In 2006, VMware saw an explosive 82% increase in sales over 2005 figures, reflecting virtualization's rising popularity in the marketplace. Virtualization, in its current form, is a young market; in 2006, only about 2% of physical servers ran virtualization software, and about 8% of logical servers, which aren't limited to one physical location, were virtualized. Right now, one of the main barriers to the penetration of virtualization technology is the perceived complexity of implementing a virtualized system.
VMware is currently the leader in the virtualization market, with its estimated market share ranging from 55% to 80%. The main risk to VMware's long-term success is the impending competition from Microsoft. Though the software giant hasn't released much in the way of virtualization software yet, it's expected to include a free version of its proprietary virtualization software with its Microsoft Server 2008, which should hit the market in mid-2008. Though this software is expected to be pretty basic compared to VMware's fine-tuned virtualization programs, the fact that it's free and carries the Microsoft name makes it a notable competitor.
VMware Inc. provides products and services for virtualization, a technology that separates a computer's software from its hardware in order to improve efficiency. Virtualization lets customers run multiple applications from one computer or server, which can reduce spending on additional, unnecessary capacity. Though the penetration of virtualization technology is still low, it should increase dramatically as IT professionals become more familiar with the concept. As of December 2006, VMware's software had already been installed on 24.6 million x86 servers and 489.7 million business client PCs for customers across various industries (including all of the Fortune 100 and 840 of the Fortune 1,000).
The majority of VMware's sales are made indirectly through a system of more than 4,000 partners, including software distributors and resellers, hardware vendors who bundle the software with their products, and IT management services. VMware also regularly collaborates with tech giants Intel (INTC) and Cisco Systems (CSCO) to develop virtualization software optimized for use with these companies' hardware. These relationships are quite close; both Intel and Cisco hold VMware stock and a seat on its Board of Directors. By leveraging Intel's and Cisco's reputations in the computer hardware industry and VMware's leading position in virtualization software, the companies hope to develop a complete package of virtualization technology that addresses all of their customers' needs.
VMware has grown substantially over the past few years, reflecting the growing demand for virtualization products and services. The company's total revenues were up 82% in 2006 from 2005, and software license revenues increased 71% in 2006.
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VMware makes most of its money by selling its software to corporate customers. Its main offerings include:
VMware also bundles and sells some of its software as all-inclusive virtualization suites.
VMware also provides several types of services, including maintenance, upgrades, and training. Typically, the company's service contracts last from one to five years. These service plans, which offer various levels of product support, provide VMware with a steady stream of recurring revenue. From 2004 to 2006, the Services segment grew to account for 30% of revenues, up from around 18%. Services usually provide higher profit margins than licensing, which will help boost the company's performance if this trend continues.
According to tech research firm IDC, a typical x86 server (the standard for business networks) utilizes only 10% to 15% of its capacity. The reason for this is that companies often run only one application per server to minimize the risk that a problem with one application will affect numerous others. While this is perhaps the safest method to ensure that one faulty program doesn't bring the whole system down, it is also rather expensive. Using VMware's virtualization technology, companies can safely run more than one application per physical machine. VMware estimates that one virtualized server can perform the same work as up to ten standard servers; this can save firms a ton of money by letting them use their existing capacity more efficiently. As companies in competitive industries like technology, pharmaceuticals, and telecommunications, look for ways to cut overhead, VMware's virtualization software will become increasingly more popular.
VMware currently dominates the virtualization market, but competition from software giant Microsoft (MSFT) could cut into the company's lead. Microsoft's offerings in the virtualization market are currently limited to entry-level software that doesn't directly compete with most of VMware's products. It does intend, however, to include free, enterprise-class virtualization software with its Microsoft Server 2008 operating system, which would put it in more direct competition with VMware. While VMware's leading position in the virtualization industry and reputation for quality give it some protection against competitors, going up against Microsoft can be a daunting prospect for any company. Even though Microsoft hasn't released much in the way of virtualization software yet, it has already started paving the way for its future plunge into the industry. It recently implemented agreements with several server and software vendors to distribute certain versions of its operating systems that only support Microsoft-based virtualization software. A free virtualization program, especially one backed by Microsoft's heft, will certainly cut into VMware's market share.
In 2006, VMware made about 44% of its revenue from customers outside the U.S. As such, it receives payment in a wide range of currencies; its revenue, however, is reported in U.S. dollars. Any change in the exchange rates between the dollar and other currencies in which VMware conducts business could have a significant effect on reported revenues. If the value of the dollar declines against other currencies, VMware's revenues would be boosted, as every unit of foreign currency would translate to a larger number of U.S. dollars. The same applies in reverse, however; a rise in the value of the dollar would make international sales look relatively smaller. Recently, the dollar has been pretty weak in comparison to other major currencies; a continuation of this trend would be beneficial for VMware and other companies that do business outside of the country.
Currently, VMware leads the server virtualization industry by a substantial margin. The next largest competitor is Microsoft (MSFT), which looks poised to make a strong push into the market over the next year or two. Apple (AAPL) has released software called Boot Camp (which allows Intel-based Macs to run Windows operating systems in addition to OS X), though this is aimed primarily at consumers and (unlike VMware Fusion) does not allow the use of both OSes simultaneously. Other, smaller competitors include Novell (NOVL), XenSource (recently acquired by Citrix Systems (CTXS)), and Red Hat (RHT), though none of these companies holds more than a 2-3% share of the virtualization market. The still-growing market has plenty of growth potential for all, however; there are so many untapped customer bases that it'll be a while before the firms really start fighting over business.
One distinguishing characteristic of VMware is that it's dedicated to the virtualization industry, whereas all of its major competitors have extensive operations in other areas of the technology industry. This puts VMware in a more leveraged position; if virtualization takes off, it stands to benefit more than say, Microsoft, whose bottom line would look about the same either way. On the other hand, if virtualization were to fail for some reason, VMware wouldn't have any revenue sources.