Blog ported to new platform

We have ported our blog to a new platform and new brand. You can follow our work on http://blog.techalpha.com

The new blog contains highlights from our most recent report Ripple Effects from Virtualization. Please check out our new blog location to read about how server virtualization will disrupt the storage, database, and middleware markets while creating large new opportunities in business continuity and cloud computing.

The report is based on feedback by 200 IT customers on vendors like VMWare, Citrix, Microsoft, Oracle, IBM, Symantec, CA, BMC, NetApp, EMC, DELL, and HP, and is also available here.

How Network Effects Are Likely To Power The Cloud

The recent posts about the economics of cloud computing between Nick Carr and Tim O’Reilly (here and here) and the panel at this week’s Web 2.0 have created a lot of buzz. The central question is of great consequence: will the emerging “cloud” operating system generate the monopoly rents and industry control that Microsoft enjoyed with Windows? For the sake of argument, let’s assume VMware is leading in private enterprise clouds and that for now Amazon leads public ones with Google, Yahoo, Rackspace, and Microsoft as contenders. It seems likely so far that Microsoft will have a significant advantage in private clouds, though not to the same extent as with Windows. Public clouds seem years further out, so they’re harder to handicap.

But at the center of the argument is whether dominance in either variety will come via Web 2.0 style “harnessing collective intelligence” or the more traditional “network effects.”  I believe we will see Microsoft emerge as a leader in private clouds in 3-5 years and it will be on account of the more traditional network effects.  Market share won’t accrue to the leader by virtue of capturing more information every time someone uses the cloud.  Instead, it will accumulate the way Windows steadily accumulated application and device support over time.

The two critical success factors in cloud computing: virtualizing the hardware and managing the software components

There are two key assets to leverage success in this market. VMware and Microsoft are likely to share self-reinforcing leadership to the first. That is the ability to make a sprawling and heterogeneous collection of servers, storage, and networking look like a single machine. Through automation interfaces, this capability dramatically changes the economics of administering data centers. The other key asset to leverage for success in this market is the ability to combine infrastructure and applications management. That is the critical requirement for turning an IT operation into a private cloud that can deliver rock solid online services.

Leveraging network effects to make the hardware infrastructure look like one big machine

As Tim explains, the cloud has multiple layers. But the bottom-facing utility layer sits on the hardware infrastructure and uses this generation’s equivalent of device drivers to make it look like a uniform pool of resources to the software above this layer. This is VMware’s strength by virtue of its lead in virtualization. Market share begets network effects at this layer in terms of device support, such as the widest range of storage devices and access to all their unique features. However, over time, it’s hard to imagine how Microsoft will fail to leverage its Windows Server and associated Hyper-V unit volume to achieve similar device coverage. So although the utility layer intrinsically has low value add, vendor concentration in private clouds will probably preserve prices and margins to some degree.

Leveraging network effects to deliver end to end application service management

In order to be able to deliver end to end online services, the upward-facing cloud software layer has to orchestrate and manage an untold number of application components, many from third parties, some from corporate developers. VMware has some leading-edge management technology that automatically wraps around applications (courtesy of the B-hive acquisition). But as long as commercial and corporate developers primarily target Windows as their application deployment platform, Windows will have a self-reinforcing advantage relative to VMware.

Microsoft’s self-reinforcing advantages are twofold, building on its leadership both as a deployment and development platform.

1. First, since it accounts for roughly 80% of X86 server unit shipments, software developers of just about any stripe have to do at least some work to wrap Microsoft management tools around their applications.
   
2. Second, because Microsoft is the leading provider of development tools on Windows, it will be able to capture even more management information about the subset of applications that use their tools. Even if both of these structural advantages haven’t yet been exploited by Microsoft, it’s hard to see that situation lasting as they roll out their Dynamic Systems Initiative.

VMware’s best potential for upside in this market is threefold.

1. First, the extent to which commercial or corporate software developers use development platforms that are independent of Windows likely means neither company has an advantage in collecting management information. Examples of these platforms include J2EE, PHP, Ruby On Rails, Spring, and Hibernate. Some of these platforms don’t require any conventional operating system.
2. Second, the extent to which VMware proliferates its platform ubiquitously, it may have more of an advantage in managing the infrastructure it sits on and the applications that sit on it.
3. Third, virtualized environments make it possible to deploy applications in “appliances” that include all the bits required to run, including operating system, middleware, and multiple application components. Today, all these appliances are deployed using Linux because of Windows licensing restrictions. If appliances take off independent of Windows, that would help VMware tilt the platform competition in its favor.

