John Chambers, CEO of the giant networking equipment company Cisco, has never lacked either optimism or ambition. Even during the most difficult of times, when his company’s spectacular inventory write down in 2001 triggered a global collapse in high-tech stocks, Chambers took to the airwaves to reassure everyone that the Internet revolution had scarcely begun.
Now, with the economy calmer, Chambers has been underlining his extraordinary ambition, and his fighting pedigree, once again. With sales of $22 biliion a year, and owning a 70% share of its core router and switch markets, Cisco towers above its rivals in scale, the breadth of its product line and its influence in the IT industry.
But that is not enough – not nearly enough. In recent years, growth has slowed in Cisco’s core router and switch markets (see charts), and its margins have come under intense pressure. The response: rather than hunker down, Cisco intends to build up to 12 new $1 billion-a-year businesses, two of which, Chambers says, could be $2 billion businesses within five years.
If Chambers is successful, it will not only cement Cisco’s already dominant position in the networking equipment industry, but it will turn the company into a $35 billion IT behemoth, taking Cisco deeper into the data centre, into new application areas, and even into the home.
If it is unsuccessful? Cisco may find that sales, and certainly prices, of its routers and switches start to fall away – and this time, it will not just be because of wider cyclical economic issues. It could be the start of long-term decline. Already, top Wall Street analysts, such as Nikos Theodosopoulus of UBS, have published notes saying Cisco’s margin decline is irreversible.
IT analysts underline the vital importance of the new initiatives. “Cisco’s future will depend on its ability to grow beyond its established strongholds,” says analyst Mark Fabbi of Gartner, the IT advisory company.
Some analysts liken Cisco’s challenges to those of some of its big customers in the telecoms industry: the network may be packed with fibre, routers and switches, but this can be also be seen as a mass of largely dumb and increasingly commoditised pipes, with the cleverer functions and higher margin services running on computers at the edge of the network.
It is here that software handles prioritisation, quality of service, security, application acceleration and new, converged multi-media applications, such as voice and video over IP. And it is here that Cisco is leading a dash to extend its domination. These areas have attracted a host of start-ups, big networking rivals and big computer systems builders, who all want a stake.
Cisco, with its billions in cash and (still) high valuation, is the favourite to take control of many of these markets – provided it executes well. With a new wave of network-oriented innovation under way in Silicon Valley, it has the power to buy its way into almost any market that is adjacent to its own – and the expertise, brand and reseller network to press home its advantage.
With double digit growth and good profitability, Cisco remains a model technology company in most respects. But pressure on router and switch margins has pushed Cisco’s shares down to a near one-year low in recent months, further exacerbating the steep decline from the best years of the Internet boom.
But industry watchers who attended Cisco’s annual analyst conference in December detected a changed mood at the company, with Chambers and his executive team far more focused on the future than they have been for several years. “Chambers presented a very strong growth picture, and this is a company that is usually very conservative,” says Peter Hall, research director for IP services at Ovum.
The new focus can be seen in its acquisition pattern. In one year, back in 2000, Cisco made 22 acquisitions worth nearly $13 billion; in the subsequent four years, it made 24 acquisitions, worth less than $4 billion. Now the spending is expected to leap again as the company seeks to grab a share of the emerging markets. In 2005, it has already bought wireless switch maker Airespace for $450 million.
Cisco has also expanded significantly into the mid and low ends of the networking market, especially through the $500 million acquisition of Linksys, the home and small business specialist.
“Cisco’s business is now pretty widely spread across enterprises and service providers, and the company is trying to increase its penetration in small and medium enterprises, a market that is still under-developed,” says Ovum’s Hall.
But most important of all, Cisco is building up its Advanced Technologies businesses. If they are successful, its 12 new businesses will not only sustain the fast growth the company is used to, but they will give Cisco the leverage and the technology it needs in its continuing battle to dominate the complex, intertwined enterprise markets.
In six of these markets, Cisco has been building up its business for the past two to three years. These include home networking (Linksys); IP telephony; optical networking; security; wireless technology; and storage area networking. In each case, the market opportunity runs into billions, and Cisco has invested hundreds of millions in acquisitions and research to take a strong, if not always leading, position.
The impact has already been dramatic and substantial. Advanced technologies are expected to contribute to more than 20% of revenues by its second quarter 2005 – amounting to more than $4 billion a year. Just two years earlier, these units accounted for less than $1 billion.
And the story is only half complete. Only six of the advanced technologies markets have been revealed. Systems management, business activity monitoring, web services management and application acceleration are likely areas of interest.
In presentations, Cisco executives frequently point out that Cisco is the market leader in some 10 product categories, ranging from established routers to new IP telephony systems. The message: why risk relying on a lesser and riskier supplier? Or on one that only provides a partial solution? It is an argument that largely works.
