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Sprint’s shares were up yesterday (well, so were a lot of shares) on reports that it would be offering the iPhone 5, and there were also rumors that analysis of app logs for that phone showed it was compatible with both GSM and CDMA networks.  I wonder now if that’s a further indication that Apple has been planning to make itself into an MVNO.

The wider you spread yourself as a phone player, the more customers you have access to but the less leverage you have with the big wireless operators.  Most handset players, like Apple, have limited their early launch to a single provider in each service area to get the most support, marketing, and subsidies.  With the iPhone long past the early-launch phase, it’s not surprising it would be widening its base, but we need to think like Jobs here.

Apple loves to eat all the Apples and not just the low ones; they like to control the ecosystem they create and to fully monetize it.  So how does that square with their letting customers pay a hundred bucks a month to get their iPhone or iPad connected to the cellular network, payment they don’t get?  That alone would make Apple consider becoming an MVNO.

I think that the Google/Motorola deal is either a further driver for Apple or an indicator that Apple’s intentions are being guessed by Google.  Google, you’ll recall, has actually threatened to bid for spectrum, and while there was never any chance that it would go through with that (at least not any time soon), there is a very good chance that Google realizes it could gain much of the benefits of owning its own cellular wireless business without the cost of licenses and infrastructure.

I wonder how many iPhone owners don’t even know who their cellular provider is, or would know only because they recognized the name from a bill or from the logo on a store where they bought the phone?  Brand loyalty in cellular isn’t with the operator as much as with the appliance, particularly if we’re talking about an Apple appliance.  Can Google afford to take any less aggressive a position in its own marketing?  Even without previous cellular aspirations to point to, would Google now have to think about MVNO status?  I think so.

The MVNO road isn’t always an easy one, of course, and it increases costs (primarily marketing) as well as revenues.  Apple and Google wouldn’t get all the money, either; they’d get what is essentially the retail spread (perhaps 25%) of the costs.  But they’d be in control, and I think that counts a lot for both companies.

 

 

 

Huawei is definitely getting to be a problem for the other network equipment vendors.  The company had a good quarter with sales up over 10%, and it’s also gaining market share in both carrier routing and switching; by our measure the fastest growth rate of any vendor.  The company is also embarking on a campaign to build its strategic influence in emerging markets, presenting what by most accounts is the best overall strategic pitch that anyone is offering to the Tier Two and Three players.  There have even been speculations that Huawei might be the one that would pick up HP’s TouchPad and webOS business.

What Huawei now has is what the Street calls “Mo”, which means “momentum”.  The competitors are all fighting to hold their own in a tough market and are in the main losing that battle while Huawei is on a roll.  They have true, convincing, price leadership and many competitors are playing into their hands with cost-based value propositions instead of feature and opportunity differentiation.  They have (according to one of our sources) DOUBLED their investment in strategic higher-layer R&D over the last year.  They are looking to double and then redouble their software efforts according to the same source.  In short, they feel they have the competition on the rocks and they’re closing in.

But right now they can’t put their opponents away.  There is still a period when the incumbency of competitors counts for something, and in that period competitors could still create some significant barriers to Huawei success by being more aggressive in the higher network layers.  The economic angst globally is limiting capex and limiting willingness to make radical changes, but our model suggests that attitude won’t last beyond 2012.  I think that Cisco may be seeing this and may be trying to get its service-layer assets in order.  They’re the player who, as the biggest incumbent, has the biggest chance, but Alcatel-Lucent and Juniper are also in play here, as I’ve noted in the past.

The timing for all of these guys is critical.  Operators tell me that their proof-of-concept trials in content monetization almost all scheduled to be underway by the end of 1H12, and about a third of operators say that they need a good cloud strategy in that same timeframe.  Mobile/behavioral networking is involved in both these activities for about two-thirds of all mobile operators, and nearly all of them say they’ll have to deploy trials in web-mobile services and social services for mobile users by the end of 2012.  That means that at the same time as the capex veil is lifted, the operators will have had to commit to a short-term approach that could end up being their long-term strategy by default.  Huawei wants that position and their efforts to get it are becoming visible, particularly in the content space.  Anyone who wants to contend with them for the role will have to be ready to do something by early 2012 at the latest.

