that EMC and Cisco are “doubling down” on VCE as a strategic investment. To date, EMC has put in well over $400M in investment toward VCE and a back-of-napkin P&L analysis would suggest that VCE has lost more than $400M cumulatively to date.

So to Chris’ point – if you look at VCE as a startup, is it failing?

I would strongly urge observers to consider that it’s too early to claim VCE is a failed effort and if anything I would say it’s on track to dramatically disrupt the data center business. If I were Joe Tucci and company I would be doing exactly what the numbers imply – investing like crazy to go after the server businesses of IBM, HP, Oracle and Dell. Specifically, EMC has more than $6B in cash and short-term investments and investing in VCE, in my humble opinion, is a much better move than spending more on stock buybacks or even a paying a dividend. VCE is a growth story and is a big threat to the legacy server business.

The bottom line to my premise is VCE is all about making VMware win and opening up new hardware, software and services markets for EMC and its partners. According to IDC there are now more virtual servers than physical servers. This says it all. I have said many (many) times over the past two years that EMC/VMware will be the next $100B market value company. While SAP might beat them, EMC/VMware are driving the data center infrastructure economy in the enterprise right now and VCE is a big part of that strategy.

10K Analysis

Here are some of the more pertinent stats from the 10K (and EMC’s recent earnings call) for those who don’t have three hours to read it.

  • From EMC’s public earnings conference call, we know that VCE exited 2011 with a bookings run rate in excess of $800M.
  • EMC recognized $133.9M in VCE revenue for the year; up from $0 the prior year.
  • EMC provided funding of $383.2 to VCE in 2011 compared to $29.6 in 2010 and $19.2 in 2009.
  • EMC’s consolidated share of VCE’s losses, based upon its portion of the overall funding, was approximately 63.2% for the year ended December 31, 2011, and 58.0% for both years ended December 31, 2010 and 2009.
  • As of December 31, 2011, EMC has recorded net accumulated losses from VCE of $253.8 million since inception, of which $209.2 million, $43.0 million and $1.6 million were recorded in 2011, 2010 and 2009, respectively.

When EMC announced VCE in late 2009, Wikibon had as many questions as answers. There was tons of marketing fluff in the launch. It was classic modern day EMC—pre-announce, put forth a vision, try to create a market and then begin to deliver. In my estimation it took VCE a year to gear up its engineering, manufacturing and support capabilities and based on the recent 10K and earnings call data the bookings and revenue are finally starting to roll in.

Taking in to consideration that EMC recognizes only the EMC portion of a Vblock platform, and not Cisco UCS or partner associated services revenue.   It is clear that VCE is being heavily funded in expectation of future growth.

So back to Chris’ question: “Is it worth the investment?”

Here’s my back-of-napkin assessment of VCE and EMC’s portion of the funding, bookings, expenses and losses:

Wikibon VCE Model

Joint Venture Total

2009

2010

2011

Cum

Bookings

0.0

10.0

500.0

510.0

Revenue

0.0

0.0

230.9

230.9

Expense

2.8

74.1

561.5

638.4

Net Income

-2.8

-74.1

-330.7

-407.6

EMC Portion

2009

2010

2011

Cum

Cash In (Funding)

19.2

29.6

383.2

432.0

Bookings

0.0

6.0

267.8

273.8

Revenue

0.0

0.0

133.9

133.9

Expense

1.6

43.0

343.1

387.7

Net Income

-1.6

-43.0

-209.2

-253.8

My bet is that EMC’s portion of VCE’s $800M bookings run rate is about $480M which says that in 2012 its entirely possible that EMC (itself) will have a Vblock pipeline approaching $1B—around where Oracle’s Exadata is today.

So to answer the question posed earlier – is this worth all the investment? I would say for a $1B business, no but the total available market (TAM) for Vblocks is much, much larger.

Market Assessment – a TAM of $400B by 2017

Here is my quick assessment of the opportunity for the converged infrastructure market. I consulted the likes of David Floyer and Stu but these are mostly my figures – meaning don’t go building a factory until you’ve vetted these numbers a bit.

We’re defining the TAM as data center infrastructure that includes hardware (servers, storage and networking), infrastructure software (e.g. systems management, backup, etc) and related services (including internal staff). I have that market at $323B in 2011 growing to $402B by 2017. Here’s the breakdown of the TAM pie.

The TAM for Converged Infrastructure is Huge

We’ve defined three classes of infrastructure:

1)   Single SKU – just that – a fully, pre-configured, pre-tested, engineered block of infrastructure (e.g. Exadata and VCE Vblock).

