What VMware's New Prices Really Mean

VMware (NYSE: VMW  ) stirred up a storm last week by announcing a new pricing model for its flagship virtual machine manager, vSphere5. Some users complained loudly that the changes would make VMware incredibly expensive for them, and many of them threatened to move over to Citrix Systems (Nasdaq: CTXS  ) or Microsoft (Nasdaq: MSFT  ) alternatives.

The company's second-quarter earnings report has arrived, and it was the usual batch of good news: the company beat Street expectations all around with $0.51 of earnings per share on revenue of $921 million. Moreover, the third-quarter forecast points to another revenue bump, which would be inconsistent with massive user defections over the license changes.

Talk about the issues
CFO Mark Peek took time out of the earnings call to explain that the new vSphere licensing model is meant to "lay the foundation for customers to adopt a more cloud-like IT cost model based on consumption and value rather than physical components and capacity."

In other words, the pricing structure is being optimized for cloud-computing usage rather than for simply cramming heaps of hardware into ever-bigger machines. CEO Paul Maritz elaborated: "We believe that [memory in use rather than available memory and processors] is a better metric for the future as customers move to operating in a more cloud-like way. Customers wish to pay for what they're actually using and have the license cost scale with actual load."

Maritz said that the "confusion" between physical memory per machine and virtual memory actually allocated to VMware's vSphere instances led to most of the negative comments. "We believe under the new model, 95% of our customers will see no change to their licensing costs," he said, with the exception being very large implementations with high demands on maximum system efficiency. In those cases, Maritz feels that customers get what they pay for because of vSphere's unmatched feature set.

Why I believe these guys
VMware itself is in a better position to judge that impact than any of us pundits and paupers. After all, the company has system data for all of its current licenses on hand, and it'd be an easy task to simply run the numbers with different pricing models. I'm inclined to believe that VMware has done its homework and knows what it's talking about.

And in that case, the new structure comes close to the memory-based pricing plans of leading cloud service providers Amazon.com (Nasdaq: AMZN  ) and Rackspace Hosting (NYSE: RAX  ) . Both Rackspace and Amazon run their core cloud services on Citrix Xen virtual platforms rather than VMware software; this change arguably makes VMware more likely to make inroads into this important market. Now, IBM (NYSE: IBM  ) does use VMware software for some of its cloud services, but runs a long way behind those two Xen platforms in the cloud infrastructure market. There's a lot of ground left to cover here.

Step by step
Not to invade and dominate it right away, mind you; Xen's head start has made it difficult to replace at the drop of a hat. And VMware's prices are still higher than what you'd pay for a comparable Xen setup because Xen is an open-source solution supported by a worldwide army of enthusiastic developers, which drives down Citrix's costs for product development.

If anything, Amazon and friends could start to offer premium cloud products based on vSphere. Perhaps a solution like that with a generous helping of migration tools might persuade a high-profile cloud user such as Netflix (Nasdaq: NFLX  ) to jump onto vSphere-based platforms. I'm sure Amazon would love to sell part-rival, part-customer Netflix some higher-priced services, after all. But for now, vSphere is mostly a denizen of the corporate data center and not so much a public cloud platform.

And no, I don't think that VMware's new prices did any significant damage to the company's user counts, much as I don't see disgruntled customers fleeing Netflix in droves over its own recent pricing changes. Product prices can be a touchy issue, but again, these guys should know what they're doing.

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