Dell’s Quarter, Router Trends, and CDN Sea Changes

Dell issued a contracted outlook for the rest of the year, which sent its shares down in after-market trading and also created concerns about tech spending overall.  Dell did decently in the quarter; only its consumer segment really missed targets, but the company lowered its guidance, citing pretty much the same factors of government spending reductions and consumer/business confidence problems that every else has talked about.  They also made some interesting comments about their Force10 deal, which we’ll get to in a minute.

The problem with confidence, according to our surveys, is in how it impacts PROJECT spending as opposed to “budgets”.  Typically, major changes in enterprise IT policy are funded by projects that link spending and some business benefit—productivity, normally.  The sustaining of the current infrastructure is “budget” or “department” spending.  In bad times, budget spending is usually sustained more than project spending, so somebody who had hoped to gain market share is more likely to be impacted.  Dell is still not a market-share leader in the server space, and it still has an exposure to the consumer market—though not as much as HP.  If project spending is indeed under pressure, then I’d expect HP to underperform in outlook as well.  If that’s the case, then it would tend to confirm that Cisco’s relative success in networking was due to the fact that as an incumbent it’s less dependent on new project dollars.

On the Force10 move, Dell indicated it was seeing data center networking as the hottest spot in the network space, which is surely consistent with my survey results.  They also said that they were launching the Virtual Network Services Infrastructure (VNSI) to brand their data center network offerings and unify them with cloud and virtualization initiatives.  We think this is very smart because it aligns with what enterprises are telling us, which is that they pay the most attention to vendors whose offerings align with their strategic priorities.  So while Dell may have many of the short-term macro-economic challenges of all the other players, they may be positioning well for the tech changes to come.

Strategic alignment may be the factor behind today’s UBS report on router market share.  In the report, Cisco and Juniper lost market share overall (Cisco by 1% and Juniper by 2%) while Alcatel-Lucent and Huawei gained.  These results are pretty consistent with the changes in strategic influence we uncovered in our spring survey, where Juniper dipped significantly in influence in the IP layer of the network and was unable to leverage service-layer positioning to gain project traction.

Cisco’s loss was due to enterprise problems, which is also interesting.  The power of the incumbent to drive spending is formidable, but if you go back to my comment earlier in this blog on project versus budget spending, you see that enterprises who pull money off the table are going to limit everyone’s upside.

There are new, real, benefits to be had for both enterprises and service providers, but vendors have been unable to grab them to drive higher investment in the network.  If that continues, then strategies of key data center IT vendors like Dell, HP, and IBM will take more and more of the data center networking pie, and network equipment vendors across the board can expect pressure.

Moving to the wonderful world of content, the latest rumor on the Street is that LimeLight has been on the block and that both AT&T and Microsoft have declined to purchase the CDN player.  Akamai, the leader in the CDN space, is widely seen as circling the drain.  Level 3 and LimeLight are now said to be in discussion on a deal to combine their CDN operations in some way.  How, you may wonder, does this square with the notion that the network operators are falling all over themselves to get into the CDN business?

Well, to start off with, network operators AREN’T eager to get into the CDN business.  They’re TOTALLY interested, even committed, to using CDNs to optimize metro bandwidth usage, particularly in mobile backhaul, and to monetize content through paid subscription and advertising.  The old sell-caching-to-content-owner CDN market is, for most, far less interesting.

Operators are deploying CDNs for their own missions and not to sell CDN services, in short.  In fact, most network operators don’t want to be providers of CDN services except as an offshoot of having deployed CDN technology for another reason.  In a third of cases, the operators say they may not offer a broader CDN service even if they actually deploy the technology internally for bandwidth optimization or content monetization.  The CDN is the central, critical, piece of content monetization infrastructure.  It’s the only feasible way to optimize metro bandwidth.  The challenge for CDN suppliers is to move out of the traditional mission, to focus on the two things that really matter to the prospective buyers of CDNs today.  This is truly critical technology, and it’s got to be sold strategically in today’s market, because the old-line CDN world is literally dying before our eyes.



More on Google/MMI

A day after the big announcement that Google would buy Motorola Mobility, we’re seeing a lot of reaction in the technology and financial media.  When I blogged on this yesterday I focused on what I thought would be the really significant and non-obvious ramifications of the deal.  Today I want to look at some of the more classical points, reflecting on the coverage the deal has gotten.

To most people the big question is whether Google is throwing Android partners to the wind.  Well, yes and no.  Yes, clearly Android partners would rather not see Google as a competitor if they had their druthers.  No, it’s not likely that the buy will really put those partners at a net disadvantage, and in any event Google believes that Android is for most the only game in town.  As we’ll see, they’re right.

