Sun Microsystems’ x86 Strategy

Over the years Sun Microsystems has been extremely apprehensive of Linux, and x86 based servers. Sun did recognize cheap x86 hardware as a threat long time ago, but the company didn’t know what to do about it. Sun was afraid of entering the x86 market as the margins in the x86 market were not healthy, and such a move would have cannibalized its high-margin UltraSparc business.

After the dotcom bubble burst, Sun made a number of bizarre moves with regards to the x86 market, but these days Sun looks firmly committed to a game plan. Solaris x86 which Sun was once planning to discontinue has become central to the company’s plans. Sun is cutting back on UltraSparc development, and is readying itself to pursue life as a major x86 server vendor.

According to a report by The Register, Sun will be rolling-out a number of in-house engineered Opteron based servers and storage solutions in 2005. Another report by The Register claims that, Sun is planning to sell 414,000 Opteron based servers in 2007, and the company is aiming for a double-digit share of the x86 server market.

Some of Sun’s x86 gains will surely come at the expense of its high margin Sparc business so the company has to compensate for that loss. But, Sun can’t expect to gain market share quickly if it doesn’t price its x86 hardware competitively. Sun is faced with two conflicting goals in the x86 market, but the company has figured out a way to extract decent margins while pricing its x86 hardware competitively.

Sun has calculated that if it generates reasonable Opteron server volume, it can get massive discounts from AMD. Sun anticipates that none of the major x86 servers vendors will move away from Intel’s Xeon processors any time soon. For pragmatic reasons, Dell, HP, and IBM can’t afford a duplication of their server lines; IBM and HP are offering a few Opteron based servers, but they are not seriously marketing them. Consequently, Sun can own the Opteron based server market, and push AMD for the volume discounts it needs to make money on x86 sales.

If Sun succeeds Dell and others will be tempted to enter the Opteron market, but by that time Sun will have developed massive Opteron server design expertise, big volumes, and a complete range of Opteron server offerings. These first mover advantages will act as entry barriers and will stop Sun’s competitors from getting in the Opteron server market.

Sun also expects that Intel will not initiate a price war with AMD. A price war will only hurt Intel’s profitability as AMD isn’t making too much from server processors. Moreover, none of Intel’s major customers can force Intel to get into a price war with AMD. Intel’s major customers Dell, HP, and IBM can only try to pressure Intel, but that is the limit of what they can do.

Dell does get special treatment from Intel but not in the form of better pricing. If Dell was getting better pricing, IBM and HP would have reported Intel for anti-competitive behavior. Intel simply allocates large quotas of premium desktop processors (processors in short supply) to Dell, and Dell sells these processors at good margins. The only thing exclusive about the arrangement is that only Dell could have benefited from any such arrangement. Intel would have gladly duplicated the same arrangement with IBM and HP, but IBM didn’t have much of a PC business, and HP likely caters to a customer-base which isn’t too interested in acquiring the latest at a premium.

Intel will only get into a price war with AMD if Sun tries to take more than 25-30 percent of the x86 server market. Of course, Sun won’t hit that kind of market share any time soon, and the company has plenty of room for profitable growth.

Sun has the hardware costs under control, but it also needs to control Solaris development costs. According to an article by Wired, Sun spent $500 million developing Solaris 10. Solaris 9 was released in April 2002 so Sun must be spending roughly $200 million a year developing new functionality for Solaris.

An operating system also requires support infrastructure and maintenance, and these costs can be quite significant. Apart from the usual, compilers/assemblers/debuggers, utilities, patches/updates, drivers, code reviews, etc., Sun also has to support multiple Solaris ports. Sun is already committed to Sparc, Opteron, and Xeon ports, and the company will likely need to support an Itanium port as well. This suggests that Sun’s total Solaris development costs are no less than $400 million a year.

This amount of money is no pocket change, Dell spent $464 million on R&D in all of 2003, and Dell is much bigger in terms of revenues than Sun. The development cost is all the more significant for Sun as in the x86 market Solaris will be competing against Linux, and Linux development costs get shared by thousands of volunteers and businesses. Right now Redhat and Novell are charging good money for Linux, but this doesn’t mean they will continue to do so even when Solaris becomes a threat. The Linux development model allows Redhat and Novell a lot of leverage in setting prices, and they will use this leverage if required.

Any attempts to duplicate the Linux development model won’t work for Sun. Sun is releasing Solaris under an open source license, but it is mostly a marketing ploy to gain mind-share, and win Microsoft’s blessing. Sun knows Linux developers are not going to switch to Solaris in the short-term, and many Linux features are being maintained by commercial companies anyway.

Sun intends to combat the Linux advantage by assuring that the money it puts in Solaris yields a competitive advantage in the form of clear technical superiority over the competition. Sun will also attempt to tightly integrate software and hardware development in order to quickly bring advanced functionality to the market. But, the real key to Sun’s success will be volumes.

If Sun manages to sell millions of servers, Solaris development costs will get dispersed over the large number of units shipped and become irrelevant. Moreover, Sun will be able to make money from add-on sales, and service/maintenance contracts. Also, Solaris will displace Linux as the open source operating system of choice, and this will allow Sun to steal IBM and HP’s Unix customers.

Microsoft will be very supportive of Sun’s attempts to push Solaris as the open source operating system of choice. In the long-term a popular and technically superior Solaris will divert development effort from Linux and hurt Linux vendors. Solaris will be open source but it will still be controlled by Sun and will not pose a threat to Microsoft as Sun’s ambitions are quite limited. Sun wants to make money and is not interested in starting margin squeezing price wars with Intel and Microsoft.

Sun’s overall strategy suggests that UltraSparc has no future. Sun has poured large sums into UltraSparc development in the past and is being forced to do so even now, but UltraSparc has been clinically dead for a long time now. It lags benchmarks and likely costs the company more than 50 percent of its R&D budget. If Sun’s Opteron sales takeoff, the company will become less reliant on UltraSparc revenue, and the incentive to keep wasting money on UltraSparc will diminish.

Sun has placed a very bold bet on x86, and the company will emerge highly profitable and competitive if it manages to execute its game plan effectively. The downside is that if the game plan fails so will Sun. In that case, Sun will get swamped by hardware and software development costs and quickly go out of business.

by Usman Latif  [Dec 20, 2004]

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