Will open source destroy VMware’s core virtualization business?

VMware, majority owned by EMC, makes money primarily by selling server virtualization software to large and medium sized businesses.  Virtualization software can be categorized into two primary segments:

1. Desktop Virtualization Software – Allows users to run multiple types of operating systems on a single desktop or notebook. For example, by using VMware’s desktop virtualization software, a user can run Apple’s Mac OS X from within a Microsoft Windows machine

2. Server Virtualization Software – Allows companies to increase the utilization of their servers by allocating server resources to software applications independent of the underlying operating system required to execute the application. In addition, the virtualization program optimizes the amount of hardware space and processing capabilities allocated to different software applications based on the software’s needs

Initially VMware made money by charging customers for both desktop and server virtualization software.  The desktop virtualization business is threatened by operating system distributions (e.g. Linux, Windows) that may include desktop virtualization software for free.  The server virtualization business is threatened by open source alternatives to VMware’s proprietary software.

In February of 2009, recognizing the threat to its desktop virtualization business, VMware decided to preemptively open source its existing desktop virtualization software meaning that end user PCs could use VMware’s software for free.  This free software, called VMware Open Client, makes it easier for businesses to host virtualized desktops from a data center which is exactly what VMware wants, since it can then sell businesses its server virtualization offering to improve data center performance.  While VMWare’s desktop virtualization software has gone free, VMware’s Software Pricing per Server has gone from ~$3000 in 2005 to ~$4500 in 2008 and we expect it to continue increasing over the forecast period.

Although VMware’s actions may have delayed the progress of Microsoft in capturing share amongst desktop virtualization offerings there remains the bigger threat that a combination of open source server virtualization alternatives and a decision by Microsoft to pursue server virtualization could limit VMware’s pricing power going forward.

Within VMware’s content on our platform, you can see how VMware’s stock would be impacted if Software Pricing per Server declined due to more open source alternatives to VMware’s offering.