2)   Reference architecture – proven, tested, documented, methodology-based, best practice configuration and deployment guidelines. This includes from server vendors (e.g. HP),  storage vendors and partners (e.g. NetApp FlexPod), system integrator “roll your own” (RYO) – e.g. ICI America NCubed and RYO from telco’s, Internet giants (e.g. Google and Facebook), cloud service providers and large customers.

3)   Legacy approaches – i.e. stovepiped components bought individually.

The Services Angle

Last June, SiliconAngle launched a new publication called ServicesAngle. What struck me about this new online publication is that: 1) Services is a rapidly changing market – IT-as-a-Service and cloud are completely transforming the industry and this market is under-served by the media; 2) Services is  a huge market and whether we size Big Data or converged infrastructure, services comes out on top; 3) Services is why people buy from the big companies. IT pros don’t buy from startups because they want to, they buy from startups because they have to. That means for the majority of initiatives, IT buyers go with the safe bet because they get better service. Dennis Ryan of Maine Medical summed it up when he told me that if he had $100 to allocate toward value, service would get 1/2 (the largest slice) of the pie while product, brand, reputation, etc would get the other half.

As it relates to VCE and Vblock, the services implications are profound. On the one hand, Vblocks will require less up front services because everything is pre-configured, engineered together and pre-tested. So why would EMC, a company which derives a large portion of its profit from services risk eating into those margins? The answer it footprint. If EMC can increase its share of wallet, it wins across the board – i.e. in hardware, software and services. EMC’s services division is an especially large beneficiary of converged infrastructure for several reasons, including: 1) It can be more strategic up front with consulting sales around cloud infrastructure; 2) As EMC increases its hardware sales, its service and support business will be dragged along; and 3) For every Vblock converged infrastructure discussions going on, there are 3-4 reference architecture conversations taking place, opening up another large services opportunity.

I’ve said many times that despite Joe Tucci’s public posture about his strong partnerships and ties with services companies such as Accenture and CSC, over time, EMC will become increasingly competitive with the large service providers. This will become especially notable as EMC increases its share of IT budget.

EMC is Still a Hardware Company

IBM is primarily a services company – it leads with services and products follow.

VMware is a software company and recently announced its first $1B quarter – a major milestone for any software company.

EMC is primarily a hardware company. Its sales reps and channels sell boxes first and while VCE is all about making VMware more ubiquitous, especially in support of mission critical applications, the financial benefits of converged infrastructure to EMC are hardware-oriented.

The hardware-only piece of these three opportunities is estimated to be $118B today growing to $149B by 2017 as follows:

 

Converged Infrastructure will Cannabilize Legacy

The single SKU piece of this business today is tiny, about .5% of the market or just over $600M. But it will grow rapidly to a forecast 15% of the business by 2017 to more than $22B. That’s big and that’s what EMC and Cisco are after. The reference architecture business is also huge and will dominate.

Why will these two segments win out over legacy stovepipes? Because they will improve hardware utilization, reduce opex (staff costs), speed deployment, reduce installation and management risk and lower software/maintenance costs. A single SKU will drive these benefits even further than will be seen with reference architectures. The question is at what price? Today that premium is shrinking because VCE is trying to gain share. Over time could VCE charge a higher premium? Maybe.  That’s the big knock on this approach – i.e. it’s the mother of all lock-ins. Regardless…it’s a ten year trend and with private cloud infrastructure and IT-as-a-Service as big trends, there’s not much to stop it.

Add in VMware and other services, plus partner services and the VMware/EMC ecosystem is looking much more attractive. Could VCE and its partners get 5% of the TAM? If so that’s a $20B marketplace for them to play in.

How much longer will EMC allow VCE to run at a loss? I think as long as they feel they can gain share, disrupt the market and secure new footprints.

I’d love to hear your thoughts on this marketplace, what you’re seeing and whether you feel converged infrastructure is all marketing hype or a technology that will deliver significant value.

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  • http://twitter.com/zappom Markus Zappolino

    As the VBLOCK architecture is driven by the Transofrmation of the Operational Model it will take time for Customers to adapt their organizational modell to consume better this kind of architecture over time. My personal experience it has the same effecte as VoIP had late 90s early 2000 where Telephony and Network teams melt together. The same happens now in the Datacenter Operation. The more consumable everything is the more Customers rely on preconfigured environments just to got a faster time to market. Again this is a mindset shift that must happen. Slightly little orgs could do this faster as teams are already operate everything (Network, Server, Storage , OS).

  • http://twitter.com/kevinclosson Kevin Closson

    The single-skew projections are very interesting. Considering the general purpose nature of VCE Vblock I’d say the future is bright!

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