Cisco's big challenge: The software switch

Channelnomics founder Larry Walsh warns that despite recent strong Q4 results for Cisco, it is not a time for celebration

Cisco Systems surprised many on Wall Street and in the channel by announcing surging profits and healthy cash flow despite prior warnings on slumping sales and the weak global economy dragging performance, writes Larry Walsh.

In almost every category, particularly data center equipment sales, Cisco was at least modest advances. While Cisco appears to have pulled off a good quarter, it's not time for celebration. The market and channel are looking forward to the post-hardware network, in which software defined networks (SDN) drive operations and performance.

Chambers says Cisco will be a leader in software-founded data centers, but today it's looking more like a laggard and that's a reason for long-term concern. Cisco has done a remarkable job righting the ship over the last year and a half. In early 2011, Cisco reluctantly conceded that it had a profit and cash flow problem brought on by failed experiments in consumer products, bloated operations and outmoded corporate structures.

It went through a sweeping reorganization that eliminated 11,500 jobs and cut more than $1 billion in operating expenses. In the process, it also streamlined channel operations, putting more resources in the field to drive solution provider sales. The results were impressive at the beginning of the year as Cisco bounced back from its doldrums.

Sales and profits were up. At Cisco Partner Summit in San Diego earlier this year, Cisco announced a series of initiatives to continue the momentum. And that's where the potential problem resides: Cisco incentives and focus, which remain on hardware. Cisco continues to press programs with a hardware-first intent. Reference architectures developed with partners VMware, Citrix, EMC and NetApp are all intended to build virtualized data centers by providing solution providers with validated system designs.

These reference architectures, though, intended to drive net-new hardware sales; the presumption being that it makes no sense to virtualize on old equipment. Cisco and other hardware vendors have ridden the virtualized data center wave well over the past three years. Cisco's entry into the server market was driven by its desire to control the data center from end to end. However, the market is moving toward software-based switches, which purport to provide similar functionality to Cisco and other networking gear without the gear.

In recent months, VMware bought virtual networking leader Nicira for $1.26bn, providing the virtualisation software company with a formidable weapon in the brewing battle for the datacentre.

Oracle also entered the game with the acquisition of Xsigo, whose Data Center Fabric (DCF) technology provides an alternative to hardware switching. And HP has developed its own Virtual Connect product, although it's limited to working with just HP networking gear.

The competitive landscape is changing rapidly even as Cisco is more aligned to battle with traditional rivals such as HP, Juniper Networks, Avaya and Brocade Communications, as well as emerging challenges such as Dell (Force10 Networks and SonicWall) and China-based Huawei. Cisco holds a 65 per cent market share in the data center switching and routing.

Even as it faced economic challenges and competitive pressure in recent years, it's done a masterful job of defending its install base. Chambers and his executive team are not oblivious to the SDN challenge.

Earlier this year, Cisco invested $100m in Insieme, a virtual networking company started by former Cisco employees. The investment is more than speculation, but a hedge to ensure Cisco is in the game as it has an option to buy Insieme for $750m.

"We think the future is going to be hardware and software combined. We think when you have knowledge of the network, and are able to know what's going on in the network, you can program to it. You can get dramatically better flexibility, etc. It's nice way of saying, we think it's going to be … hardware and software combined," The VAR Guy reported Chambers saying on yesterday's earnings call.

And what Chambers' said may be part of the future problem - the hardware, software future.

Cisco partners tell Channelnomics they're diversifying their portfolios and adding more software independent of Cisco. They're turning to other vendors to fill gaps in their technology toolkits to meet customer needs. And, while they don't see hardware going away, they do see software taking share away from hardware at a rapid pace.

"Cisco has made a good living thus far with its dominant share of enterprise and service provider routing and switching gear. However, increasingly cloud services companies seem to see the network as the problem and see by-passing Cisco as part of the solution," wrote Alex Henderson, an analyst Needham & Company, in a 9 August investor note.

In the end, the biggest challenge Cisco may face is breaking its own addiction to hardware sales and revenue while building a competitive and market leading software business.

Larry Walsh is founder of Channelnomics, a division of the 2112 Group.