Is VMware Killing Itself?

The law of unintended consequences can be cruel and merciless. Fixing what ain't broke can be even worse.

I'm not sure in which of those categories we should fit VMware (NYSE: VMW  ) today, but it's not a pretty picture either way. The virtual-computing guru released a new version of its vSphere software this week, packed with higher performance and new features -- and a dramatically different cost structure.

The software itself is getting mildly positive reviews (learn more about what a virtual machine is and how it enables the cloud-computing trend -- VMware is a leader in these markets) but the new pricing plans are not as popular. In fact, the firestorm of criticism over the new plans can be compared with the outrage over Netflix's (Nasdaq: NFLX  ) decision to start a whole new pricing model this week with as much as 60% higher prices for a basic plan. Price changes matter.

What's wrong?
The software guru, majority-owned by storage giant EMC (NYSE: EMC  ) , ostensibly wanted to simplify its licensing terms and make vSphere more affordable for small IT shops. But the effect on large, enterprise-class IT environments appears to be quite the opposite.

The previous licensing model encouraged building very large systems with tons of memory and fewer but more powerful processors. Under the new model, it's often cheaper to get more physical servers with less memory instead. Estimates of the costs involved in applying this new structure to systems built with the old pricing in mind range from mildly higher to many times the old expense. The consensus seems to land somewhere around two to three times higher licensing costs, which makes the virtualization software at least as expensive as the hardware it's running on. Ouch!

Is this a big deal?
Well, judging by the public outrage, you'd certainly think so. In reality, I think VMware saw it coming and forged ahead anyway -- after calculating the risks.

Some market watchers see this blunder driving customers into the waiting arms of competitors Microsoft (Nasdaq: MSFT  ) and Citrix Systems (Nasdaq: CTXS  ) , with perhaps a smattering of refugees to the less heralded camp of Linux-based virtualization as championed by Red Hat (NYSE: RHT  ) . That way, you could stick with your established system-building principles without a sticker-shock heart attack courtesy of VMware.

VMware could certainly change the pricing scheme to appease grumpy customers, but that's probably not going to happen. The company is more likely to drive a hard sell for the new product based on its technical advances and unmatched feature set. For some, there's simply no substitute for the best of the best, which VMware remains with or without boneheaded pricing plans.

I've previously called out Autodesk (Nasdaq: ADSK  ) for a similarly customer-unfriendly pricing policy, only to see the maker of 3-D design tools laugh in my face and accelerate its growth with wider margins. I think VMware has done its homework and is willing to lose a few disgruntled customers in exchange for fatter margins.

What now?
In short, I see no reason for VMware investors to panic. Microsoft, Citrix, and friends sure pose a threat to the incumbent king of virtualization, but this war was never fought on a price-sensitive battlefield to begin with. If anything, VMware is justifiably proud of its premium pricing, kind of like a fruit-themed tech company I won't mention here. This strategy has been proven to work.

That being said, VMware is priced for absolute perfection at 107 times trailing earnings and 59 times EBITDA, and there's always a chance that a bold move like this could misfire.

The company is set to report earnings on Tuesday, and we might hear more about the license situation then. If the outrage really is affecting business, management would be crazy not to address it on that very convenient stage. Until then, I'd rather not touch VMware shares with a 10-foot memory stick.

Did you miss the video on cloud-computing and virtual machines and how they are affecting your portfolio? No harm, no foul -- watch it now.

Fool contributor Anders Bylund owns shares of Netflix, but he holds no other position in any company mentioned. Check out his holdings and a short bio. The Motley Fool owns shares of EMC and Microsoft. Motley Fool newsletter services have recommended buying shares of VMware, Microsoft, and Netflix, as well as buying puts in Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (30) | Recommend This Article (7)

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  • Report this Comment On July 16, 2011, at 11:17 AM, Semprasectum wrote:

    SO you advise WAITING until AFTER they give their spin on the license situation. . .seriously?

    Its your job to KNOW. . and invest or not invest before they put their spin out. ..

    NO wonder so many of you stood WAITING while some of US were buying AAPL by the truckload BEFORE the iPOD. and iPHONE. . ...you are a financial HACK and should not be followed. ..putz

  • Report this Comment On July 16, 2011, at 2:24 PM, gregschulz wrote:

    Good article and analysis Anders

    To say that VMware has been getting some heat (among other things) this past week over its new license models would be an understatement. In fact the license "discussions" (ok, debates) have very much over shadowed what would otherwise have been conversations about some new cool, and business enabling technology.

    The new technology introduced as part of vSphere 5 address scaling with confidence for virtual, private and public cloud as well as dynamic infrastructure or other forms of abstracted information services delivery. For example support for more memory (1TB), more CPUs (32), virtual storage appliance to liberate trapped internal hard disk drive (HDDs) inside of servers, management and automation tools, a bunch of security enhancements and new functionality to name a few.

