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Cisco's Secret Software Strategy

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News Analysis
Light Reading
1/13/2005
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Sources say Cisco Systems Inc. (Nasdaq: CSCO) has launched a long-term software initiative that could bring the company closer to IBM Corp.'s (NYSE: IBM) model of offering full consulting services.

Cisco has already set up a special software group (yet unnamed) to develop middleware, Web applications, and services products, says one reliable source who is close to the company but asked to remained unnamed. Other sources say Cisco has indeed set up a new software group but that it may have less dramatic goals.

Adding to the fun, Cisco may be planning to rehire Selby Wellman, a former senior vice president whose responsibilities included Cisco's alliance with IBM, according to several sources. That deal, signed in 1999, paired IBM's Global Services division with Cisco's hardware -- and also marked IBM's exit from the router business. Wellman, whose pre-Cisco career had included a stint at IBM, retired from Cisco in 2000 to pursue other business interests.

One unnamed source within Cisco says Wellman has already been hired and is heading the new software group along with Cliff Meltzer, senior vice president for Cisco's Network Management Technology Group.

This source says Cisco's goal with the new software group is to create "application-aware" networks, a move that could tread on the turf of partners IBM and Microsoft Corp. "This has been kept totally quiet by Cisco because they do not want Microsoft to get mad enough to hurt other lines of business," the source says.

Cisco officials declined comment, noting they do not discuss "rumors and speculation." But given the political implications, some analysts find the plan hard to believe.

So why would Cisco do this? Experts point out that with networking technology becoming increasingly commoditized -- and with a looming fret from low-cost hardware competitors in China -- Cisco could help insulate itself from these trends by moving up the software stack and marketing consulting services and developing more sophisticated software.

"They're going to need something like [a software group] to bulk up those consulting services. It's part of their move to quietly become more like IBM," says Deb Mielke, managing director of Treillage Network Strategies Inc.

Other sources believe the group's task is less grand, possibly related to future developments with XML and Layer 7 traffic engineering.

Depending on where the project is going, it's clear that Cisco will have to be careful in developing the project around its relationship with IBM and Microsoft, major partners.

"Cisco has an enormous dependency on their relationship with IBM," says Tom Nolle, president of consultancy CIMI Corp. "The only thing I had heard was that they were expanding their professional services stuff, but I don't think they're doing applications development."

Nolle says he'd heard of Wellman contacting Cisco about re-employment. But, he adds, "I had not heard there was any convergence on his actually returning." Wellman's name does not appear in Cisco's voicemail directory.

Cisco CEO John Chambers has already dropped some hints about a startegy toward moving to consulting, software, and services. At Cisco's analyst meeting in December, he outlined a strategy to make Cisco more of a consultant, showing customers how to change their business processes to take advantage of new capabilities in the network. Cisco's new Integrated Service Router (ISR) product line reflects that thinking by making routers to become the roosting place for network applications such as voice over IP (VOIP) (see Cisco Rolls Out Roadmaps and Cisco Takes Apps on Board).

Tough Crowd
If Cisco is considering a middleware play, it's got a tough fight ahead. "I fear they would know not where they tread. The software ballgame is not for the faint-hearted," says Frank Dzubeck, president of Communications Network Architects. In addition to IBM and Microsoft, Cisco could be up against BEA Systems Inc. (Nasdaq: BEAS), Computer Associates International Inc. (CA) (NYSE: CA), Hewlett-Packard Co. (NYSE: HPQ), and Veritas Software Corp. (Nasdaq: VRTS).

Then there's the question of whether it makes sense for Cisco to develop this software on its own. "I would be very surprised if Cisco would embark on third-party custom software development as a service or develop a software applications package," Nolle says. "With all the cash Cisco has, they'd be better off buying somebody."

Adding to the difficulty level, Cisco's superpowers in routing could prove useless in the software dimension. "It's a different set of rules and a different set of customers. The buyer [of applications software] is not the one that buys the routers," Dzubeck says. "No one would believe you're talking about putting your crown jewels in the hands of a communications company."

