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Cisco: What's the Sum of the Parts?

It's great for news people and analysts when companies do interesting, different, stuff. "News" means "novelty" after all, and Cisco's certainly making it. They've been pushing their HD telepresence, announcing studies showing radical traffic growth from video, the Internet, and mobile broadband. Now they're branching out, and the question is where they're headed.The data center is one destination, clearly. The market interest in Cisco's Unified Computing System (UCS) has certainly been justified. After all, Cisco is entering a totally new market with its blade server line, it's taking on other giants who were at least somewhat partners in the past, and it's talking about totally new data center paradigms.

But then Cisco goes out and buys Pure Digital, a company that makes USB video cameras for consumers. Some bloggers have speculated that Cisco might be doing "portable telepresence," but that seems a titch farfetched given that the Flip Video is tethered and that video on smartphones is an easier solution for that. Others think Cisco might be looking to equip every man, woman, and child with easy portable video in the hopes they'll share their results and create an explosion in Internet traffic that would drive a quantum jump in provider investment.

Some might argue that Cisco is just losing it, but Cisco's not a company you can ever afford to underestimate. We need to look a bit deeper and see what they're up to because they are a major force--perhaps the major force--in networking.

Let's start with a question. Who's doing best in the networking market in the current economic crisis? Answer: Huawei and ZTE. Why are they doing well? Answer: Because they're price leaders. The simple reality is that technology from optics to the Internet has commoditized bandwidth. Providers are seeing revenue per bit fall by over 50% per year worldwide. That kind of price erosion can only mean pressure to produce bits more and more cheaply. Cisco is not a low-margin player, and so they need to find market areas with lower margin pressure.

Then there's the problem of organic growth. If you want to see opportunity for growth, be a little active predator in a fresh ecosystem. You don't want to be the top predator in an ecosystem that's already saturating its resources, because you can't go anywhere but down. Networking is not a growth industry in the sense it was in the 1990s, and it never will be again. Sure, it will grow, but it will not grow at the pace Cisco wants its own revenues to grow, nor with the margins Cisco wants to obtain. It's time to climb over the mountains into the next valley and look for new opportunity, and that's exactly what Cisco is doing.

Cisco, I think, is a company with its eyes on two very different icons, Apple and IBM. Apple showed, with iPods and iPhones, that consumer electronics is a big opportunity and that people will pay handsome premiums for status. For a company like Cisco who needs ten-figure markets to create even a blip on the bottom line, the Apple example is a compelling one. But so is IBM. What technology company that's a powerhouse today was also one 20 years ago, 30, even 40? Only IBM. They showed the value of flexibility and agility in addressing the business market. Apple motivated Pure Digital; IBM motivated UCS.

But why UCS and Flip Video in particular? Surely there are consumer markets larger than the personal video market, not to mention the fact that practically everyone with a digital camera can take videos already. Surely there are spaces less crowded and more differentiable than blade servers. The answer is that Cisco knows that it's great to spread out into adjacent valleys of opportunity, but you've got to control your home turf. Networking is Cisco; networking's new scope and role is the path to Cisco's opportunities--because it has to be that way. Any other approach is just too risky.

Networking is changing; it's been doing that all along. Look at the profit margins on fiber cable, then of fiber transducers, then optical transmission systems, then Ethernet, and finally IP. The margins are lower at the bottom because there's less features to differentiate among products or vendors. No feature differentiation equals price differentiation. Companies have talked about "climbing the OSI stack" for years because of this. But if you remember your OSI layers, you know that Level 3 (where IP is) is the top of the network. Step up one layer and you're on-net, not in it.

UCS aims at the inevitable redefinition of information technology that happens when the network that connects computers becomes really fast and really cheap--the transformation to cloud computing. When a resource becomes very much cheaper, the higher-level things change their operation to consume the ever-cheaper commodity. Networking transforms IT out of cheapness, and in that transformation lies Cisco's opportunity to climb the OSI stack out of the network into the data center.

Flip Video is a play on social communications. There was once an enormous gulf between a real in-person conversation and one where the participants were anything more than a room away. Bandwidth commoditization is making that gulf very small, and so it will empower the tools that let us share not only voice and thoughts but also our visual presence at a distance. Telepresence and Flip Video are the "higher OSI layers" of personal communications. Off the network and into people's lives.

Cisco doesn't want to shape the future, it wants to be the future. It wants what Wall Street calls its "total addressable market" to be measured in the trillions of dollars, to create an ever-expanding set of new valleys to enter and dominate. Can it do that? The risk is as familiar as the goal. The wider you spread, the thinner your resources and the broader your risks. It's a classic management challenge, to an organization whose management below Chambers has been churning quite a bit over the last couple years. If Cisco spreads to far too fast, it will create a risk the military types call "defeat in detail," a picking away of prize segments by specialized competitors with better focus. But IBM proves that companies can grow and prosper while jumping in and out of market segments. Perhaps Cisco can do it too.