    VMware is a premium product when it comes to x86 server virtualization and associated management tools, hence as you point out in your piece, the associated pricing. However, Microsoft has been expanding their installed base footprint with Hyper-V over the past couple of years for servers and then there is the virtual desktop infrastructure (VDI) that includes Citrix. Btw, did you catch that Citrix announced this week that they bought cloud.com and the cloud stack technologies?

    There is another trend that Im seeing in more environments which is that customers are running to different degrees, mixed or multiple virtualization or hypervisor tools for various reasons. Some started out with Hyper-V adding vSphere, others with VMware ESX or vSphere adding Hyper-V and so forth. This is no different than how many IT environments have multiple types of servers, storage or operating system tools aka tiered resources that get aligned to the applicable need.

    What this means is that as we enter the next major wave of virtualization which is life beyond consolidation. Life beyond consolidation expands the focus of virtualization towards enabling agility, flexibility and dynamic infrastructure for those servers or applications or storage that do not lend themselves to being consolidated or squeezed. Instead, this next wave that we are now in requires more functionality of underlying virtualization hypervisors such as Citrix/Xen, Microsoft Hyper-V and VMware vSphere for enabling scaling with confidence to address the large market of servers and applications that have yet to be virtualized.

    Those same applications and servers are often described as not being able to be virtualized as that is assumed to mean squeezed, aggregated or consolidated. As a result, companies like VMware, Microsoft and Citrix along with other software and management tool vendors have a multi-front marketing campaign which includes the consolidation market that continues, as well as moving up market to start addressing those server and application footprints that in the past have been perceived as not possible to virtualize (e.g. consolidate). Too make things more interesting if they were not already, these different marketing campaigns apply across desktop/workstation, servers and storage on both a local as well as remote or cloud basis.

    Perhaps what is needed is more clarify from the vendors including tiered pricing or licensing models that align with the different deployment campaigns. For example one model that aligns well for consolidation scenarios and another for non highly consolidated environments where the focus expands more to premium service delivery, performance Quality of Service among other characteristics.

    There is another message hidden in this VMware discussion which is people are perhaps starting to wake up and look at the cost of software licensing along with the opportunity to reassess, analyze and start optimizing those resources with the same vigor that some focus on with for hardware resources.

    Before rushing to judgment, unless you have already done an analysis of the impact for yours or your customer’s environments, take a look at what the actual cost ramifications will be. I have seen some comments where on first look the new model looks bad however on deeper analysis, it can be ok.

    On the other hand, it could also look good on the surface only to have surprises as you dig deeper. For VMware, their partners, VARs and consultants, this should be a good opportunity to get in front of your customers to begin if you have not already done so a conversation around license management and different models along with what how the value of new features impact the TCO (total cost of ownership) and ROI (return on innovation) by using them.

    For VMware customers, if you have not yet done so, call your VAR or business partner or VMware representative to have them explain the new features as well as have them do a license model assessment with you to determine how to move forward. For VARs, you have a golden opportunity to get in front of your customers and add value to help your clients to the best fit for a licensing strategy vs. trying to differentiate on price.

    VMware could do very well right now to make some noise and if needed, launch a quick campaign from a positive angle (or spin) of now is the time to start analysis your investment in license which should be seen as a key IT resource. Of course if there is something to be scared of, then I suggest VMware put their helmets on, mouth guards in, strap on the knee and elbow pads, perhaps a Kevlar jacket and take what the customer base has to say.

    Here are some links for those that are interested in some of the themes mentioned about:

    Should Everything Be Virtualized?

    http://www.storageio.com/blog/?p=719

    Server and Storage Virtualization – Life beyond Consolidation

    http://storageioblog.com/?p=426

    Whets your take on open virtualization alliance and VMware?

    http://storageioblog.com/?p=1958

    Ok, nuff said for now

    Cheers gs

    Greg Schulz

    Independent IT Advisor at http://storageio.com

    Author Cloud and Virtual Data Storage Networking (CRC Press) www.cvdsn.com

    Blogger at http://storageioblog.com

    Twitter at http://twitter.com/storageio

    Independent VMware vExpert

  • Report this Comment On July 16, 2011, at 6:30 PM, hill4and6 wrote:

    Over 90% of the VMware clients don't have to buy additional license.

  • Report this Comment On July 16, 2011, at 6:31 PM, hill4and6 wrote:

    VMware said that only about 2% of its clients have to buy additional licenses.

  • Report this Comment On July 16, 2011, at 6:44 PM, hill4and6 wrote:

    Please get the most basic facts straight.

  • Report this Comment On July 16, 2011, at 6:45 PM, hill4and6 wrote:

    This site has difficulty posting long responses.

  • Report this Comment On July 16, 2011, at 6:46 PM, hill4and6 wrote:

    All my reponses longer than 2 sentences were lost.

  • Report this Comment On July 16, 2011, at 6:49 PM, hill4and6 wrote:

    VMware sets 24GB vRAM for Essential (or Plus)/Standard, 32 GB for Enterprise, 48GB for Enterprise Plus.