The problem with Android today is it’s not only a horse designed by a committee, it’s a series of committees that aren’t even converged on “horse” as a goal.  Nominally, Android is an open-source project whose code is eventually released for all.  As a practical matter, the handset partners have influence on the state of development before such a public release.  The problem is that they all have different goals and interests, the only common point being “mess up Apple”.  While Android has the lion’s share of the handset market and is almost certain to have the same lead in tablets, it doesn’t have a conspicuous player to push it in the marketplace.  Apple can run iPhone commercials because nobody else (well, nobody except maybe in China)  makes iPhones but Apple.  The Android players have to be careful with promotion, particularly of software features, lest they promote the platform and all their competitors as much as they promote themselves.  Google’s entry into the market means that there will be a giant player who has every reason to want to push Android.

When IBM launched an open PC architecture, the competitors didn’t stay out of the space because IBM was still in it.  They relied on IBM to promote the concept and then they focused on differentiating themselves versus IBM in implementing the concept.  That’s what I expect will happen here.  Android will be better for the deal, and partners will be better off.

Given this, you’re not going to be surprised to hear that this isn’t good for Nokia and Microsoft, as some on the Street have suggested.  It’s bad.  The “great-news-for-Nokia” theme is based on the presumption that all the current Android handset vendors, seeing the Giant Google Gorilla looming over them, would flee to Microsoft and Phone 7 or Windows 8.  Ha!  You flee from Google to Microsoft?  How is that smart.  Neither of the two would be favoring your personal interests, but at least Google is gaining market share with Android and Microsoft is losing it.  I bet every Android handset vendor is sending press clippings of the “Flee-Android-For-Microsoft” stories to all their other Android-based competitors.  Jump over, gang, and die on the vine while I live and prosper.

Might this mean that somebody will now buy Nokia?  Sure.  Google (owner of Android) buys Motorola Mobility (purveyor of Android handsets).  Ergo Microsoft (owner of Phone 7) buys Nokia (you’ve figured out the relationship by now!)  Well, that was the rumor all along.  The deal opens no new buyers for Nokia, and I would contend it relieves pressure for Microsoft to do the deed, not increases it.  With a big head-to-head battle between numbers one and two in smartphones and tablets, and with Nokia already jumping ship to Microsoft, where else can they go?  Why buy Nokia when you own their soul already?  Then of course, logic doesn’t seem to play with Microsoft these days, so I guess anything is possible.

The idea that Google is just sharpening its patent portfolio seems specious to me too.  That’s a heck of a lot of money to pay to get patents.  I don’t disagree that they’ll be happy to see the patents under their control instead of under Apple’s or inside some patent troll, but who thinks Motorola was going to be sold to Apple or some patent troll anyway?  And InterDigital has plenty of mobile patents and has been on the block for a fraction of the price.  And defense?  MMI was an Android shop so Google probably wasn’t afraid they’d join the fray against Android.  The MMI deal does make it possible for Google to present a stronger counter-position against the hordes of competitors it claims are conspiring against it, but that’s only as valuable as you think conspiracy theories are in general.

What does the deal do in the mobile appliance space?  Hasten.  It hastens, as I said yesterday, the expansion of both parties from appliances as a front-end for services to appliances and services as an integrated offering.  It also hastens the migration of Android and iOS to more different devices, more form factors, more specialized appliances.  It hastens because all of this was coming anyway; it just happens faster because the competition between Apple and Google is more direct.

Are there losers in this happy story (besides Microsoft and Nokia?)  Sure.  One example is Google ChromeOS.  Google would be crazy to keep pushing that platform independent of Android at this point; they’ll only create confusion.  HP loses with its WebOS platform for the same reason RIM loses (more) with its line.  When two giants wrestle, the others in the market are collateral damage.  Neither HP nor RIM can hope to muster the pace of innovation that we’ll see from Apple and Google now.



What Will Google/Motorola Mean?

Google, ever a shaker of markets, has certainly given the mobile market the greatest shaking since Android, even the greatest since the iPhone.  They plan to buy Motorola Mobility, the mobile appliance arm of Motorola, in an all-cash deal.  The deal will at once make Google one of the major manufacturers of smartphones and tablets, putting the company on a level playing field with rival Apple.  There are obviously going to be plenty of objections made to regulators, but early indications are that the deal will go through.

