I read through the transcript of the recent earnings call by Cisco and then read Eric's blog about it as well and it got me thinking about a topic I've been thinking about for a while. When does Cisco's switch business peak?.Yes, indeed: Switching, the cash cow of Cisco's business, carried the company again (as it has for many years), but I have been wondering recently how much longer that can be the case. Many industry experts have been calling for the commoditization of the Ethernet switch business for years now as the thing that might eventually topple that mighty business unit. While I think pricing will fall, I think we're a long way from commoditization, so we won't see any kind of rapid price decline like we have in other markets.
For example, I remember a day when I was a network engineer and I'd routinely pay $40 for a 10/100 3Com 3C905 NIC card to put in a PC. For years that was the de facto standard NIC. Then LAN on motherboard and other factors caused the pricing of the NICs to fall from $40 to about 40 cents in a 2-3 year time frame. To me, that's commoditization. I certainly don't expect that in this market, but there are some factors that could weaken Cisco's share or margins.
* Price pressure, which is led by but not exclusive to HP. The switching market is a HUGE market, somewhere between $16 billion and $18 billion per year depending on what you include and don't include. Everyone wants a bigger piece of the pie now and I've seen more aggressive pricing in the past year than I have in the previous 5 years combined. I've also seen Cisco do some non-Cisco things like discount past normal levels and create a lifetime warranty program. Much of the pricing pressure comes from HP of course, whose starting point is often 40% or so lower than Cisco. Add in the fact that HP is inheriting an excellent, low cost engineering and R&D group based in China through its 3Com acquisition and you wonder how Cisco can price match without having to cut deeply into the fat margins on the switching equipment. Make no mistake, HP buying 3Com is going to have a major impact on the cost structure of this industry.
* A stronger set of competitors. Five short years ago we referred to this market as Cisco and the seven dwarves. There was Cisco and a few niche vendors like Extreme and Foundry and some larger vendors (Nortel, 3Com) that had mismanaged the Ethernet switch business down to almost nothing. Today Cisco's competitors are companies like HP, Brocade, Avaya and Juniper. Bigger, stronger companies that can leverage other strengths to get a foothold in this market. This many larger competitors in the market create many more options for evaluators of network equipment, so Cisco's ability to just stomp all over the competitive landscape is limited.
* The 802.11n wireless standard. Traditional networks were designed to be primarily wired and then have WiFi as an augmentation for lobbies, conference rooms and other shared areas. Recently though I've run into a few companies (and this is more the exception than the norm) that are doing the opposite. Make wireless the primary and use wired only where you need a fixed connection. The main reason for this is that at 11n speeds, from a user experience perspective, the difference between wired and wireless is negligible and the benefits of mobility far outweigh the difference between a Gig-E connection and 802.11n. I expect this to be a bigger trend over the next few years, which could cause the Ethernet switch market to eventually decline.
* The ABC's of networking. The term ABC is used as an acronym for "anything but Cisco" and has been used recently to describe the group of companies that compete with Cisco. Because of many of Cisco's recent acquisitions and product innovation, the list of ABC-qualified companies is growing. Today companies like Polycom, Avaya and HP band together to create competitive solutions where before they would have worked with Cisco.
Realistically, I don't think it's peaked--yet. We're in an upgrade cycle that seems to have some legs under it so Cisco's absolute revenue will likely grow, as will the Ethernet switch revenue for Juniper, HP, Brocade and all the other vendors that play in this market. However, due to the factors listed above, I do think Cisco will be significantly challenged to keep its share and margins in switching where they are. My guess is that Cisco will do everything they can to keep the share where it is since many of the sales of the advanced technologies are based on the fact that Cisco owns the network, so it needs to keep the share where it is to sell all that other stuff that has even bigger margins associated with it.
