We have some financial news from the industry today, and we can weave it with some of the technical topics that have been buzzing around to pose a question. How would SDN and NFV transform the competitive landscape? Will the business of networking, the vendors who drive it, be significantly impacted by these technologies? The Street is obsessed by that point, and while I don’t favor shared obsessions, I do think we should consider the impact of change on the business of those who must drive or resist it.
My models suggest that SDN and NFV combined will account for about 14% of capital spending by operators in 2018, and that the number will increase slowly to about 18% beyond that. However, the mix of equipment purchased will be more dramatically impacted. We’ll see lower-layer technologies (fiber and first-layer electrical) increase by almost 60%, traditional routing and switching decrease by about 25%, and server spending explode. Total capex will actually grow through the remainder of this decade, but shift away from Layer 3 (and to a slightly lesser extent Layer 2) to move upward and downward.
If we assumed that SDN and NFV were productized—you could buy an NFV like you can buy a router—the impact of this on vendors would be fairly clear. You’d see competitive pressure increasing and margins decreasing for the traditional network vendors and you’d see increased focus on being the “enabler” of these changes so that you could pull through your own products by framing the projects in your own terms. Thus, if you are a network equipment vendor the best SDN/NFV strategy would be to field a product that could quickly address the benefits that will drive all this change. You can then re-frame your own products and strategies to capitalize on the moves you’re driving.
If you’re an IT player, it’s more complicated. The largest capital investment made in either SDN or NFV is likely to be servers. The problem is that the servers will be under enormous margin pressure from the first. COTS (commercial off-the-shelf) servers are already so price-constrained that IBM doesn’t want to sell them. So can you differentiate your servers? Never. That pressures you to field a complete SDN/NFV solution so you can drive the market’s evolution yourself and make room for your own stuff. If you don’t, others will drive the deals and you’ll get the leavings.
What makes it complicated is that if you decide to try to drive the deals, you end up competing with the network equipment vendors who have a better position in the current market, better control of the accounts. So there’s a tendency for the IT players to think in terms of providing servers into what they hope will become an open solution to SDN and NFV.
All of this can be seen in the way the industry is acting this year. Capex is under pressure, not because of SDN and NFV but because operator return on infrastructure is declining. SDN and NFV could, if aggressively and correctly applied, fix this problem. That means that much of the decline in network-equipment capex would happen with or without NFV and SDN. The things we fear are actually what we are depending on to save us. And for the usual reasons of protecting incumbencies, we’re not moving much.
You can see from the financial reports this week that vendors like Alcatel-Lucent and Juniper are increasingly securing profit growth by cutting costs rather than by raising revenues. That’s because they won’t or can’t be aggressive enough to be drivers of an SDN/NFV revolution. They need to offer operators either higher revenues or lower opex, or capex pressure will continue. While Alcatel-Lucent has a decent strategy for both SDN and NFV, their positioning is weak. Is that because they don’t know any better, or because they don’t want to drive changes just yet?
Two winners emerge from this—Huawei and Ericsson. If we have capex pressure and no systemic response to improve operator return on infrastructure, we eventually kill margins for everyone but the price leader, which is Huawei. I told one of the traditional network vendors about five years ago that I wasn’t listing Huawei as their “competitor” because Huawei wasn’t a competitor—they were the winner if everyone else decided not to compete. That’s true.
Ericsson’s case is more interesting. Remember that I talked earlier about SDN/NFV productization as the logical course? All the Street pressure on near-term financial performance tends to force vendors to neglect revolutionary technology because revolutions take too long and also tend to further suppress current capex until the new stuff is proved in. But SDN and NFV conceptually advance (yes, slower than they should) and operators don’t want to see their networks become loss leaders. If I need the technology, and if there are no productized versions of it, what do I do? Answer: Integration.
Ericsson is the leader in network professional services. They are essentially taking a position that there will not be a cohesive set of SDN or NFV offerings available for years to come. Your problems, dear buyer, are here and now and these other vendor competitors of ours are building little islands where you need massive continents of new stuff. We will bridge your islands and build you those continents. Sign here, please, and be saved!
My model says that an integrator-driven model of SDN/NFV evolution would hurt every class of equipment vendor involved in networking other than the integrators. It would lower margins on servers, switches, everything. And because an integrator has no real incentive to build a cohesive tinker-toy product architecture, it could inhibit full realization of an open architecture.
It also says that integration-based approaches will take longer because they’re adopted more as a last-ditch defense than as an offense. Capex in networking could fall by 8% more by 2020 in an integration-driven model, because fewer benefits will be realized early on to improve things. More hurt, sooner hurt, isn’t a good thing.
The moral here is that every vendor in both the server and network equipment space is at risk not to the rapid success of SDN and NFV but by delays in achieving what either/both could do. They won’t tear the heart out of networking, displace everything we have now. They might add enough benefits to the pot to stop margin erosion and capex decline.