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Cisco Feels Switching Pains

A recovery in Cisco's switching business could take a while, and lower margins might simply be a fact of life from now on

Craig Matsumoto

May 20, 2011

3 Min Read
Cisco Feels Switching Pains

Even as Cisco Systems Inc. (Nasdaq: CSCO) prepares to possibly cut more businesses (Linksys and WebEx have been mentioned recently), it's facing some issues with one of the units it has to keep.

The question is how quickly the Ethernet switching business, as much a Cisco franchise as French fries are to McDonald's, can return to growth, and whether it can retain the same margins as before. On Cisco's recent earnings call, CEO John Chambers mentioned switching -- where revenues are down 9 percent from a year ago -- as one of the company's biggest challenges.

Competition is a primary reason. "Switching is an area Cisco has less control over, given the rising competitive forces," wrote analyst Ittai Kidron of Oppenheimer & Co. Inc. , in a recent research note.

At the high end, switch chips from Broadcom Corp. (Nasdaq: BRCM), Fulcrum Microsystems Inc. and Marvell Technology Group Ltd. (Nasdaq: MRVL) are giving rise to a tough new generation of 10Gbit/s switch boxes. Consultant Nick Lippis of Lippis Enterprises counted nine top-of-rack switches being announced at Interop earlier this month.

And in plain enterprise switching, competitors -- HP Inc. (NYSE: HPQ) gets cited a lot here -- are helping drive down prices, which in turn is helping to lower Cisco's prized margins. The company's overall gross margin has fallen to 63.9 percent from 70 percent a couple of years ago, one of the factors that's led investors to push Chambers for changes.

What does it all add up to? Possibly, a chance for a competitor to put a long-term dent in Cisco's market share, much the way Juniper Networks Inc. (NYSE: JNPR) did on the service-provider side years ago. "A combination of factors has opened up opportunity for a second vendor to enter the discussion," says Scott Dennehy, an analyst with Technology Business Research Inc. (TBR) .

It's possible, then, that Cisco might have to accept lower switching margins as a fact of life. That's not the same thing as becoming a commodity switch vendor, Dennehy tells Light Reading: "I don't think they'll ever accept margins as low as HP would accept." But he suspects the pressure on Cisco is here to stay.

He thinks Cisco's best response might be to concentrate on the high end, not only because margins are better, but because price isn't always the trump card in those markets. Education, for example, might be an area for Cisco to emphasize less. "If you go into a school and say you can save $1 million with HP, they're going to go with that," Dennehy says.

Another reason to focus on expensive switches is that Cisco's big architectures -- grand schemes that include interlocking groups of products -- might not appeal to some switch customers. With role models like Amazon Web Services Inc. and Google (Nasdaq: GOOG), some cloud and data center owners might wonder if the same model -- building commodity networks out of throwaway boxes -- could work for them as well.

Follow the headlines below for a quick summary of Cisco's latest reorganization so far.

  • How Deep Will Cisco Cut?

  • Cisco Preps for Layoffs

  • Cisco Reports Q3

  • Cisco Cuts Down on Councils

  • Reading Cisco's Signage

  • End of an Eos

  • Cisco Flips on Consumer Business

  • Cisco Starts Spring Cleaning

  • Cisco Signals Major Restructuring

— Craig Matsumoto, West Coast Editor, Light Reading

About the Author(s)

Craig Matsumoto

Editor-in-Chief, Light Reading

Yes, THAT Craig Matsumoto – who used to be at Light Reading from 2002 until 2013 and then went away and did other stuff and now HE'S BACK! As Editor-in-Chief. Go Craig!!

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