Public clouds are likely to be more diverse, like a set of services, but with the core or anchor services having similar economics

Windows Azure has all the economic characteristics of a private cloud – masking the infrastructure, managing the application services – but with the margin-depressing overhead of tightly-integrated data centers. It will clearly have higher-level services like SQL Services, Exchange, and .NET, but it will be easy to integrate premise-based software as well as third-party services such as Salesforce.com’s Force.com or Google Adwords.  In other words, if Microsoft delivers on its promise, it will be an anchor platform at a higher value, higher margin layer than Amazon, but with bridges to other services.  Considering how it appears to build on Microsoft’s on-premise software tools and interfaces, it appears likely to have a leading market share.

Controversy over Cloud Adoption and Economics

The Economist came out with an excellent special in its Oct 25 edition entitled ‘A Survey of Corporate IT’.  A series of articles explore the future of cloud computing.

The public’s excitement though around cloud computing overrates what is happening and under-estimates the dramatic impact that internal and external clouds will have in the medium term.

Hopes too high on pace of adoption

Our own research with customers indicates that businesses are slow to adopt the public cloud (outside of SaaS of course).  Top concerns are data protection (security, privacy) and lock-in to one cloud provider (lack of standards).  Early enterprise adopters are those with spiky traffic (e.g., media and entertainment) where the cloud provides low baseline cost with infinite scalability.

Our survey also indicates that enterprises are building private internal ‘clouds’ right now which are enabled through virtualization (see prior post just below).

We have heard repeatedly that joining these with external clouds is a few years out, though we are encourged that it’s on VMWare’s roadmap.

Profound impact on IT industry not well understood

Mark Stahlman of Gartner is quoted in the article that “hardware always wins when new demand for computing is uncovered.”  While we agree that lower cost and complexity will drive new applications for computing, we see significant disruption to the IT industry as we know it once cloud computing gathers pace:

1. Server and storage vendors will face lower margins and a period of lower growth.  Customers move from ‘just in case’ forward buying to a ‘just in time’ capacity on tap model, which is a roadblock to unit growth.  Moreover, concentration of buying power in the hands of a handful of big clouds is a negative for margins, witness the recent Amazon – EMC deal.  We are not confident that the extra demand which Stahlman sees will compensate for that fairly tangible downside
2. Cloud technologies in the enterprise, growing out of virtualization and service-oriented management, promise at least an order of magnitude greater administrative productivity.  Today, one IT administrator typically manages 20-30 physical servers.  By contrast, these emerging private clouds can manage far more sophisticated and scalable application services without growing staff.  At the extreme, public clouds like Microsoft’s and Google’s leverage one administrator across several thousand servers.
3. Cloud computing will not provide material profit upside for the providers of large clouds anytime soon (e.g., Microsoft, Google, Amazon.  Rackspace is the only pure-play in the group.)  Cloud provision will be a commodity business except for niche clouds, e.g., ‘high security’ for regulated industries or government customers where you need to prove or restrict the physical location of the data
4. While Windows may appear to be consigned to the history books today, Microsoft will attempt to change that with its announcements at the Professional Developer Conference next week.  We expect them to create a new set of tightly integrated online services that resemble Tim O’Reilly’s much talked about Internet Operating System.  It is likely to deliver not only dramatically higher administrative productivity for their internal operations, but dramatically higher developer productivity than any of the competing cloud platforms.  Microsoft shouldn’t be counted out yet.

Here’s a view of one of the seven Economist articles, contrasting our view with those of others on the topic.  I encourage our readers to check out the full special report at newstands or online (subscribers only).

the-economist-a-survey-of-corporate-it-economics-of-the-cloud-article

Is VMware’s Hyper-Growth Phase Over?