The drivers of the move seem pretty clear.  At the surface level, it probably rankles Google to see Apple become the largest US corporation in market cap.  Envy counts for a lot in Silicon Valley, where everyone is known by the size of their startup.  At a deeper level, it’s probably clear to Google that its Android strategy has two serious disadvantages; it’s not creating a single ecosystem like Apple’s is, and it’s not giving Google enough control to be the primary driver of innovation.

If we step back from the obvious Google/Apple dynamic, the deal would almost certainly put network operators even further into the back seat.  I’ve noted in the past that Apple’s approach to mobile was to create an economic framework around appliances that sucked in value and thus reduced operator opportunities for differentiation.  Appliances and apps have become effectively the pretty face on the services space, anonymizing everything behind no matter how critical and expensive that “everything” might be.  But even this comment probably doesn’t surprise anyone, so let’s look deeper at what it means.

First and foremost, it puts tremendous pressure on operators to figure out how to do what monetizing they can, and quickly.  With Google and Apple duking it out directly, how long will it take for “service clouds” linked to mobile appliances to become the norm for both?  That would consign operators to being nothing but water-bearers for the hunting party.  The space that will be particularly important, of course, is content.  Because that generates the most traffic and has the most direct and immediate revenue stream associated with it, it’s important.  Because mobile content could short-circuit operator TV Everywhere and telco TV investment by tapping off some of the market, it could compromise the whole shift to video for them, and that’s critical.

Second, it means that Apple and Google are both virtually certain to become MVNOs.  The marketing power of appliances becomes market ownership of the mobile space if an appliance giant can, by creating a wholesale relationship with facility-based mobile operators, become an overlay mobile operator to its own device base.  Such a move would freeze the operator into a transport role, and provide a platform onto which Apple and Google could inject cloud-hosted services.  These would help the handset giants with “device churn” by hooking their customers to features that were hosted ONLY on that virtual network by Apple or Google service clouds.

Third, it means that we’re going to see a combination of an increase in the traffic rates for mobile networks and at the same time greater emphasis on femtocell and WiFi offload.  The push to differentiate, to generate more and more reasons to go with either Apple’s or Google’s devices, network, and services will generate more traffic that operators need to monetize or offload.  Operators are going to realize they have no option but to cut favorable MVNO deals with the handset giants, and those deals will offer better usage terms.  Femto and WiFi deployment can help offload traffic, and in any event there is no question that Apple and Google will begin to deploy WiFi hotspots on their own.

There are other more speculative outcomes here.  For example, will a war of the two glamour giants of tech—a war that will certainly include cloud services—accelerate the migration of computing, at least in the personal sense, into the cloud?  Will that accelerate Microsoft’s decline by killing off growth in the PC space even further, and by raising the competitive bar for Windows 8?  Will we see a real “carrier WiFi” market emerge by federation among the various hospitality hot-spot providers?  Will “MuniFi” networks deployed by cities who want to empower their citizens, networks that have pretty convincingly failed up to now, suddenly succeed and change the market?  Will Apple and Google push to become resellers of wireline broadband services?  The list goes on.

Revolutions have casualties, and the guys who are most at risk here are ironically the guys who built the Internet, who built wireless, at an even more fundamental level than the network operators.  I’m talking about the equipment vendors.  Here’s a community BEHIND the operators that Apple and Google are pushing into the background!  The network, and its equipment, are getting submerged, and with submergence can come only commoditization.  Do any network vendors believe they can sell switches and routers to a virtual network operator?  If not, they’re fatally divorced from the value chain.

For five years now I’ve been complaining that vendors have not supported operator transformation goals.  The operators themselves have been complaining right along with me, and yet I’m still seeing major disconnects between what operators want in their monetization projects and what vendors are delivering.  That’s why I’m disappointed that Cisco, who has a real chance of taking control of the cloud-service space, made no attempt to claim it on its earnings call.  By next quarterly call it may be too late.  We have never seen such risk in the network equipment space for those who do wrong, and never such opportunity for those who do right.  Anybody interested?


Verizon Illustrates why FTTH and Cord-Cutting Aren’t for Everyone

Those who hope to find fiber broadband snaking through their neighborhoods will be unhappy when they read a Reuters interview with Verizon’s CFO.  Those who have followed my research on the subject of broadband profitability won’t be surprised, though.  What Shammo said was that FiOS won’t be as profitable to Verizon as wireline had been, and that’s a perfect picture of the dilemma of the modern service provider.