It looks as though there may be some hope for Clearwire; Sprint is said to be seeking cable partners to help fund a buyout of the firm.  There’s some logic to this move, I think, because with mobile becoming the hottest spot in all of networking, the cable MSOs are generally without a mobile property.  They need to come up with a strategy that will let them into the mobile game without each of them building out private mobile infrastructure.

The question is whether ganging up on a single solution for mobile is an answer.  The cable companies are competitors in the major metro areas, and thus it’s hard to see them playing nice in the mobile space.  The biggest problem would be the integration of TV-Everywhere content with mobile delivery when potentially several competitors in a given market have different rights under different terms.  The rumor is that Sprint would establish itself and Clearwire as a host for MSO MVNO relationships and that they would all deploy their own rights management layer on top.  But what about the CDN space?  CDNs for mobile service would be expected to require deep caching that’s tightly coupled to the backhaul network to optimize utilization and QoE.  Does that mean one shared CDN or would every MSO have to deploy their own?  It’s hard to see how the latter would work, but also hard to see how they’d keep fairness in the first option, or even decide what “fair” meant.  Weighted access based on cable customers, mobile customers, or what?

The media has been having a lot of “fun” with the HP decision to exit the PC space.  HP has been generally castigated for buying Autonomy, often castigated for pulling out of PCs.  The HP move has been called an opportunity for Dell and Apple or a warning.  PCs are dead or they’re still healthy, and the $99 fire sale on TouchPads is a seed for a needy market or will suppress everyone’s sales forever.  You get the picture.

HP had little choice in exiting the PC business.  The problem is that there is really no convincing “brand” of PC anymore, so there’s little opportunity to gain brand loyalty.  The market at the consumer level is really determined by retail availability; whoever’s on the shelf at a good price wins.  That’s not a market where anyone will make a good margin, and it’s been shifting convincingly to Asian manufacturing anyway.  The thing that’s more surprising is that HP not only stayed the course in the PC space, it made a biggish (over one billion dollars) acquisition of Palm to get WebOS and a tablet position.  Then it tossed that out with the PC.  It’s pretty clear that HP has been struggling with the right position in the “client” space.

There isn’t one, at least not in the long run, and not even for Apple.  There can’t be a long-term, margin-rich, consumer market.  It either commoditizes or is superseded (or both).  Apple jumps from trend to trend to be successful, something it can do because it’s cultivated a leading-edge-hip-consumer image.  HP is hardly that, nor could it hope to be.  It might have been reasonable for them to hope for a position in tablets when Google wasn’t buying Motorola Mobility, but once that deal was done so was the HP tablet opportunity.  They gambled and lost.

 

Well, revolutions are interesting at least, and we certainly have one now.  HP has said it will be “considering” exiting the PC business, spinning off its PC unit and doing some M&A to boost itself as a player in the software and systems space.  In fact, if you look at what seems the Plan of the Day, it seems as if HP wants to be Oracle; software-intensive, enterprise-focused.  In their spring quarter, HP was hurt by the soft consumer PC market where Dell (who had less consumer exposure) did better.  Now with Dell taking an outlook hit and HP following suit (again) there was little the company could do except to admit that PCs were not now, nor ever in the future, what they used to be.

Tablets and smartphones aren’t in HP’s future either; they’ve said they’re dumping the whole WebOS effort and all of the devices that came with it.  The move is in some ways more dramatic than the decision to spin out PCs because it’s a retreat from the client business completely, a sharp turn toward the center of the action that would seem to be irreversible.  Are they abandoning the client world to Asia or to Apple?  Both.

To round out the move, HP will (buy a British software specialist, Autonomy, who has very strong credentials in database searching and business, as well as some expertise in content management.  The price for the software company seems high to Wall Street; it’s probably one reason why HP’s shares have been off in pre-market.  It’s the price and not the concept; HP has been buying software companies for some time as a part of a transformation that started with the hiring of former SAP CEO Apotheker.  Most IT players at this point realize that software is the key to establishing a direct connection to the users’ business case, and HP is proving its commitment to that approach.  But remember that HP is still a broad-based data center player, a giant in enterprise computing.