VMWare’s Opportunity to Expand Into and Potentially Disrupt Adjacent Markets

By George Gilbert and Juergen Urbanski

We’ve talked to a fair number of VMware customers and investors over the past few weeks.  In the process, we’ve repeatedly been asked whether VMWare is done with its phase of hyper-growth.  While it isn’t likely to grow anywhere near triple digits again, it is likely to grow into a strategic platform provider for both data centers and desktops, though this will require solid execution in a tough macro environment.  Its opportunity comes from its chance to both expand and disrupt a series of large adjacent markets.  The ripple effects of this sea change in computing will also affect many markets which VMware has no plans to compete in, though that will be fodder for future posts.  (Disclosure: the authors own shares in VMware)

VMware’s biggest near-term challenge is that it over-sold both units and high levels of functionality with their enterprise license agreements.  These ELA’s were an attempt to encourage customers to deploy more virtual servers with richer functionality ahead of Microsoft’s entry into the market this past summer.  While this may have had some success in making adoption of Microsoft technology more challenging in some accounts, it has actually had unintended side effects.  It left VMware competing with its own inventory of licenses already on the shelves of its customers.  While VMWare works its way out of that near-term hole, some have lost sight of the bigger picture opportunity.

How VMWare And Cisco Might Bring The Nexgen Data Center Closer

Rumors of an alliance between Cisco and VMware have been swirling with varying levels of intensity for some time.

What’s the business problem that a potential alliance needs to address?

1) The most obvious one is that current VMware Distributed Resource Scheduling (DRS), Disaster Recovery (DR), and High Availability (HA) functionality built on core capabilities like VMotion are incomplete. It’s hard to move the Virtual Machine (VM) for spare capacity or to deal with downtime to any random server and maintain the connections to the same isolated data and storage area network (SAN). Instead, administrators either have to open up the network so any server can see any other server and any storage device, a security risk, or they have to manually remap the connections.

2) The less obvious and more speculative problem to be addressed is the management and automation of business services across resources and applications. It is still primitive, though the big 4, CA, BMC, HP Openview, and IBM Tivoli are all hard at work addressing this, and CIOs are looking for the provider of a strategic, new provider.

Economic Fallout From Virtualization In The Data Center

This is our first set of hypotheses about how virtualization is impacting each of the layers of the IT stack. We will elaborate and refine them as we continue to collect insights from vendors and our upcoming survey of IT decision makers.

The Ultimate Objective

· It’s more than just the savings from server consolidation and more than just greater flexibility in managing planned (VMotion) and unplanned downtime (disaster recovery, high availability)

· Ultimately, it’s about automating the data center in order to make it easier for companies to deliver online business and consumer services. The iconic example of an online service that complemented a traditional business was the Sabre travel reservation system born in the ‘60s. It was based on purpose-built infrastructure that required intense collaboration between the customer, American Airlines, and the vendor, IBM. More recent examples include Fedex package tracking or the familiar dot.com services from Amazon, eBay, and Google. In order to make it easier for businesses to build or assemble end to end services from existing assets, technology vendors have to convert “assets” into “pools of services” using virtualization at every layer of the IT stack.

Looking at the IT Stack Layer by Layer

Death of the VAR in a SaaS World

In general, offline channels have not played a big role in SaaS GTM strategies. The early focus of business and infrastructure SaaS solutions has been on SMBs. SaaS delivery makes it economical to serve SMBs, and online channels make it economical to reach SMBs. As SaaS grows up though (see our earlier post), what role will offline sales channels, in particular VARs, be able to play?

We are very skeptical that VARs will be able to thrive and prosper in their current business model as SaaS adoption continues to gather momentum. The reason is that the TCO model that is promised by SaaS drastically reduces the revenue pool accessible to channel partners. (As we point out in our earlier post, the TCO model still needs to be proven in the long run.) In a June 2007 article, the McKinsey Quarterly compared the total cost of ownership (TCO) for a 200-seat CRM license as on-premise ($2.3m) vs. SaaS ($1.6m). More interesting though than the headline 28% reduction in TCO is the fact that the non-software revenue pool accessible to channel partners shrinks by 90%. Specifically, in this midmarket example, the $1.1m that is spend in the on-premise model for implementation, deployment and ongoing operations shrinks to a meager $106k in the SaaS world.

When, If Ever, Will SaaS Crack Core, Mission Critical Processes In The Enterprise

It’s no secret Software as a Service (SaaS) has generated tremendous excitement among many customers for its apparently transformational adoption model and ownership experience.  Unlike client-server applications, SaaS delivers faster time to value often via a viral buying cycle as well as lower risk deployment.  The early adopter focus has been on small and midsize businesses (SMBs) because SaaS makes it economical to reach them with broad penetration for the first time.  Where SaaS has carved out successes in large enterprises, it has largely been in more independent, non-mission critical departmental functions who have no capex budgets such as HR, CRM, or marketing, not end to end suites.  Despite the undoubted progress that SaaS is making, we believe the adoption of core, mission critical processes (Financials, order management, industry-specific processes such as manufacturing or securities processing) in large enterprises is still many years out for a variety of technical and business challenges.