Copper loop infrastructure is relatively inexpensive to install and maintain.  The cost per foot for the media is low, and there are no special techniques needed to make connections.  You can deploy copper in support of POTS (plain old telephone service) that you sell for ten bucks a month.  Even augmented at the CO end with DSL equipment, the cost of the loop per customer has been hovering about a hundred bucks, and long useful life pays back on that decently.  That’s why telcos have been able to stay in business.  But fiber to the home is a LOT more expensive.  It costs about $700 to pass a home in a high-density territory like Verizon’s, and about $350 more to connect the customer.  That’s ten times the cost of copper.

Now, if telco TV and broadband earn operators like Verizon over a hundred bucks on the service per month (ten times POTS) then why isn’t fiber TV and broadband similarly profitable at ten times the cost?  The answer is twofold.  First, POTS delivered voice calls that consumed, in digital form, only 64 kbps.  Fiber delivers broadband Internet at 15 Mbps, and the aggregation network has to be a lot more robust to move that much larger amount of traffic.  So where the loop cost including switch termination was the big cost for POTS, the upstream aggregation in the metro network is a formidable added cost for broadband and FTTH.  Second, nobody would pay enough for broadband Internet to justify FTTH anywhere in the US.  What motivated Verizon to get into the FTTH game wasn’t broadband, it was channelized TV, and in that application you have to pay for the programming.  POTS was totally fulfilled internal to the telco world; its costs were their costs.  FiOS has a substantial cost component (up to 60%) in licensing fees for programming.

This is why the whole wireline game is so precarious for telcos.  If you stay with your copper plant, as AT&T has done, you have fundamental limitations in the quantity of channelized material you can deliver, and anything you do in TV reduces what you can deliver in Internet service.  You pay the same programming fees, too, so while your costs are low your hold on the market is threatened by every advance, including HDTV, and by cable competitors whose copper plant is the higher-capacity CATV.  But if you move to fiber, you’ll pay an enormous capital cost up front that you’ll have to amortize over decades to afford, and profit per year after fees to pay back on that is shrinking as licensing fees rise.  No wonder we have fiber only in very economically dense areas, which is what my models have shown would be the case all along.

If you then look at what the “cut-the-cord” types would like the future to be, you see the problem there too.  Right now, only people like AT&T with U-verse deliver channelized TV over IP, and frankly I’ve never believed it was a sound strategy even for them.  But if you moved to a true OTT TV model, you’d have an enormous problem of traffic growth.  A single TV show might consume about 5 Mbps (average between SD and HD) of bandwidth per channel, so sending all 200 channels to a CO for distribution would consume about a gigabit of capacity.  If that CO has 20,000 households, the same material delivered on-demand and OTT would consume ONE HUNDRED TIMES that bandwidth.  More significantly, that is nearly 800 times more than the typical per-CO peak Internet traffic level today.  There is simply no way something like that is going to work.  At what consumers are prepared to pay for broadband (an average of less than $40 per month), what operator is going to expand aggregation bandwidth by nearly a thousand times?  And in any case, how are those who are providing low-cost OTT video going to pay programming fees if those fees rise to where they’d have to be for networks to survive the loss of channelized TV?


Cisco Gets Breathing Room

Cisco’s quarterly earnings call was in one sense a far cry from the previous one, but it was still not exactly a return to the glory days when everyone wanted to be “the next Cisco”.  The company narrowly beat estimates and it guided to 1% to 4% growth for the current quarter.  It’s this guidance that likely helped boost Cisco’s shares in after- and pre-market trading; other networking companies have been guiding downward.

Views on what all of this might mean are mixed.  You can start with the fact that some Street analysts believe that Cisco won’t meet its guidance, particularly given the increased economic threat globally.  Of course, you can always blame macro-economic conditions when you don’t make your numbers, so that risk probably wouldn’t deter Cisco’s issuing a more rosy forecast if it felt it had some assets in play, so it’s safe to assume that’s what they think.

They do, of course.  Number one on the list is incumbency.  Nobody can unseat an incumbent in a commoditizing market except a price leader.  Because network equipment vendors have let their market commoditize, Cisco’s position and market share are safe as long as the company discounts enough to stave off competition.  That’s likely to be easier for Cisco in the enterprise space because the Cisco brand is strongest there and competitors like Huawei are weakest.  If you look at Cisco margins you see some erosion, though not as much as the Street had feared.  And Cisco is coming into the second calendar half, when hold-back spending of budgeted funds could still buoy their sales.  Incumbents benefit most from this end-of-year impact because they can draw on both project and departmental update dollars; competitors typically have to chase the project budgets that are more likely to be suspended in bad economic times.

One thing this quarter suggests is that Chambers, who the Street had widely believed would exit Cisco around the end of the year, may not be in that much of a hurry.  The company can still hope to regain some of its Street luster if it can cut costs significantly and essentially accept that it’s going to spend the rest of its corporate life in price wars with Asian competitors in the service provider space and account control wars with IBM and HP in the enterprise.