Dzubeck thinks it's more likely the new software group targets "higher-order Layer 7 things like XML." Such a program would tie nicely with recent acquisitions such as P-Cube Inc. and with Cisco's recent interest in traffic engineering technologies (see Cisco Reroutes Traffic Management, Cisco's Parc Purchase: An MPLS Play, and Corvil: Another Cisco Secret?).

Software plans aside, Mielke, who was once a consultant with MCI, sees plenty of pitfalls ahead for Cisco the Consultant. One crucial adjustment is that services -- network designing help, for example -- aren't supposed to be free any more. "That can be a tough transition" for a sales force that's given away services "all their lives," she says. "I'd call my MCI guy and he'd be giving away services to get a $2 million voice contract. It's a tough change."

So, why would Cisco even pursue things like consulting and middleware? The answer might have to do with Cisco's flagging stock price. Institutional investors reportedly are losing patience with the company, as its stock lost more than 20 percent of its value in 2004, even though Cisco had a decent year. Even the closely watched launch of the CRS-1 core router couldn't break the stock's doldrums (see 2004 Top Ten: Stock Gains & Pains and Cisco Sees Big, Bold Growth).

Given the company's dominance in routers, something like consulting might be Cisco's best way to create new revenue streams. "There's nowhere else to go," Dzubeck says.

— Craig Matsumoto, Senior Editor, Light Reading

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materialgirl
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materialgirl,
User Rank: Light Beer
12/5/2012 | 3:29:46 AM
re: Cisco's Secret Software Strategy
They do not call it convergence for nothing. As SUNW said years ago "The Network is the Computer".
As I mentioned last time this story was leaked, CSCO has to sell something other than their existing networking gear to be credible with this new strategy.

Clearly, L1-3 is getting commoditized and CSCO must move up stack to hold their value. At the same time, issues like security (L7 worms, XML flows and load balancing require an up-stack awareness in the network. Networks and computer applications are indeed converging. CSCO is just moving up stack with customer needs.

However, do not think they can just buy their way into software. Ever heard of "open source?" And they think Chinese hardware is a problem! The new paradigm will be very different in terms of earning money.
krbabu
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krbabu,
User Rank: Light Beer
12/5/2012 | 3:29:43 AM
re: Cisco's Secret Software Strategy
If the story is true, it is tacit admission on Cisco's part that the Chinese have already come, not that they are coming! Networking equipment intelligence has to move up from IP routing & transport to encompass the higher layers of the so-called 7-layer OSI stack and the pure software players such as Microsoft will want to integrate parts of their software solutions into the network elements.
I guess no one has the correct crystal ball.
-
Ramesh
DoTheMath
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DoTheMath,
User Rank: Light Beer
12/5/2012 | 3:29:41 AM
re: Cisco's Secret Software Strategy
The issue is not just the Chinese. Cisco simply has an "excess margin problem", and has had it for a long time. Even assuming a very optimistic 20% revenue growth (tough in an environment of inevitable price erosion), I see only potential for margin compression for them, and that is going to keep the bottom line growth feeble. They have also squeezed the heck out of their suppliers and have wrung out the most from their employees, so there isn't a lot of room there either. The stock market seems to have figured it out, and that would explain the lack of momentum in the stock.

What has kept the game up for so long is their outstanding sales execution (I tip my hat to Chambers), coupled with some outstandingly lousy execution of their competition. Companies like 3Com and Nortel simply self-destructed. The staying power of companies like Juniper or Foundry or Adtran (in a variety of markets) shows how to survive and thrive against Cisco. This ain't no Microsoft.

But the flip side of a sales-driven culture is that there simply isn't much of a long range technology strategy there, HFR notwithstanding. Witness the recent Wi-Fi acquisition (congrats, Airespace!): it is beyond pathetic for Cisco to have to pay this kind of price in today's market, when the whole of silicon valley knew what kind of Wi-fi companies were coming, circa mid-to-late 2002. In late 2002, if Cisco had gotten its act together product management and engineering-wise, they wouldn't have had to shell out the $450 million they are shelling out now. I can understand investors getting tired of this endless dilution paying god-knows-how-many-times sales for products they should have built in house.

So this is one story that is weaker than it looks, however good the short term numbers may be.
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