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Cisco Charts a New Future in IT

Craig Matsumoto
News Analysis
Craig Matsumoto
12/7/2012
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Cisco Systems Inc. (Nasdaq: CSCO) thinks it's time to take over the IT sector.

The company is launching a new strategy to emphasize service and software, taking advantage of the fact that IT has become more about the network than about the computer. That transition has been apparent for years now, and Cisco thinks it's time to pounce, to complete the transition to an IT vendor as opposed to a communications vendor.

"Most of our sales in the future will be heavily integrated with services," CEO John Chambers said in announcing the strategy on Friday. "Services are going to go from 20 to 21 percent of our business to 25 and beyond that if we execute right."

The percentage numbers might not seem impressive, but they represent the start of a major shift in Cisco's business. Going beyond routers and network architectures, Cisco now wants to provide an "Internet of everything," comprising major projects, such as water delivery for cities or smart highways populated by networked cars.

A new marketing campaign, with the theme "Tomorrow starts here" launches on Monday to back up the new philosophy. The campaign will be big and relentless, Chambers promised, full of interactive ads and social media.

Running the numbers
More subtly, the services focus means accepting that Cisco is no longer a hot growth company.

"We comfortably believe our long-term growth is in the 5 to 7 percent range," Chambers said. "For the last 10 years, we've been in the high end of that range." (Put more cynically, it means Cisco fell short of the 12 to 17 percent growth it predicted not so long ago.)

What's important about that 5 to 7 percent is to get revenues to occur more smoothly, Chambers said. By shifting emphasis to services and software, the company hopes to develop a base of recurring revenues to do just that.

Services are already in position there, representing $10 billion per year in revenues. The services business has been growing at 10 percent per year for 12 years, with gross margins of 65 percent, Chambers said.

Cisco's software sales will have to change, however, Chambers said. Software will continue to be tightly integrated with Cisco's hardware and Application-Specific Integrated Circuits (ASICs), but Cisco will have to learn how to charge for it on a recurring basis, letting customers pay for it as they add capabilities or expand networks.

Chambers thinks Cisco has a shot at doubling its standalone software revenues to $12 billion per year in the next three to five years.

Then there's security. As kind of a sub-goal within the larger IT goal, Chambers has tasked Senior Vice President Chris Young with trying to turn Cisco into the industry's top security player, increasing market share to 50 percent from the current 32 percent. It's a risky attempt that might not work out, Chambers admitted out loud Friday. Chambers's endgame
So, what makes Cisco belive it can pull this off? In Friday's talk, Chambers set the stage by pointing out, as he often does, that Cisco has managed to overtake the competition in many other major market transitions, the most recent being the company's entry into data-center servers.

In the services area, Chambers is playing off what he's been touting as Cisco's strengths: an ability to think big, an affinity for creating interwoven architectures of hardware and software, and really close ties with governments and the largest enterprises.

It's hard not to draw parallels to IBM Corp. (NYSE: IBM), which transformed from a computer company into more of a consultancy. Chambers, of course, previously worked at IBM and at Wang Laboratories, two technology giants whose power eventually crumbled.

The new strategy, whether it works or not, is likely to become Chambers's legacy at Cisco. He has told the media he's expecting to retire within four years.

— Craig Matsumoto, Managing Editor, Light Reading

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