What do I think?  First, I don’t think that Cisco can become a networking commodity-market leader, and certainly not under Chambers.  They need to be a growth company, which means they have to figure out how to grow.  Nothing they’ve done so far is compelling; the company tells carriers that they need to carry more traffic no matter how unprofitable it is, and the tell enterprises that servers made by Cisco link to the network better despite the fact that servers from every source have linked to the network all along.  So their future still depends on coming up with something compelling.

In the enterprise space, Cisco is actually doing better than their numbers might suggest at first blush.  If you discount the public-sector components that are clearly in trouble now and for the foreseeable future because of budget cuts, they grew switching by about 13% in a market where competitors saw a lot of softness.  Our enterprise contacts say that Cisco has been stronger than expected in the data center, which is the key place to be strong for any network player because it’s the place where the network meets the worker.  It’s that meeting that Cisco must consider now, not just in the tactical sales sense but in the strategic sense.

Cisco is at a crossroads.  Down one path, they can re-invent networking.  They can do that only by creating a coherent vision of the network as a software platform, and that’s the inside message of the cloud.  Down the other path, they can re-invent themselves.  That can’t make them into the Cisco of old because that can never be in the network equipment market again; not for Cisco or anyone.  What Cisco can become is HP, a full-service IT giant.  They have the pieces.  And I hope you can see that in terms of execution, these choices are the same.  The cloud is IT plus networking.

Of course, if Cisco wants to define “networkware” for the future, they have competition there too.  For now, that competition is vulnerable.  Alcatel-Lucent has been talking their Open API and Application Enablement stuff, but their story is really aimed at the service provider space only and they’ve not baked their own architecture well enough to communicate it even to those providers.  Juniper has been talking about a Junos ecosystem, but their execution has narrowed the “ecosystem” down to meaning nothing more than network transport and connection behavior, which is no ecosystem at all.  Neither company has a cloud story, neither has an enterprise story for their networkware either.

So Chambers has renewed his lease for a bit, but what that means is that he’s going to have to clean house at the senior management level to transform Cisco into either a computer company or a networkware visionary.  And he has to do it quickly, because even incumbency and discounting won’t work forever.

Is Cord-Cutting REALLY Real?

Data for the last quarter shows that cable and satellite TV providers lost a significant number of customers, and while the media is declaring this to be a victory for OTT video I think that’s an oversimplification.  There are major changes in video consumption, some driven by technology, some by economics, and some by population demographics.  We need to look at all of them to understand what’s happening, and then we need to explore the consequences.

TV subscribership is a household affair; people buy subscriptions for independent households and particularly for families with children.  Every year we create new households as youth becomes independent, people separate, and through immigration.  Every year, marriage, death, and other factors will destroy households.  The total household count is dynamic, but more significant is how that count is divided among viewing segments, particularly the population between 18 and 25.

Our surveys and our modeling of industry data have showed that TV behavior is fairly static in the over-25 population area, meaning that the percentage of households with TV subscription is fairly consistent.  We see a slight dip post-2008 to reflect economic impact on those with marginal financial resources, but in general TV is so important as an entertainment vehicle that most people will skimp elsewhere to sustain their access.

The one place where we do see a shift is in what we could call “transitional” households.  The households headed by the 18-25 age group are normally the most economically stressed, and they have also had less time to develop a “TV dependency”.  For the period when young adults sustain their own households, single or married, and before children arrive, they are four times as likely NOT to have a TV subscription as the normal population.  While that’s alarming to cable and satellite companies, even that number hasn’t changed all that much.

What HAS changed?  First, young graduates are far less likely to live independently now, so we’re creating fewer households.  Second, people have children later in life and households without children are less likely to have a TV subscription.  Finally, the mobile broadband generation has learned a different kind of entertainment, one driven first by social interaction and second by viewing.  In their entertainment model, they share and talk about clips on YouTube and not about TV shows.  That behavior carries over, and as long as they’re not using the TV to babysit, they are 20% less likely to subscribe to TV than their non-broadband-generation predecessors.

What I’m saying here is that cord-cutting is a great story, but there’s still no hard data to show that it’s having a significant impact on television consumption.  If it were, one symptom would be an increased reliance on VoD versus scheduled TV viewing, and the cable companies report that’s not happening.