SMBs have been the early SaaS suite adopters because traditional vendors couldn”t reach them

SMBs have been the low hanging fruit for early SaaS adoption because they’ve historically been underserved by application vendors.  Small deal sizes and bare bones cost of ownership requirements typically were critical stumbling blocks.  The small deal sizes mean vendors have to reach them with a much lower cost channel than direct sales.

Why Selling Search To Microsoft Would Damage Yahoo’s Core Display Ad Business

I was really intrigued by David Kirkpatrick’s last story on Microsoft and Yahoo in Fortune Magazine.
His key insight was about search market share creating a more liquid marketplace for advertisers.   Search market share drives up the demand for and value of keywords.  That’s why Google’s search ad revenue share is even greater than its search query market share.

But there’s one other thing that Microsoft doesn’t mention when it talks about purchasing just “search”: there really is synergy between search ads and display ads, which is where Yahoo gets the majority of its revenues.  It’s very hard to measure the value of display ads because they don’t surface when a user does something that shows their immediate intent (e.g. search for a lawnmower) – that’s why they can only charge for eyeballs/impressions while search engines can charge for clicks on keywords.

But everyone knows that those display ads create brand equity or other awareness that search ads ultimately get to monetize.  So all the major online vendors (MSFT, Yahoo, GOOG) who happen to have both major display ad networks (Google’s I think was built on Doubleclick) and search engines are planning to track what display ads users look at over time.  Then they will be able to correlate that with later search queries and search ad click-throughs.  In other words, they are finally going to start attributing more value to the display ads, which have never really been measurable.  But Microsoft has a plenty big display ad network so they just want to carve the search business from Yahoo.  And Yahoo is under such pressure to do a deal that they’re willing to sacrifice the future synergy of their search and display ad businesses.  Without search, they won’t be able to offer advertisers the same measurement capabilities as Microsoft and Google.  Their display ad pricing and revenues will suffer as a result.

They have been unable to articulate this synergy, or any other part of their strategy for that matter. It’s ironic, but they probably would be able to leverage that synergy with the Google search deal.  They also seem to be turning their internal platform for their properties into an Internet scale Web developer platform.  But they can’t even convince their top talent to give them some breathing room.  It’s game over.

Web 2.0 Turns The Enterprise Inside Out

A couple of good examples emerged from the Churchill Club session yesterday on “Succeeding with Web 2.0 within the Enterprise”:

• Serena Software is using Facebook as their corporate intranet and it now seems to be morphing into a sort of extranet. To overcome adoption challenges among its employee base, most of whom are ages 45 and over, Serena brought in a bunch of 16-year olds for Facebook Fridays. Serena’s SVP Marketing Rene Bonvanie claims 90% of employees are now using it. The primary benefit seems to be increased collaboration. Bonvanie says this makes it easy for both employees as well as customers to identify the right person for a specific question. Conversations have become more open and imbued with better knowledge. Thus, marketing and sales are losing some of their monopoly power as touch points with the outside world. In addition, knowing more about your previously face-less co-workers may also help increase a sense of common purpose at the workplace, states Bonvanie
• Best Buy’s Steve Bendt shared how their internally-focused ‘Blue Shirt Nation’ network helps generate recommendations that can increase store sales. Giving this online market place of ideas the look and feel of ESPN and online games was key to creating adoption among Best Buy’s young workforce, where turnover of 60% per year is the norm
• Paul Pedrazzi from Oracle shared how it’s internally-focused Oracle Connect and externally-focused Oracle Mix social networks do a great job of filtering content. One use case for Mix – once the traffic picks up more – is prioritizing customer needs and feature request prioritization. A common challenge is that product managers tend to overweigh feedback that is recent, local or comes from the largest customers – those who can afford to send their folks to Oracle’s executive briefing centers
• Shiv Singh from Avenue A / Razorfish shared how their own internal wiki, now used by 75% of employees, aims to increase internal information sharing. There is no silver bullet for overcoming employees’ tendency to ‘keep information close to their chests to impress their boss’. As you would expect, measures that can drive the right behavior range from executive sponsorship to making sharing fun to incorporating collaboration in the informal and formal reward and recognition systems