Storage Drives Are Low on Fibre

Storage vendors are grappling with a shortage of higher-margin Fibre Channel drives.

EMC Corp. (NYSE: EMC) CEO Joe Tucci said during his companys earnings conference call Tuesday that he is concerned over how the shortage of Fibre Channel drives will affect his company through the first half of this year (see EMC Closes Year With a Bang). Tucci says he expects EMC to fill enough orders to hit its targets, but the shortage will cut into the company’s profit margins until drive vendors catch up with demand.

Seagate Technology Inc. (NYSE: STX), which supplies at least 50 percent of enterprise hard drives to system makers worldwide, confirmed the shortage last week as its executives admitted they had trouble keeping up with orders at the end of 2004 (see Seagate Reports Q2).

“Information from various sources suggests there is an industry wide enterprise drive shortage," writes analyst Tom Curlin of RBC Capital Markets in a research note today. He says lead-time for EMC systems extended to three or four weeks in December and current delays at Hewlett-Packard Co. (NYSE: HPQ) are two to three weeks because of the drive shortage.

The shortage is not a bad deal for Seagate or its competitors, which include Fujitsu Computer Products of America Inc., Hitachi Global Storage Technologies (Hitachi GST), and Maxtor Corp. (NYSE: MXO). The drive makers have traditionally lowered pricing by around 10 percent every quarter to win the storage vendors’ business, but the drive shortage now gives them leverage.“The drive manufacturers don't exactly have a lot of reasons right now to continue to drop their costs. That's kind of how we see it," said Tucci yesterday.

The bad news applies to Seagate customers, including EMC, which buys nearly all its drives from Seagate, and to Dell Inc. (Nasdaq: DELL), IBM Corp. (NYSE: IBM), and HP. For these companies, the profit equation has been tipped.

Here's the basic problem: Disk drives make up 25 to 35 percent of the total cost of a storage system. At the same time, the system vendors sell Fibre Channel drives at a higher margin than SATA drives, which appeal to customers for their low cost. Fibre Channel drives command a premium price because they are more reliable and perform better than SATA (see Cheaper Than Fibre Channel, Faster Than Tape and Survey: SATA, IP SANs Hot Priorities).

Bottom line? Vendors like EMC won't be taking home that little extra joy that makes Fibre Channel drives, particularly in high-end systems, so nice to sell.

The consequences are tough to predict. But at least one analyst thinks Fibre Channel system price hikes are unlikely to occur. “It is very hard to pass along any price increases of components to end users,” says analyst Kaushik Roy of Susquehanna Financial Group. “Especially when your competitors are heavily discounting the storage subsystems.”Given the current heightened competition among high-end system vendors EMC, Hitachi Data Systems (HDS), and IBM, storage vendors will probably absorb the costs rather than pass them on to customers, he says.

Since the shortage is mainly affecting high-end systems, it's also unlikely to drive customers toward puchasing alternative products, such as IP SANs. Still, much depends on the severity and duration of the problem -- and its cause.

RBC's Curlin says in his note that the shortage is caused primarily by the impact of recent earthquakes and floods on Asian manufacturers.

But Seagate CEO Bill Watkins attributes the shortage to a sharp increase in demand. Perhaps aided in part by Maxtor's woes (see Maxtor Shoots for Enterprise Growth), Seagate shipped a record 3.3 million enterprise drives last quarter -- up 22 percent from the previous year and 11 percent sequentially. On their earnings call last week, Seagate executives said they had trouble meeting demand by the end of last year.

Although storage sales usually drop sequentially in the first quarter of the year, demand appears to be still running ahead of supply.

“As we move into the March quarter, we're currently in a situation where more is being demanded of us than we can supply,” Seagate worldwide sales EVP Brian Dexheimer told analysts last week. “And it's unclear at this point where the endpoint is on that.”Tucci’s guess is that the shortage won’t last longer than midyear. “My experience shows me that you kind of get through these things in a kind of six-month period, so we'll see how that goes."

— Dave Raffo, Senior Editor, Byte and Switch