While the notion of a cord-cutting generation creating an explosion in streaming video warms the hearts of network equipment vendor CFOs, the truth is that any major shift toward that sort of thing would likely be a disaster.  We already see that usage pricing is coming, but so far it’s being limited to the 5-8% of users who really DO consume a lot of streaming video.  For most Internet users, broadband is still usage-free, and as long as that’s the case the Internet will continue to grow pretty much as before.  If TV keeps its role as the primary video entertainment media, then the Internet can keep its role as the framework for social and entertainment innovation.



Verizon’s Strike: Last Gasp of Wireline?

Strikes against telcos aren’t anything new, but Verizon’s current strike may be of special significance because it’s coming at a time when the company is wrestling with a question no one ever believed would be asked; is there any future in telephony?  While Verizon has been profitable, the profits aren’t extravagant by any measure of OTT giants, and the profits that do exist are almost entirely on the mobile side.  In wireline, Verizon faces the dilemma of all network operators; how to leverage the loop.

Just short of a third of households don’t even have a wireline phone any more, and that trend is accelerating because nearly all new households (created by recent graduates) have only cellular phones.  On the other hand, TV and broadband are still normally delivered by wires (or fibers), and this means cable MSOs have an advantage over telcos.  CATV can deliver video and broadband and voice at high capacity (1 Gbps) while copper loop is limited to somewhere between about 25 and 60 Mbps depending on the loop length and condition.  The limitations of the local loop are critical because operators have to ask whether to try to leverage it (as AT&T’s U-verse does), replace it with fiber (as Verizon FiOS does), or just toss it and exit wireline.

The broadband policy debates worldwide make the issue more complicated, because there’s tremendous government pressure to deliver higher-speed broadband despite the fact that virtually all users choose cheaper over faster where the options exist.  Policies like net neutrality also close off the easy paths to monetization; sell your own stuff at better QoS.  Almost half of the major operators have had discussions on whether there was a long-term future in wireline.  Almost a quarter think there isn’t, even in the fiber side.

The implications are significant to equipment vendors because almost 75% of infrastructure that’s deployed supports wireline services, which given the fact that wireline isn’t anything close to 75% of revenue, illustrates the dilemma nicely.  For some operators like Verizon, subscriber economic density is high enough to justify a successor plan for the local loop, but for many operators there’s simply no way fiber can return on investment.  Without fiber, it’s going to be an increasing challenge to deliver video and broadband together, and without that there’s nothing to keep mobile-infatuated users from dropping the only wireline service that’s still profitable.

Look at the labor dispute with this background and you see it’s a risky play for everyone because any negative trend in wireline costs, including and perhaps especially in the labor component, tends to push operators in the direction of dropping wireline completely and staying in wireless.  The question “What would people do who wanted their old phone service?” is just as irrelevant as “What would people do for home broadband?”  What do people who want a BMW for a hundred bucks do?  Cope.  Operators don’t want to make this critical decision right now; labor doesn’t want them to make it at all.  We’ve seen plenty of destructive face-offs in our world recently; this could be another.

The mobile broadband explosion is also troubling to some strategists on the operator and equipment side.  The question is whether users are becoming tuned to what might be called the “tablet experience model”.  You don’t watch an hour TV show, you watch a bunch of three-minute snippets.  You really don’t consume that much bandwidth from the perspective of wireline; the average wireline user with 5 Mbps service would likely hit those caps in as little as a week.  I’ve said for years that mobile broadband and behavior were creating a kind of hysteresis; changes in one are changing the other, which in turn change the first again.  It may well be that behavioral apps are going to be the real revenue stream of the future, that cloud hosting of features that will enhance our decisions and lives will be the real “content”.



Is Ethernet Going Sour?

With Brocade’s cut in guidance on its earnings call, the company joined what seemed a parade of network equipment vendors who’ve called the future of network spending into question.  Most Wall Street analysts have suggested that Ethernet is coming under pressure and that corporate IT spending is likely to be weak.  Both are likely true, but I think the Street is (as usual) content to catalog symptoms rather than address problems.

In the enterprise space, our spring survey found that enterprises were still generally holding their capital plans but were slow-rolling project spending.  A part of the reason was concern over economic conditions, which was a visible issue even before the harsh political face-off that’s virtually killed market confidence this summer.  Another part was some concern over their cloud plans, concern that arose from getting more insight into cost and benefit as they got deeper into the topic.  Both these issues appear to have grown over the summer, and I expect our fall survey to show that.

Data center modernization is the only real driver of network change in today’s market.  Nobody has demonstrated any direct productivity gains out of network change, despite Cisco’s attempts to make telepresence the water-carrier for network expansion.  The problem is that virtualization as a driver for data center modernization appeared to have tapered off even this spring.  It’s not that people weren’t doing it anymore, but rather that the network change part was largely baked and they were back-filling into pre-existing plans.  Cloud computing was the big driver remaining, and the cloud has proved more complex than enterprises had expected.

