VMware's Revenue Growth Slows as VM Player Debuts

by Timothy Prickett Morgan

The VMware subsidiary of disk array maker EMC continues to be a bright spot in its financial results and is equally importantly a clear example that EMC is capable of innovating--even if it did buy in the smarts of the VMware team as well as that from Data General, Legato Systems, Documentum, and others. While VMware accounted for a small portion of EMC's $2.37 billion in sales in the third quarter, VMware has an installed base of over 10,000 enterprise customers and is growing like crazy.

In talking to Wall Street analysts last week about EMC's third quarter results, the company said that during the third quarter, VMware's sales were $101 million, the first time in that subsidiary's history (before or since EMC acquired it in December 2003) that quarterly sales broke the $100 million mark. While this is a milestone, like all other explosive and innovative businesses, eventually the revenue streams start to settle down. And this seems to be happening to VMware, which had sales of just under $100 million in 2003 and sales of $218.2 million in all of 2004--about $39 million in Q1, $51 million in Q2, $61 million in Q3, and $71 million in Q4--and sales of $272 million in the first three quarters of 2005. Call it $590 million since VMware has been talking about its financials. And since EMC took over the company, VMware has posted $490 million in sales. To one way of thinking, EMC has already got 78 percent of its $625 million acquisition cost for VMware back (yeah, I know I didn't add in the time value of money).

What is clear, and what EMC did not mention, is that the triple-digit growth rates VMware saw in 2004 have slowed. For instance, the VMware unit pushed $61 million of products and services in the third quarter last year, and $101 million this year, an increase of 65.6 percent. Which is quite large. But this time last year, the growth rate was over 100 percent. And while it is quite possible that growth for virtualization will explode again because, let's face it, there are millions of X86 and X64 devices that could use virtualization technology, it seems more likely that even this current growth rate is unsustainable. EMC will certainly get its bait back, and probably by early 2006. And from there on out, what VMware brings in will be gravy. But it seems safe to say that with Microsoft, SWsoft, the open source Xen project, and now Parallels all peddling virtualization tools on X86 and X64 boxes, VMware is going to have to strike it big and convince a lot of companies to spend money on virtualization software if it wants to continue growing. I happen to think VMware's prices are too high for many customers, regardless of the immense value that its virtual machine and management software provides. I also believe that VMware has done the math and knows that until virtualization software goes more mainstream, it has to charge as much as possible for its wares. For if there is one sure thing, when server virtualization does go mainstream and does get sophisticated enough for relatively unsophisticated customers to make use of it, there will be a price war. This happens with every new technology. At some point, instruction set, memory, and I/O virtualization become standard features of embedded devices, laptops, desktops, and servers. And as new technology becomes standard--as in expected, not as in adhering to an industry standard--that has meant the price comes down. Vendors make it up in volume to drive out competition.

VMware is to be commended for trying to foster open standards for virtualization, which it started doing with some seriousness this summer. And Joe Tucci, the company's president and CEO, bragged about that in the conference call last week. But industry standards have the potential to hurt as much as help VMware's business. As far as customers are concerned, standards in any technology are preferable, since they reduce vendor lock-in. But standardization makes it easier for competitors to come into the market, and it can also allow competitors to work in concert to force VMware to adopt a technology that customers want when it doesn't necessarily want to go that way. This hasn't happened yet, of course--and maybe it won't, either.

What VMware can do to keep growing at an explosive rate is keep innovating, and that is something the EMC subsidiary has clearly shown it is good at. A few months ago, VMware was talking up the idea that it wanted its VMs--which are compatible across its Workstation, GSX Server, and ESX Server product lines--to be the new-fangled, electronic version of the shrink-wrapped cardboard box and CD set for the delivery of configured software. This is a very clever idea.

Last week, at the VMworld user group meeting in Las Vegas, Diane Greene, the president of VMware, demonstrated this new technology, which is being rolled out as a product called VMware Player. Here's how it works. You have to buy a VMware product and create the initial virtual machine and the software that resides within it first. But after that, you can take your VM partition off your machine (which is in essence your machine), load the free VMware Player on any machine, and then install your personal VM inside the player and have access to your virtualized machine. To prove that it works, Greene took an image of her PC, loaded it onto an Apple iPod nano, and then moved it over to another machine and ran it inside VMware Player. With this kind of approach, your PC becomes the software in the virtual machine stored in some kind of glorified flash drive (like the Apple iPod nano) and you run it on any X86 or X64 you can get your hands on. VMware handed out a copy of the VMware Player to the 3,500 people in attendance at the show in Las Vegas, and is distributing it for free from its Web site as well.

Incidentally, the player not only supports VMware's VMs, but also those generated by Microsoft's Virtual Server 2005 and Symantec's LiveState Recovery disk formats. The player allows applications inside the VM to access CD drives, DVD drives, network adapters, and plug-and-play USB devices on the host machine. You can copy and paste and drag and drop between the VM and the host environment and use shared folders between the two as well. You can tune virtual memory inside the VM to boost performance and you can run 32-bit and 64-bit (provided hardware support is there) operating systems within the VM. You can also roll back to a previous state of the VM if it gets whacky.

It will be interesting to see if this idea catches on.

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