Until the 1980s the computer industry was characterized by a vertical integration of the major players. They produced their own CPUs, operating systems, applications, networks, peripherals, interconnects, and in some cases clusters.
With the advent of the PC and Ethernet the industry had for the first time a high-volume computer and network. The IBM PC’s use of a Microsoft operating system and an Intel processor in an inadvertent open architecture set in motion a new set of economic forces that in less than 10 years drove several billion dollar plus minicomputer companies out of business.
Likewise ethernet volume drove the development of very low-cost networking components. With the broad acceptance of the TCP/IP protocol stack the die was cast and existing network architectures, including IBM’s Systems Network Architecture, DECnet and new ones that used token ring or token bus architectures were crushed.
Increasing volumes drove cost down the learning curve. Intel, after getting out of the DRAM business, used its gusher of money to drive process technology faster than any of its competitors could. Board and system vendors, able to concentrate on a single CPU architecture, drove their costs down creating an economic implosion that wiped out most competing chip architectures in less than a decade.
Likewise, Microsoft’s DOS and Windows operating systems, became effective standards for the high-volume computer business. Application vendors either migrated to Microsoft or died along with their minicomputer hosts.
The horizontal industry
In a decade the structure of the industry was radically changed: large vertically oriented computer companies such as DEC, Wang, Prime, Data General, CDC, and most of the seven dwarves ceased to exist. In their place arose a new group of horizontally integrated companies such as Intel, Microsoft, Cisco, Oracle, SAP and, in services, IBM Global Services.
In this new world the battles took place within these horizontal layers: Intel versus AMD and spark; Microsoft versus Linux; Oracle versus Informix and mySQL.
The vertical reintegration
But after 2 decades where it was obvious that horizontal integration was the winning strategy, we’ve seen a U-turn towards vertical business models again.
- Cisco moving into servers – and with that big warchest, how about storage too?
- EMC buying VMware to offer virtual servers. And selling real servers in Atmos.
- Oracle buying Sun and saying they’ll offer fully integrated HW/SW systems.
- Apple stocking up on chip guys.
- Other buys, like HP buying LeftHand and EDS, Dell & EqualLogic, IBM & XIV, that point to more integrated offers.
What’s going on?
Ask yourself what drove companies horizontal.
- Economy of scale. $10B companies could maintain credible R&D on all the pieces, but smaller companies couldn’t – creating a market for vendors who focused on 1 layer.
- Standards. Whether de jure or de facto, standards such as TCP/IP, MSDOS, Netware, SCSI and IDE opened people’s eyes to multi-vendor infrastructures and freedom from lock-in.
- Distribution costs. Dedicated account teams can keep CIO’s happy, but down market the margin dollars aren’t there for that kind of handholding. Enter the VAR channel and the distributors who support them.
- Increased capital intensity. With multi-billion dollar chip plants, coming investments for patterned media & HAMR, 10 & 40 GigE, small companies just couldn’t afford to stay in the game.
- Margin cherry-picking. Disk drive vendors did the work, but the array products got the margins. Likewise, Intel got great margins while server vendors didn’t – and the same with Microsoft and Cisco.
The dynamics are fascinating. This is only a partial list.
- Wall Street. If you want a higher stock price you need to show Wall St. that you can and will grow. When, like Cisco, you dominate your segment, what else can you do?
- Vertical is cheap. Companies are cheap right now. Lots of open source software. Fabless semiconductor design, commodity infrastructures, scale-out storage and computes: it just isn’t that expensive to move up the stack.
- Best defense. Cisco served notice on HP’s and IBM’s server business. EMC is plucking the high-margin software from commodity servers. Oracle could be packaging up dedicated app/database/server/storage racks and containers. Or sell you a service that does most of the same stuff.
- Solutions, not products. Sun made great building blocks – but customers don’t have the people to put them together and VARS aren’t getting the margins to do it for them. “I want an X that will do Y” is the customer demand. Package it up and win the sale.
- Shrinking margins. There is no shelter from this storm. Cisco knew its free ride was ending as IBM and HP look for more revenue – see “best defense” above.
The StorageMojo take
Blood on the streets. More M&A. Shifting battle lines.
“Co-opetition” is shifting to plain old bare-knuckle competition.
Vendors can say goodbye to 60% gross margins. Point product diversity will increase until the product landscape stabilizes. That will be about 5 years.
Courteous comments welcome, of course.