In the service provider space, I’m seeing the result of five years of declining revenue per bit.  But the thing that’s really hitting now is a more subtle structural issue.  Content, which everyone knows means “video” is the driver of traffic in both wireline and wireless, to the point that you could almost neglect other growth sources in planning.  But content isn’t “Internet” traffic as most would know it.  More and more content is served out of metro cache points, and so it’s the metro capacity that’s consumed.  Metro means Ethernet, and the growth of Ethernet to support content delivery has been the driver in a shift for operators from IP-dominated planning and spending to capital planning that’s Ethernet-dominated.  That process at first tended to focus on more premium players and products because early metro/aggregation Ethernet was an expansion on the previous business-focused Ethernet services infrastructure.  In most metro areas today, according to our operators, the impetus for Ethernet growth is consumer video, and that’s the worst service in terms of ROI.  Thus, price pressure on Ethernet is inevitable.

Where the economic situation enters the picture is double-edged.  On the enterprise side, uncertainties about the revenue line will encourage most businesses to hold back, to delay spending as much as possible.  I think it’s pretty likely that Q3 will be soft for that reason no matter what happens at this point with the economic picture, simply because it’s not possible to wash all the uncertainties out of the market by the end of September.  The question will be whether project budgets take the larger hit, which they normally do.  That’s important because nearly all IT spending growth comes from the project side, because that’s where new benefits are typically introduced.  But in addition to representing the incremental spending for this year, the project budgets for 2011 reset the baseline for 2012.  If those dollars are not spent this year, then the later spending that depended on those projects is also curtailed.  That’s the risk, and it’s particularly acute given that enterprises will be starting their fall tech planning for next year in only a month.

The Ethernet shift for operators will be critical because it’s an illustration that spending is increasingly focused on places where the only differentiation is cost.  Ethernet features are virtually impossible to make meaningful, and “cost” beyond the direct cost of equipment has gotten tied up in conflicting vendor claims, none of which have been compelling to the buyer.  I asked operators what role vendor studies and figures on operations savings meant to their selection, and they told me that these were used where it was convenient to build a management justification for the choice they wanted to make, but almost never actually influenced that choice.  Thus, Ethernet is incredibly subject to pricing/commoditization, and that’s what we’re going to see.

Cisco’s earnings are due on Wednesday, and the Street seems to think they’ll roughly meet guidance.  If they fail to beat the estimates nicely or if they are also cautious in guidance, it will be an indication that the networking industry is in for a very tough patch in 2012.  Switching will be the place to watch too.  The word is that Cisco has been aggressively discounting its own Ethernet products and UCS servers as well, and that’s not helped the industry’s margins in the Ethernet space.  More discounting will confirm my thesis, I think.



News Buffet

A number of interesting but small new items have emerged in the tech world, and so we’ll do a quick analysis of them before tackling the ugly economic picture.  We’re going to range from network capex to virtualization, but perhaps in the opposite order.

VMware has decided that maybe its pricing was more of a problem then it believed.  As I said in our blog on the change, our analysis showed that most users would expect to pay quite a bit more, particularly users who had just designed virtualization-ready data center architectures.  The new model doesn’t penalize virtual memory as much as the old.

I think that customer angst here was expected; the big driver is likely to be the sudden softening of the economic picture, attributable to the political deadlock in the US and the sovereign debt problems in Europe.  Virtualization is a cost-management approach and could see a pick-up in bad times, but people want to save money on the means of saving money, so a price increase at the wrong time could hurt VMware’s market share.  Our model suggests that while some users will still see higher prices, the critical new-data-center players will likely find the new pricing model neutral to even slightly favorable versus the old.

DirecTV’s US subscriber numbers were disappointing to say the least (though its profits were up on Latin American growth), and the company has admitted it does have an interest in Hulu, thus in the concept of using OTT streaming as a means of augmenting a channelized model.  Comcast has said that for its part it’s not interested in using OTT to extend its service reach, and the difference in perspective here is what’s interesting.

DirecTV is fighting the natural disadvantages of satellite delivery, which is the lack of personalization and interactivity.  But that disadvantage set arises out of the fact that they don’t supply broadband Internet.  An OTT supplementation for them is a logical step because it could help address their limitations while at the same time consuming somebody else’s bandwidth.  Comcast, like all cable operators, has a market-share limit set by the FCC.  It can grow only through something like OTT, but trying that would validate a model that might create a kind of OTT explosion, which works against any broadband provider.

