Cisco's Turnaround Linked to Customer-First Approach

Cisco this week announced its fourth quarter and fiscal year 2018 results, which show the company finished its year with a bang.

Revenue grew 6%, marking the third consecutive quarter of growth. The $12.843 billion it posted for Q4 was a record for the company, and it closed its year at $49.3 billion. The company has never had a $50 billion year, but if current trends hold, Cisco will easily exceed that in its 2019 fiscal year.

Shareholders have rewarded Cisco as well. A year ago, the stock was trading a shade over $30 per share. As of this writing, the stock is just under $46 per share, and I'm fully expecting it to keep growing. The growth in stock price shows a renewed confidence in Wall Street. As many of you may know, I work closely with many financial firms, and there were many investors that felt Cisco's best days were behind it and that trends like software-defined networking and the cloud would be the death knell for Cisco's core business--enterprise networking.

Transforming the Network Business

For years, I have maintained the position that the network would not be commoditized. In fact, it was my opinion that the network would become more important. Digital transformation has run amok with CxOs focusing on drivers such as mobility, cloud, and IoT. But the network is now the key enabler for business transformation.

For years Cisco tried to establish itself as a major IT vendor, using its growth in blade servers and storage as proof points. I felt that was a mistake; Cisco needed to be patient and let the industry move to the network. Now the shift has happened, and Cisco is at the heart of it. A number of highlights from the quarter bear that out.

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The most notable data point is that product gross margin was 61.5%. When SDNs were introduced around 2012, many felt that the commoditization of the network had begun and that all businesses would be buying white boxes, which would effectively end Cisco's reign as the dominant network vendor. Around the same time, Cisco's product margins dropped under 60% for the first time in its history. Since then, Cisco stepped on the product innovation pedal and has seen its margins grow. This demonstrates that if a vendor can create differentiation in its product, commoditization can be avoided.

A deep dive on product reveals that Cisco's largest source of revenue--infrastructure platforms--has now come alive and is growing. In particular, campus switching had been dying a slow death, but Cisco's new Catalyst 9000 (Cat9K) family of switches are seeing exception traction, with over 9,500 customers having adopted it, as CEO Chuck Robbins said on the earnings call. Collaboration, security, and Wi-Fi turned the corner years ago, but those do not have the same needle moving effect that switching does. The Cat9Ks are the building blocks of Cisco's Intent-Based Networking solution, and they have an entirely different value proposition than the older catalyst switching products.

Most customers do not upgrade the network for speed, as networks have plenty of capacity. But networks do need to become easier to manage and provide better security, and that's the calling card of the Cat9K. Cisco had tried pushing things like multi-gig, but quickly found out that speed for the sake of speed isn't all that exciting. During the earnings call, Robbins said this about his new flagship switching product: "This quarter we saw continued strength in infrastructure platforms, driven by the Catalyst 9000, as customers look to us to simplify and automate their networks." Not one mention of speeds and feeds. During the Q&A portion of the call, he discussed how encrypted traffic analytics (i.e. the ability to see malware in encrypted traffic) has also been a big driver for the Cat9K.

Bringing the Customer into Focus

The impetus for change at Cisco came years ago when it made the decision to do what's best for its customers and not for itself. Roll back the clock a few years and recall the early days of SDN. Customers were coming to Cisco for help in making this shift, and instead of helping them, Cisco tried to hold them back. Inevitably, these customers started looking elsewhere. I asked Robbins about this just after he took over for John Chambers as CEO, and he admitted it was a mistake and the company would never do that again. In his mind, Cisco needs to help its customers through these market shifts, and the business would come.

Today, Cisco's Application-Centric Infrastructure (ACI) solution is one of the most widely deployed SDN solutions in the industry. Similarly, with SD-WAN, Cisco acquired Viptela to give it an easy to deploy, low-cost option for its Integrated Service Router (ISR) based IWAN.

On the earnings call, Robbins highlighted the fact that Viptela now has over 800 customers. For Cisco, that's a very low number, but dropping it into Cisco's channel will help to quickly grow that number. Robbins also noted that the driver of sales of Viptela has been Cisco's "ability to provide higher capacity at a lower cost." Without a doubt, Viptela will cannibalize the ISR business. The recent integration between Viptela and IWAN will certainly help maintain the ISR base but there are many businesses--particularly companies with lots of small branch offices--that don't need a box like an ISR. This is a great example of Cisco doing what's best for its customer, rather than itself. Cisco can likely make some or all of that revenue back with services, security, cloud management, or other applications.

This is a new era in IT, and Cisco has evolved accordingly. A decade ago, the company used to almost revel in the complexity of its products. If you weren't a black belt in Cisco CLI, you had no business working with the product. This ensures a kind of lock-in because the engineers couldn't be replaced. Businesses need to move faster, and the old days of doing things one command line at a time are over.

Today, Cisco listens to its customers better and is driving innovation around their wishes; and that's turned around the fortune of the company. Things certainly aren't perfect. The router business is still weak, DRAM pricing is fluctuating, and 5G is still on the horizon to deal with... but the core has been fixed. Barring some crazy macro event, I expect this three-quarter run Cisco has been on to continue into the foreseeable future.

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