As Cisco attempts to hold onto its domination in routers, and gain control of new markets, it will increasingly emphasise the importance of having a full, and coherently integrated product set.
This is also vitally important in routers and switches, where more and more functions are being brought into the core devices – especially routers. If a router has the intelligence to spot a rogue server or workstation on a network and quarantine it, or the ability to choke back the type of traffic that is generated by a denial of service attack, then networks will become more reliable and more secure, Cisco argues.
This is all part of what Cisco is calling the Intelligent Information Network (IIN). “What was running at the computer layer will increasingly run at the network layer,” says Nick Earle, VP of marketing, planning and operations for Cisco, EMEA. This means that rules, policies, security and some business processes – along with a whole array of network services – will be managed and run at the network layer.
It is a widely accepted argument – with one caveat. Not everyone agrees that it needs bigger, more integrated routers. “I agree it’s right to put more intelligence into the network. But when the router was designed, we did not envisage the types of problems we have today,” says Eric Benhamou, the chairman of 3Com, and of Swan Labs, a start-up that supplies application acceleration devices. He believes certain functions cannot be retrofitted, and are ably supplied by third party suppliers.
Cisco is also pushing a related concept: the Next Generation Network (NGN). This is the idea that a single intelligent IP network can be used to handle voice, video and data. Issues such as quality of service, as well as pure bandwidth, will be dealt with through the IP NGN infrastructure.
The NGN is particularly important to carriers, where Cisco still faces many weighty competitors, some with more complicated multi-protocol solutions. Cisco presents the IP NGN as a way for service providers to cost-effectively offer new services, such as integrated voice, video and data.
Joined up, signed up
Many customers find the argument of one joined-up, intelligent and largely single supplier network persuasive, and Cisco has signed some huge deals with carriers and enterprise customers. For Cisco, this is good news – success with this approach is crucial for the growth of its advanced technologies businesses, and for preventing commod-itisation of routers and switches.
“Building the components of a network system where each serves an integrated role in the network requires far greater design vision and coordination,” says Cisco’s chief development officer Mario Mazzola. “We must develop each part to fit together like pieces of a puzzle.”
But others are not so sure, arguing there is a counter trend: the increasing dominance of Ethernet technology and IP-based services is eroding any one vendor’s ability to differentiate itself in the marketplace. That, they say, means that the networking equipment market could look more like the PC market, with competition bringing down prices and margins.
Fabbi of Gartner warns customers they “should not just assume Cisco’s products are the best fit for all of their circumstances”. Competition remains intense. Chambers acknowledges competition will increasingly come from Asia – and many analysts see a market where it is no longer necessary for enterprises to buy from the best of breed supplier. In many product areas, rivals might not have to offer a better product. A lower price will be good enough.
“Cisco is trying to stay one step ahead, but they are running out of problems to solve,” says Jon Collins of analysts Quocirca. “That is why they are working on combining voice, video and storage. But once they have done that, what is Cisco’s differentiator?”
Cisco’s response: it offers a rich, strategic vision, and provides all the integrated components. Its strategists see the network as a fabric of intelligent, interworking devices, with routers at the core.
“In the enterprise market, Cisco’s philosophy is to make the customers’ premises equipment more and more complex,” says Hall at Ovum. “They have routers that support security and IP telephony and storage. Who knows where it will stop? You could run business applications on the routers.”
This approach dovetails with a wider trend in IT: outsourcing. A more intelligent network makes it much harder for customers to switch to alternative suppliers, but it also means managing the network becomes more critical and more difficult.
This explains Cisco’s passionate engagement with service providers. It increasingly sees telecoms and Internet service providers as its channel to market, with service providers increasingly running the complex equipment for their enterprise customers. Gartner notes that whatever the pattern of the recent years, the carrier market is the single largest growth opportunity for Cisco.
Cisco’s approach requires that the company makes an impression, not just with the networking managers but with CIOs and other top level executives. It needs to persuade them that the network drives sufficient business efficiencies and opportunities to merit investment, and that premium equipment from Cisco will deliver the greatest efficiencies of all.
“The visibility of networks, at the CEO and senior level, has only emerged in the last couple of years,” says Chris Dedicoat, Cisco’s sales director for EMEA. “Companies realise that networks are a complex set of products and that the network is something they completely rely on”. Security and reliability, he says, are worth paying for – as is exploiting the power of new applications such as voice over IP.
“The key variable for us is how well we align what we do as a company with what our customers will pay a premium for. If you look at 2005, if Cisco executes well it will be the year that we took our whole focus to the new level,” says Chambers. If it does not, a growing number of competitors are willing to challenge Cisco’s leadership.