Credit Suisse has issued the third of its operator capex reports, and there’s really nothing new in this most refined prediction.  They think that 2H11 numbers will generally be up over 1H11, and there’s the only place I part company.  My sources are suggesting that there will be a serious hold-back now because of economic conditions, and I’m tentatively modeling 2H11 as just slightly over 1H11 and down significantly from the 2010 levels.  They continue to stress that the ROI on capital projects will be the determinant; money will flow only to where it earns provable returns.

In that regard, I still see the operators’ big problem as the lack of solution-oriented vendor positioning of their wares.  Operators struggling to get “new money” can’t expect to do that by deploying boxes under old paradigms.  That’s pretty obvious, but if it’s true then vendors have to offer some new ones.  What raises ROI?  How does it do it?  Some of my clients are getting so poor a set of monetization-project responses that they can’t even cost out the build-out needed because they can’t find any reasonable assumptions on what products can do now, what they will do in the near future, and what it will cost to augment that to meet monetization goals.

Well, we’ve avoided the point as long as we can so let’s take up the economy.  The big stock dump of the last couple of days (depending on what time zone the exchange is in) shows first and foremost the problem I predicted in our 2008 analysis.  Europe has common currency and divided government, and so it was unable to mount an effective stimulus program.  That led to reduced economic growth, and that in turn led to lower tax revenues and higher safety net costs.  The sovereign debt crisis is the result of that, pure and simple, as I’ve said all along.

What’s now changed is that the US now has the same thing.  If we didn’t see a classical example of divided government in a unified economy, I couldn’t suggest where one could be found.  The impasse, even when corrected at the last minute, has sapped the confidence of both consumers and business, and that’s enough by itself to slow economic growth.  It did.  It’s not over.  Slower growth here means less support for EU growth through exports to us, and that exacerbates their growth problem, which exacerbates their sovereign debt problem.  Which reduces their ability to buy our exports, which makes our growth slower.  You get the picture.

The Washington Post said it beautifully yesterday:  “The forecasts and models created by agencies such as the International Monetary Fund emphasize the point: Miss a revenue or spending target and the numbers look a little worse; miss the growth forecast and debt spirals out of control.”  Our debt fight simply guaranteed our loss of control, and we now join Europe in playing catch-from-behind on a problem we had control over.  The committee to implement the debt compromise hasn’t formed yet, but the politicking is already underway.  Do you think this is going to go better?  If it does, it will only be because politicians on both sides are staring into that death spiral the Post described.  The employment numbers today were unexpectedly good; the confidence crisis isn’t pushing us to disaster quite yet.  We have perhaps two months to fix this, and then we’re in another recession that could easily be as bad as that of 2008.  Remember, doubters; I bucked the positive trend early in that crisis and said it would be the worst since WWII.  I could be right here too.

Cisco’s Video Changes

Cisco is consolidating its video activities into a single unit and its Videoscape head is leaving.  The decision seems an odd one to me if you look at things from a market perspective.  Videoscape was arguably the most complete suite of content delivery elements available from anyone, but the sheer scope of the product seemed to confound the sales process and especially customers.  But is a single video unit the best way to promote video delivery?

Operators have all been eager to monetize video, but while it’s been easy to set objectives for these projects and at least possible to outline functional requirements, operators are still having a tough time putting all the functional blocks inside products they can buy or software they can build or contract.  In theory, Videoscape could have been the mechanism to support that effort, since it has all of the blocks.  For example, Videoscape even includes a service bus architecture that would serve admirably as the technical foundation for a service layer aimed at content monetization.  The problem is that it was never presented effectively.  We’ve seen Cisco presentations that either raised issues and never addressed them or that praised features without putting them in a value context.

Creating a single end-to-end vision of video, one that includes both streaming/channelized and collaborative, is in one way interesting and potentially highly useful and in another way likely to further dilute messaging.  Yes, video monetization has to embrace any delivery model.  Yes, streaming and collaborative video have much in common in terms of service-layer elements (they fall out of a single approach in our current application-note monetization example).  But if I was never able to make Videoscape sing as a solution, how does making the orchestra bigger really help?

Maybe it helps by creating a unit that could be sold or spun out.  One possibility here is that Cisco is preparing to divest itself of the whole video area, and of course having the whole video area under one organizational roof would make that easier.  Furthermore, a video-centric subdivision might be attractive to a bunch of players, from Apple to Microsoft to Google to even IBM and Oracle.  More buyers, more bidders, more shareholder value.