Cisco Transitions from Network Equipment to an IT Company: Will SDN Overlays Help?

Cisco Systems, the world’s largest supplier of Internet routers and switches, has struggled over the past year as slowing product sales and sliding data-center equipment prices hurt performance in its core business. The company has responded by diversifying its revenue base with more profitable software and services—yet tight corporate budgets and government cutbacks have made the transition harder to accomplish.

“A lot of the challenge stems from weak public-sector spending, in particular U.S. federal, along with softness in financial services,” Juniper Chief Executive Kevin Johnson said last month after delivering a weaker-than-expected view of
future revenue. “We have communicated steadily over the last several quarters about expected weakness in federal. We do not expect this pattern to improve in the near term.”

“When the economy fluctuates, one of the first things people cut back on is Cisco boxes,” J.P. Morgan analyst Rod Hall said, because a large part of Cisco’s sales aren’t subject to a recurring contract. “That’s why it’s such a good bellwether.”

The slowdown in sales of routing and switching gear reflects many companies’ decisions to hold onto equipment longer, according to ISI Group analyst Brian Marshall.  “Cisco is making the best of a difficult situation,” Mr. Marshall said.
“They’ve got a big chunk of their business coming from an area that’s a single-digit growth market.”

Cisco has taken steps to shuffle its product portfolio. It recently sold the Linksys home-router business to Belkin International Inc., soon after acquiring wireless-carrier software developer Intucell Ltd. for $475 million and Meraki
Inc., a provider of Enterprise WiFi equipment for midsize businesses, for $1.2 billion.

The acquisitions fit with Chief Executive John Chambers‘s effort to recast Cisco as more of an IT company than just a
seller of network equipment. The company has pledged to double its software revenue over the next few years as it diversifies its customer base beyond machines that shuttle data between computers.  For example, Cisco’s data-center servers are typically less profitable than high-end routers, yet they helped support its revenue over the past year when router sales sputtered.

Cisco’s Open Network Environment is the company’s response to SDN.  It’s based on “Virtual Network Overlays” and is differentiated from SDN as follows (i.e. according to Cisco):

• First, network programmability and many of the use cases that benefit from it require APIs or interfaces at multiple layers of the network (not just at the control and forwarding planes). There are deeper internals in our operating systems, and even hardware and ASICs, that can be accessed to extend and enhance the network. Similarly, further up this network stack are higher level services, such as the management and orchestration APIs, for example, our Network Services Manager (NSM) API that supports orchestration and cloud portal applications such as Cisco® Intelligent Automation for Cloud (CIAC). In the Cisco environment, we imagine an application development environment that can access APIs at all levels of this stack.

• Second, many of the use cases for which organizations are looking not only require programming the network to the desired or optimal behavior, but also are seeking to extract the enormous amount of information and intelligence contained in the network infrastructure. Deeper and more insightful network intelligence can be pulled into a new class of analytical applications that can promote more sophisticated network policies and support business logic that impels the network. This ultimately makes the network more valuable and can support more innovative and revenue-generating services.

FBR’s Scott Thompson wrote in an email that “SDN Overlay solutions are gaining more traction than expected, which lessens the near term pressure on Cisco’s switch/router revenues.”

“SDN overlays provide opex savings and rapid service deployment, diminishes need for service providers to aggressively reach for cost parity with hyperscale competitors. Our discussions at Interop revealed that hybrid/overlay SDN networks are beginning to gain momentum among the service provider and large enterprises.

Overlay SDN solutions provide network-wide provisioning across both traditional and full SDN-based architectures. While we expect hybrid/overlay SDN solutions will allow large-scale networks to drive significant opex savings, they also appear to slow the transition to new architectures that could significantly affect traditional revenue streams. This is likely to allow traditional networking vendors additional time to shift to more software-based business models. For Cisco, we expect this development could drive two to four quarters of respectable returns before commodity and silicon-based network architectures begin to affect Cisco’s financials.”

“Checks indicate that both service provider and large enterprise channels have found the implementation of Network Function Virtualization (NFV) and SDN solutions more time consuming and costly than initially expected. Initial setbacks with carrier implementation of NFV and SDN technologies are likely to provide Cisco additional time to develop product that will help to transition its customer base to more software- and service-based revenue.”

Closing Comment:  We are quite surprised by Thompson’s last statement regarding ” implementation of Network Function Virtualization (NFV) and SDN solutions more time consuming and costly than initially expected.”  How can something be implemented if it is not fully standardized?  Especially NFV where ETSI NFV ISG is NOT producing any standards!