Oracle Triggers Price War in the Servers Market

Global database software vendor Oracle Corp. (NYSE: ORCL) recently introduced a new generation of aggressively priced engineered systems. Engineered systems are a type of server, or “converged” system, into which data storage and networking systems have been integrated into a single product. Integrated as well, typically, are applications and any required middleware, so that converged system can be offered, with via the cloud or on-premise, as a bundled solution. Naturally, these engineered systems carry far higher prices and margins than standalone servers.

Now, Oracle has introduced the fifth generation of its Exadata line named Oracle Exadata Database Machine X5, at cutthroat prices. This new system is priced at $562,000, which i claims is about 40% cheaper than the existing products offered by VCE, the joint venture of Cisco (NYSE: CSCO) and EMC (NYSE: EMC). ^[1] The relative market position of these participants is clouded by virtue of the fact that Oracle leads the segment that is dedicated to application specific platforms while VCE leads the general-purpose segment. Thus, according to a report by IDC, Oracle leads the Platforms segment (with Q2 2014 revenues of $1.0 billion) with over 50% market share and VCE leads the Infrastructure segment (with $1.3 billion) with 24% share.  Aggressive pricing claims aside, it is clear that vendor selection is generally driven by software decisions.

In this report, we will evaluate Oracle’s strategy with respect to engineered systems and if it has the potential to rescue its floundering hardware business.

We currently have a prices estimate of $47 for Oracle, which is slightly higher than its market price.

See our complete analysis of Oracle here

Revival of Oracle’s Hardware Business Pinned on Engineered Systems

Oracle’s sales of new hardware have declined continuously since fiscal 2011 due to the failure of its bet on the Unix platform for standalone servers. As a result, it steadily lost market share in the global server market to competitors offering the x86 platform.  Consequently, last year Oracle lost its 4th position in the global server market to Cisco. In December 2014, we opined that the loss of market shares in the global servers industry is not a matter of major concern because Oracle is focusing on the rapidly expanding ‘integrated systems’ (common parlance for what Oracle calls ‘engineered systems’) market (Read: Oracle Loses 4th Spot in Global Server Market to Cisco).

According to IDC, integrated systems are a nearly $8 billion market that has been growing at rates as high as 68% in third quarter of 2013. This nascent market is already nearly as big as the stand-alone server market, which is estimated to be generate $10 billion in 2014. The high rate of growth in the integrated systems market and the limited number of players having the requisite customer base to capitalize on the market size makes it an attractive market for Oracle. Further, the high-value and high-margin nature of integrated systems present additional incentives for the company to revive revenues and profits in its hardware business.

Price War May Hurt Short Term Prospects

Oracle commands more than half of the specific-purpose integrated systems market, but lags behind competitors like VCE, Cisco and EMC in the general-purpose integrated systems market. Oracle has bolstered its specific-purpose integrated systems product line with the simultaneous release of a number of new products. These include the new Virtual Compute Appliance X5, Oracle FS1 Series Flash Storage System, Oracle Database Appliance X5, Oracle Big Data Appliance X5 and Oracle’s Zero Data Loss Recovery Appliance X5. These application-specific integrated computing systems come with Oracle’s tightly bundled software, so as to speed implementation for customers and relieve them of the burden of installaning and configuring software and middleware.  And in this sense they compete not only with VCE, but with SAP and the integrated solutions of IBM, HP and Dell, as well.

As per our estimates, Oracle’s cash profits from its Enterprise Servers division (which includes engineered systems) have remained stable around $1 billion since 2009. This is on the basis of a reported gross margin 56% for sales of new hardware. Even to maintain the current level of cash profits, Oracle needs to achieve at least a marginal improvement in gross margin in the near term. However, engineered systems already command over a third of its total hardware sales. Therefore, the aggressive pricing strategy for engineered systems may well exert a significant drag on the overall margins of Oracle’s hardware division. Note that only a deeper analysis of Oracle’s pricing claims will suggest the actual disparity with competitors like-for-like products.  As is always with case in Enterprise systems, first-to-market products often lack comparable products on which to base a comparison.  And Oracle has a long reputation for self-promotion. That said, we will continue to monitor segment profitability with care.

The company may be able to mitigate such a potential loss of profits by attaining substantial volume growth in engineered systems. But buyers of enterprise servers, whether integrated or standalone, are a notoriously sticky segment and acquisition of new customers is a difficult aim to achieve. Given that Oracle has a long way to go before it catches up to rivals VCE, Cisco and EMC, the former may have signed up for considerable short term pain from its hostile pricing strategy. Whether or not such short term pain provides adequate gains in the long term remains to be seen.

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1. Oracle Unveils Aggressively Priced Servers, Nasdaq, January 21, 2015 [↩]