David takes on Goliath in storage market

What may be good news for investors in IT companies is often not good news for technology users. Proof of this adage came to light last month when an IT analyst in New York raised his rating on storage supplier EMC and the stock promptly moved up by five per cent.

The bad news for users was that the Wit Soundview analyst, Gary Helmig, based his views on what he saw as a lack of competition for EMC in the mainframe storage market. Helmig, quoted by Reuters, said he believed "there is nothing aggressive in the pricing of the Hitachi 9000, and IBM is not really aggressively pricing Shark".

EMC has suffered most criticism over the cost of its disk arrays and attendant software, especially in the Big Iron arena. While the company rejects the notion that its mainframe business is a 'cash cow', with a 60 per cent market share, the ground is potentially fertile to exploit.

While EMC has successfully broadened out its traditional mainframe business to cover open systems and the new dotcom sector, there is ample evidence that it can still defend its massive margins in the mainframe arena.

EMC is expected to generate revenues of about $10bn this year and aims to be a $13bn company next year. It will spend $2.5bn on research this year alone to try and bolster growth, which at 30 per cent per year is considerably faster than the 20 per cent Dataquest predicted for the market as a whole.

And the supplier is doing all of this while defending a hefty net profit margin of about 25 per cent. Gross profit margins in key areas such as mainframe storage, are clearly much higher.

From strength to strength
But as far as EMC is concerned, things can only get better. At the Networld+Interop trade show in Atlanta in September, its chief executive Michael Ruettgers predicted the overall storage market would be worth as much as $100bn by 2005. EMC clearly wants to grab as large a slice of the pie as possible.

EMC is also touting its recent ECOstructures alliance with Oracle and Cisco as another potential revenue earner. Last month, the three rolled out their latest blueprint for building integrated systems based on a combination of their products. They are also opening an 'integration centre' to show off their wares in the UK later this year.

EMC, Oracle and Cisco are three of the members of what BusinessWeek calls "the four horsemen of the New Economy" - the other is Sun Microsystems - and it's no surprise that they are such natural team-mates. All three are market leaders in their area - and all face equal charges of exploiting their positions by charging high prices.

But EMC's rivals are still trying to sort themselves out in the storage market. IBM has faced delays in supplying key software for Shark, but is attacking on other fronts. Its alliance with Compaq makes sense for both companies as Compaq has a good hold over the PC network storage market and in the mid-range space, and IBM has the raw storage technology and high-end know-how.

Together, they are trying to push an open, non-proprietary message, and IBM even pulled out of the EMC-dominated Fibre Channel Alliance on the pretext that EMC was pushing proprietary offerings.

But despite IBM and Compaq's high profile, EMC's real competition could be coming 'under the radar' from a much smaller source.

The dark horse
Network Appliance generated just over half a billion dollars in sales last year, but the company is growing at 70 per cent per annum. Its strategy is simple: in a market dominated by a supplier of sophisticated and expensive hardware, offer an unsophisticated, cheap and cheerful product.

Network Appliance's offerings are built from off-the-shelf components, are easy to install and maintain, and take up less room than anything EMC provides. It's also usually about 30 per cent cheaper.

According to analysts at Merrill-Lynch, Network Appliance "should thrive and, over time, threaten EMC". They also recommend that investors hold on to shares in both companies for the next few years and then "be wary of EMC". So it seems that what may be bad news for EMC, could be good news for users.

• EMC's success is built on a lack of any strong competitors, according to analysts
• EMC aims to be a $13bn company - in revenue terms - by next year. It will spend $2.5bn on research this year
• EMC is working with Oracle and Cisco to develop integrated systems based on all of their products
• The biggest threat to EMC could be Network Appliance rather than IBM and Compaq