The Net on Cisco’s Numbers: It’s Time to Think Above UCS

Cisco reported their numbers last night, and while their results were better than expected, they showed both a drop in profits and in revenues.  That’s not the kind of indication that Cisco likes, and so it was pretty certain that Chambers would be raising the hope of change.  In the call, his “keynote” statement was:

Our conviction around how we’re evolving Cisco is strong and resolute. You’ve seen us deliver incredible innovation, make bold moves in the market to capture future opportunities and disrupt our competitors and ourselves when necessary. We remain committed to do the right thing to increase our long-term strategic value to our customers and advanced Cisco toward our goal of becoming the number one IT Company.

Cisco knows it needs to evolve, to make bold moves, to capture future opportunities and be disruptive “when necessary”.  But first and foremost, Cisco needs to make its numbers, beating at least slightly the expectations of the Street.  That’s not really that easy to do these days because of the dreaded problem of TAM, or Total Addressable Market.

Service providers have historically spent about 18 cents of every revenue dollar on capex.  That means that Cisco’s base opportunity is growing relatively slowly.  At the same time, competitors (especially Huawei) are driving down the prices and eating some of Cisco’s market share.  Cisco is forced to cut costs to avoid a highly negative trend in gross margins, and so far they’ve succeeded in doing that.  But if Cisco wants to be a market leader and sustain itself in its strategic “Number One IT Company” goal, they have to broaden their base, increase their TAM.

UCS was a big success story for Cisco in the quarter, with revenues up 29%.  The problem is that margins on UCS are lower than Cisco’s average, one reason why giant rival IBM sold off its x86 business.  Cisco has been able to drive UCS forward largely by leveraging network-related opportunities arising in its own installed base.  If Cisco decided to broaden its server thrust, it would encounter competitors who had a longer-standing position in the new spaces, and likely that would further erode UCS margins.  Switching, which is the data center stuff we know is critical, is off 6%, showing that competition and lack of differentiation are hurting Cisco where they can’t afford to be hurt.

Cisco needs a bold move that expands TAM and margins at the same time, and to me that means they need that “platform strategy” I’ve blogged about this week.  All my survey data shows that both enterprise and service provider buyers are having a difficult time creating a trial of next-gen technology or next-gen services that actually builds credibility for the business quality of the solution and not just the technology.  If you could bundle more business value into your product, you’d have a leg up on competitors who rely on the customer to do the heavy lifting up what’s clearly a pretty high ladder to major changes and opportunities.  Platforms start with data center support, and Cisco actually has a better hardware portfolio in the data center than IBM now has.  But, as we’ll see, it’s not enough.

Chambers said that Cisco generated about $3.2 billion in free cash flow, and spent $3 billion of that on dividends and stock buyback.  That means that Cisco is spending a heck of a lot just protecting share price.  Their reduction in OpEx of about 6% means they’re shedding people and product areas too, and this reduces their ability to innovate, even where it would be possible to do so without compromising near-term sales.

Everyone wants Cisco to jump out and win in “SDN”, but some realize that if you follow the current arguments on SDN its success is inevitably and explicitly going to reduce TAM, the very TAM Cisco needs to grow.  SDN is a way of doing connectivity cheaper based on current sales/trial manifestos, and that’s not a good thing for the market leader to support.  SDN, in OSI terms, is a trip down the stack at the very time when operators are demanding new services and revenues that live much higher up.  SDN is not the right strategy for Cisco, it’s a good tactic to help bootstrap the right strategy.

I can’t help but think that Cisco’s big opportunity is in the NFV space.  No, I’m not saying that the sun, rising in the east, will exhibit the letters “NFV” on the face tomorrow AM, or any other time.  NFV isn’t a directly consequential issue, but it’s a poster child for the need of the markets today and the way that need can be addressed in an evolutionary way, which is what Cisco has to have.

We aren’t entering the cloud era, or the SDN era, or even the NFV era.  We’re entering the virtual era.  Virtual means that we abstract functions to make the portable, composable, and agile across a pool of technically and geographically diverse resources.  This notion is going to transform applications.  It’s going to transform services, and it’s also going to transform the very foundation of infrastructure by creating a whole new set of relationships, issues, and optimalities.  The fact is that we don’t know what this new stuff will look like, not exactly.  We do know its properties, and that’s where Cisco could stand tall.

Cisco’s platform future could be solidly based on a set of layers that augment what we have—hardware, Linux, OpenStack—with the kind of platform-services-middleware stuff that will support the virtual era.  NFV is exposing the key issues, even if the body doesn’t necessarily see that or even want it.  In fact, I see in the discussions over what the NFV ISG becomes after the formal sunset of the first phase in January 2015, the first hints that the ISG sees the outlines of the “New NFV”.  Cisco hasn’t been exactly bombarding the NFV space with support and relevant follow-up.  It’s time they did something there.

Most of all, it’s time Cisco platformized their own cloud, SDN, and even network evolution.  The future of infrastructure is more like a vast swirling moat of specks of this and that, collected ad hoc to do something valuable.  That’s not what we have today.  Cisco is one of the few vendors who actually has most of the pieces needed to create this new superplatform.  So, John, if you’re serious about being disruptive when necessary, here’s your disruptive opportunity.

Leave a Reply