Everybody Wants to Eat EMC’s Lunch

It’s a humdrum office park 27 miles west of Boston. But through the ’90s,
the Hopkinton (Mass.) home of EMC Corp. (EMC ) was the global capital of the
soaring data-storage market. EMC’s stock rose from a split-adjusted 7 cents to
$101, making it the top performer in the Standard & Poor’s 500-stock index
during the ’90s.

The world was bursting with digital information, and EMC’s massive
disk-drive machines, regarded as the best of breed, gave companies around the
world a secure place to store every last bit. Naturally, it came at a premium
price. One competitor joked that "EMC" stood for Excessive Margin Co.

Those
margins are shriveling fast, as legions of competitors, including IBM,
Hewlett-Packard, Dell Computer, and dozens of upstarts, rush into the market.
They’re not all building the refrigerator-size machines that EMC made famous.
These days, even startups and midsize companies want storage, and they’re
demanding cheaper machines–all of them linked to networks. The key is no
longer simply to save the information but to manage and retrieve it faster.

That’s why on Aug. 20, Cisco Systems Inc. made a play to grab a bigger
chunk of network storage. It announced an agreement to purchase Andiamo Systems
Inc., a maker of storage switches. For now, Cisco is angling for leadership in
the $1 billion switch market, which is off EMC’s turf. "But Cisco may
have grander ambitions," says Steve Duplessie, founder of The Enterprise
Storage Group Inc. "Then it could get ugly for EMC."

EMC already has all the competition it needs. Its stock price has withered to
a mere 7% of its 2000 high, and HP, strengthened by its Compaq Computer Corp.
acquisition, has raced ahead in market share, with 25.6% to EMC’s 17.3%. The
question now is whether EMC CEO Joseph M. Tucci can lead the $7 billion company
through a wrenching transformation to software and services–without succumbing
to a takeover. To do so, he must match former IBM Chairman Louis V. Gerstner
Jr., who pulled off a similar makeover in the ’90s. That was a Herculean task.
What’s more, analysts say, EMC, a far smaller company than IBM, with a market
capitalization of $16.8 billion, could get even cheaper, becoming irresistibly
bite-sized as it struggles to remake itself in a merciless market. "Their
window is closing," says Ashok Kumar, senior research analyst
at U.S. Bancorp Piper Jaffray.

Who would buy EMC? Now that storage is growing in corporate networks,
practically every big tech company is pushing into the business. They all want
to sell a complete suite of digital offerings to their customers, and EMC,
despite its bumps and bruises, is still at the front of the class in storage
hardware and software. This would make the former highflier a juicy target not
only for IBM and HP but also for newcomers to storage such as Cisco and Dell.
Bear, Stearns & Co. analyst Andrew Neff predicts a possible HP-EMC merger.
Of course, HP, fresh from its Compaq purchase, won’t likely be in a courting
mood for a year. Still, the deal has a certain logic: EMC would provide HP with
its own top-of-the-line offering, Neff says–while breaking up EMC’s
increasingly chummy relations with Dell.

EMC’s ability to remain independent hinges on software. The big challenge
is to come up with a program that stitches together today’s crazy quilt of
storage systems. The typical data center has several types of storage boxes on
its floor that can’t talk to one another or share storage space if one gets
overloaded. The magic bullet for them would be software that connects them all
and automates management, taking much of the manual labor–and cost–out of
the process.

A Powerful Packof Competitors
	Its share rose from 12.7% in 2000 to 15.6% in ’01, while EMC’s fell from 20% to 17.3%. It hopes to up the ante with software linking storage and networks.
	The acquisition of Compaq made HP No 1 in storage. It now rules the fast-growing midsize market with a 41% share, vs. EMC’s 6%. On Aug. 20, it said it would share key technical specs with IBM.
	A punishing hardware market has pushed longtime storage leader EMC into the red and battered its stock. EMC’s goal now is to move into more profitable storage software and services. The risk: head-on collisions with burly rivals.
	As storage moves onto networks, it enters Cisco’s realm. On Aug. 20, the company took a big step into storage networking by agreeing to buy switchmaker Andiamo.
	Last year, it partnered with EMC to sell midrange storage boxes. Now Dell plans to make and sell a low-end unit, using EMC technology. The risk: Dell’s knowhow will grow until it no longer needs EMC.

EMC engineers are racing to come up with just such magic. A program called
AutoIS promises to let corporate managers store and retrieve data no matter what
machine it resides on. Trouble is, rivals are following suit–and AutoIS isn’t
complete, though a big piece is due in October.

Tucci doesn’t downplay the immense job ahead. He’s too busy mapping out a
plan for his specialty business to survive in a world of giants. The strategy:
EMC, in the fashion of Japan’s keiretsu, teams up with a group of service
partners, including Accenture and Electronic Data Systems, to sell and install
the systems. And an eventual merger? "I don’t spend a second worrying
about it," he says. He has more immediate concerns. Hardware makes up 56%
of his business, and prices are plunging at least 30% a year. This is likely to
help drive down revenue from $7 billion last year to $5.7 billion in 2002, while
earnings tumble from last year’s $168 million, excluding restructuring charges
of $825 million, to a net loss of $84 million, predicts Neff of Bear Stearns.
Even with revenue shrinking, Tucci is resisting temptations to slash spending on
research and development. He’s holding it nearly flat at $800 million, or 14%
of revenue.

Much of it is going into software. But here, Tucci’s proposed keiretsu
threatens to punish his margins. The reason is simple: If EMC’s partners sell
its software, they hold on to a piece of the profits. Sanford C. Bernstein &
Co. analyst Toni Sacconaghi estimates that EMC’s 85% margins for direct
software sales in the midrange market will plunge to 55% in the Dell
partnership.

Tucci remains confident that he’ll be able to bolster margins in other
ways. Over the past year, he has attacked costs by trimming inventories,
reducing manufacturing and testing time, and cutting staff. For growth, he
concluded a key deal in October with Dell to sell co-branded products. This
gives EMC entrée to thousands of new customers in the midrange storage market
dominated by HP, which has a 41% share to EMC’s 6%. But competitors call it a
desperate move, one that benefits Dell more than EMC.

EMC and Dell also are crafting a plan for Dell to make a low-end storage box
designed by EMC. Royalties from the deal, Tucci says, will boost margins. He
predicts that overall gross margins will return to 45%-plus from 38.3% now–still
down from a peak of 59%.

Software will be the key to fatter profits, and EMC currently has the edge.
It leads its rivals with a 30.4% market share; IBM and EMC have yet to agree to
an exchange of technical specs. Tucci says he has made an offer and is still
waiting for Big Blue to respond. IBM says EMC has been resistant to open
standards.

Such difficulties are typical of an industry rife with bad blood after a
decade of EMC’s dominance. But EMC’s easy years are history. Now the onetime
storage king has to do whatever it can to keep standing on its own feet.

By Faith Keenan in Boston, with Spencer Ante in New York and
Cliff Edwards in
San Mateo, Calif in BusinessWeek. Copyright 2002 by The McGraw-Hill Companies, Inc