  • Report this Comment On July 16, 2011, at 6:50 PM, hill4and6 wrote:

    Vast majority satisfy those requirements.

  • Report this Comment On July 16, 2011, at 6:52 PM, hill4and6 wrote:

    The claim that really use (24GB*4), (32GB*4), or (48GB*4) per CPU is just unreal.

  • Report this Comment On July 16, 2011, at 6:53 PM, hill4and6 wrote:

    Go to VMware's community sites, to see a testing thread.

  • Report this Comment On July 16, 2011, at 6:54 PM, hill4and6 wrote:

    communities_dot_vmware_dot_com_slash_thread_slash_321065?tstart=0

  • Report this Comment On July 16, 2011, at 6:57 PM, hill4and6 wrote:

    I am sorry for having to cut my response into pieces to get it posted.

  • Report this Comment On July 16, 2011, at 6:58 PM, hill4and6 wrote:

    "The consensus seems to land somewhere around two to three times higher licensing costs, which makes the virtualization software at least as expensive as the hardware it's running on." is very wrong.

  • Report this Comment On July 16, 2011, at 6:59 PM, hill4and6 wrote:

    "Estimates of the costs involved in applying this new structure to systems built with the old pricing in mind range from mildly higher to many times the old expense." is very wrong!

  • Report this Comment On July 16, 2011, at 7:00 PM, hill4and6 wrote:

    Vast majority don't have to buy more licenses when upgrading.

  • Report this Comment On July 16, 2011, at 7:06 PM, hill4and6 wrote:

    I think that VMware could/should significantly increase those limits.

  • Report this Comment On July 16, 2011, at 9:29 PM, hill4and6 wrote:

    In Jan., you wrote a post "Is VMware's Honeymoon Over Already?"

  • Report this Comment On July 16, 2011, at 9:32 PM, hill4and6 wrote:

    "It's harder to like the nosebleed-inducing price-to-earnings ratio at 125 times trailing earnings. "is very wrong.

  • Report this Comment On July 16, 2011, at 9:34 PM, hill4and6 wrote:

    Excluding one-time items, P/E is about 55, forward P/E is about 40.

  • Report this Comment On July 17, 2011, at 10:25 AM, jabberwolf wrote:

    A vast Majority DO have to buy when upgrading when it concerns any VDI projects. Or if there are high CPU or even high density core servers - this will cost more $.

    VMWARE has always been a financial annoyance will all its surprise licensing fees. But now its boiled over from an annoyance to down right anger.

    Dont get me wrong (as I think Vmware has the best HA failover technology in the business) but now if there are servers I can move over, I will to Xenservers.

    This coming from an IT admin. So I do see the article's point.

  • Report this Comment On July 17, 2011, at 11:44 AM, hill4and6 wrote:

    The testing thread indicates vast majority doesn't have to buy more licenses. This is a licensing realignment. These days, physical memory per CPU is getting bigger and bigger (so is virtual), so it makes more sense to charge on vRam.

  • Report this Comment On July 17, 2011, at 11:59 AM, hill4and6 wrote:

    Did you run one of those scripts to show your licensing requirement? You can post the result there, as a feedback. So far, only 2 people in that thread need to buy more licenses. The more serious one is 6 licenses short (when having 10). It is nothing like "concensus...2 or 3 times higher".

    Of course, as I had said, the limits set by VMware should be increased some.

  • Report this Comment On July 17, 2011, at 12:04 PM, hill4and6 wrote:

    The first post's biggest problems were presenting a minority's case as majority' case, and exaggerating the difficutly of buying more license for the minority by too many times.

    This is a new typle of licensing model. So there should be adjustments down the road.

  • Report this Comment On July 17, 2011, at 12:15 PM, hill4and6 wrote:

    The new licensing intends to have some users to pay more, for it is realigning based on use of virtual Ram. VMware feels that some clients (2% according to its estimation) needs to pay more.

  • Report this Comment On July 17, 2011, at 12:29 PM, hill4and6 wrote:

    "VMware View is licensed by concurrent connection and the vSphere Desktop included in the View bundle continues to be licensed by concurrent connection with unlimited vRAM entitlement." No license change in this case.

  • Report this Comment On July 17, 2011, at 12:29 PM, hill4and6 wrote:
  • Report this Comment On July 17, 2011, at 1:49 PM, hill4and6 wrote:

    So, you have the option of NOT UPGRADING to vSphere 5, or moving to vSphere Desktop.

  • Report this Comment On July 17, 2011, at 1:54 PM, hill4and6 wrote:
  • Report this Comment On August 03, 2011, at 10:30 PM, gregschulz wrote:

    Looks like VMware has made changes to their new license model that was announced on July 12 and discussed above.

    Here is a link that VMware put out today talking about the changes.

    http://blogs.vmware.com/rethinkit/2011/08/changes-to-the-vra...

    Cheers

    gs

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