Sunday, 19 October 2014

Cisco - their future?

(I wrote this over three years ago, when Cisco first started to show serious signs of losing the plot. They seemed to make a miraculous recovery, but now things look grimmer than ever, and my conclusion remains as valid now as it was then).


Cisco's recent woes will be no surprise to those who know the company from the inside. The only surprise is how long it has taken. I was surprised, though, by the naivety of some of the analysts' remarks, and in particular the apparently universal view that all Cisco needs to do is get rid of a few dubious acquisitions like Flip, for everything to be restored to its rosy past. One I read said, "The fall in Cisco's gross margin from 67% to 50% is due to the lower margin on consumer products. Disposing of these is a necessary step to restoring margins." Or something like that anyway.

The simplest of arithmetic shows that this cannot be true. Linksys is by far the largest part of the consumer portfolio, but it is still well under 5% of revenue. The others are just noise. Even if all these business ran at zero margin, the total effect on overall margin would be a couple of percentage points. So it can't be that.

Cisco has been trapped in an awkward spot for a long time, and the consumer business is just one aspect of a well-motivated attempt to get out of it. When you have a near-100% market share, there is just nowhere else to go. Well over half of large enterprises in the US still furnish their entire network infrastructure more-or-less unquestioningly from Cisco. Practically all of Cisco's actual profit comes from the switches and routers that are to be found in nearly every wiring closet and data center in the western world. Everything else is funded out of this apparently inexhaustible gravy train. Growing this to a $40B business has been an amazing achievement, but it's not easy to find another one like it, and this is no longer a rapidly growing sector as it was a decade ago. Hence the moves to the consumer, the data center and others.

But nothing lasts for ever. The core functions of enterprise networks, exemplified more than anything by the Catalyst 6500 family, are already a commodity. For well under $500, Broadcom or Marvell will sell you a chip that does everything you actually need from the Cisco product. They'll even give you complete designs, ready to be sent to a board shop. The days are long gone when Cisco's added value lay in the extraordinary breadth of IOS's support for obscure proprietary protocols. Networks now are all-IP - as indeed John Chambers has been saying. It's only inertia, combined with quite a lot of Fear, Uncertainty and Doubt, that makes people stick with Cisco's high-margin products. And just to twist the knife, the maturity of WiFi means that the enterprise is - finally - moving away from the all-wired model that puts multiple ethernet jacks in every office and cube. That alone has the potential to demolish Cisco's profitability. Worse, competition from HP, Huawei, and white-box vendors - none of whom have Cisco's cost structure or grossly inflated overheads - is driving down the margin.

Let me expand a little on the "grossly inflated overheads". Cisco's development organization functions like 18th century Europe or India - lots of principalities with headstrong leadership, who (mostly) do not compete with each other for territory, but have no intention of sharing anything either. That's why every Cisco product family has its own system architecture, its own ASIC development, and - increasingly - its own software. (Time was when everything ran IOS, which was reasonably common across all platforms, but now IOS has no future relevance for most of them. Only the name, IOS-something-or-other, remains common to what are in fact totally different software systems). The good thing about this strategy is that it avoids the "one egg, one basket" problem that for example brought down DEC in the 90s. The bad thing is that it is hugely expensive, and tends to get worse and worse - it's rare that divergence returns naturally to convergent paths.

This has been a deliberate strategy on Chambers' part. The last time Cisco had any real cohesive technical strategy was under Ed Kozel, in the late 90s. Since then the CTO has been paid to not interfere in the operation of the individual principalities. Charlie Giancarlo seemed to be looking for some kind of unification during his brief reign, and for his pains - ahem - decided to seek new opportunities. Since then there hasn't even been the pretence of any overall leadership of product development, just a "council" whose role is to rubber-stamp whatever each group was doing anyway.

So what can Cisco do? The core business is moving to a commodity, and shrinking anyway. Numerous attempts to move out of this area have met, at best, moderate success (by Cisco standards that is - even the failures make more revenue than many mid-sized companies, but they aren't profitable). What does Cisco really have? The answer, of course, is a vast and mostly loyal customer base. Cisco as a vendor and integrator still has huge strengths - in particular, its (entirely justified) reputation for digging customers out of the dirt no matter how they got there. It's still true, in the enterprise at least - as it once was for IBM - that "nobody gets fired for buying from Cisco".

So Cisco needs to make the same transformation that IBM did 20 years ago under Lou Gerstner, from being primarily a product company to being primarily a service company. And, in the process, to realise that practically all of its product development is context, not core. That will be very tough to accept - it means questioning everything, even the core switch business, not just closing down Flip. It will take a while to happen, and the risk in getting from here to there is huge.

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