NetApp faces challenging future: why?

Though NetApp has expanded in strategic technology areas, the enterprise networking company’s shrinking R&D spend portends future challenges.

NetApp’s renewed execution for a more focused portfolio and faster sales of strategic solutions such as all-flash arrays and its Clustered DataONTAP software enabled the vendor to reverse six consecutive quarters of  operating margin declines, driving the metric up 240 basis points to 0.5 percent during Q2 2016, said Krista Macomber, senior analyst at TBR.

NetApp’s 0.6 percent product revenue decline during the quarter demonstrates the technology vendor is rebounding from its problematic entrance into the flash storage market, as well as initial challenges around Clustered DataONTAP functionality and go-to-market initiatives. Notably, the number of systems shipped with Clustered DataONTAP grew 35 percent  during Q2 2016, with 82 percent of NetApp’s core FAS systems shipping with the platform during the quarter, and NetApp’s all-flash array revenue grew by 385 percent , vastly outpacing the overall flash storage array market in growth. Consequently, strategic solutions revenues grew 24 percent  to $857 million. NetApp still derives 39 percent of its revenue from legacy, mature solutions, and only 32 percent of its installed base currently runs Clustered DataONTAP, pointing to substantial opportunity for NetApp to continue shifting its business towards more profitable and sticky technology areas.

However, TBR notes headwinds for NetApp to overcome to secure its stance in a rapidly changing storage market. Most significantly, NetApp’s operating margin improvements were driven mainly by a third consecutive quarter of  reductions to R&D spend, as the company’s cost of goods sold and SG&A expense structures rose as a percentage of revenue. This is a threat as agile and cutting-edge innovation increasingly influences storage vendors’ ability to differentiate, as long-standing architectures and purchase models become massively disrupted by customers’ need to serve rising, data-centric demands from lines of business with greater efficiency and agility. As a result, TBR believes it will become more challenging for NetApp to sustain bottom-line improvements as it seeks to remain aligned with customers’ evolving workload requirements.

TBR identifies a key opportunity for NetApp to overcome this developing challenge by applying its cost restructuring program to stabilize its gross margin. We also believe that the extent to which NetApp can reduce attrition to hyperconverged platforms will substantially influence its revenue and profitability moving forward. TBR research indicates that the hyperconverged platforms market will grow at a 50 percent CAGR from 2015 to 2020 to more than $7 billion, increasingly displacing legacy storage technologies and offering customers an accelerated onramp to private cloud and software-defined storage implementations. However, unlike key peers including EMC and HPE, NetApp does not currently have a dedicated hyperconverged platforms offering. TBR believes unified initiatives around NetApp’s FlexPod, Clustered DataONTAP, and SolidFire capabilities that target hyperconverged platforms customers’ critical, workload-specific requirements around rapid time-to-deployment, scalability, and cost-effectiveness will help NetApp to protect its installed base and improve financial performance.

NetApp enhances its data protection solutions to support customers during their transitions to hybrid cloud environments

As part of NetApp’s strategy to refine its data fabric capabilities to better capitalize on customers’ ongoing hybrid cloud migrations, the vendor is enhancing its data protection portfolio with a focus on streamlining its user interface and enhancing support for cloud-based applications and cloud-integrated backup methodologies. These developments will further NetApp’s ability to address customer pain points around capacity and cost constraints as well as complex, lengthy recovery processes in their disaster recovery, backup and archive environments.

NetApp plans to tailor its solutions to address specific customer requirements around availability and security of disaster recovery and backup and archive environments, in increasingly complex and heterogeneous, cloud-based environments – while also converging and simplifying management. At the same time, NetApp is bolstering its ability to address customers’ holistic requirements as they transition to hybrid cloud environments. These ambitious moves require heavy investments, however. TBR believes they will place further pressure on NetApp’s margins in the short term, but position NetApp in the long term to expand its market share as well as increase its footprint upstream, serving large enterprise customers’ data protection requirements. Additionally, NetApp faces challenges from competitors who are also making updates to their data protection offerings; for example, Fujitsu recently launched its ETERNUS CS200c S3, a backup solution designed for hyperconverged platforms, as customers are often using hyperconverged platforms to assist with private and hybrid cloud buildouts.

NetApp is messaging the increased agility, limited downtime and cost-effectiveness that its updated data protection offerings provide to its customers. To differentiate from competitors such as HPE and EMC, NetApp points to the interoperability of its data protection and primary storage offerings, including the improved integration of core management capabilities. Going forward, NetApp will message the ability of its new data protection solutions to integrate with NetApp Private Storage for Cloud, enabling high-performance and low-latency storage performance. TBR believes these messaging campaigns will help maintain NetApp’s mindshare among customers evaluating data protection solutions for cloud environments.

NetApp ramps up investment in flash storage to sharpen focus on next-generation storage opportunities

Following its February 2016 acquisition of SolidFire, NetApp has been refining its approach to capturing burgeoning demand for flash storage. These efforts enabled NetApp to grow its all-flash array revenues 385 percent , to a run rate of $775 million. Enhancing its ability to capture demand for flash storage is strategic for NetApp; TBR’s Q2 2016 Data Center Server and Storage Market Forecast indicates that the volume of flash storage arrays sold will increase to more than 50 percent of storage market revenues by 2020. To accelerate its flash storage sales, NetApp is offering flexible subscription-based pricing models while also enhancing scalability and adding new capabilities such as containers. NetApp also is targeting all-flash requirements, seen through the announcement of its FlashAdvantage 3-4-5 program, which is a marketing initiative designed to accelerate the adoption of NetApp storage addressing customer demand for a low-cost, simplified entry into the flash market. TBR believes the 3-4-5 program will help NetApp gain more customers, especially in the SMB segment, for its all-flash storage solutions.

NetApp is leveraging technologies gained from SolidFire to differentiate around the scalability and software-defined functionality that customers increasingly require to serve next-generation applications, while strengthening its presence with large service providers. NetApp is executing its flash storage portfolio roadmap and pricing models to address these needs, for example, by enhancing support for application containers and offering utility-based pricing. In addition to helping NetApp gain flash storage market share, these developments enhance NetApp’s value proposition in serving hybrid cloud, hyperscale and hyperconverged platforms customer requirements.

Although NetApp is accelerating its execution in the flash storage market, competition is strong. For example, IBM has long messaged the value of an all-flash data center, and broadly expanded and refreshed its flash portfolio during 1H16. Additionally, the pending acquisition of EMC by Dell creates an inroad for competitive displacements for NetApp. To help block competitors’ inroads, NetApp is refining its channel programs to increase monetization of its recent flash portfolio investments. For example, NetApp and SolidFire are in the process of integrating their channel programs and partner ecosystems to extend their customer reach in the market. Increased sales to service providers such as LeaseWeb, supported by traction that SolidFire has in the market, better position NetApp to further maximize its market reach by addressing customer demand for “as-a-Service” IT delivery.

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