It is now being widely reported that Cisco is going to undertake a major restructuring. The Street said Cisco would lay off between 12% and 20% of its global workforce, and that it’s related to shifting resources from hardware to software. In their earnings call, Cisco confirmed the latter but said that only about 5,400 would be laid off. Since Cisco is the market leader in IP, which everyone seems to think is invincible as a technology, any significant restructuring would create considerable market shock and raise the inevitable “What now?” question. Let’s try to answer it.
Cisco and all the other network equipment companies got to where they are by ignoring the future to feed the present. The primary reason for this was the knee-jerk reaction of legislators and regulators to the NASDAQ bubble of the late ‘90s. Sarbanes-Oxley (SOX) in 2002 made it very difficult for companies or the Street to push anything but the current quarter. If you reward a particular class of behaviors, or more dramatically if you demand them by law, you get what you asked for.
Feeding the future means doing what’s needed to strengthen your position with your buyers in the long term. Sometimes that means taking a hit in the near term, supporting product and technology transitions that could hurt your revenue for multiple quarters. Because of SOX, in large part, that doesn’t happen much and certainly didn’t with Cisco, who is notoriously sales-driven. As a result, they face an immediate threat in the operator space, and a delayed one in the enterprise market.
The root of Cisco’s operator problem, and the market’s, is that despite hope and hype, operator profit per bit carried has been declining for two decades, for as long as SOX was operative though the timing I think is coincidental. Operators have been talking about the problem openly for a full decade, and proposing various projects to relieve the pressure under the name “transformation”. Everything that’s been going on in the network equipment space for the last decade, including things like SDN and NFV, the cloud, mobility, 4 and 5G and so forth, have been driven largely by the converging cost/price curves for bits. Operators have pled for relief. They’ve shifted increasingly to Huawei as a price leader, to the point where Huawei is probably the only equipment company doing well. Still everyone, Cisco included, stuck their head in the sand.
If revenue per bit and cost per bit are converging to exclude profit and ROI, you spend less. I’ve read transcripts on a decade’s worth of earnings calls and I never saw any vendor point out this obvious point or claim a strategic shift that was explicitly aimed at correcting it. Where I will fault Cisco specifically is that it instead implicitly promoted the notion that as long as Internet traffic was exploding, operators were obliged to carry it, profitable or not. Their Internet index stuff never called for any steps to address ROI with the increases in traffic, and they’ve backed regulatory positions that would favor settlement for Internet traffic and “non-neutral” concessions.
But that was then and this is now. Even now, nobody including Cisco is stepping up to say that things can’t go on as they are, but restructuring sure implies that, and the promise of a software shift is explicit. The question is what they mean by “software”. You can do a software transformation of your network gear, shifting to a hosting and subscription model. You can elevate your story to a higher, above-network layer too. Cisco seems to be focusing on the former, which changes their business less but changes their revenue prospects more.
Shifting to software-based networking and cutting costs by cutting staff is an admission of change, but it doesn’t specifically make a critical point, which is that operators are going to put capex under stringent pressure if they can’t raise ROI. Yes, a software-centric vision could be more appealing in a cost sense, but if it is then you’re making an important point in a too-subtle way. We are shifting to software to allow operators to spend less. Thus, we will make less.
The interesting thing is that while constraining capital spending seems to be the pathway of choice for operators, the fact is that it’s not one that they generally believe in. Way back in 2013 a group of global Tier Ones told me that they didn’t believe that NFV or any other new technology would reduce capex by more than 25% (they now tell me less than 20% is likely) and that they could get that much by “beating up Huawei on price.”
That poses the central question raised by all of this, which is whether there is a way to transform networks that solves the profit-per-bit problem a lot better than just buying cheaper switches and routers. If the answer is “Yes!” then Cisco could hope to restructure itself to fit the new demands of the transformed network space. Cisco has the capability of supporting this kind of transformation, but they seem unwilling to get involved in “transformation education” for their buyers. If it’s “No!” then it’s doubtful that operators could be induced to try any radical new infrastructure models, and network connection and transport will totally commoditize.
On the enterprise side there’s also a “driver” problem. While customer revenues are the top-line engine for operator profits, worker productivity is the top-line engine for enterprises. The problem is that we haven’t had an effective new driver for productivity enhancement since the late 1990s. Historically, networking has followed the rest of IT in that spending was a combination of sustaining current infrastructure (“budget”) and supporting new and beneficial activities (“projects”). Over the last decade, project spending as a percent of total spending has steadily declined, which means that most spending by enterprises just keeps the network lights on. How do you, as a buyer, make that better? By spending less.
It’s pretty clear that software would have to drive enterprise productivity changes, and Cisco has in the past aimed at productivity, but not very insightfully. The answer, they suggested, was full-room videoconferencing. The number of workers that such a technology would touch is minimal, neglecting the question of whether even for them there’d be a productivity benefit to justify the cost. Work is populist by nature, and if you want to empower workers you have to empower a lot of them or nothing much happens to your bottom line.
Collaboration is an option for empowerment. So is mobility, and contextual communications, and IoT. However, you can’t empower people by just connecting them, which means the mission for productivity software has to go beyond simply generating traffic. You have to get to the worker, what the worker needs in terms of information and relationships, and only then worry about connections. This is a complicated undertaking, requiring a lot of planning and a lot of sales effort educating the buyer. It’s not the sort of thing you do when regulations demand that you be rewarded only for your current quarter.
This is Cisco’s challenge now, and the industry’s challenge too. For decades we’ve thought about the problem of the future as being “connected”. More networking means more value, because the network was what was holding things back. That’s not the problem anymore, and Cisco’s moves prove that. The problem is being relevant, valuable in what we present though the connections. You can’t outrun product creation with product delivery.
Software can define a network. Software can automate manual tasks, and software can create information and contextual value. But a software-defined network is still really defined by a connectivity mission, and manual-task automation eventually runs out of humans to displace. Cisco’s software changes will help it only if they follow the network-to-value trail farther than they have in the past. The rest of the industry will have to learn the same lesson.
They could, and still can. Cisco is unique in the industry in the breadth of its technology offerings. The cloud, both the technological and “spiritual” fusion of network and IT, is something they probably get better than any other network vendor. Certainly they’re better positioned to leverage it than any other network vendor, but they have been bound by their own constraints, and by the ubiquitous SOX. They now have to break free.
Apply software to connection networks and you commoditize faster and are eaten by open-source. Cisco has to focus on the leading edge of the productivity and profit value proposition in both the enterprise and operator space, or they will never be a high-margin company again, with command of the markets and their destiny. There is absolutely nothing to stop them from doing all of this…but themselves. We’ll see if it does.