The Road Ahead for the Networking Industry

Think network hardware is going great?  Look at Cisco’s results, and at Juniper’s decision to push even harder in security (which by the way is also a hot spot for Cisco’s quarter).  Look at the M&A in the vendor space.  Most of all, look at everyone’s loss of market share to Huawei.  USTelecom Daily Lead’s headline was “Network Hardware Woes Crimp Cisco Sales in Q2.”  SDxCentral said “Cisco’s Switching and Routing Revenue Dragged in Q2.”  Switching, routing, and data center were all off for Cisco and total revenue was down (again).  Do we need to set off fireworks to signal something here?

We clearly have a classic case of shrinking budgets for network buyers.  On the service provider side, the problem is that profit-per-bit shrinkage that I’ve talked about for years.  On the enterprise side, the problem is that new projects to improve productivity are half as likely to have a network budget increase component as they were a decade ago.  The Street likes to say this is due to SDN and NFV, but CFOs tell me that neither technology has had any measurable impact on spending on network gear.  Price pressure is the problem; you beat up your vendors for discounts and if that doesn’t work you go to Huawei.

None of this is a surprise, if you read my blog regularly.  Both the service provider and enterprise trends are at least five years old.  What is surprising, perhaps, is that so little has been done about the problem.  I remember telling Cisco strategists almost a decade ago that there was a clear problem with the normally cyclical pattern of productivity-driven IT spending increases.  I guess they didn’t believe me.

We are beyond the point now where some revolution in technology is going to save network spending.  In fact, all our revolutions are aimed at lowering it, and Cisco and its competitors are lucky that none of them are working very well—yet.

Equipment prices, according to my model, will fall another 12% before hitting a level were vendors won’t be willing/able to discount further.  That won’t be enough to stave off cost-per-bit pressure, so we can expect to see “transformation” steps being taken to further cut costs.  This is where vendors have a chance to get it right, or continue getting it wrong.

There is no way that adding security spending to offset reductions in network switch/router spending is going to work.  Yes, you could spend a bit more on security, but the gains we could see there can’t possibly offset that 12% price erosion, nor can they deter what’s coming afterward.  What has to happen is that there is a fundamental change in networking that controls cost.  The question is only what that change can be, and there are only two choices—major efforts to reduce opex, or a major transformation of infrastructure to erode the role of L2/L3 completely.

Overall, operators spend perhaps 18% or 19% of every revenue dollar on capital equipment.  They’ll spend 28% of each dollar on “process opex”, meaning costs directly attributable to service operations and customer acquisition/retention, in 2017.  If we were to see a reduction in capex of that 12%, we’d end up with about a two percent improvement.  Service automation alone could reduce process opex by twice that.  Further, by 2020 we’re going to increase process opex to about 31% of each revenue dollar, an increase larger than the credible capex reduction by price pressure could cover.  By that time, service automation could have lowered process opex to 23% of revenue.  That’s more than saving all the capex budget could do.

SDN and NFV could help too, but the problem is that the inertia of current infrastructure limits the rate at which you could modernize.  The process opex savings achieved by SDN/NFV lags that of service automation without any infrastructure change by a bit over two years.  The first cost of the change would be incurred years in advance of meaningful benefits, which means that SDN/NFV alone cannot solve the problem unless the operators dig a very big cost hole that will take five years or more to fill with benefits.

The infrastructure-transformation alternative would push more spending down to the fiber level, build networks more with virtual-wire or tunnel technology at the infrastructure level, and shift to overlay (SD-WAN-like) technology for the service layer.  This approach, again according to my model, could cut capex by 38%, and in combination with service management automation, it could cut almost 25 cents of cost per dollar of revenue.  The problem is the time it would take to implement it, because operators would have to find a way to hybridize the new model with current infrastructure to avoid having a fork-lift-style write-down of installed equipment.  My model says that SD-WAN technology could facilitate a “soft” migration to a new infrastructure model, so the time needed to achieve considerable benefits could be as little as three years.

So, what can the network equipment vendors do here?  It doesn’t take an accountant to see that the service automation approach would be better for network equipment vendors because it wouldn’t require any real infrastructure change.  However, there are two issues with it.  First, the network equipment vendors have been singularly resistive to pushing this sort of thing, perhaps thinking it would play into the hands of the OSS/BSS types.  Second, it may be too late for the network vendors to jump on the approach, given that operators are already focused on lowering equipment spending by putting pressure on vendors (or switching to Huawei, where possible).

Some of the network equipment strategists see inaction as an affirmative step.  “We don’t need to do anything to drive service automation,” one said to me via email.  “Somebody is going to do it, and when they do it will take capex pressure off.”  Well, I guess that’s how the waffling got started.  Others tell me that they saw service automation emerging from SDN/NFV, which they didn’t want to support for obvious reasons.

The potential pitfall of the inaction approach is that a competitor might be the one who steps up and takes the action instead of you.  Cisco can afford to have Amdocs or perhaps even Oracle or HPE become a leader in service automation, but they can’t let Nokia or (gasp!) Huawei do that.  If a network vendor developed a strong service automation story they could stomp on the competition.

Worse, an IT vendor could stomp on all the network vendors if they developed a story of service automation and our push-down-and-SD-WAN model of infrastructure.  Operators are receptive to this message for the first time, in no small part because of something I’ve mentioned above—they’ve become focused on cutting capex by putting price pressure on vendors.  SD-WAN has tremendous advantages as a vehicle for offering business services, not the least of which being that it’s a whole lot better down-market than MPLS VPNs.  It’s also a good fit to cloud computing services.  A smart IT vendor could roll with this.

If we have any.  The down-trend in network spending has been clear for several years now, and we still find it easier to deny it than to deal with it.  I suspect that’s going to change, and probably by the end of this year, and we’ll see who then steps up to take control over networking as an industry.  The answer could be surprising.