Enterprise IT – Let’s Go to the Cloud

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We are bearish for near-term IT spending, and concerned about the implications of the cloud for many vendors. Global government spending and Japan represent nearly 30% of the enterprise IT market, and both are likely to decline in the face of obvious pressures.  Strong spending from non-Japanese corporate buyers is unlikely to be enough to meet aggressive market expectations in the face of these headwinds.  Meanwhile, the ongoing architectural shift to virtualization in the data center is a boon to leading IT vendors, but a further transition to cloud-based operations in the intermediate future looms as a catalyst for the commoditization of major product categories.  Internet savvy software, IT consultants, carrier-class gear and hosts with scale and skills are expected to prosper

Enterprise IT spending faces severe headwinds over the next year or two.  Specifically, governments at all levels have grown from 12% of total enterprise IT spending to nearly 18% over the last decade.  Scrutiny on current deficits, debt levels and future social spending commitments pushing local, state and national governments toward austerity, here and around the globe.  We believe government will shrink sharply as a percent of enterprise IT, with absolute spending shrinking.  Meanwhile, Japan represented almost 11% of the total enterprise IT market in 2010, a significant market that could be under pressure for obvious reasons.  Together, more than 25% of industry revenues will be under severe pressure, a major risk to vendors with exposure

Recovering corporate spending in 2011 will be driven by virtualization. Surveys of IT managers put virtualization at the top of the priority list.  Moving applications off of PCs and onto data center servers cuts costs, facilitates software deployment, enables user collaboration and remote access, and increases IT management control.  With 2011 enterprise IT growth (ex. Government and Japan) projected to be 4.4%, companies facilitating the move to virtualization with strength in corporate data centers without undue exposure to desktop PCs – e.g. VMWare, EMC, IBM, Accenture, etc. – should be beneficiaries

Rapid growth in cloud infrastructure driven by consumer tablet/smartphone boom. Internet-based data centers operated by consumer-oriented cloud companies like Google, Amazon, Facebook and Apple, and by commercial content delivery network providers like Akamai, Level3 and Limelight have become an important growth segment for IT spending.  Capital investment by this sector should continue at breakneck pace in 2011 as the explosive growth of tablets and smartphones, the step-function jump in wireless network speeds as 4G rolls out, and the demand for on-line video drive extraordinary traffic growth

Enterprises are also moving toward a cloud future, albeit with caution. Even as 2011 shapes up as a big year for bringing applications into enterprise data center centers via virtualization, organizations on the cutting edge have begun the further move to deploy their applications to virtual machines on servers operated by third parties in the Internet cloud.  Cloud software vendors targeting collaborative standard applications with need for broad accessibility, such as CRM, have been early success stories.  While shifting applications to the cloud has clear benefits– i.e. major scale economies, ubiquitous access, superior off-site performance, ease and speed of upgrades/deployment, etc. – the significant enterprise concerns – i.e. data security, transition costs, management control, regulatory issues, etc. – will take time to resolve.  Parsing applications by their degree of standardization and breadth of access required, only the most customized, with narrow and fixed access requirements are likely to be immune from a transition to the cloud

The cloud is bad for leading IT vendors. Virtualization is a boon to the traditional IT equipment vendor, pulling spending into the data center environment where long-standing relationships, turn-key solutions, and stellar customer support translate to premium prices.  The cloud is a 180-degree turn, taking spending away from the enterprise data center and moving investment to large-scale on-line hosts with the expertise and buying power to get the lowest possible prices on bare-bones servers, storage, and networking gear, then adding their own value with internally developed software infrastructure typically based on open-source programs.  As virtualization peaks, and enterprises shift to the cloud, vendors that thrived in the corporate data center – e.g. VMWare, EMC, Cisco, HP, Dell, IBM, Oracle, etc. – may find themselves structurally uncompetitive with the lowest cost alternatives.  This may take years to play out, but will be an evident threat within 3-5 years

The cloud is good for web-savvy software, IT consultants, carrier-class gear, and hosts with scale and skills. We believe that cloud infrastructure will become the primary growth driver for the IT market.  As this architecture begins to supersede traditional enterprise data centers, companies offering software-as-a-service (SaaS) that exploit the advantages of the cloud and minimize enterprise concerns will take significant market share from software vendors that focus too intently on evolving their data center based products.  Salesforce.com has been a pioneer in this regard.  We also believe that the move to the cloud will create opportunity for IT consultants such as Accenture, and IBM.  As cloud-hosted applications will contribute to the already prodigious Internet traffic growth, we anticipate ongoing investment in carrier class optical and IP networking gear, a boon for vendors like Juniper, Ciena, F5 and others.  Finally, we believe web hosting will reward operators with substantial scale and expertise in software development, such as Google, Amazon, Microsoft and IBM

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