Trouble In Store For Data Storage King?

The market leader is facing heat from aggressive rivals

On a gray November day in New England, the mood inside EMC's (EMC) headquarters in Hopkinton, Mass., is sunny and bright. Executives of the data-storage market leader see no limits to the world's expanding appetite for machines that hold digital versions of everything from CEO speeches to marketing pitches to X-rays. With EMC execs predicting that storage demand will soar fiftyfold by 2003, Chief Executive Officer Michael Ruettgers is so confident that he calls EMC recession-proof. "We make the highest-performing stuff," he says.

Having masterfully managed EMC from obscurity to market leadership in eight years, knocking off IBM (IBM) in one of its core franchises along the way, Ruettgers' confidence is understandable. As other tech stocks have been taken to the woodshed and punished for falling demand or squeezed profits, EMC has scarcely been nicked. Its shares today trade at about $80, 10% over their price in March. The reason? Gross margins of 57% and sales and earnings gains of 30% to 50% in recent years. EMC is the class act in the $31 billion-a-year storage business, which researcher Dataquest Inc. expects to grow at 19% a year until 2004. The company's storage machines--arrays of hundreds of disk drives that hold millions of documents--dominate corporate data centers.

Sound too good to be true in today's doom-and-gloom tech market? It just might be. The storage giant faces a growing roster of rivals--from reinvigorated old-timers such as IBM to upstarts like Network Appliance Inc. (NTAP)--who say EMC is a vulnerable target with a shrinking technology edge. They may soon have even more company. Venture capitalists have tripled their investments in the sector, to $411 million, since 1998, says researcher VentureOne Corp. And customers who have long been willing to pay a premium for EMC machines are tiring of pricing policies and product strategies that lock them into using expensive software that works only with EMC's hardware.

Take StorageNetworks (STOR), which manages data storage for large companies. Last year, StorageNetworks bought virtually all of its gear from EMC. This year, it will spend less than half of its $96 million budget on EMC machines. StorageNetworks wanted more flexibility than EMC could offer. Storage buyers "are a lot smarter today," says Peter Bell, a former EMC exec who is now CEO at StorageNetworks.

Couple those trends with a possible slowdown in overall tech spending, and EMC could be headed for a rougher ride than it has grown accustomed to. While the company is unlikely to be unseated as market leader anytime soon, the combination of restive clients and hungry competitors could slow EMC's stellar growth and pinch its hefty margins. There is some evidence this already has begun. Customers are "holding EMC's feet to the fire" in negotiations, says John Webster, an analyst at market researcher Illuminata Inc.

Just ask Gene Deans. He's the database administrator for EchoMail Inc., a Cambridge (Mass.) e-mail management company. When Deans was shopping for a new storage system last spring, EMC offered one of its big machines for $900,000. After IBM proposed a comparable unit for $512,000, Deans says EMC came back at $600,000. Deans ended up with IBM. Big Blue was still cheaper, and offered a more economical path to higher-capacity machines down the road. Not long ago, "EMC was the only game in town," Deans says. "Now there's another player." EMC would only say that many customers will pay a premium for reliability.

In fact, there are lots of other players. The growing ranks of storage makers include the likes of Sun (SUNW), Dell (DELL), Compaq (CPQ), Hewlett-Packard (HWP), and Hitachi Data Systems. Hitachi, for example, has bailed out of the mainframe computer business to focus on big storage machines and now expects more than $1.6 billion in storage sales this year, up from $900 million in 1999. Dell Computer Corp., the company most responsible for driving margins in PCs to their current razor-thin levels, increased its storage revenues by 73% last quarter and should see more than $1 billion in sales next year, says Russ Holt, general manager of Dell's Storage Systems Group. "Our goal is to commoditize the low-end to midrange portion of this market," Holt says. In time, he warns, as the smaller machines become more capable, that will put pricing pressure on EMC.

Scores of lesser-known companies are targeting EMC as well. Network Appliance, of Sunnyvale, Calif., has been especially nettlesome. Its machines are smaller than EMC's and can often do the same work more cheaply. Debra Martucci, a vice-president at software maker Synopsys (SNPS), has two EMC units. When it came time to add capacity this year, though, she chose Network Appliance. She says NetApp offers all the capabilities of EMC's equipment and came in at about a quarter of the cost.

Though EMC remains the gold standard for large centralized storage systems, its advantages, along with its juiciest profits, have come from software. Its programs have long been ahead of competitors' in allowing EMC systems to instantly send backup copies of data to storage machines in remote locations. And EMC's programs have an unparalleled reputation for reliability. Best of all--for EMC, at least--these programs run only on EMC boxes. That means any customer who wants to take full advantage of EMC's software is locked in to a double whammy of top-shelf pricing.

Rivals, though, have begun to duplicate EMC's software. Hitachi can now do remote backups. Veritas Software Corp. (VRTS), based in Mountain View, Calif., writes programs that run on server computers instead of the storage devices, avoiding the EMC software-hardware lock-in. And IBM is developing a program that will manage storage on devices from various vendors--including EMC.

With rivals on the attack, EMC has developed a full arsenal of hardball tactics to protect its storage turf. EMC's salespeople won't accept a "no" from a client's technology chief and will often go over his or her head to close a sale. When top customers buy a competitor's machines, EMC has been known to buy the device from the customer and install one of its boxes instead. And to counter the threat from Network Appliance, EMC is readying a new, smaller device that many in the industry are dubbing a "NetApp Killer." Ruettgers, though, has drawn the line at software. While opening his programs to run on rival machines might please customers, it could threaten margins. He likens his systems to high-performance cars and sniffs, "You can't always take the tires off a race car and put them on motorcycles."

EMC's defensive measures will certainly help to maintain its lead in the storage industry. But each step deeper into the fray presents a threat to EMC's precious margins. To remain competitive, EMC will often undercut rivals' prices--something it rarely had to do when it was alone at the top of the market. Nonetheless, EMC is confident that it can more than hold its own against its rivals. "The competition will set their prices under our umbrellas," says EMC'S chief operating officer, Joe Tucci. But as too many companies have learned, when the competitive winds start swirling, the umbrellas can all too suddenly collapse--darkening even the sunniest of moods.

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