Virtualization and “The Cloud”: No Silver Lining Ahead For Enterprise Data Center Vendors

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Virtualization and “the cloud” are NOT equivalent concepts.  Virtualization is a software technology that allows many users to flexibly and securely share a computing resource.  It can be implemented within a single private enterprise data center, or by a public host with a distributed network of Internet attached shared data centers.  It is the latter example that is typically called “the cloud” and the large-scale providers offering this service have very different technology needs and buying habits than do enterprise IT departments.  As enterprises shift focus from the virtualization of their own data centers, through web connecting them as a “private cloud”, and onto public cloud hosts, so will the basis of competition for most IT vendors.  With incremental demand growth coming from public cloud hosts, IT hardware markets will commoditize, commercial infrastructure software vendors will lose share to self-supported open source solutions, and applications will see the rise of new cloud optimized rivals.

Virtualization software divides underlying computing, storage and network resources amongst many users, each with a secure “virtual machine” that appears as a dedicated resource.  Users may not be aware that their applications are not running on their own device, but rather on a shared server, using shared storage, and appearing on their monitors via shared networks.  The data center may be local or distant, and, keeping individual sessions strictly separate, will allocate resources as necessary and authorized.  For the enterprise, virtualization offers many advantages, chief amongst these are avoiding device hardware upgrades, efficient allocation of data center resources, greater ease of software maintenance and upgrades, and reduced burden on IT organizations.

Cloud computing refers to data centers that are accessed across many locations using the Internet, typically using virtualization technology to efficiently share IT resources.  Cloud computing is not synonymous with virtualization, although most cloud implementations employ virtualization technology.  Today, most virtualization takes place in enterprise data centers accessed by a closed set of users across a proprietary enterprise network.

Enterprises are completing the virtualization of their privately operated data centers, and many are adding internet accessibility, a configuration often called a “private cloud”.  Private cloud implementations are a very modest step from data center virtualization.  The computing and storage resources are shared only within the enterprise itself, limiting the opportunity to gain economies of scale, maximize capacity utilization or off load management responsibility.  Moreover, the operational benefits possible from providing broader access may be muted if the applications are not designed to take proper advantage of opportunities for greater collaboration, more timely access, and location awareness.

Most CIOs anticipate moving much of their computing to commercial 3rd party cloud-based hosts offering significant long-term cost and flexibility advantages.   For most organizations, virtualizing data centers is a step on a longer road to the public cloud.  Relative to private solutions, public cloud data centers offer superior performance for users, reduced costs via scale and utilization, greatly improved flexibility, world-class support and maintenance, and opportunities for collaborative, time sensitive and location aware applications.  As such, “The Cloud” has risen dramatically in recent CIO surveys, while “Virtualization”, meaning private data center virtualization, has fallen in priority.

Enterprise data center virtualization, including “private cloud” implementations, has been lucrative for IT hardware and software leaders, but spending may be peaking.  Growth for major virtualization linked vendors like VMWare, EMC, NetApp, Citrix, RedHat, Oracle, and the server arms of Dell and HP, has been strong.  However, this growth has been decelerating, making the drop in priority for CIOs and Oracle’s recent miss ominous.  We believe that 2012 is likely to be disappointing for enterprise data center spending with increasing pessimism over future years likely.

Spending on public cloud data centers will accelerate, spurring market shift to commodity hardware and open source software.  The big bright spot in IT spending will likely be aggressive expansion by major public cloud hosting operations, such as Amazon, IBM, Microsoft, and Google.  While many companies have turned to focus on this arena, we believe dramatic economies of scale and the ability to lever investments in enterprise cloud businesses will quickly separate leaders from pretenders.  Unfortunately for data center hardware and software players, these leaders are amongst the most technology savvy companies on earth.  As the cloud becomes the primary agent of industry growth, it will drive commoditization and an increasing reliance on open source and internally developed proprietary software, to the detriment of the existing market leaders.

Big public cloud will win.    Specifically, the top cloud hosts, the best purpose-built SaaS vendors, the most cloud savvy IT consultants, and the lowest cost commodity component suppliers are positioned to capture a disproportionate share of enterprise IT market value.

Traditional enterprise IT vendors will lose.   Similarly, premium hardware and software vendors into the enterprise IT data center will suffer, as customer relationships open to competition and commodity solutions pressure prices.  This includes makers of PCs, servers, storage systems, and networking gear, as well as most traditional software players.

For the full research note, please visit our published research site.

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