IT and storage economics 101, supply and demand

In my 2012 (and 2013) industry trends and perspectives predictions I mentioned that some storage systems vendors who managed their costs could benefit from the current Hard Disk Drive (HDD) shortage. Most in the industry would say that is saying what they have said, however I have an alternate scenario. My scenario is that for vendors who already manage good (or great) margins on their HDD sales and who can manage their costs including inventories stand to make even more margin. There is a popular myth that there is no money or margin in HDD or for those who sell them which might be true for some.

Without going into any details, lets just say it is a popular myth just like saying that there is no money in hardware or that all software and people services are pure profit. Ok, lets leave sleeping dogs lay where rest (at least for now).

Why will some storage vendors make more margin off of HDD when everybody is supposed to be adopting or deploying solid state devices (SSD). Or Hybrid Hard Disk Drives (HHDD) in the case of workstation, desktop or laptops? Simple, SSD adoption (and deployment) is still growing and a lot of demand generator incentives available. Likewise HDD demand continues to be strong and with supplies affected, economics 101 says that some will raise their prices, manage their expenses, make more profits which can be used to help fund or stimulate increased SSD or other initiatives.

Storage, IT and general Economics 101

Economics 101 or basics introduces the concept of supply and demand along with revenue minus costs = profits or margin. If there is no demand yet a supply of a product exists then techniques such as discounting, bundling or other forms of adding value to incentivize customers to make a purchase. Bundling can include offering some other product, service or offering that could be as simple as an extended warranty to motivate sellers. Beyond discounts, coupons, two for one, future buying credits, gift cards or memberships for frequent buyers (or flyers) are other forms of stimulating sales activity.

Likewise if there is a supply or competition for a given market of a product or alternative, vendors or those selling the products including value added resellers (VARS) may sacrifice margin (profits) to meet revenue as well as unit shipped (e.g. expand their customer and installed base footprint) goals.

Currently in the IT industry and specifically around data storage even with increased and growing adoption and demand deployment around SSD, there is also a large supply in different categories. For example there are several fabrication facilities (FABs) that produce the silicon dies (e.g. chips) that form nand flash SSD memories including Intel, Micron, the joint Intel and Micron Fab (IMF) and Samsung. Even with continued strong demand growth, the various FABs seem to have enough capacity at least for now. Likewise manufactures of SSD drive form factor products with SAS or SATA interfaces for attaching to existing servers, storage or appliances including Intel, Micron, Samsung, Seagate, STEC and SANdisk among others seem to be able to meet demand. Even PCIe SSD card vendors have come under pressure of supply and demand. For example the high flying startup FusionIO recently saw its margins affected due to competition which includes Adaptec, LSI, Texas Memory Systems (TMS) and soon EMC among others. In the SSD appliance and storage system space there are even more vendors with what amounts to about one every month or so coming out of stealth. Needless to say there will be some shakeout in the not so distant future.

On the other hand, if there is a demand however limited supply, assuming that the market will support it, prices can be increased from what discounts had applied. Assuming that costs are kept inline any subsequent increase in average selling price (ASP) minus costs should result in higher margins.

Another variation is if there is strong demand and shortage of supply such as what is occurring with hard disk drives (HDD) due to recent flooding in Thailand, not only prices increase, there can also be changes to warranties or other services and incentives. Note some of HDD manufactures such as Western Digital were more affected by the flooding than Seagate. Likewise the Thailand flooding was not limited to just HDD having also affected other electronic chip and component suppliers. Even though HDDs have been declared dead by many in the SSD camps along with their supporters, record number of HDDs are produced every year. Note that economics 101 also tells us that even though more devices are produced and sold, that may not show a profit based on their cost and price. Like the CPU processor chips produced by AMD, Broadcom, IBM and Intel among others that are high volume, with varying margins, the HDD and nand flash SSD market is also high volume with different margins.

As an example, Seagate recently announced strong profits due to a number of factors even though enterprise drive supply and shipments were down while desktop drives were up. Given that many industry pundits have proclaimed a disaster for those involved with HDDs due to the shortage, they forgot about economics 101 (supply and demand). Sure marketing 101 says that HDDs are dead and if there is a shortage then more people will buy SSDs however that also assumes that people are a) ready to buy more SSDs (e.g. demand) and b) vendors or manufactures have supply and c) that those same vendors or manufactures are willing to give up margin while reducing costs to boost profits.

Note that costs typically include selling, general and administrative, cost of goods, manufacturing, transportation and shipping, insurance, research and development among others. If it has been awhile since you looked at one, take a few minutes sometime to look at public companies and their quarterly securities exchange commission (SEC) financial filings. Those public filing documents are a treasure trove of information for those who sift through them and where many reporters, analysts and researchers find information for what they are working or speculating on. These documents show total sales, costs, profits and losses among other things. Something that vendors may not show in these public filings which means you have to look or read between the lines or get the information elsewhere is how many units were actually shipped or the ASP to get an idea of the amount of discounting that is occurring. Likewise sales and marketing expenses often get lumped into or under general selling and administration (SGA). A fun or interesting metric is to look at the percentage of SGA dollars spent per revenue and profits.

What I find interesting is to get an estimate of what it is costing an organization to do or sustain a given level of revenue and margin. For example, while some larger vendors may seem to spend more on selling and marketing, on a percentage basis, they can easily be out spent by smaller startups. Granted the larger vendor may be spending more actually dollars however those are spread out over a larger sales and revenue basis.

What does this all mean?

Look at multiple metrics that have both a future trend or forecast as well as trailing or historical perspective view. Look at both percentages as well as dollar amounts as well as both revenue and margin while keeping units or number of devices (or copies) sold also into perspective. For example its interesting to know if a vendors sales were down 10% (or up) quarter over quarter, or versus the same quarter a year ago or year over year. It is also interesting to keep the margin in perspective along with SGA costs in addition to cost of product acquired for sale. Also important is to get a gauge of if sales were down, yet margins are up, how many devices or copies were sold to get a gauge on expanding footprint which could also be a sign of future annuity (follow up sales opportunities). What Im watching is over the next couple of quarters is to see how some vendors leverage the Thailand flooding and HDD as well as other electronic component supply shortages to meet demand by managing discounts, costs and other items that contribute to enhanced margins.

Rest assured there is a lot more to IT and storage economics, including advanced topics such as Return on Investment (ROI) or Return on Innovation (The new ROI) and Total Cost of Ownership (TCO) among others that maybe we will discuss in the future.

Ok, nuff fun for now, lets get back to work.

Cheers gs

Greg Schulz – Author Cloud and Virtual Data Storage Networking (CRC Press, 2011), The Green and Virtual Data Center (CRC Press, 2009), and Resilient Storage Networks (Elsevier, 2004)

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