Our industry is driven by a lot of almost-hidden forces as well as by the more obvious buyer/seller tension. One of the most significant is the responsibility that a public company has to its shareholders. While we talk all the time about how companies need to “listen to their customers”, the fact is that a public company isn’t responsible to customers except in the sense of any warranties and truth-in-representation rules. It has very broad responsibility to its shareholders, and we may be seeing an example of that right now.
In the last month, both Cisco and Juniper have announced they are going to issue corporate debt (bonds) and use the proceeds in part to buy back shares. In and of itself this may not seem like it matters, but it is a very strong signal about the future as seen by these two companies and so we need to look closely at what it means and how it works.
The goal of a company is to provide gains for its shareholders; that’s what “investment” is all about. To do that, the company has to work to increase its stock price. That stock price is typically based on its earnings per share, meaning the net profit the company makes divided by the number of shares of stock outstanding. If a company is increasing its profits it would typically see its share price rise, and of course the opposite is also true. Companies can increase profits and share price by cutting costs or by increasing sales, and these are the mechanisms we hear most about. They can also increase share price by reducing the number of shares, and that’s what we’re seeing now.
Many companies have “stock repurchase” programs, and little is said about them in the technical press. These programs, which have to be filed with the SEC, allow a company to buy back and retire shares of stock, reducing the total shares outstanding and increasing the earnings per share as a result. It’s more unusual for companies to borrow money to fund these programs, but there are reasons (like the fact that a lot of their cash on hand is offshore and would have to be taxed to be repatriated and available) for it. However, the fact that both Cisco and Juniper feel that they have to buy more shares back is a pretty strong signal that they can’t meet market expectations with normal profit growth alone. That’s an important truth.
I’ve blogged for some time about how the network industry and the IT industry alike have been, in effect, eating their own young. By falling into a cost-management mindset, both have accepted a buyer goal of “spend-less-each-year” that inevitably lowers sales industry-wide, and thus spurs first market-share battles and eventually (and inevitably) commoditization and contraction. I think that Cisco’s and Juniper’s decision to borrow to buy back stock is an indicator that margins in networking are now dead and will never be resurrected. Even the high end of network equipment, the seemingly resilient IP routing, is doomed to commoditization by the admission of the two prime advocates of that market.
There’s no point crying over this now; I think the Cisco/Juniper move demonstrates that it’s too late in networking, and I also think that the IBM decision to sell of its COTS business shows the same thing is happening in servers. What we have to do is decide whether technology has run its course and can’t generate more value, and if that’s not true then decide how the new value can be generated. The answer, I think, is a combination of chips, software and professional services.
Hardware, including network hardware, is essential but it’s not particularly differentiable because the features of hardware today are created by software, even if the software is embedded rather than purchased and run independently. Inevitably hardware will lose margins, so inevitably you have to view it as a platform for software. Vendors like Cisco and Juniper had a chance to re-frame their stuff as platforms for hosted features but elected to try to sustain a doomed model instead. As a result, we have SDN and NFV, which formalize the migration of software features off the non-responsive network hardware onto already-commoditized COTS servers.
Commoditization, of course, is driving down prices all along the food chain. I remember when there were a few hundred sites with multiple T1(1.5 Mbps) lines and perhaps a dozen with T3 (45 Mbps). Today you can buy residential Internet at speeds of 100 Mbps and hardly anyone would regard 1.5 Mbps as even marginally adequate for consumer Internet. You low prices and mass markets are synonymous. So, of course, is technical illiteracy and mass markets, which is what brings us to professional services.
We can make computers affordable by all, we can make every device smart, we can augment every aspect of our lives with technology…but not if it means we all have to be technologists. Even relatively high-tech buyers like businesses and network operators are finding it difficult or impossible to sustain the skill levels needed to adopt the state-of-the-art stuff that’s out there. And as we drive more toward software features we create more complicated integration and management, which means we need more professional skills. At some point, what a company can do to help its buyers install and use their stuff becomes more important than the stuff itself, and we’re already on the edge of that today.
The other thing that we need to have for this mass-market technology is semiconductors. We can take a ten-thousand-dollar server and shrink it down to a thousand bucks, but inside it we still need the processor and memory and so forth. Yes, all this stuff will be under margin pressure but that’s been true for years now so the vendors have learned to live with it. And unlike network equipment that can’t proliferate almost organically as it gets cheaper, consumer electronics is already demonstrating it can expand almost endlessly.
What all this adds up to is a changing of the guard. I remember when IBM was the sole tech giant. I remember Cisco’s rise and what seemed to be a shift away from computing to networking. What we’re now going to see is chip companies (Intel, AMD) and software players (Oracle, Microsoft) taking the lead if they play their cards well. Who will lead in SDN? Chip and software guys. Same with NFV, same with IT, mobility, everything. The traditional models of both IT and networking have now fallen too far behind market reality to catch up. That’s what Cisco and IBM and Juniper are signaling. The future lies with the new generation.