So is the PC now chopped liver?  There is no denying the declining interest in the PC as the primary consumer appliance.  That’s something that even Microsoft realizes, apparently.  Their Windows 8 is obviously a transition product, something that would let them run the same basic OS across any suitable appliance.  The announcement that Windows 8 will have its own app store seems to me to confirm a trend that’s been developing in the consumer market for several years.  Driven largely by Apple, we’re seeing a transformation of “computing” into “appliancing”, a shift from designing personal computers as small computers to designing them as information portals.  It’s not (at least not yet) as much about replacing the PC as about doing something the PC was never really needed for to begin with.  The consumer wants entertainment, period.  When PC games and PC browsers were their only conduit to that goal, that’s what they bought.  With game consoles, tablets, and smartphones increasingly becoming the user’s window on the world, the PC is old news for consumers.  Can the enterprise be far behind?

The HP move will certainly put pressure on a lot of players.  To start off with, that means that Dell might find it necessary to do its own cut-and-run move.  Their decision to get into networking with Force10 and their creation of a cloud-and-virtualization focus on the data center seems like it might be laying the groundwork.  I think that the loss of the PC would help Dell’s overall financials and also help the company focus on the data center, where it’s been showing most of its strength.  In any event, it may have little choice at this point.

IBM, of course, shed its PC business by selling it to Lenovo.  As a pure play on enterprise computing, it’s had its ups and downs, but there is no question that IBM is still the big tech success story.  They proved that making big moves to cut your losses is as important as making moves to cement gains.  With IBM now seeing giant HP aiming at IBM’s turf without being encumbered by PC baggage, what does IBM do?  Networking?  HP has networking products; rival Dell just picked up a line.  Does IBM follow suit, and if it does who does it pick up?

Before we go there, let’s look at an important point about enterprise networking.  The only part of it that’s strategic is data center networking, and data center networking is about (you guessed it) the DATA CENTER, which is where servers and software and IBM and HP and Oracle and Dell all live.  If “computer companies” are going to say that “computer” doesn’t include PCs then they’re focused totally on the data center, and unlikely to ignore the fact that the data center network is a big part of that picture.  Networking first collapses into data center networking and unimportant branch junk, and then data center networking collapses into the server/storage technology plans of the buyer.  That’s surely how the IT guys see it.

There are two players (IBM and Oracle) who might see themselves becoming a full-service data center company and who lack the network piece.  There are probably four network vendors who might be targets of acquisition—Brocade, Extreme, F5, and Juniper.  Only two players max from this group could be acquired.  If enterprise networking commoditizes and gets subducted as the current moves suggest it will, then the rest of these, and other non-target players like Cisco, have got to make it on their own.  In the new market, is that possible?  Who might be forced to find out?

Cisco might be feeling good; they seem to have accidentally occupied the space that everyone else wants to converge on.  With servers, networking, and a reduced consumer exposure they’re in a way a bit ahead of HP in terms of a transformation out of the business space.  But Cisco isn’t an IT player no matter what they want to believe—at least not yet.  Their understanding of IT is short of what’s needed to compete with the big boys, and they’ve got nothing in software despite continued efforts.  In fact, Cisco may find itself under a bit more pressure as HP steps up the “we-do-all-the-data-center” story at the sales level.

 

 

NetApp, like so many this quarter, turned in OK numbers and somewhat weak guidance, which was enough for the Street to send the stock down by 15% in after-hours trading.  Coming after Dell and a downgrade of HP pre-earnings, the NetApp news was seen as a reinforcement of the challenges tech stocks face.  In yesterday’s trading, the tech-rich NASDAQ was off when the Dow and S&P were both very slightly up.

In fact, it looks like the Street has decided tech is in trouble, interesting less for the conclusion than for the fact that the signs have been around since the spring and the Street was happy to put on its look-only-at-the-quarter blinders.  I noted in June that our survey was showing a pushback of project spending combined with some front loading on budgetary items.  That netted a roughly on-track trajectory for the first half.  When, in the second half, project spending continued to be pushed back and budget spending had to slow, we took a hit.

The good news is that while “lost” budget funding is rarely made available in the following year, we’re not dealing with that in 2011.  What’s happening is that project spending is being slow-rolled, and because projects have a specific benefit case attached, they are likely to be funded in 2012 if conditions improve.  That would create a hike in spending next year, again presuming macro-economic problems that are hurting consumer and business confidence are solved.

 

 

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.

 

 

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.

 

 

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?

 

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’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.