Cisco at a crossroads?

You have to admire Cisco Systems. The company dominates enterprise networking to such an extent that it's even hard to remember who's No. 2.

Cisco has been so successful that it can simply outspend its adversaries to reinforce its messages and tie up would-be competitors. But Cisco may soon find itself at a crossroads because of impending changes to network architecture.

Let's start with the company's core switching and routing business, which made up 63 percent of Cisco's revenue in the third quarter. Over the next few years, there is going to be a lot of ripping and replacing of network pipes as companies deploy multigigabyte installations for their PCs and servers. And as with any big architectural transition, customers will naturally invite competitors such as Juniper, Nortel and 3Com to compete for their business.

CIOs know that Cisco's prices (and margins) are far higher than the industry norm. So don't be surprised if a fair number of them decide to buy competing products just to send a message. Don't think it will happen? Ask EMC. It got the same treatment a few years ago when Hitachi introduced a competitive product to Symmetrix.

Even Cisco's die-hard customers will be shocked when they compare Cisco's pricing to the competition's. Low-end guys such as D-Link, Netgear and SMC already have pretty sophisticated 10Gb equipment available at bargain pricing. Meanwhile, the 3Com-Huawei partnership will likely result in core switches and routers that offer 90 percent of the functionality of Cisco technology for half the price.

There's another major challenge ahead for Cisco. LANs and WANs (local and wide-area networks) are moving away from so-called dumb pipes at an unbelievably rapid pace. Loads of companies are now using lightning-fast, cheap hardware to add layered intelligence for services such as security, identity management, application-layer switching and network acceleration.

But each new network layer opens a door for the competition and threatens Cisco account control. Industry heavies see this opening--just look at Juniper's acquisitions over the past few years. First it grabbed NetScreen to jump into the enterprise network security market. Then it bought Peribit and Redline Networks to get into the application and WAN acceleration space.

This is a classic seed-and-harvest strategy. Juniper establishes a beachhead in a few tactical areas, surrounds the Cisco architecture and positions itself for those strategic network architecture deals down the line.

Cisco sees this coming and continues to enhance its portfolio with its own acquisitions. The problem is that Cisco can't integrate the piece-parts any faster than anyone else.

What's more, there is evidence to suggest that users aren't willing to wait around for Cisco anymore. In a recent ESG Research security survey, respondents were asked to rank their security device purchasing criteria. Users overwhelmingly rated product attributes such as architecture, scalability and feature/function on top and vendor characteristics at the bottom.

By no means is the sky falling for Cisco. Its incumbent status means it will get in on every opportunity while others still have to scratch, claw and find an opening. Cisco also has a rich portfolio of products, killer sales and marketing, top support, deep pockets and a focus on key growth areas such as security and VoIP. Nevertheless, it's facing a much tougher fight ahead where it's likely to lose its share of deals and have to live with lower margins.

Last December, CEO John Chambers hinted to analysts that Cisco needs to offer more business solutions and consulting services. Perhaps he is taking a page from IBM's 1990s playbook. That strategy probably saved IBM, which was paying the price for overreliance on the mainframe while ignoring the industrywide embrace of client-server computing.

Chambers' statements demonstrate that he recognizes the ongoing architectural and economic transitions--and that Cisco must adapt accordingly. Good thing. The game is changing far faster than most could have anticipated.

biography
Jon Oltsik is a senior analyst at the Enterprise Strategy Group.